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CORNELL LAW SCHOOL

LEGAL STUDIES RESEARCH PAPER SERIES

A Legal Ethics Perspective on Alternative Litigation Financing

W. Bradley Wendel

Cornell Law School Myron Taylor Hall

Ithaca, NY 14853-4901

Cornell Law School research paper No. 14-12

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A LEGAL ETHICS PERSPECTIVE ON ALTERNATIVELITIGATION FINANCING

W. Bradley Wendel*

One of the foundational principles of legal ethics is that the lawyerowes an obligation of undivided loyalty to the client, and no otherinterests or relationships can be permitted to interfere with thelawyer’s exercise of independent professional judgment on behalf ofthe client. The strongest non-consequentialist doctrinal objection tothird-party litigation funding is that it may compromise the lawyer’sindependence. Yet this argument cannot be made in too strong aform, because lawyers are already permitted to enter into relation-ships or have interests that present a prima facie risk to the lawyer’sindependence. In the United States, two such situations are therepresentation of plaintiffs in contingent-fee financed litigation andthe representation of insured defendants by lawyers compensated,and substantially controlled, by liability insurers. Both of thesesituations present conflicts of interest that are mitigated for the mostpart not by formal rules of professional conduct but by other legaland non-legal sources of constraint. In the insurance defense context,many apparent conflicts are mitigated by doctrines within insurancelaw that limit the extent to which insurers can act self-interestedly atthe expense of the insured. Regarding contingent-fee representation,market mechanisms are entrusted with the role of regulating the sizeof fees, while agency and tort principles regulate the conduct oflawyers representing plaintiffs in contingent-fee matters. Thesecomparisons show that third-part litigation finance should not becondemned categorically as compromising the lawyer’s independentjudgment. Rather, the acceptability of third-party finance should be

* Professor of Law, Cornell University, Ithaca, New York. I served as co-Reporter,with Tony Sebok, of the Working Group on Alternative Litigation Finance, partof the American Bar Association’s Commission on Ethics 20/20. The viewsexpressed in this article are solely mine and do not represent the position of theWorking Group or any of its members. I am grateful to the participants in theNew York City Legal Ethics Scholars’ Roundtable, held in February, 2013 atCardozo Law School, for their feedback on a preliminary version of this paper.From time to time I provide legal advice to commercial-sector litigation fundingcompanies and law firms involved in litigation funding transactions. I have notreceived any direct or indirect compensation for work on this article. While myunderstanding of these issues have developed over the course of my working onlegal ethics in litigation funding, both as a scholar and as a paid legal advisor,none of the positions expressed here were influenced by my outside legal advisingwork.

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dependent upon the extent to which the relationship between thefunder and the recipient of funding is regulated to mitigate the risk ofself-interested behaviour on the part of the funder.

I. INTRODUCTION

The traditional approach to legal ethics, at least in the UnitedStates, is that parties must be placed into one of several categoriesin order to determine what duties a lawyer owes. The majorcategories are client, tribunal, opposing party (in litigation or anegotiation), and stranger. Anyone belonging to the client categoryis owed the full panoply of quite stringent professional obligations,including competent and diligent representation, communicationof material information, undivided loyalty, refraining from self-dealing, and strict confidentiality. Courts and other tribunals areowed demanding duties of candour, requiring lawyers to refrainfrom making false statements and even to rectify false evidenceintroduced by a client or a non-client witness called by the lawyer.Opposing parties can mostly be dealt with at arms’-length,although procedural rules do provide some protection againstabusive conduct in litigation, and lawyers may not make materialmisrepresentations of fact to non-client parties in transactionalmatters. Finally, true strangers are owed some relatively unde-manding duties, including the prohibition on some types ofharassment and abuse, lawyers implying that they are disinterestedin a matter, and making false statements of material fact. Theassignment of duties tends to be categorical and binary, withparties deemed “clients” being owed either a full range ofprofessional duties, and non-clients being owed nothing beyondduties in general law to refrain from fraud and other types ofharm-causing conduct.In an insightful article, Geoffrey Hazard argues that the

categorical approach is insufficiently granular to account formany of the rights and duties recognized in the law governinglawyers.1 There are numerous contexts in which this problemarises. Constituents — that is, natural-person agents — oforganizational clients are not the lawyer’s client, but it would bea mistake for the lawyer to think of them as true strangers. Theyare owed something less than the duties owed to true clients, butsomething more than the duties owed to strangers. The entity-

1. Geoffrey C. Hazard Jr., “Triangular Lawyer relationships: An ExploratoryAnalysis” (1987), 1 Geo. J. Legal Ethics 15.

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constituent problem is an instance of a more general predicamentthat can be represented graphically as follows:

In this picture there is only one true, formal attorney-clientrelationship, represented by Line B. There is an additionalrelationship along Line A, however, with some party in anintermediate position between a true, formal client and a genuinestranger. That party could be an agent of a corporate client, apartner or shareholder in a closely held corporation, thebeneficiary of a trust, or a liability insurer paying for the defenseof an insured. A careful reading of numerous leading cases in thelaw of lawyering shows that the lawyer is not permitted to treatthat party with indifference, and may owe some legal duties alongLine A. For example, a major debate within insurance law is overthe characterization of Line A. Does a defense lawyer, retained andpaid by a liability insurer, have an attorney-client relationship withthe insurer (along Line A) in addition to the attorney-clientrelationship along Line B with the insured? While many states haveadopted a dual-client rule and maintain that, in the absence of aconflict of interest, the attorney represents both the insurer and theinsured,2 other state courts have held that there is no attorney-

2. See Ronald E. Mallen and Jeffrey M. Smith, Legal Malpractice (West Publishing,Eagan, Minnesota, West Publishing, 2009), § 30:3, at p. 150 note 9 (“In a conflict-free situation, the purchase of a liability policy, containing such a provision [i.e.allowing the insurer to select counsel for the defense of the insured], has been heldto be a prior consent by the insured to the dual representation.”). The provisoabout the absence of a conflict of interest is important. Discussion of theinsurance-defense situation is often confused by vacillation between an analysisof (1) whether there is a conflict of interest and (2) what duties are owed by thelawyer to the insurer. The answer to (2) informs (1), but not necessarily vice-versa. For example, the court in Swiss Reinsurance America Corp., Inc. v. Roetzel& Andress, 837 N.E.2d 1215 (Ohio Ct. App. 2005), held that under thecircumstances, where there was a conflict of interest created by an excess of limitsclaim and an assertion of bad faith in failing to settle within limits, the insurer

2014] Legal Ethics Perspective onAlternative Litigation Financing 135

client relationship along Line A. Nevertheless the attorney owessome duties to the insurer, including the duty to use reasonablecare to protect the insurer’s interests.3

The duties owed to the insurer along Line B are related to theinsurer’s legitimate interests, for instance: An insurance companypaying a lawyer’s bill will want to know how the defense is going;companies have typically reserved the right to settle cases withinpolicy limits; they therefore want the freedom to decide how muchspending on a defense is cost-effective; if a lawyer is careless orincompetent, the loss will fall on the insurance company; insurancecompanies have employed staff attorneys, and there may be a costor quality advantage to employing them.4 One might thereforeassume that the insurer would meddle in the attorney-clientrelationship in order to protect its interests, and that this meddlingwould interfere with the lawyer-client relationship along Line A.Insurers are deterred from meddling, however, by duties of goodfaith that they owe to their insureds, as a matter of state insurancelaw. On the triangle diagram these are duties owed along Line C.From the point of view of the lawyer at the apex of the triangle,Line C duties have a stabilizing effect on what would otherwise beconflicting obligations to the insurer and insured. Line C duties arethe reason the drafters of the Restatement of the Law GoverningLawyers concluded that it would be permissible for lawyers toacquire duties to two parties (whether the insurer is characterizedas a client or not) that risk creating conflicting interests:5

Certain practices of designated insurance-defense counsel have becomecustomary and, in any event, involve primarily standardized protectionafforded by a regulated entity in recurring situations. Thus a particularpractice permissible under this section may not be permissible for a lawyer innon-insurance arrangements with significantly different characteristics.

On its face it seems odd to exempt lawyers in one area of practicefrom the conflicts of interest rules that apply to other lawyers, but

lacks standing to sue the lawyer for malpractice. For further discussion seeSection II, infra.

3. See, e.g., Paradigm Insurance Co. v. Langerman Law Offices PA, 24 P.3d 93 (Ariz.2001); Nevada Yellow Cab Co. v. Eighth Judicial District Court ex rel. Clark, 152P.3d 737 (Nev. 2007). For an example of a “single client” case that neverthelessallows a lawsuit by the insurer against defense counsel under an equitablesubrogation theory, see Atlanta International Insurance Co. v. Bell, 475 N.W.2d294 (Mich. 1991).

4. See Thomas D. Morgan, “What Insurance Scholars Should Know AboutProfessional Responsibility” (1997), Conn. Ins. L.J. 1.

