“Steve Jobs called the first computers a bicycle for the human brain. We've designed a law firm that serves as a fighter jet for the trial lawyer's mind.”

—John Pierce, Pierce Bainbridge LLP.

Legal periodicals and public relations pieces are plastered with tales of entrepreneurial legal practices, touting explosive growth fueled by innovative structures, legal technology, and, most hotly, litigation funding. The recurring theme is “disruption” of the practice of law, and the use of litigation funding to grow non-traditional law firms, share risk with clients, and increase business. As third-party financing has slowly begun to take hold, this article discusses three case studies which highlight the perils of “innovative” practice—and law firms being accountable to third-party investors.

Three Case Studies

Pierce Bainbridge. Founded in 2016, Pierce Bainbridge Beck Price & Hecht has employed an aggressive marketing and advertising strategy to establish itself as “a high stakes litigation force” and the “next generation of litigation excellence.” The firm launched with an unconventional public announcement of a portfolio litigation funding transaction to foster firm growth and a book of contingency fee cases. In the U.S., it is atypical for a law firm to publicly announce that it is connected with a litigation funder: most law firms prefer anonymous funder relationships, so as to convey stability and prudence rather than a risk-taking or venture-based approach. Pierce Bainbridge, however, embraced its funding relationships as a marketing tool, calling itself the “fastest-growing law firm in the history of the world in terms of law firms that have started from absolute scratch,” and gobbling up expensive lawyers who would add to the firm's roster.

A suit recently filed by a former partner of Pierce Bainbridge details explosive allegations concerning the culture, financial structure, and growth of the firm. Donald Lewis v. Pierce Bainbridge Beck Price & Hecht, No Index Number Assigned (Sup. Ct. N.Y. Cty 2018). According to the ex-partner, Pierce Bainbridge engaged in serious financial improprieties, enabled by the pitfalls of using litigation funding to build a contingency case portfolio. The suit alleges that Pierce Bainbridge's former partner was discharged as pretext for internally raising concerns about the firm's “cover-up [of] Pierce's financial fraud.” According to the complaint, the firm abused litigation funding to fulfill Pierce's $1.5 million in tax liens, mishandled client and funder funds, and diverted hundreds of thousands of dollars for improper purposes. Notably, Pierce Bainbridge had allegedly inflated case valuations among the firm and to litigation funders (including one “Billion Dollar Case,” that preceding counsel had thought should be settled for $400,000).

CKR Law

Also in the news recently has been CKR Law, a prominent “virtual” law firm. The virtual law firm model, pioneered by other firms such as Fischer Broyles and Rimon Law, leverages technology to eliminate much of the overhead associated with traditional law firms. These firms offer the partners the ability to leverage centralized marketing, billing, and operations software, and a higher percentage of their generated fees, while decentralizing the law firm from a “brick and mortar” office to a virtual affiliation of attorneys and support staff responsible for maintaining their own work environment. CKR had grown to 200 attorneys across 50 offices in under four years.

According to publicly-available sources, CKR Law had fallen into financial difficulties, including the failure to pay partners regular guaranteed draw, and a lawsuit for hundreds of thousands in back rent. CKR Law dismissed the issues as a mere “cash flow crunch” and suggested that it would be letting go of underperforming partners as a remedy.

Liddle & Robinson

Finally, Liddle & Robinson, a decades-old employment law boutique, and its principal Jeffrey Liddle, recently filed for bankruptcy. The firm had been known for representing individuals, most notably finance professionals, in employment litigation—often on a contingency fee basis.

According to publicly available sources, the firm had borrowed $5.6 million in 2016 from law firm lender Counsel Financial, which had accrued to $7.8 million by 2019. As with Pierce Bainbridge, it is alleged that Liddle improperly used loan proceeds to pay $1.1 million in debts to the IRS. The firm had been plagued with partner and associate turnover, and had allegedly concentrated control with its managing partner, without meaningful input from other partners.

Pitfalls of Explosive Growth and Law Firm Financings

These cases highlight the complications that can arise when a firm focuses on expansive growth and becomes accountable to third-party investors. All three situations reiterate the time-old struggle between long-term firm goals, i.e., to maintain or grow headcount, build a brand, and develop long-lasting goodwill within the firm, balanced against the need for the firm to perform and manage profit-and-loss in the short-term.

Rule 5.4 of the Model Rules of Professional Conduct prohibits non-attorneys from holding equity ownership in a law firm. The policy behind Rule 5.4 is that attorneys should not put themselves in a position where their professional judgment could be clouded by a non-attorney maintaining a financial stake in one's legal practice. For that reason, law firms are owned by the partners who practice at the firm, and are most typically structured in a manner that compensates partners on an annual basis, and only for so long as a partner remains in the partnership.

