Do Your Clients’ Litigation Funding Contracts Violate Kentucky’s Champerty Prohibition?

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Kentucky courts have long recognized the common law doctrine of champerty. …. As Kentucky’s highest court has noted:

At common law champerty is defined to be a bargain by the terms of which a person having otherwise no interest in the subject matter of an action undertakes to carry on the suit at his own expense or to aid in so doing in consideration of receiving, in the event of success, some part of the land, property or money recovered or deriving some benefit therefrom. (Boling V. Prospect Funding Holdings, LLLC, 2017 BL 104180, W.D. Ky., Civil Action No. 1:14-CV-00081-GNS-HBB, 3/30/17.)

ABA/BNA Lawyers’ Manual on Professional Conduct’s April 5, 2017 Current Reports in writing about Boling v. Prospect Funding Holdings led with the headline:

“Lawsuit Funding Illegal in KY, Fed Judge Says in Setback to Litigation Finance Industry.”

Nationally, public policy on third-party funding of law suits evolved from the strict application of champerty to a cautious approval of lawyers assisting clients in getting third-party funding if ethics requirements are met. The national trend is to reduce, not increase champtery, especially in civil litigation matters. Some states specifically revoked champerty laws and others take a relaxed view of litigation funding, if seen in the best interest of the client. Boling reverses this trend for Kentucky lawyers. Boling was burned when a gas can exploded. He was in a coma for six months, had full thickness burns over 40% of his body, and spent six months in the hospital. Boling and his wife sued the gas can manufacturer.

During the litigation the Bolings borrowed money from two lenders secured by Boling’s prospective recovery from the gas can manufacturer. Five different loans were made for a total of $30,000. The terms of the original loan provided that the funds were for the necessities of life or medical care. The agreements further recognized that the funds were needed so Boling would have time to seek justice through the courts or negotiations. The lender specifically provided in the loan contract that it “wishes to make an investment and purchase the Proceeds in the Plaintiff’s Action ….” The loans were to accrue interest at the rate of 4.99% a month.

On June 19, 2014 Boling filed suit for a declaratory judgment that the loan agreements were unenforceable under Kentucky law. The Court calculated that as of August 22, 2014 the amount owed the lender was $340,405.

Boling provides a thorough analysis of the status of champerty in Kentucky including public policy and ethics considerations. The following extracts from the opinion provide an overview of the opinion:

• The borrowed money was explicitly intended to sustain Boling financially while he pursued his suit against the gas can manufacturer. Thus, these loans unquestionably aided Boling’s prosecution of his case.
• [N]either party has identified any specific pronouncement by Kentucky’s highest court addressing whether agreements granting security interests in prospective tort claims would be enforceable under Kentucky law.
• When evaluating an undecided question of Kentucky law, a federal court sitting in diversity must make “the best prediction, even in the absence of direct state precedent, of what the Kentucky Supreme Court would do if it were confronted with [the] question.”
• Kentucky still recognizes the doctrine of champerty, and the reasoned decision in Stice explains why the Kentucky Supreme Court would likely reach the same conclusion. (see Incline Energy, LLC v. Stice, No. 3:09-CV-58-H, 2009 WL 1975038, W.D. Ky., July 6, 2009.)
• These types of funding arrangements can permit third parties to influence the settlement decision-making process by removing or diluting control of the tort victim. Litigation funding also potentially discourages settlement because an injured party may be disinclined to accept a reasonable settlement offer where a large portion of the proceeds would go to the firm providing the loan. Under those circumstances, a plaintiff could feel compelled to try the case and ultimately run the risk of receiving no recovery for his or her injuries.
• In light of the undecided question of Kentucky law at issue, the Court concludes that the Kentucky Supreme Court would hold that the Agreements violate Kentucky public policy and the statute proscribing champerty for the reasons articulated in Stice. Because the Agreements are therefore void, the Court will grant summary judgment in favor of Boling on this basis.
• Here, there is no question that Prospect charges interest on the funds advanced to Boling. The face of each Agreement provides for an interest rate of 4.99% per month, which is compounded every month to yield an annual effective interest rate of nearly 80%. Because the interest rate provided for in the Agreements violates KRS 360.010(1) (Legal interest rate), the Court will also grant summary judgment for Boling on this basis.

Boling provides a comprehensive review of champerty in Kentucky supported by extensive case and law citations. We urge all Kentucky lawyers to read it. We also recommend you review your client files for any indication of litigation funding arrangements that are unenforceable in Kentucky. This information should be an affirmative defense when a lender attempts to enforce such a contract.