5. Restatement (Third) of the Law Governing Lawyers (Philadelphia, Pennsylvania,American Law Institute), §134 cmt. f (2000) (“Restatement”).


the reason for this different treatment is the effect of duties alongLine C, between the insurer and insured. Line C duties harmonizeand prevent conflicts among Line A and Line B duties.This is a vitally important point to appreciate when thinking

about the impact of third-party litigation financing on theattorney-client relationship. Third-party litigation financing(TPLF), also referred to as litigation investment (LI), alternativelitigation financing (ALF), litigation funding, lawsuit lending, andother similar labels), denotes most broadly any form of financingthe cost of litigation other than the practices of (1) self-funding, byan individual or entity out of capital on hand or borrowed fromtraditional commercial lenders; (2) contingent fee financing, inwhich the attorney advances the value of her services and pays theexpenses of litigation, in exchange for a share of the recovery; and(3) payment of defense counsel by a liability insurer. Third-partylitigation investments are often (but need not be) non-recourse,meaning that the financing firm receives nothing if the case is notconcluded successfully, by way of judgment or settlement. Thereturn amount due to the financing firm is generally calculated (butagain, there are variations) based on a multiplier of the amountinvested, which may increase over time. For example, in acommercial litigation financing transaction, the financing firmmay invest $5 million, either as a lump sum or in a staged series ofpayments, and in exchange obtain the right to recover two timesthe amount invested ($10 million) if the case terminates bysettlement or judgment within one year, three times the amountinvested ($15 million) if the case proceeds for more than one yearbut less than two years, and four times the amount invested ($20million) if the case is concluded after two years. Transactions in theconsumer sector, generally involving personal-injury claims, aretypically much smaller, with investment amounts in the range of$5,000 to $15,000. The rate of return for consumer litigationfinancing transactions is typically quite high, however, becauseinvestors in this sector employ an almost pure diversificationstrategy, with very little due diligence at the individual case level.Commercial sector financing firms, by contrast, generally conductextensive due diligence before investing in cases, so they are lessexposed to risks created by information asymmetries.One frequently encounters the argument that any form of

financing other than the traditionally accepted practices of self-funding, contingent fees, and liability insurance will interfere withthe independence of counsel. For example, the U.S. Chamber of


Commerce’s Institute for Legal Reform warns that third-partylitigation financing “undercuts plaintiff and lawyer control overlitigation” and “compromise[s] the attorney-client relationship anddiminish[es] the professional independence of attorneys.”6 As hasbeen frequently observed, this argument assumes that litigationfinancing firms seek to exercise control over the litigation and toaffect the decision-making of counsel. The Chamber simplyasserts, without any evidence, that third-party litigation investorsacquire the right to control the strategic decision-making of eitherthe claimant or the claimant’s lawyer:7

TPLF changes the traditional way litigation-related decisions are made. Whenno TPLF investment has been made, the plaintiff, advised by counsel, decidesthe legal strategy for pursuing the claims asserted. TPLF can be expected tochange that dynamic. As an investor in the plaintiff’s lawsuit, the TPLF

company presumably will seek to protect its investment, and can be expectedto try to exert control over the plaintiff’s strategic decisions.

The word “presumably” is a signal that this is pure speculation.Other jurisdictions, most notably Australia, permit third-partyinvestors to exert some control over litigation strategy, includingthe selection and firing of counsel and even decisions respectingsettlement.8 To the best of my knowledge, however, no Americancourt has approved of anything like the Australian position, andmoreover, no litigation financing firm operating in the UnitedStates has sought to exercise anything approaching the degree ofcontrol permitted in Australia.Assume for the sake of argument, however, that litigation

financing firms did acquire some right to influence the decision-making of a litigant, acting through counsel. What would bewrong with that? Specifically, what would be the problem from thepoint of view of the ethical conception of the lawyer-clientrelationship? That question is the subject of this paper. The aimhere is to use the law of professional responsibility as a lensthrough which to view the interaction between all parties with aneconomic stake in the outcome of a lawsuit where third-partyfinancing is present. The attorney-client relationship has bothintrinsic and instrumental value. Intrinsically it is valuable as a

6. U.S. Chamber Institute for Legal Reform, Stopping the Sale on Lawsuits: AProposal to Regulate Third-Party Investments in Litigation (Washington, D.C.,October 24, 2012), at pp. 1-2.

7. Ibid. at p. 5.8. See Campbell’s Cash and Carry Pty Ltd. v. Fostif Pty Ltd., [2006] HCA 41 (Aus.

H.C.).


relationship of trust and confidence, which respects the dignity andautonomy of the client.9 Instrumentally, the ethical obligations ofthe attorney ensure that the rights of the client are protected up tothe limits established by law. If third-party financing does placeintolerable pressure on the attorney-client relationship, it wouldsignal that there is something wrong with it from a broader,systemic perspective. If, on the other hand, the attorney-clientrelationship can accommodate the presence of a third-partyfinancier without undue difficulty, this would suggest that third-party financing is not an innovation that should be rejected orviewed with too much scepticism.The argument proceeds by analogy from two practices that are

very closely related, perhaps even economically indistinguishable,from third-party litigation financing — namely, payment ofcounsel by third-party liability insurers and contingent feefinancing by plaintiffs’ lawyers. In the case of insurance defense,what would be intolerable conflicts of interest are managedeffectively due to the presence of legal duties running along Line Cin the diagram above, i.e. between the formal client (the insured)and the party that would otherwise be the source of a conflict ofinterest for the lawyer (the insurer, whether or not regarded as asecond formal client). These duties, recognized by state insurancelaw, include various obligations of good faith and fair dealing inconnection with the insurer’s involvement in the litigation. In thecontingent fee situation, on the other hand, Line C duties areremarkably under-developed. Nevertheless, the adverse economicincentives created by contingent fees are not thought to produceintolerable conflicts of interest for the attorney. The reason is thatgeneral fiduciary duties and the ethical obligations imposed onlawyers by rules of professional conduct are believed to besufficient to deter lawyers from behaving self-interestedly.10

9. See, e.g., David Luban, Legal Ethics and Human Dignity (Cambridge, CambridgeUniversity Press 2009), Chap. 2; Stephen L. Pepper, “The Lawyer’s AmoralEthical Role: A Defense, A Problem, and Some Possibilities” (1986), 11 Am. B.Found. Res. J. 613; Charles Fried, “The Lawyer as Friend: The MoralFoundations of the Lawyer-Client Relation” (1976), 85 Yale L.J. 1060.

10. This is not to say that contingent fees are without critics. Lester Brickman, to citeone prominent example, believes much more must be done to curb abuse ofcontingent fees. See Lester Brickman, Lawyer Barons: What Their ContingencyFees Really Cost America (Cambridge, Cambridge University Press, 2011).However, the point is not whether the legal system has got it right from thenormative perspective, but whether the legal system can tolerate a certain amountof tension in the lawyer-client relationship created by a funding mechanism thatpotentially misaligns the interests of lawyers and clients. In the case of contingentfees, it clearly can.


Both of these examples are specifically American, depending asthey do upon the characteristics of the tort system and the lack ofpublicly financed legal aid for poor and middle-income litigants.The analysis here also is based on the American law governinglawyers, as found in the American Bar Association’s Model Rulesof Professional Conduct, decisions interpreting state versions ofthese rules, and the critical summary of decisional law provided bythe American Law Institute’s Restatement of the Law GoverningLawyers. Despite the parochial setting of this analysis, I believe itshows something of general importance for all common lawsystems considering the relatively new phenomenon of third-partlitigation financing. Although sometimes called an innovation,third-party financing does not create stresses within the lawyer-client relationship that are different in kind that have beenaccepted for decades by the legal profession. Thus, the subtext ofthis paper is, “keep calm and carry on.” While third-partylitigation financing is not exactly the same as insurance orcontingent fee financing,11 it is not relevantly different in termsof the policy concerns that seem to animate opponents of third-party financing. The lawyer-client relationship has not crackedunder the strain of the inherent conflicts created by either thepayment and direction of liability insurers or the self-financing oflitigation by lawyers through contingent fees. Unless one can showthat third-party financing is different in relevant respects, there isno reason to worry that it will fundamentally alter the existingstructure of fiduciary duties owed by the attorney to a party inlitigation.

II. INSURANCE DEFENCE REPRESENTATION

Professional responsibility and insurance law scholars haveanalyzed extensively the sometimes conflicting duties of anattorney retained and paid for by an insurance company torepresent the insured policyholder in the defense of a lawsuitarising out of an event for which the policy provides coverage.12 A

11. See Michelle Boardman, “Insurers Defend and Third Parties Fund: AComparison of Litigation Participation” (2012), 8 J.L. Econ. & Pol’y 673.

12. For highlights of the literature, see, e.g., Douglas R. Richmond, “LiabilityInsurer’s Right to Defend Their Insureds” (2001), 35 Creighton L. Rev. 115;Ellen Smith Pryor and Charles Silver, “Defense Lawyers’ Professional Respon-sibilities: Part II – Contested Coverage Cases” (2001), 15 Geo. J. Legal Ethics 29;Ellen Smith Pryor and Charles Silver, “Defense Lawyers’ Professional Respon-sibilities: Part I – Excess Exposure Cases” (2000), 78 Tex. L. Rev. 599; TomBaker, “Liability Insurance Contracts and Defense Lawyers: From Triangles to


host of questions arise when a third party – here, the insurer – hasa contractual relationship with the client that gives that party theright to participate in the litigation in which the lawyer isrepresenting the client. In addition to having the right to receiveinformation and make decisions about even such critical matters assettlement, the insurer pays the attorney’s fees in the matter athand and is likely a source of repeat business for the attorney,while the insured is merely a one-off player. Thus, one may ask:13

Is an insurance carrier a defense lawyer’s client? If so, what does it mean tosay, as many authorities do, that a defense lawyer owes undivided, exclusive,or primary loyalty to an insured? If not, how can defense lawyers takeinstructions from insurers? Are policyholders entitled to information aboutdefense lawyers’ compensation arrangements with insurers? Do somemethods of controlling defense costs interfere with lawyers’ ability to formindependent professional judgments or prevent them from representinginsureds competently? What if a carrier’s cost control program causes adefense lawyer to make a mistake? Is the carrier responsible for the harm tothe insured? Is the lawyer?