To address the unavailability of “equity” financing to law firms, lawyers sometimes rely on high-yield loans and/or “portfolio funding.” Providing portfolio funding directly to law firms is a relatively new business, even for a young litigation funding industry. In traditional litigation funding, capital providers provide capital directly to a plaintiff, often for dedicated use in pursuing the litigation (though sometimes as a pure advance), secured by the recoveries on a single case. This structure addresses a variety of issues, including the ethical prohibition on splitting fees between attorneys and non-attorneys (the finance provider) under Rule 5.4. In contrast, with portfolio funding, funders provide a sum of capital to a law firm, which is used to support the operations of the firm, and then repaid from either a subset of, or all of, a firm's contingency fee portfolio. Funders generally believe that financing a firm's portfolio of claims gives them better, more-diversified risk, rather than financing a “one-off” claim for an individual plaintiff.

These innovative funding arrangements are not without historic controversy. The contours of what is permissible in portfolio funding arrangements are still being tested under Rule 5.4. New York courts overwhelmingly condone the legality of these arrangements. See, e.g., Hamilton Capital VII v. Khorrami, 22 N.Y.S.3d 137 (Sup. Ct. N.Y. Cty. 2015). Lawsuit Funding v. Lessoff, 2013 WL 6409971 (Sup. Ct. N.Y. Cty 2013). A recent New York City Bar Association Formal Opinion, however, in finding that “Rule 5.4 is equally applicable when the lawyer's payment to the funder is based on the recovery of legal fees in multiple matter,” threatens to put ethical limits on otherwise expansive interpretation—leaving legal scholars and practitioners unclear as to the precise line between permissible and impermissible fee-splitting. Formal Opinion 2018-5: Litigation Funder's Contingent Interest in Legal Fees.

But Model Rule 5.4 only scratches the surface: the above-referenced case studies suggest new, less-discussed areas of concern arising out of law firm loans and portfolio financing. While portfolio funding can be a useful tool to support meritorious claims and law firm capital needs, under the wrong conditions, it can also create a toxic debt instrument for law firms—with a high cost of capital, collateralized by inherently speculative contingency fees.

This creates attendant issues with respect to attorney-client relationships. When a law firm seeks to off-load risk onto a third-party funder, does it create a potential conflict of interest between the attorney and client, who might have differing financial goals in pursuing and repaying legal funding? New York City Formal Op. 2011-2 discusses the possibility of a conflict when a litigator assists a plaintiff in procuring litigation funding. Do attorneys have an obligation to disclose to a client the firm's financial situation, or whether a contingency case has been de-risked through funding? How should lawyers ethically balance their focus among their various clients, when law firm loans are collateralized by cases from multiple, unrelated clients?

Attorney's financial dealings—including personal financial situations, and interactions with funders—also implicate ethical concerns. Attorneys no doubt owe a duty of honesty and candor to their clients and the courts—but what duties do litigators seeking access to litigation funding owe concerning law firm health or the portfolio of cases for which funding is sought? Attorneys have a duty to self-police: but what are the obligations of passive, non-managing partners who suspect ethical impropriety? Finally, how can attorneys best navigate legal ethical boundaries when, as is often necessary in closely-held private businesses, they are required to balance the interests of their law firm—including client, business, and financial considerations—with personal financial considerations and challenges?

For funders, funding law firms carries its own risk, which typical litigation underwriting may be ill-equipped to evaluate. Funders tend to focus on the merits of the underwritten litigation, with varying degrees of diligence on infrastructure (e.g., how firms maintain books and records), firm and partner financial health, turnover, the firm business model, and ongoing case evaluation. These are all critical factors to be considered in evaluating the soundness of a portfolio investment, especially where an emerging law firm may have limited experience in operating a business. Without proper servicing, controls, and reporting, third-party funders may wind up holding a portfolio of illiquid junk obligations, rather than a performing debt.

“Next generation” law firms promise to disrupt the traditional law firm model, in part by taking on capital that allows them to expand and build a portfolio of cases with non-traditional or thinly-capitalized plaintiffs. These funding arrangements, however, can create ethical and operational challenges—both for the integrity of the investment and for the attorneys who benefit from them. Lawyers and funders need to confront these challenges head-on and address them, or there will surely be more case studies to follow.

David Slarskey and Evan Fried are litigators at Slarskey LLC, a commercial litigation boutique which regularly represents parties in legal professional misconduct cases, and disputes concerning litigation funding transactions and operations. Mr. Slarskey served on the New York State Bar Association Task Force on the Future of the Legal Profession. Mr. Fried was previously a partner at a third-party litigation funder that focused on third-party funding to clients of AmLaw-200 law firms.