Whistleblowers & Litigation Finance: a Tangled Web

Originally Published September 9, 2014

‍We previously wrote about the complex relationship between companies that finance plaintiffs and attorney-client privilege. We concluded that in most cases, plaintiff financing companies only require information not covered by attorney-client privilege anyway-such as information the defense already has or public records like pleadings and police reports. But what about cases that depend on total confidentiality? In this guest post, attorney Mathew Andrews discusses the role of litigation finance in one of the most secretive (and lucrative) types of lawsuits-whistleblower cases-and suggests how attorney client-privilege, even in these types of cases, might be preserved. 

Over the past two decades, so-called "whistleblower" suits have become a multi-billion dollar source of settlements and judgments. Until recently, however, such suits have gone largely unnoticed by litigation finance. This trend is beginning to change. As profiled in the Yale Law Journal, both whistleblowers and their counsel are increasingly seeking funding to mitigate the rising costs of litigating qui tam claims. 

These suits provide attractive investment options for litigation financiers. Whistleblower suits are ordinarily filed against large, multinational corporations whose insolvency is unlikely. Whistleblower claims produce legal settlements not correlated with market movements. And given the outsized settlements involved with such cases-recently as much as three billion dollars in the GlaxoSmithKline litigation-the returns for investors can be enormous.

Despite the potential gains to both whistleblowers and financiers of litigation funding, the process of writing a litigation finance contract is more complicated than meets the eye. In order to properly vet potential suits, financiers require as much information about a claim as possible. Yet courts are split on whether a whistleblower's disclosure of confidential information to financiers waives attorney-client privilege and work product protection. Without such protection, defendants can access the transferred materials during discovery and uncover damaging information or strategy.

"The process of writing a litigation finance contract is more complicated than meets the eye."

Should this occur, whistleblowers are unlikely to share privileged information with financiers, and financiers will likely lack sufficient information to conduct their due diligence. The Journal piece, The Growth of Litigation Finance in DOJ Whistleblower Suits, demonstrates that the current means of dealing with this dilemma-the so-called "common interest" agreement-is inadequate to protect privilege. Nonetheless, financiers can still prevent waiver by adopting two innovations into their funding contracts.  

A Brief History of Whistleblowing

Before moving to the opportunity and obstacles involved with funding whistleblower suits, it is useful to understand the federal law that authorizes such claims. The False Claims Act (FCA), which establishes whistleblower enforcement, was originally enacted during the Civil War to deter fraud by defense contractors. Since then, the FCA has become what federal judges refer to as the Government's "primary litigation tool for recovering losses sustained as the result of fraud." Through a unique legal mechanism called qui tam litigation, the FCA authorizes individuals to bring civil suits on behalf of the federal government. In return, these "relators" receive a share of the damages. That recovery can be substantial. Since the FCA was amended in 1986, whistleblowers have brought nearly ten thousand complaints under the act, recovering nearly $26 billion in settlements and judgments. In 2012, a whistleblower helped the U.S. Department of Justice (DOJ) obtain the largest health care fraud settlement in U.S. history.

"Since 1986, whistleblowers have recovered nearly $26 billion."

Financiers are taking notice. In October 2011, Australia's largest finance company, IMF Ltd., launched its New York subsidiary-Bentham Capital Ltd. Among the suits that Bentham has announced it will pursue: qui tam actions. The field of qui tam funding is not for hedge funds alone. A simple Google search reveals nearly a dozen third-party funders that specifically target qui tam suits. As these developments make clear, the market for litigation financing in qui tam suits is rapidly accelerating. Despite this trend, financiers of qui tam suits face unique challenges not present in other types of claims. Ordinarily, funders do not seek confidential information during their due diligence for risk of waiving privilege. Instead, financiers primarily use publicly available information, such as pleadings, motions, and trial records. No such public information exists for qui tam claims. Whistleblower suits are filed under seal with the Department of Justice and remain confidential. In fact, if there were publicly available information about the frauds involved in any particular suit, the whistleblower would be rendered ineligible to bring a suit under the FCA's public disclosure bar. Thus, financiers in qui tam actions are left to gauge the strengths and weaknesses of any claim by relying on privileged documentation provided by the whistleblower and her lawyer.

Common Interests

The rub is that transferring privileged materials risks waiving protection during discovery. While federal courts approach the issue differently, numerous federal judges have held that litigants waive attorney-client privilege and work product protection if they transfer protected documentation to a third party. The exception to this rule is if the litigant and the third party share a "common interest" in the litigation. Financiers have responded by seeking to contract out of the privilege problem. In particular, financiers have adopted a tool from multi-defendant litigation: common interest agreements. Pursuant to such an agreement, the litigant and financier would sign a contract indicating that they intend to share a common interest in the litigation. The agreement would then cite case law and specifically outline the common interest, types of protected communications, and the parties involved.

"Transferring privileged materials risks waiving protection during discovery."

The present strategy of common interest agreements is an inadequate method of preventing waiver. At present, federal courts are split on whether such formalistic agreements create any substantive common interest between financiers and litigants. Financiers in the future need additional tools to prevent waiver of privileged information, both in whistleblower suits and any other type of claim. Still, two common sense changes to financiers' funding contracts can cement the common interest between financier and recipient and prevent waiver.