As this passage shows, it is difficult to pull on only one thread ofthis tapestry of interwoven legal issues. Calling a party a “client”— in this case, the insurer — entails conclusions about duties owedby the lawyer, including competence, communication, andundivided loyalty. It is logically fallacious, however, to infer fromthe existence of duties to the insurer that the insurer is also a clientof the attorney. An attorney may have a duty of reasonable care tothe insurer —for example, to investigate the existence of otherpolicies providing overlapping coverage — while neverthelessbeing deemed to have only one formal client, the insured.14 The

Tetrahedrons” (1997), 4 Conn. Ins. L.J. 101; Thomas D. Morgan, “WhatInsurance Scholars Should Know About Professional Responsibility” (1997), 4Conn. Ins. L.J. 1; Stephen L. Pepper, “Applying the Fundamentals of Lawyers’Ethics to Insurance Defense Practice” (1997), 4 Conn. Ins. L.J. 27; Nancy J.Moore, “Ethical Issues in Third-Party Payment: Beyond the Insurance DefenseParadigm” (1997), 16 Tex. Rev. Litig. 585; Nancy J. Moore, “The Ethical Dutiesof Insurance Defense Lawyers: Are Special Solutions Required?” (1997), 4 Conn.Ins. L.J. 259; Douglas R. Richmond, “Lost in the Eternal Triangle of InsuranceDefense Ethics” (1996), 9 Geo. J. Legal Ethics 475; Charles Silver and KentSyverud, “The Professional Responsibilities of Insurance Defense Law-yers”(1995), 45 Duke L.J. 255; Charles Silver, “Does Insurance Defense CounselRepresent the Company or the Insured?” (1994), 72 Texas L. Rev. 1583; RobertO’Malley, “Ethics Principles for the Insurer, the Insured, and Defense Counsel:The Eternal Triangle Reformed” (1991), 66 Tul. L. Rev. 511; Hazard, supra,footnote 1.

13. Pryor and Silver, supra, footnote 12 at p. 604.14. Paradigm Insurance Co. v. Langerman Law Offices PA, supra, footnote 3.


insurer may be deemed a quasi-client or the beneficiary of impliedprofessional obligations, but will not be considered a client forpurposes beyond the specifically recognized duty. Whether theinsurer is a formal client or not, the possibility arises that therelationship with the insurer will create conflicts of interest inrelation to the lawyer’s representation of the insured, but theconflicts analysis turns on underlying law in a way that makes itdifficult to generalize about the duties owed by the lawyer to theinsurer and the insured, and also in many ways makes the questionof whether the insurer is a co-client with the insured anunimportant one.The rule on concurrent conflicts of interest, Model Rule 1.7,

states that an attorney has a concurrent conflict of interest if “thereis a significant risk that the representation of one or more clientswill be materially limited by the lawyer’s responsibilities to anotherclient . . . or a third person.”15 It is immaterial whether the insureris deemed a co-client or a third party; if the lawyer’s duties owed tothe insurer, as a matter of state contract or insurance law,materially limit the lawyer’s representation of the client, the lawyermay not proceed without the informed consent of her client.Notice, however, that there must be a significant risk of a materiallimitation. The concurrent relationship with the insurer andinsured does not constitute a conflict in the absence of thissignificant risk. The Tennessee Supreme Court, considering thepossibility that duties to the insurer might complicate the lawyer’srepresentation of the insured, wrote:16

While this practical reality raises significant potential for conflicts ofinterest, it does not become invidious until the [insurer’s] attempted controlseeks, either directly or indirectly, to affect the attorney’s independentprofessional judgment, to interfere with the attorney’s unqualified duty ofloyalty to the insured, or to present “a reasonable possibility of advancing aninterest that would differ from that of the insured.”

The Tennessee court’s holding represents the majority position ininsurance cases, recognizing at least some duties owed along LineA (possibly even referring to the insurer as a co-client of theattorney), while ultimately maintaining that the attorney’s inherentduty of independence owed to the primary client, the insured,

15. See American Bar Association (ABA“) Model Rules of Professional Conduct,Rule 1.7(a)(2) (”Model Rule“).

16. Givens v. Mullikin ex rel. Estate of McElwaney, 75 S.W.3d 383 (Tenn. 2002), p.395 (citing Tennessee Board of Professional Responsibility, Formal Op. 00-F-145(September 8, 2000)).


along Line B supersedes any obligations owed to the insurer in theevent of a true inconsistency. From the legal ethics point of viewon insurance-defense representation, Line B is the most importantthing. No other obligations can be permitted to compromise orinterfere with Line B duties. But Line B does not do all of thiswork alone. Central to this analysis are duties of good faith owedalong Line C, recognized as a matter of state insurance law.As an example, consider a hypothetical developed by insurance

law scholar Tom Baker.17 An insurance company hires a lawyer todefend what appears to be a garden-variety negligence case filed bya spectator injured at a high school softball game. The insured wascovered under her parents’ homeowners’ insurance policy, whichprovided coverage for accidentally caused bodily injuries, butexcluded coverage for intentional acts. The lawyer conductedinformal interviews with numerous spectators at the game, two ofwhom told her that the insured had intentionally thrown her bat atthe plaintiff, a player on the opposing team, who had been trash-talking with the insured. The defense lawyer talked to the insured,who denied the story. In a follow-up conversation with the twospectators, they told the lawyer that they had since spoken with theplaintiff’s attorney, who told them the plaintiff would prefer totreat the case as an accident, and that they would not be called aswitnesses. What should the lawyer do?If the event occurred in one of the numerous states that

considers the insurer a co-client of the insured,18 the lawyer seemsto be in a real pickle. The lawyer owes to one client, the insured,the duty of confidentiality, which prohibits disclosure of all“information relating to the representation”, without the informedconsent of the client, subject to exceptions not applicable here.19

The story told by two potential witnesses would support a denial ofcoverage by the insurer; thus, the insured would prefer that theinformation not be communicated to the insurer. On the otherhand, the lawyer owes a duty to the other client, the insurer, tocommunicate material information about the matter,20 includingthe witnesses’ account that would form the basis of a decision to

17. See Tom Baker, Insurance Law and Policy: Cases, Materials, and Problems, 2nded. (New York, New York, Aspen Publishers, 2008), p. 591.

18. See, e.g., State Farm Mutual Automobile Ins. Co. v. Federal Ins. Co., 72 Cal. App.4th 1422 (1999).

19. Model Rule 1.6. This is broader than the evidentiary attorney-client privilege,which protects communications between the lawyer and client, made inconfidence, for the purpose of obtaining legal assistance. Restatement § 68.

20. Model Rule 1.4.


deny coverage. Having access to confidential information of oneclient that would be material to another client is a classic conflict ofinterest scenario,21 and ordinarily would require the lawyer towithdraw from representing both clients. If the lawyer had beencareful at the outset, she may have specified in her retaineragreements with both the insurer and the insured a course of actionthat would be followed in circumstances such as these. Forexample, she might have stated that information developed in thecourse of the litigation would not be communicated to theinsurer.22 As long as the insurer had given informed consent tothis provision of the retainer agreement, it would be a validlimitation on the attorney’s duties.23 For the sake of this analysiswe can assume that the lawyer was not careful and had notspecified in advance the duties she would owe to each client; thequestion would then be what are the baseline duties owed to eachco-client in this situation. Unfortunately for the lawyer, the defaultrule, which governs in the absence of a contractual provision to thecontrary, is that the lawyer owes irreconcilable duties to both theinsurer and the insured. Thus, the lawyer would be required torepresent only one client or to withdraw from the representationentirely.24

21. See, e.g., A v. B, 726 A.2d 924 (N.J. 1999). In this case, different lawyers at thesame firm represented (1) a husband and wife, preparing joint wills, and (2) thehusband’s girlfriend, in an action seeking to establish paternity of her child. Thehusband’s last name had been misspelled in the conflicts-checking database andso no one at the firm realized there was a conflict of interest until the girlfriend’slawyer served a subpoena on the husband. Because the wife was a co-client in theestate planning matter, the firm owed her a duty to communicate the informationconcerning the existence of her husband’s illegitimate child, who would beentitled to take part of her husband’s estate under the wills as they were currentlydrafted. The law firm also owed a duty of confidentiality to the husband,however, regarding the existence of the girlfriend and the child. If the case hadnot been resolved on the basis of the idiosyncratic confidentiality rule in NewJersey, the firm would have had to withdraw from representing all three partiesand would undoubtedly have been sued for negligence and breach of fiduciaryduty.

22. See, e.g., Kuhlman Electric Corp. v. Chappell, 2005 WL 3243498 (Kentucky App.2005).

23. See Restatement § 19 (providing that a lawyer and client may contractually limit aduty the lawyer would otherwise owe to the client, as long as the client isadequately informed and consents, and that the limitation is reasonable under thecircumstances).

