Last year the New York Court of Appeals held that a purchase by an off-shore shell company of notes that were in default when the payment of the purchase price was contingent on recovery by the shell company violated the New York champerty statute, N.Y. Jud. L. 489, which prohibits the acquisition of notes, securities, and other choses in action “with the intent and for the purpose of bringing an action or proceeding thereon.” See Justinian Capital SPC v. WestLB AG, 65 N.E.3d 1253 (N.Y. 2016). While the case at first blush seems to be adverse to litigation funding, the opposite is actually the case. First, in enacting section 489 the New York legislature intended to abolish the common law doctrine of champerty. Id. at 1259 (Stein, J. dissenting). Thus, litigation finance transactions that do not involve the purchase or assignment of choses in action are not champertous under New York law. Second, even under the statute a purchase or assignment is only champertous if the primary purpose of the transaction was to enable the assignee to bring suit. For example, if the assignment or purchase was in connection with a bona fide business purpose, such as acquisition of a business, the transaction is not champertous. See Fairchild Hiller Corp. v. McDonnell Douglas Corp., 270 N.E.2d 691 (N.Y. 1971). Financing of litigation is a legitimate business purpose, and any litigation to enforce collateral given in connection with the financing agreement would not be champertous. Finally, the New York statute exempts transactions in which the purchase price is greater than $500,000. In Justinian Capital the court found that the exception did not apply because Justinian Capital did not make an actual payment, and any payment by it was contingent on recovery in the underlying litigation. In litigation finance transactions the lender is always making a payment, so in any commercial litigation finance transaction in which the amount financed is greater than $500,000 the exception should apply.
Since the enforceability of a litigation finance agreement may depend on which state’s law is applicable, a well-drafted litigation finance agreement should include choice of law and choice of forum provisions. However, the enforceability of such provisions may be questionable. In Maslowski v. Prospect Funding Partners, LLC, 890 N.W.2d 756 (Minn. Ct. App. 2017), the litigation finance agreement had both a New York choice of law and a New York forum selection clause. Maslowski brought suit in Minnesota claiming that the agreement was void; Minnesota still recognizes champerty as a defense to an agreement. She sought an injunction to prevent Prospect Funding from enforcing the agreement in New York. The Minnesota court of appeals affirmed the trial court’s decision to grant the injunction on the ground that the choice of law/forum clauses were invalid in that they violated a strong Minnesota public policy.
For more information on this and more generally on the application of champerty to litigation finance, Nathan M. Crystal