Due Diligence vs. Arm's-Length

First, financiers should write two contracts instead of one. At present, federal courts have refused to find common interest between financiers and potential recipients because the two parties negotiate at "arms-length." Thus, even if the recipient and funder share a common legal interest after signing the funding arrangement, the parties lack a common interest during the initial arm's-length negotiations when the transfer of privileged materials occurs.

"...there is a strong inference of common interest during the due diligence phase that is not necessarily present in the arm's length negotiations phase..."

This "arms-length" view suffers from an analytical problem. It assumes that the due diligence phase of the transaction-where the funder requests information to vet the claim for merit-is the same as the arm's-length negotiation phase of the transaction-where the parties actively bargain over terms. In fact, these two phases are distinct and should be treated as such. Litigation finance contracts should therefore be phase-specific: due diligence versus negotiations. Additionally, the due diligence contracts should contain something along the following language:

The parties understand that any transfer of privileged information is solely for the purposes of determining the merits of the putative recipient's legal claim. Such information will not be used for the purposes of determining material terms of any later funding arrangement. If the parties choose to later enter into negotiations over the terms of a funding arrangement, any such privileged information will be returned to the original sender.

A clear delineation-between the due diligence phase and the arm's length negotiations period-can greatly enhance the commonality of interest between funder and potential recipient. There is a strong position that financiers and potential recipients share a common interest during the due diligence phase. During this phase, both entities are united in a common effort to investigate and litigate against the defendants. Both entities benefit from identifying the strengths and weaknesses of the potential recipient's claim. And both entities stand to profit tremendously from the successful prosecution of the defendant. As such, there is a strong inference of common interest during the due diligence phase that is not necessarily present in the arm's length negotiations phase. By clearly identifying that privileged materials are being transferred as part of the due diligence phase, financiers and recipients can prevent the waiver problems that have plagued litigation finance in the past.

Partial Assignments

Second, financiers should supplement their common interest agreements with what are known as "partial assignments." Unlike a contract, which creates a legal right, an assignment is an agreement to transfer a right. Accordingly, a partial assignment is a partial transfer of a right. In the context of litigation finance, if a potential recipient seeks funding, it would transfer a portion of its damages claim to a financier. Likewise, if the litigant's counsel seeks funding, it would transfer a portion of its contingency fee to the financier. Financiers can take advantage of the law of partial assignments through revocable or irrevocable partial assignments. Unlike contracts, which ordinarily require consideration to be enforceable, assignments do not require a quid pro quo in order to be valid. Should the assignment be gratuitous, the assignor can freely revoke the assignment up until the point that the assignee provides some form of "value" in return.

"Financiers need only borrow a longstanding tool of the federal government."

This framework provides an opportunity to litigants. If a potential recipient wants to ensure that the financier has an interest in the claim prior to exchanging privileged information, he or she could make a gratuitous partial assignment to the financier. Should the financier decline to fund the case, the potential recipient would revoke the partial assignment. Should the financier fund the suit, the potential recipient could revoke the first assignment and enter into a second irrevocable assignment based on an exchange of "value." The use of gratuitous partial assignments to create common interest is not merely theoretical. Whistleblowers and the federal government employ the same method to protect their own exchange of privileged materials. Thus financiers need only borrow a longstanding tool of the federal government to protect their own communications with litigants/recipients.

Minimal Assignments

Alternatively, if financiers are concerned about the protection offered by a gratuitous partial assignment, potential recipients could instead make an irrevocable assignment giving the funder a marginal percentage of the his or her claim. In return, the funder would provide some form of value to make the assignment irrevocable, such as the results of the funders' due diligence. At that point, the parties would share a common interest in the litigation ––albeit a minimal one. The "minimal assignment" approach does run the risk of privileging form over substance. Nonetheless, the Supreme Court has recognized that the strength of an assignee's legal interest does not depend on how much it stands to recover. For example, in Sprint Communications Co. v. APCC Services, Inc., the Court held that assignees for collection purposes satisfy Article III standing requirements, even though the assignees would receive none of the proceeds of the suit. As the Court reasoned, the assignee had "a contractual obligation to litigate 'in the [assignor's] interest'" and therefore would redress the assignor's injury.

"The courts have held that partial assignments, no matter how small, are sufficient to create common interest."

Although Sprint is a decision in a related field of law, its holding is highly relevant to the privilege dilemma. If a partial assignee can litigate on behalf of another-because their interests are common-it follows that a partial assignee may also exchange privileged information with the assignor. This analysis of the Supreme Court's decision in Sprint is not merely conjectural. The courts in other contexts have held that partial assignments, no matter how small, are sufficient to create common interest. A partial assignment therefore fills the missing piece in common interest agreements. Presently, ALF entities are only using the first tool in Sprint-contracting to align the assignee and assignor's interests. But without the second tool, a partial assignment, the funder and recipient lack an independent legal interest to be jointly shared in the first place.

The growth of litigation finance in qui tam suits offers tremendous opportunities for whistleblowers, financiers, and society at large. Given the enormous costs and significant length of qui tam cases, whistleblowers and their attorneys are increasingly in need of financing. Financiers can fill this gap and ensure that legitimate fraud claims are not ignored for lack of resources. Litigation finance therefore has the potential to dramatically decrease the amount of fraud committed on the federal government. The challenge is for whistleblowers and financiers to make common sense changes to their funding contracts in order to turn this aspiration into a reality.