24. See, e.g., Tank v. State Farm Fire & Casualty Co., 715 P.2d 1133 (Wash. 1986)(holding that simultaneous representation of both insurer and insured isimpermissible where the insurer denies coverage). In some jurisdictions thedenial of coverage by the insurer entitles the insured to independent counsel, paidfor by the insurer, whose duties are unambiguously to represent the interests of


Declaring that the sole client is the insured, as some states havedone,25 does not solve this problem if state law recognizes thatsome duties may be owed to the insurer regardless of its status as aformal non-client. Numerous courts in states that adhere to thesole-client view allow lawsuits by insurers for malpractice,notwithstanding the lack of an attorney-client relationship.26 Thereal question is whether the duty of reasonable care owed to theinsurer includes the duty to communicate facts that may create acoverage issue, to the benefit of the insurer and to the detriment ofthe insured. In the much-discussed Parsons case,27 the defenselawyer retained by the insurer to represent the insured learned factsthat suggested the injury-causing event was an intentional act, notnegligence. The lawyer communicated this information to theinsurer, leading it to deny coverage. The court held that the insurerwas estopped to deny coverage because it had taken advantage of abreach of fiduciary duty by the lawyer it retained to defend theinsured.28 It cited an Arizona ethics opinion declaring that theinsurer and insured were both clients of the lawyer, but that thelawyer’s highest duty is to the insured.29 Parsons thereforerepresents a kind of middle ground. Although both insurer andinsured are deemed to be clients, the lawyer’s duty of confidenti-ality to the insured has priority over the duty of communication tothe insurer.All of this discussion so far has been based upon the standard

professional responsibility perspective on insurance-defense repre-sentation. From this point of view, the question is whether thelawyer has only one client and one set of duties (Line B on thepicture above) or, if there is a second line of duties to a party,whether deemed a formal client or not (Line A on the picture),whether there is a principle by which one set of duties issubordinated to the other. In a case like Parsons the lawyer mayfulfill duties along Line B to the exclusion of duties along Line A

the insured alone. See San Diego Navy Federal Credit Union v. Cumis InsuranceSociety, Inc., 162 Cal. App. 3d 358 (1984).

25. See, e.g., In re Rules of Professional Conduct, 2 P.3d 806 (Mont. 2000);Continental Casualty Co. v. Pullman, Comley, Bradley & Reeves, 929 F.2d 103 (2dCir. 1991); Higgins v. Karp, 687 A.2d 539 (Conn. 1997); First American Carriers,Inc. v. Kroger Co., 787 S.W.2d 669 (Ark. 1990); Employers Casualty Co. v. Tille,496 S.W.2d 552 (Tex. 1973).

26. See, e.g., Atlanta International Insurance Co. v. Bell, 475 N.W.2d 294 (Mich.1991) (relying on an equitable subrogation theory).

27. Parsons v. Continental National American Group, 550 P.2d 94 (Ariz. 1976).28. Supra at p. 99.29. Supra at p. 98 (citing Arizona State Bar Op. 282 (1969)).


and not be concerned with the possibility of professional disciplineor civil liability. If the lawyer has duties along both lines and thereis no subordination principle, however, the lawyer may be requiredto withdraw from the representation if the duties owed to bothparties are incompatible. In Tom Baker’s softball case, hearing theaccounts of the two witnesses who described an intentional actmay effectively “taint” the lawyer’s representation of the insuredand require withdrawal. The lawyer would have a classic conflict ofinterest arising from the incompatible duties of confidentiality andcommunication, owed to the insured and the insurer, respectively.The standard professional responsibility perspective leaves out

something extremely important, namely the influence of dutiesowed, as a matter of contract and insurance law, between theinsurer and the insured. In the diagram above, these are dutiesalong Line C. Insurance defense representation is not an ad hoc,unprincipled muddling through of competing duties. There aregood doctrinal reasons for the results courts reach in disciplinary,malpractice, and breach of fiduciary duty cases. Understandingthese cases requires careful consideration of the interactionbetween Line C duties and those duties owed along Lines A andB. Based on the liability insurance contract, here are the Line Cduties owed by each of the parties to the other:30

The defense lawyer is situated at the apex of a triangle, owingduties to both the insured and the insurer. The content of thoseduties is very much dependent upon what the insurer and insuredowe each other. Cooperation clauses in liability insurancecontracts are intended to protect the insurer’s right to a fairadjudication of the liability of the insured.31 They require from theinsured a standard of “honest cooperation . . . telling the truth . . .[not] persistent falsehood going to the very essence of the

30. From Silver and Syverud, supra, footnote 12, at p. 269.31. Arizona Property & Casualty Ins. Guaranty Fund v. Helme, 735 P.2d 451 (Ariz.

1987).


problem.”32 In the softball example, one might therefore imaginethat the insured’s duty to cooperate in the defense of the claimwould require the insured to disclose information tending to showthat the injury-causing act was intentional, even if it would supporta denial of coverage. If that were a rule of insurance law, then thedefense lawyer would not have a conflict of interest. The lawyer’sduty of confidentiality is subject to two exceptions – one, ifdisclosure of the information is impliedly authorized to carry outthe representation, and two, if disclosure is required to complywith other law.33 If the insured were required to disclose theadverse information, then the lawyer’s disclosure would be eitherimpliedly authorized or permitted in order to comply with therequirements of insurance law. Thus, what appears at first to be anirreconcilable conflict of interest turns out to be no conflict at all,and this result is entirely due to the obligations imposed bysubstantive state insurance law, along Line C.As it happens, however, the result in the softball case in most

jurisdictions is that the cooperation clause in liability insurancepolicies is interpreted not to require the insured to disclose factsthat might tend to defeat coverage.34 From the lawyer’s perspectivethe result is the same — i.e. what at first seemed like a conflict ofinterest, possibly even a non-consentable conflict,35 is resolved by apriority principle arising from state insurance law. If thecooperation clause in the contract does not require disclosure ofadverse facts, then the lawyer, acting as the agent of the insured,would have no greater disclosure obligation than her client does,and indeed would be prohibited by the duty of confidentiality fromdisclosing the conversations with the potential witnesses. Inresponse the insurer might contend that the duty of communica-tion arises from the agency relationship between the insurer andthe lawyer, and that duty should not necessarily be trumped by theduty of confidentiality. But the balance of duties along Line C

32. Wildrick v. North River Insurance Co., 75 F.3d 432 (8th Cir. 1996) (internalcitations omitted).

33. See Model Rule 1.6(a) (implied authorization) and 1.6(b)(6) (disclosure requiredby law).

34. See, e.g., Carey-Canada Inc. v. Aetna Casualty & Sur. Co., 118 F.R.D 250(D.D.C. 1987); Rockwell International Corp. v. Superior Court, 32 Cal. Rptr. 2d153 (Cal. Ct. App. 1994); Pittston Co. v. Allianz Ins. Co., 143 F.R.D. 66 (D.N.J1992); see also Pepper, supra, footnote 12, at pp. 58-59.

35. If a conflict of interest is so severe that the lawyer does not reasonably believe itpossible to “provide competent and diligent representation to each affectedclient”, then the informed consent of each client does not suffice to cure theconflict. See Model Rule 1.7(b)(1).


clearly favours the insured in these situations. Thus, from the pointof view of the lawyer at the apex of the triangle, the duty to theinsured trumps the duty to the insurer.A similar result is reached in cases involving policy-limits

settlement offers where the insurer has an incentive to take the caseto trial, essentially gambling with the insured’s money. Imagine apersonal-injury case in which expected judgment at trial is $52,000,as determined by the defense attorney based on the average ofpotential verdicts multiplied by their likelihood. The liabilityinsurance policy has limits of $100,000.36 The defendant — theinsured — would be delighted to accept the plaintiff’s offer to settlefor $99,000. The insurer, on the other hand would be able toimprove its situation by going to trial, and in any event “has littleto lose from the judgment that it would not already lose in thesettlement.”37 Assuming the defense attorney has either a dual-client relationship with the insurer and the insured, or a singleformal client (the insured) and “some duties”, including reasonablecare, to the insurer, what should the attorney do? The answerdepends not on professional responsibility norms standing alone,but on the relationship between the duties owed by the lawyer toeach party (whether called “client” or not) and the duties owedinter se by those parties.As insurance law scholar Kent Syverud points out, both the

insurer and insured have a stake in the outcome, and thus bothhave an incentive to take advantage of the other. The doctrinalsolution to this problem has been a regime of divided control overthe litigation, with duties respecting cooperation and settlement asshown above. Neither party has an absolute right to control thedefense. “[U]nbridled control of the defense of litigation by eitherthe insurance company or the insured creates incentives for theparty exercising that control to take advantage of the other.”38 Inthe example given here, the insurer is obligated to exercise itscontrol over settlement (allocated to it by contract) in good faith,which means giving at least equal consideration to the interests ofboth insured and insurer. Refusing to settle a case within policylimits can subject an insurer to tort liability if the insurer acted in

36. See Kent D. Syverud, “The Duty to Settle” (1990), 76 Va. L. Rev. 1113 at p.1130.

37. Ibid.38. Kent D. Syverud, “What Professional Responsibility Scholars Should Know

About Insurance” (1997), 4 Conn. Ins. L.J. 17, p. 23.


bad faith.39 Exercising good faith does not mean simply acquies-cing to the insured’s demand that the insurer settle the case withinpolicy limits, but the insurer does have to conduct the investigationof the case and the settlement negotiations with due regard to theinterests of the insured.40

The lawyer in the case would be uncertain how to proceed if sheconsidered only duties along Lines A and B, owed to the insurerand insured, respectively. It is absolutely clear that a lawyer mustrespect a client’s decision with regard to settlement of a civilmatter; that decision is unambiguously within the client’s exclusivedecision-making authority.41 What happens, however, when oneparty has delegated the right to make decisions regardingsettlement to another party? Must the lawyer defer to the insurer’sdecision, or will the lawyer be potentially subject to liability forfailing to protect the insured from overreaching by the insurer? Theanswer is that the lawyer can reconcile Line A and Line B dutiesonly with reference to Line C. Advising the insurer and insured

39. The landmark case establishing tort liability for bad faith conduct by the insureris Crisci v. Security Insurance Co. of New Haven, 426 P.2d 173 (Cal. 1967).

