Hunton Insurance Recovery Blog

Third-party funding of high-stakes litigation can often make the difference between litigating the case or walking away.  The financial arrangement often makes good sense, with investors helping to facilitate the pursuit of bona fide claims that might otherwise be forgone in exchange for a piece of the recovery.  Insurance coverage disputes fit this model well, since those claims typically involve an insured who has already suffered some financial or other hardship and an insurance company with deep resources that refuses to pay the claim.  It should come as little surprise, therefore, that the Insurance Services Office (ISO), an advisory and rating organization for the property/casualty insurance industry, recently approved a new endorsement that requires disclosure of third-party litigation funding agreements. The approval comes as courts and state legislatures step up demands for transparency in funding to curtail influence that funders may have over litigation strategy.

The Endorsement

The endorsement, drafted as a modification of multiple lines of commercial liability insurance, including CGL, operates to add a new condition to the policy.  The endorsement provides, in pertinent part:

A. The following is added to the Conditions section:

Litigation Funding Mutual Disclosure

If we and an insured do not agree whether or to what extent a claim or "suit" is covered by this Policy, either party may make a written demand for mutual disclosure of any "third-party litigation funding agreement(s)" regarding that claim or "suit".

When this demand is made, each party must disclose in writing within 30 days whether they or their attorney(s) have executed any "third-party litigation funding agreement(s)". If a party or their attorney(s) have executed any "third-party

litigation funding agreement(s)", the written disclosure must include:

a. A copy of such "third-party litigation funding agreement(s)";

b. The names of each person or organization who has entered into such "third-party litigation funding agreement(s)";

c. Whether such person or organization is required to approve of or be consulted on litigation or settlement decisions, and if so, the nature of the terms and conditions relating to that approval or consultation; and A brief description of the financial interest of any person or organization who provided such funding.

Each party must provide to the other party a copy of any update of their written disclosure within 30 days of:

a. Any change in the above information in Paragraphs through d.; or

b. When the parties or their attorney(s) have executed any "third-party litigation funding agreement(s)" after the initial demand.

The endorsement also goes on to add a definition of “Third-party litigation funding agreement” that broadly includes any agreement to provide litigation funding to a party or its attorneys.

Thus, in sum, the endorsement makes it a condition of coverage that the insured disclose all funding agreements that pertain to the subject claim or lawsuit upon request by the insurer, even where the funding agreement belongs to counsel. 

The Potential Problems

1. Condition of Coverage.

Rather than add the disclosure requirement as a post-loss duty that the insurer might invoke in certain cases, the disclosure is added as a condition to coverage, meaning that a failure to satisfy that condition could jeopardize coverage under the policy without regard to a particular claim.  It likewise potentially affords the insurer a remedy of policy rescission, which carries much more severe penalty than ordinary breach.

2. Unilateral, Not Mutual.

The endorsement purports to require a mutual disclosure that can be invoked by a request from either the insurer or the policyholder.  To call the disclosure mutual is facially deceptive.  Insurers do not use litigation funding, and certainly not on any regular basis.  Thus, it is highly unlikely that an insurer is ever going to have a litigation funding agreement to disclose.  And why would it?  The insurer has deep resources, so there is no reason for an insurer to require financial backing and no reason to share a substantial portion of any recovery with a litigation funder.  Second, in terms of recovery, in almost all instances where an insurer is litigating with its insured, the insurer holds the money that the insured is fighting to recover.  The litigation funding model therefore would not work since there would not be a recovery from which the funder could recoup its investment, much less a multiplier on its deployed capital.

3. Potential Overbreadth and Conflicts.

The endorsement also is grossly overbroad.  The endorsement calls for the disclosure of “any” funding agreement that concerns the claim or suit.  Such broad wording would include both the underlying litigation and any subsequent related coverage litigation. However, although the endorsement purports to encompass the underlying litigation that has led to coverage, there would never be a need for funding in connection with that litigation since it is upon the insurer to defend consistent with its reservation of rights that is a prerequisite to any disclosure.

Additionally, the disclosure obligation extends beyond the policyholder and its insurers to include policyholder counsel. This is problematic on multiple levels.  In almost all instances, counsel are not a party to the insurance policy and, thus, never agreed to be contractually bound by the terms and conditions of coverage.  Yet a failure to abide could jeopardize coverage for its client.  This presents a conflict of interest between the policyholder and its attorneys where the attorneys are unwilling or unable to disclose their counsel-side or portfolio-level funding.  It likewise puts counsel in a Catch-22, where no matter what counsel chooses to do, it will either violate the condition to coverage or violate its own agreement to keep its funding agreement confidential.

4. Discovery Implications.

The endorsement may also have discovery implications. For example, courts in Delaware and New Jersey permit further discovery about funders only if the requesting party demonstrates good cause or shows the funder has authority over litigation decisions. In jurisdictions with similar rules, required disclosures may expedite expanded discovery as insurers can be expected to want to fully understand the financial backing of its adversary in any significant litigation.  Conversely, in jurisdictions that do not ordinarily permit funder discovery, the new funder disclosure endorsement could open the door to funder discovery since the funding agreements will become part of the evidentiary record upon a disclosure demand under the policy.

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At bottom, as litigation funding continues to evolve, policy endorsements mandating the disclosure of litigation funding agreements stand to play a critical and potentially disruptive role in coverage litigation by, among other things, potentially forcing a conflict between the policyholder and its coverage counsel where the law firm has engaged in a counsel-side funding agreement that it was not required to disclose to its client.