 By Timothy D. Scrantom There is a mild debate among scholars of English legal tradition concerning the functional role of a small pouch that even to this day hangs on the back of the black robe English barristers wear in court. Some say it is a vestige of a mourning hood that was appended to the robe sometime in the 16th century, when barristers marched in a funeral procession of a popular English king. Others attribute an even more quaint purpose: It functioned as a money pocket to be used by solicitors to anonymously (and one could even say reverently) deliver to the barrister a discretionary cash honorarium for the barrister’s performance that day in court. According to lore, the barrister would return to the robing room to discover, to his delight or disappointment, what tribute had been placed in his pouch and how his efforts that day had been recognized and rewarded. Regardless of the true origins of the pouch, it is historical fact that originally barristers – English lawyers who until recently had exclusive rights of audience before English courts – would never stoop to charge “fees” for their noble enterprise. Even to this day, they remain largely cloistered from the world of private enterprise. Of course, the opportunity to make money hand-over-fist in innovative ways was never lost on their English solicitor counterparts, who have evolved into leaders of some of the world’s largest global businesses. But barristers, most of whom were traditionally financially secure in their own right and very often “trust babies,” were taught to eschew the characterization of their calling as “commerce” and to disdain all associations with the London City Markets just up Fleet Street. These are the roots of the American legal profession, still celebrated by American Inns of Court and wistfully named law school societies like the Order of the Coif. It is worthwhile to pose the curiosity of the barrister’s pouch and the ironies of names like “Order of the Coif” in the context of the modern American legal system to introduce a fundamental question: “Why have law markets traditionally been seen to be inaccessible by capital markets?” Historically, law markets have actually been quarantined from capital markets. This state of affairs evolved, I proposed, in an effort to insulate the business of law from the potential evils and distortions believed to infect other sectors of free market economies. Indeed, the legal profession itself has fostered the protectionism, as in its best interests. Whatever the basis and logic for the segregation of law and capital markets, the support of the barrister’s livelihood through mere honoraria is anachronistic indeed, as are a variety of other early statutory antecedents – such as champerty, maintenance and prohibitions against any form of financial speculation in court cases or otherwise – believed necessary in early times to preserve the complete independence of officers of the Crown’s courts and to promote the financial rationality and fairness of Crown subjects bringing claims before those courts. It is rarely spoken openly, but common knowledge, that the legal profession is now big business. It is equally common knowledge that law and legal services, including mechanisms to value and transfer legal claims and legal risk, play an indispensible and crucial role in capital markets. If the industry of professional legal services and capital markets are so interwoven, why should capital flow into law markets be constrained at all? After all, major corporate transactions succeed or fail based on speculations about litigation outcomes and the perceived inability to transfer litigation risk after an uninsured or uninsurable event; lawyers play central roles in the tectonics of finance and commerce; and the insurance industry has grown largely based on products that remove risks from their customers – in return for premiums and what amounts to a purchase of legal claims before the event. Yet based largely on tradition and beliefs, law markets still seem to suffer in their ability to directly access the power of capital markets, and law firms are unable to speak publicly and openly about their need for access to those markets. Law firm management committee members wring their hands over how to ethically access money to smooth cash flows and monetize receivables within the straightjacket of competing internal partner-profit competition, pressures to annually distribute profits for income tax purposes and professional ethics rules. Law firms that undertake contingent fee work can be likened to hapless investment bankers, seeking joint venture opportunities with no internal capital reserves and in the face of pressures to dump out cash while making fair (and forward-looking) allocations of firm resources among competing power centers within the firm. The somewhat perverse result of these pressures, dynamics and perceptions is that law firms are forced to grow inorganically in order to “manage” cash flow and fund expansions – all because operating capital, so the belief goes, must be generated internally, rather than externally. For different reasons, businesses find themselves in a similar situation with respect to their litigation-oriented assets and liabilities. Prospective recoveries in cases are generally believed to be un-monetizeable, except through the unique opportunity for clients to share risk with their lawyers through contingent fee arrangements. To make matters worse, under some accounting rules, a company’s prospective recoveries in litigation (often no matter how robust the prospect of winning) cannot generally be assigned much if any value prior to an actual recovery. Such rules trap sometimes massive capital values inside “claim assets” for an indefinite time. Businesses faced with litigation liabilities confront the inability to accurately value those liabilities in merger and acquisition transactions, resulting in distortions in transaction prices – and even failed deals. The perceived inability of businesses to unlock wealth embedded in litigation opportunities and liabilities, or to turn to the marketplace for help even in valuing claims, likely distorts capital transactions, requires businesses to sit on risk and leaves the corporate law department as a pure cost center in most corporations. In other words, businesses, like law firms, want and need access to capital markets for a variety of everyday business needs. To restrict that access is economically inefficient, if not damaging. The “third-party litigation finance” market can also serve important access-to-justice aims. In the United States, the public can generally turn to lawyers to finance their litigation. Whether this joint venture model has worked to provide efficient access to justice is not currently the subject of much debate in the United States (although, tellingly, a number of retail litigation financing companies have sprung up in many states), but it is in the United Kingdom. Last year the UK government recognized that state-sponsored legal aid programs, which, in the absence of contingent fees traditionally provided the means for impecunious claimants to bring claims there, are inefficient, costly and lead to their own distortions in claim prosecution and the overall administration of justice. The result was groundbreaking legislation that will allow third-party financing of legal claims and even outside investments in and stock market listings of law firms. These developments are being watched closely by major U.S. law firms as they try to imagine competing against publicly traded London “Magic Circle” firms for global business client opportunities. The irony of these bold moves in the UK, when viewed from the prospect of the barrister’s pouch, is delightful to many Americans. More importantly, it is instructive in the emerging debate over the role capital markets should play in the legal marketplace in the United States. The debate centers on a specific phenomenon: whether there can be a rational role for outside capital within law markets that does not jeopardize the core social values of professional legal independence, unfettered lawyer-client relationships and proper administration of justice. Throughout history, these goals have been enshrined in professional ethics rules, including the fee-splitting and conflicts-of-interest rules, as well as laws prohibiting champerty, maintenance and frivolous litigation. The central question is whether these goals can still be served while allowing third-party capital to meet the needs of law firms, businesses and plaintiffs. There are paradoxes embedded in this question. Scholars and proponents of tort reform recognize that the effective monopoly U.S. lawyers enjoy over investing in litigation outcomes (through contingent fees) is outmoded and inefficient. They point out that the superior bargaining power lawyers possess in the negotiation of contingent fee arrangements with their clients and the potential conflicts that emerge from such arrangements can lead to inefficiencies in the provision of legal services and even in distortions in the overall justice system. Page: 1 of 2 pages for this article 1 2 >
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