40. Doug Richmond reviewed numerous cases from jurisdictions around the UnitedStates and distilled the following factors as relevant to the determination ofwhether an insurer acted in bad faith with respect to a settlement offer:(1) theprobability of the insured’s liability; (2) the amount of the policy limits; (3) theextent of the claimant’s damages; (4) the adequacy of the insurer’s investigation;(5) the adequacy of the defense provided by the insurer; (6) whether the insurerfollowed the defense attorney’s advice regarding settlement; (7) whether theinsurer heeded its own adjusters’ advice regarding settlement; (8) the insurer’swillingness to engage in settlement negotiations; (9) whether the insured madeany misrepresentations that may have misled the insurer in settlement negotia-tions; (10) the openness of the communication between the insurer and theinsured; (11) whether the insurer kept the insured informed of settlementnegotiations; and (12) any other conduct demonstrating that the insurer felt orshowed greater concern for its financial interests than it did for its insured’sfinancial risk.Douglas R. Richmond, “Advice of Counsel and Insurance BadFaith” (2003), 73 Miss. L. Rev. 95, p. 101. The example in the text can be flippedaround so that the insured’s interest is not to settle within policy limits. Althoughno court has recognized a claim for bad faith in these circumstances, someinsureds, particularly physicians, have resisted settlement in order to protect theirreputational interests. See, e.g., Hurvitz v. St. Paul Fire & Marine Ins. Co., 109Cal. App. 4th 918 (2003), p. 930 (the law does not require the insurer to take intoaccount “the entire range of the insured’s well-being”, but just one thing: thejudgment at risk in the claim against the insured); Shuster v. South Broward Hosp.Dist. Physicians’ Professional Liability Ins. Trust, 591 So. 2d 174 (Fla. 1992), p.176 (“The . . . insured was put on notice that the agreement granted the insurerthe exclusive authority to control settlement and to be guided by its own self-interest when settling the claim for amounts within the policy limits.”). Seegenerally Silver and Syverud, supra, footnote 12 at pp. 266-267.

41. Model Rule 1.2(a).


requires knowledge of the duties these two parties owe to eachother. For example, the insurer would need to know the likelihoodof a bad faith claim asserted by the insured if it refused the offerwithin policy limits. It may be the case that the positions of the twoparties were so far apart that a lawyer could not provide competentand diligent representation to both; in that event the lawyer wouldhave to withdraw and, in some jurisdictions, separate counselwould be appointed to represent the insured’s interests alone.Apart from the situation of a severe conflict of interest, however,the lawyer’s relationship with the two parties is extensivelystructured by the duties the parties have to each other. Thepresence of the second party may complicate the relationship withone party, but it does not create a per se interference with thelawyer-client relationship. At most it creates the possibility of asituation in which the interests of the two parties becomesirreconcilable, but this is the case in any instance of concurrentrepresentation, and the rules of professional conduct do notabsolutely prohibit the representation of multiple parties. In short,not only are the conflicts in the insurance-defense contextmanageable, but they are quite predictable and therefore readilymanaged because of an extensive, fairly stable body of insurancelaw that regulates the relationship between the insurer and insured.Some critics of third-party litigation financing have sought to

distinguish liability insurance by appealing to the alignment ofinterests between insurer and insured,42 or by citing the dual-clientrule that is the default in many jurisdictions.43 Note, however, thatthe resolution of the softball case and the settlement exampleassumes that the insurer and insured have opposing interests withrespect to coverage, litigation strategy, and settlement decisions.Only superficially are the insurer and insured on the same side ofthe litigation. Even in a dual-client state the lawyer must be alert toconflicts that become so severe that the lawyer may no longereffectively represent the insured. As any lawyer who has doneinsurance-defense work knows, there can be cases in which theinterests most closely aligned are actually those of the plaintiff anddefendant/insured. Cases sometimes settle with an assignment tothe plaintiff of the insured bad faith claim against the insurer,which the plaintiff’s lawyer may pursue along with a malpracticecase against the lawyer who represented the insured.44 Michelle

42. See, e.g., Boardman, supra, footnote 11 at p. 686.43. Id. at p. 691.44. See, e.g., Kumar v. American Transit Ins. Co., 854 N.Y.S.2d 274 (App. Div. 2008);


Boardman, a critic of third-party financing, has argued that “theproblem with the claim that insurers are litigation financiers is notits inaccuracy but its superficiality.”45 A proponent of third-partyfinancing would heartily agree that only a superficial analysiswould suggest that the interests of insurers and insureds aregenerally, or even very often well aligned. From the lawyer’s pointof view, however, insurance-defense representation is fairly routineand does not often involve insoluble conflicts of interest. Thereason is that the duties owed to each other by insurer and insurerare clearly delineated as a matter of state law. Boardman arguesthat “in an analysis of third-party litigation funding, little can besaid to automatically follow from the fact that insurers fundlitigation.”46 That is correct. Nothing automatically follows, but ifdue account is taken of the content of the obligations mutuallyowed by the third-party financier and the recipient of third-partyfunding, it may be the case that third-party funding is no more orless problematic, from a lawyer-deontological perspective, than thewell accepted practice of liability insurers paying defense costs andexerting significant control over the conduct of the litigation. Agreat deal depends on the underlying duties between the fundingentity and the recipient of funding – that is, the way the standardof conduct is defined. Section IV returns to this issue in the contextof litigation financing.47

III. CONTINGENT FEE FINANCING

If the objection to third-party litigation financing is that itinterferes with what should be a purely fiduciary relationshipbetween the lawyer and client, then those who make this objectionshould be prepared to explain why the interests of a third-partyfinancier presents a more severe threat to this relationship than thelawyer’s own financial interests. Contingent fees shifts the risk ofnon-recovery between the client and lawyer, just as third-partyfinancing shifts the risk from the litigant to the financing firm;both the lawyer and the financing firm are believed better able tobear the risk because of the possibility of diversification across a

Mutuelles Unies v. Kroll & Linstrom, 957 F.2d 707 (9th Cir. 1992); SafecoInsurance Co. of America v. Butler, 823 P.2d 499 (Wash. 1992).

45. Boardman, supra, footnote 11 at p. 691.46. Ibid.47. For a more detailed analysis of these duties, see Anthony J. Sebok and W.

Bradley Wendel, “Duty in the Litigation Investment Agreement: The ChoiceBetween Tort and Contract Norms When the Deal Breaks Down” (2013), 66Vand. L. Rev.1831.


portfolio of similarly funded claims and greater expertise inassessing the merits of the litigant’s case.48 Historically speaking,the common law considered contingent fees just as much of athreat as third-party financing. The centuries-old common lawdoctrines of champerty, maintenance, and barratry limit theinvolvement of non-parties in litigation. “[P]ut simply, main-tenance is helping another prosecute a suit; champerty ismaintaining a suit in return for a financial interest in the outcome;and barratry is a continuing practice of maintenance orchamperty.”49 As the leading modern academic treatment of thesedoctrines defines these doctrines:50

Champerty occurs when the intermeddler provides something of value to aparty in a lawsuit in return for a portion of the recovery. Champerty isconsidered a type of maintenance. Barratry has been defined as the offense offrequently exciting or stirring up suits and quarrels between others, and isalso a species of maintenance.

Contingent fees were formerly lumped in with champerty andmaintenance, and subject to the same opprobrium in the commonlaw world.51 At some point this history diverged in an interestingway, with contingent fees winning acceptance in the United States,though continuing to be viewed with considerable scepticism inother common law jurisdictions.52 Along the way, we got used to

48. See Restatement § 35, cmt. b. (noting that contingent fees “enable a client to sharethe risk of losing with a lawyer, who is usually better able to assess the risk and tobear it by undertaking similar arrangements in other cases”).

49. Osprey, Inc. v. Cabana Ltd. Partnership, 532 S.E.2d 269 (S.C. 2000), p. 273(quoting In re Primus, 436 U.S. 412 (1978), p. 424 note 15.

50. Anthony J. Sebok, “The Inauthentic Claim” (2011), 64 Vand. L. Rev. 61, p. 98.51. See Charles W. Wolfram, Modern Legal Ethics (St Paul, Minnesota, West

Publishing, 1986) at p. 527. Traditionally “[c]ourts lumped the contingent fee inwith other champertous practices that were thought to stir up unwanted litigationand involve unscrupulous lawyers in the nefarious business of brokeringlawsuits” (citing Coon v. Landry, 408 So. 2d 262 (La. 1981)). See also PeterKarsten, “Enabling the Poor to Have Their Day in Court: The Sanctioning ofContingency Fee Contracts, A History to 1940” (1998), 47 DePaul L. Rev. 231.

52. There is now guarded recognition of “conditional” or percent-uplift fees in theUnited Kingdom. See Solicitors’ Code of Conduct 2007 § 2.03(2); added by § 58of the Courts and Legal Services Act 1990 (taking effect 1995). See also AratraPotato v. Taylor Joynson Garrett, [1998] 3 All E.R. 65 (Q.B.); Thai Trading Co. v.Taylor, [1998] Q.B. 781 (C.A.). The Thai Trading case recognizes so-calledspeculative fees, which means fees payable only if the client wins, but without theuplift portion. The key difference between contingent and conditional fees is that,under the U.K. practice, the success fee portion is calculated on the originalunderlying fee, not the client’s recovery; also the client remains liable toreimburse the lawyer for cost disbursements. The English rule that the client hadto remain liable for costs persisted for quite a while in some American states. See,e.g., Bennett v. Tighe, 112 N.E. 629 (Mass. 1916), p. 630. Politically speaking, it is


the inherent conflict of interest created by contingent fees. Thequestion to be considered in this section is whether the techniquesused to manage these conflicts, both doctrinal and ethical, areadequate, and what implications can be drawn from the experiencewith contingent fee financing for the regulation of third-partylitigation financing.Contingent fees share a feature with insurance defense

representation that is important to understanding the relevanceof these areas of law to third-party litigation financing. Thatfeature is shared control over something of value, either theplaintiff’s claim (in the case of most contingent fee representationsand third-party financings) or the defendant’s liability by way ofjudgment or settlement (in the case of insurance-defense repre-sentation). The economic analysis of shared control emphasizes thebilateral agency problem thereby created.53 In a contingent feerepresentation, the plaintiff’s claim can be divided into two parts,representing the plaintiff’s interest and the attorney’s interest. Withrespect to the plaintiff’s interest, the attorney is an agent, but theattorney is the principal with respect to her own interest. Inaddition, the plaintiff is an agent of the attorney with respect to theattorney’s interest to the extent it is affected by the plaintiff’sparticipation in litigation, e.g. as a witness. Further sources ofagency costs include the fact that the lawyer who owns only afractional interest in the claim will invest less in the claim thansomeone who owns the entire claim, and the structural problemthat, the client to capture the full surplus generated by thelitigation, the lawyer must take away, in expected terms, no morethan her investment.54 The conflicts of interest that are endemic tocontingent fee representation are instances of this general problem,which arises in areas from oil and gas leases to commercial lendingtransactions.55

useful to note that the recognition of conditional fee agreements in the UnitedKingdom was a quid pro quo for eliminating legal aid for personal injurylawsuits). See Richard L. Abel, “An American Hamburger Stand in St. Paul’sCathedral: Replacing Legal Aid with Conditional fees in English Personal InjuryLitigation” (2001), 51 DePaul L. Rev. 253.

53. Geoffrey P. Miller, “Some Agency Problems in Settlement” (1987), 16 J. LegalStud. 189.

54. Bruce L. Hay, “Contingent Fees and Agency Costs” (1996), 25 J. Legal Stud. 503,p. 509.

55. See, e.g., Richard A. Posner, Economic Analysis of Law, 5th ed. (New York,Aspen Publishers, 1998) at pp. 72-86; Ian Ayres and Eric Talley, “SolomonicBargaining: Dividing a Legal Entitlement To Facilitate Coasean Trade” (1995),104 Yale L.J. 1027; Richard A. Epstein, “Past and Future: The TemporalDimension in the Law of Property” (1986), 64 Wash. U. L.Q. 667. The problem


Conflicts of interest arising from the lawyer’s financialincentives are quite familiar in legal ethics:56

First, the lawyer may not have a direct economic incentive to work for hisclient’s victory because the lawyer’s profit may be unrelated to-the case’soutcome. Second, the lawyer may not have a direct economic incentive towork the number of hours necessary to maximize the size of his client’s netrecovery, if any, because to maximize his own profit the lawyer may have towork a different number of hours.

An attorney representing herself would naturally view the case as aresource, and her time as a cost, and would invest time into thecase up to the point at which a marginal hour of work no longerproduced a marginal increase in the settlement value of the casegreater than the lawyer’s effective hourly rate (i.e. that returnwhich could be realized by working on other cases).57 Themisalignment of incentives is clear in contingent fee representation.To give an oversimplified example, a lawyer on a one-thirdcontingent fee may be able to work 10 hours on a case and obtain a$90,000 settlement for the client, or work 100 hours and obtain a$180,000 settlement for the client. While the lawyer’s absolute feeincreases from $30,000 to $60,000 if she works the additionalhours, her effective hourly rate goes from $3,000 to $600 as aresult. Thus, the lawyer has an incentive to try to talk the clientinto accepting the early settlement offer.58 On the other hand one

of shared ownership or mutual agency arises in the insurance defense context aswell, where it is handled by the duty to cooperate (running from insured toinsurer) and various good faith duties that run from insurer to insured. See suprafootnotes 34-39 and accompanying text. Consider, for example, the representa-tion of corporate defendants who have high deductibles or self-insured retentions.In such a case, the insurer has a great deal of control over the conduct of thelitigation, including the right to settle the case, but the insured is entitled to knowabout settlement offers and otherwise to participate in the defense, given itsinterest in either the self-insured retention or some non-monetary aspect of thecase, such as reputational concerns; thus insurance law imposes a duty on theinsurer to communicate settlement offers to the insured. See Douglas R.Richmond, “An Overview of Insurance Bad Faith Law and Litigation” (1994), 25Seton Hall L. Rev. 74, p. 90.

56. Kevin M. Clermont and John D. Currivan, “Improving on the Contingent Fee”(1978), 63 Cornell L. Rev. 529, p. 534.

57. Ibid. at p. 542.58. The client retains the authority to decide whether to accept or reject a settlement

offer. Model Rule 1.2(a). Nevertheless the lawyer may be able to sweet-talk theclient into accepting the early offer, and may even believe in subjective good faiththat it is in the client’s best interests given the uncertainty inherent in thelitigation process, the client’s short-term need for funds, or some similarconsideration. The conflict of interest arises in connection with the lawyer’sability to give impartial advice, given the lawyer’s own interest in maximizing her


could compute a measure of the “real” value to the client of thelawyer’s time, based on the effect of the lawyer’s effort on theexpected verdict and likelihood of success at trial, which will bereflected in the settlement value of the case. Particularly in anhourly fee representation, an agency problem arises from theclient’s inability to ensure that the lawyer does not put time intothe case that is worth more to the lawyer than it is worth to theclient, in terms of increasing the settlement value of the claim. Norational client would want the lawyer to invest more time than isoptimal.As this formulation suggests, the agency problem or conflict-of-

interest critique is not limited to contingent fees. The hourly fee atbest leaves the lawyer indifferent to the client’s economic interestsand at worse creates incentives to perform work that is of no valueto the client. (Of course, this analysis assumes the lawyer is billinghonestly in hourly rate cases, and the difficult the client has inmonitoring the lawyer to ensure the time written down wasactually worked on the client’s matter.)59 Flat fees do not createincentives to churn bills, but they do no better than hourly fees atcreating incentives for the lawyer to work hard on the client’s case.Clermont and Currivan accordingly argue that there’s a kind ofsweet spot of the optimal amount of work a lawyer ought to putinto a case, and neither hourly nor contingent fee structures areparticularly well designed to incentivize it: Hourly fees tend tomake the attorney indifferent to the number of hours worked;contingent fees incentivize the lawyer to work fewer hours, whichmay not be in the client’s interests.60

Returning to the triangle model above, the lawyer’s economicinterests can be represented not as duties but at least as incentivesalong Line A, competing with the duties the lawyer owes to theclient along Line B. With respect to Line A, the lawyer’s incentivesare those that are standardly thought to create agency costs61 —that is, the lawyer might run up the bill if charging for her work onan hourly basis, or in the case of contingent fee representation,slack off when her effective hourly rate on one matter falls below

effective hourly rate. As discussed below, however, this conflict is not treated as aformal conflict and handled under Model Rule 1.7 or 1.8.

59. Clermont and Currivan, supra, footnote 56, at p. 568.60. Ibid. at p. 537.61. See generally see Sanford J. Grossman and Oliver D. Hart, “An Analysis of the

Principal-Agent Problem” (1983), 51 Econometrica 7; Steven Shavell, “RiskSharing and Incentives in the Principal and Agent Relationship” (1979), 10 Bell J.Econ. 55.


the rate she could realize on another matter. Interestingly, there arerelatively few particularized duties along Line B that purport to domuch about the agency problem. Lawyers representing clients on acontingent fee basis are required to provide some additionaldisclosure in their retainer agreement, with the goal of ensuringthat the client understands the basis for calculating the fee.62

Unlike other situations in which the lawyer has a personaleconomic interest that is misaligned with the client’s,63 however,the lawyer is not required to obtain the client’s informed consent toconflicts of interest created by factors such as the lawyer’s incentiveto maximize her effective hourly rate. And there is nothingcomparable in contingent fee financing to the extensive disclosureand substantive fairness requirements in the rule on businesstransactions between lawyers and their clients, even though thelawyer arguably has an economic interest adverse to that of herclient.64 As Clermont and Currivan recognize, “[a]bsent a directeconomic incentive to make the lawyer work in the client’s bestinterests, our legal system must rely exclusively on noneconomic orindirect restraints to forestall the potential economic conflict ofinterest between lawyer and client.”65 Alternatively one may seekto rely on market mechanisms such as price competition toregulate contingent fees. Unfortunately, there is considerableevidence that the reliance on either attorney self-restraint or themarket is misplaced.For one thing, contingent fees are remarkably “sticky” and

resistant to price competition. It is unlikely that lawyers who arecomplying with their fiduciary obligations would charge the samerate for all cases, insensitive to considerations such as the risk ofnon-recovery presented by the case. Given the number of lawyerscompeting for personal-injury clients, one would expect that priceswould be driven down, particularly after lawyers were permitted toadvertise. Those predictions have not been borne out, however.66

There are many possible explanations for this paradox, includingthe fact that lawyers do not advertise on price,67 the low salience ofcontingent fee percentages in the deliberation of prospective

62. Model Rule 1.5(c).63. Cf. Model Rule 1.7(a)(2).64. Cf. Model Rule 1.8(a).65. Clermont and Currivan, supra, footnote 56, at pp. 535-536.66. See Nora Freeman Engstrom, “Attorney Advertising and the Contingency Fee

Cost Paradox” (2013), 65 Stan. L. Rev. 633, pp. 667-668.67. Ibid. at pp. 682-685.


clients,68 and the inability of potential clients to evaluate thequality of their own claims (and therefore the leverage they have inbargaining with lawyers over fees).69 Whatever the explanation,neither the market nor the self-restraint of lawyers has done muchto reduce contingent fees. Nevertheless, only a few particularlypassionate critics believe that contingent fee financing poses afundamental threat to the civil justice system. By and large theAmerican legal profession has reconciled itself to contingent feesnotwithstanding the inherent conflicts of interest they present.The significance for the argument here is as follows: Contingent

fee contracts are relatively unregulated, they are well known tomisalign the interests of attorneys and clients, and yet they are anaccepted part of the landscape of civil litigation in the UnitedStates. As for the first observation about regulation, other than therequirement of written disclosure in Model Rule 1.5(c) and therequirement of reasonableness in Model Rule 1.5(a), applicable toall attorney fee contracts, there is very little judicial supervision ofcontingent fee financing. Courts sometimes impose discipline onlawyers who charge contingent fees in cases where there was noreal ex ante contingency. For example, if a lawyer charges a one-third contingent fee to file an application for benefits under a lifeinsurance policy where no grounds exist for the insurer to contestthe application, the lawyer will be deemed to have actedimproperly.70 Outside these unusual cases, however, there is verylittle prospect of professional discipline for lawyers who aremotivated by their economic self-interest to do something likestrongly urging a client to accept an offer of settlement that thelawyer reasonably believes could be improved over time, but at ahigh cost to the lawyer’s effective return on investment.71 There are

68. Ibid. at pp. 686-687.69. Brickman, supra, footnote 10, at pp. 75-76.70. See Restatement § 35, cmt. c. and Illus. 1; Comm. on Legal Ethics v. Tatterson,

352 S.E.2d 107 (W. Va. 1986).71. Granted, the decision whether to settle a case always belongs to the client alone.

Model Rule 1.2(a); Restatement § 22 and cmt. c. Many clients, however, andparticularly unsophisticated ones, will rely on the lawyer’s advice regardingacceptance of a settlement offer. When advising the client, the lawyer must behonest and explain the objective pros and cons of accepting the settlement versuscontinuing with the litigation. Restatement § 20, cmt. e. But many considerationsmust be taken into account by the client in deciding whether to accept an offer,and the attorney can subtly influence the client’s decision by emphasizing factorsin favour of an early settlement (e.g., the uncertainty of results, the tendency oflitigation to drag on) and deemphasizing those factors favouring staying in thelitigation. See, e.g., Douglas E. Rosenthal, Lawyer and Client: Who’s in Charge?(New York, Russell Sage Foundation, 1974); Herbert M. Kritzer, “Contingent-


real dangers associated with the potentially conflicting incentivesinherent in the practice of contingent fee financing, and yet wetrust that, by and large, everything will be okay. Why? Again,because of Line C, although in this case the constraints are notprovided by enforceable positive-law duties but the ethicalcommitment of lawyers. Personal-injury lawyers may be able topersuade their clients to accept a low settlement offer (the terms ofwhich would be economically advantageous to the lawyer), but ifwe believe that for the most part they do not, it is because lawyerstake their fiduciary responsibilities seriously. Lawyers know howto put aside their financial self-interest and provide candid,independent advice that is in the best interests of their clients.

IV. THIRD-PARTY LITIGATION FINANCING

Third-party litigation financing represents an intermediate casebetween insurance defense practice and contingent fee litigation.Because it is relatively new, at least in the United States, a legalregime comparable to state insurance law has not yet developed toregulate the legal relationship between financing companies andthe recipients of litigation financing. I have argued, along withTony Sebok, that duties of good faith imposed on the parties as amatter of contract law, not tort, best respond to the risks faced byboth parties to a commercial litigation financing relationship.72

Fee Lawyers and Their Clients: Settlement Expectations, Settlement Realities,and Issues of Control in the Lawyer-Client Relationship” (1998), 23 L. & Soc.Inquiry 795. In the analogous context of criminal defense lawyers advising clientson whether to accept an offered plea bargain, a famous study showed thatdefense lawyers act as “double agents”, seeking to persuade their clients that theyare providing zealous representation while simultaneously trying to talk theirclients into accepting offers that prosecutors and judges will deem reasonable. SeeAbraham S. Blumberg, “The Practice of Law as Confidence Game: Organiza-tional Cooptation of a Profession” (1967), 1 Law & Soc’y Rev. 15.

72. Sebok and Wendel, supra, footnote 47. Consumer-sector legal funding raises verydifferent policy issues and is not the subject of either the Sebok and Wendel paperor this article. See Steven Garber, Alternative Litigation Financing in the UnitedState: Issues, Knowns and Unknowns (Santa Monica, California, Rand Corpora-tion, 2010) (describing the differentiation of the litigation-funding market),available at <http://www.rand.org/pubs/occasional_papers/OP306.html. Propo-sals to regulate the consumer sector of the litigation-investment market (asopposed to calls for its outright elimination) have typically focused ontransparency, capping rates of return, and meaningful disclosure requirements.See, e.g., Susan Lorde Martin, “Litigation Financing: Another SubprimeIndustry That Has a Place in the United States Market” (2008), 53 Vill. L.Rev. 83; Susan Lorde Martin, “The Litigation Financing Industry: The WildWest of Finance Should Be Tamed Not Outlawed” (2004), 10 Fordham J. Corp.& Fin. L. 55.


Whether that argument ultimately proves persuasive, there are notyet enough decided cases to constitute a robust body of lawgoverning third-party litigation financing as between funders andfunded claimants. This does not mean, however, that commerciallitigation financing is unregulated to the same extent as contingent-fee financing. Private ordering by contracts is likely to be moreeffective due to the considerably greater sophistication (as a class)of the recipients of financing, many of whom are entity clients within-house legal representation, and many of whom are alreadyrepresented by outside counsel in the litigation for which they areobtaining financing. The parties to a litigation-financing contractare in a much better position to protect themselves by bargainingfor specific contract terms than are the typically unsophisticatedpersonal-injury clients represented by lawyers on a contingent feebasis or the insureds under many third-party liability policies.For the purposes of this analysis, assume that some duties are

owed along Line C, probably as a matter of contract, betweenfunders and those litigants who desire this form of financing. Thestringency of those duties seems likely to fall somewhere betweenthe comprehensive and demanding system of insurance law and therelatively unregulated practice of contingent fee financing. Theduties are best analogized to a relational contract, in which theparties’ performance obligations are sequential. A financingcompany may have the opportunity to make a series ofinvestments in tranches, and may have the right to withholdfurther investments if certain conditions are not satisfied. Therecipient of the financing — the party to the litigation — is likelyempowered by the financing contract and by applicable procedurallaw to make decisions regarding the selection of counsel, theconduct of the litigation, and particularly settlement. (As notedabove, Australia is something of an outlier in permittingcommercial litigation financers to exercise influence over thesefundamental decisions.) The litigant is aware, however, that if itmakes decisions with which the financer disagrees, it mayjeopardize future investments. Each party is vulnerable to someextent, for reasons such as the information asymmetry arising fromthe financer’s undertaking not to seek access to communicationsprotected by the attorney-client privilege; the risk that the litigantwill simply “take the money and run”; and the possibility that thefinancer may hold for more favourable terms if it becomes awareof the litigant’s desperate need for an infusion of more cash.73 The

73. See Sebok and Wendel, supra, footnote 47 (detailing these risks).


reciprocal character of the parties obligations, reinforced by theparties’ parties’ sequential performance, thus creates a bondingmechanism, protecting each party from opportunistic conduct bythe other.74 Contract bad faith norms (as opposed to a free-standing tort cause of action for bad faith conduct) are definedwith reference to the parties’ bargain. Bad faith with respect to thecontract is therefore defined as the attempt to recapture someportion of the opportunities foregone at the outset, when theparties established the terms of their relationship by contract.75

The standard is rendered determinate by consideration of the termsof the parties’ bargain.The implication for the lawyer-client relationship should be

clear. As a baseline, it is always the case that a lawyer is obligatedto exercise independent professional judgment when advising oracting on behalf of a client.76 She may not permit her judgment tobe influenced — that is, for her representation to be materiallylimited — by a responsibility to another client or a third party.77

The lawyer must always be free to “consider, recommend or carryout an appropriate course of action for the client” withoutconsidering the interests of others, whether clients or non-clients.78

To put the point bluntly, however, in a commercial litigationfinancing relationship, the client is a grown-up and can make itsown determination about what is an appropriate course of action.Most of the clients who make use of commercial litigationfinancing are independently advised by counsel, either in-houselawyers or an outside law firm. Even in the absence of advice ofcounsel, they are highly sophisticated parties who are, and shouldbe, free to enter into value-enhancing bargains. If a client is willingto accept a tiered financing structure, in which a funder hasdiscretion to make or decline a subsequent tranche of funding, thenits autonomy must be given effect. Now imagine that, subse-quently, the client has a choice to do X or Y. If the client does X,the financing firm will refuse a new tranche of funding, but if theclient does Y, the funding will be forthcoming. Is the lawyer’sindependence compromised when she advises the client to do Y, if

74. See, e.g., Daniel R. Fischel, “The Economics of Lender Liability” (1989), 99 YaleL.J. 131; Clayton P. Gillette, “Commercial Rationality and the Duty to AdjustLong-Term Contracts” (1985), 69 Minn. L. Rev. 521.

75. See Steven J. Burton, “Breach of Contract and the Common Law Duty toPerform in Good Faith” (1980) , 94 Harv. L. Rev. 369.

76. Model Rule 2.1.77. Model Rule 1.7(a)(2).78. Model Rule 1.7, cmt. [8].


doing so will be financially advantageous to the financing firm? Anegative answer is supported by consideration of the relationshipalong Line C of our triangle structure. The financing firm and thelitigant have already decided to establish certain rights and dutiesinter se. When the lawyer advises the client, she is merely takinginto account the structure of obligations agreed upon between theparties to the contract. The financing relationship does notinterfere with the lawyer’s judgment on behalf of the client becausethe client has already made the decision to accept the financing,subject to the conditions specified in the financing agreement.The lawyer’s predicament in this case is quite a bit less severe

than in the insurance defense scenario. Depending on the state, theinsurer is either a co-client with the insured or a non-client towhom some professional duties are nevertheless owed. By contrast,nothing about a typical commercial litigation financing arrange-ment confers client or even quasi-client status on the financingfirm. The Restatement rule, which reflects the position of moststate courts and bar associations who have considered the issue,allows lawyers to muddle through the conflicts that are created bythe liability insurance contract.79 The potential for interferencewith the lawyer’s independence of judgment is not so great that thelawyer must withdraw from the representation, at least in theordinary course of events. A fortiori, where nothing is owed by thelawyer to the financing firm (Line A of the diagram), there is lesscause for concern about the interference with lawyer independence.Circumstances external to the lawyer-client relationship, such asobligations owed by the client to the financing firm, may affect thecontent of the advice given to the client, but it is always the casethat external circumstances may bear on what the client has reasonto do all things considered. For example, a client may have a lineof credit with a commercial lender which includes covenants not totake on additional debts. If a lawyer advises a client that aparticular transactional structure should not be employed becauseit would violate the covenant in the lending agreement, this advicereflects not the lawyer’s compromised independence but merely thefrank assessment of the client’s options given the pre-existingobligation to the lender. Litigation financing is really no different.The lawyer’s advice must reflect what the client ought to do in lightof all of the circumstances, including obligations that may be owedto the financing firm, but this is not an interference with thelawyer’s independence, because the obligation of independent

79. Restatement §134 cmt. f.


judgment always makes reference to the client’s best interests,bracketing only the lawyer’s obligation to another client, a non-client, or the lawyer’s own financial interests.When it comes to the lawyer’s own financial interests,

commercial litigation financing contracts present considerably lessof a threat to the lawyer’s independence than contingent feefinancing arrangements. Contingent fee financing presents anobvious, glaring conflict of interest, yet the American professionhas almost completely reconciled itself to the contingent fees. Thereason, interestingly enough, is that the profession retains someconfidence in the ethical backbone of lawyers. Granted, there maybe an incentive to talk a client into settling early and increasing thelawyer’s effectively hourly rate, but lawyers know they should notdo this. The decision respecting settlement is within the client’sexclusive authority, the lawyer is obligated to provide independentadvice, and we quite simply expect that lawyers will do what theyare supposed to do. In a class action civil rights case called Evans v.Jeff D., the U.S. Supreme Court refused to use the term “ethicaldilemma” to refer to a settlement offer conditioned upon anagreement by the plaintiff’s lawyer to waive a statutory entitlementto seek attorney’s fees.80 Some state bar ethics opinions hadpreviously stated that it would be unethical for defense counsel tomake an offer conditional on a waiver by plaintiffs’ counsel of theentitlement to receive statutory fees. However, writing for thecourt, Stevens J. wrote that sometimes litigation, as well as life,presents hard choices:

[A] lawyer is under an ethical obligation to exercise independentprofessional judgment on behalf of his client; he must not allow his owninterests, financial or otherwise, to influence his professional advice.Accordingly, it is argued that a lawyer is required to evaluate a settlementoffer on the basis of his client’s interest, without considering his own interestin obtaining a fee; upon recommending settlement, he must abide by theclient’s decision whether or not to accept the offer.

The lawyer is obligated to communicate the offer to the client and“render objective advice about its merits that is independent of thelawyer’s own interests in protecting the fee.”81 It may be difficult,even painful, for the lawyer to advise the client that her bestinterests would be served by accepting an offer that eliminates the

80. Evans v. Jeff D., 475 U.S. 717 (1986).81. American Bar Association and the Bloomberg Bureau of National Affairs, ABA/

BNA Lawyers’ Manual on Professional Conduct (Washington, D.C., Bureau ofNational Affairs), para. 41:1609 (citing numerous ethics opinions).


lawyer’s own fee, but sometimes compliance with ethical normsrequires sacrifice or hard choices.I have never been persuaded that the lawyer’s self-interest in

cases financed by commercial litigation funders exerts a strongerinfluence on the lawyer’s judgment than the interests of lawyers incontingent fee representation or in cases like Jeff D. In those cases,the unambiguous message of courts and bar associations toAmerican lawyers is, respect your commitment as a fiduciary to actin the best interest of your client. Those would regard third-partylitigation financing as a unique threat to the lawyer-clientrelationship have the burden of pointing out something aboutlitigation financing that makes the tension it creates worse than thetension in Jeff D., where the lawyer was ethically obligated torecommend a highly favourable settlement from the client’s pointof view which would eliminate the attorney’s fee altogether. Thereis a theme in the law governing lawyers — not just in Jeff D. but inother cases such as Walters v. National Association of RadiationSurvivors,82 and Balla v. Gambro83 – that being a lawyer is anethically demanding undertaking and there may be cases in which alawyer simply has to do the right thing, no matter what the costs toherself personally. On the triangle diagram, this is an assertion ofthe importance of duties owed to the client, along Line B. Thelawyer may feel the pull of interests along Line A, but unlike theinsurance defense situation they are not genuine duties, and in anyevent the lawyer’s ethical obligation is to ensure that the client’sinterests come first.

V. CONCLUSION

The comparison of third-party litigation finance with insurancedefense representation and contingent-fee financing is meant toshow that the lawyer’s basic ethical obligations, includingexercising independent professional judgment, can withstand acertain amount of instability created by the presence of thirdparties or the lawyer’s own financial interests. Understanding thisrequires an appreciation for how the triangular structure of

82. 473 U.S. 305 (1985) (upholding a $10 statutory limit on fees for representingveterans in government benefits cases).

83. 584 N.E.2d 104 (Ill. 1991) (refusing to recognize cause of action for wrongfuldischarge where attorney disclosed confidential client information to preventshipment of defective medical devices; court observed that “all attorneys know orshould know that at certain times in their professional career, they will have toforego economic gains in order to protect the integrity of the legal profession”).


relationships creates duties that are informed by the presence ofmultiple parties, each of whom owes duties to the other. Lookingat only one side of the triangle obscures not only the complexity ofthe lawyer’s ethical role in certain cases, but the way that otherlaw, outside the domain of the rules of professional conduct, exertsa stabilizing influence on the lawyers’ duties. Third-partycommercial litigation financing has its critics, but they have theburden to explain why this form of financing is different in kindfrom the arrangements considered here, in terms of their effect onthe lawyer-client relationship. The title of this article is a perhapsclumsy attempt at alluding to an important pair of articles aboutthe insurance-defense situation,84 from which the legal professionlearned that the ethical obligations of defense lawyers cannot beunderstood without taking insurance law into account, and certainaspects of insurance law, such as the insurer’s duty of good faith,really only make sense when considered in conjunction with therole of the defense lawyer. This article proposes that a similarapproach is necessary when considering third-party commerciallitigation financing. Only by understanding the relationship amongduties owed along all three legs of the triangular relationshipbetween financers, litigants, and lawyers can we understand theimpact of litigation finance on the lawyer-client relationship. If theinsurance defense and contingent fee cases are any guide, existinglegal doctrines are more than sufficient to protect all of therelevant interests. It may be complicated, and may require a bunchof articles with titles like “what professional responsibility scholarsshould know about litigation financing”, but the impact oflitigation financing on legal ethics is merely an instance of ageneral problem, the solution to which is already known.

84. Thomas D. Morgan“, What Insurance Scholars Should Know About Profes-sional Responsibility” (1997), 4 Conn. Ins. L.J. 1; Kent D. Syverud, “WhatProfessional Responsibility Scholars Should Know About Insurance” (1997), 4Conn. Ins. L.J. 17.


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