Buyer Beware

By James Wootton
July 2001

Some of the outside lawyers for the state tobacco lawsuits are swapping their future claims to fees in exchange for cash now. An investment bank has reportedly bought $1 billion worth of future tobacco settlement legal fees for $308.1 million. The bank plans to sell bonds to investors who will get to collect the stream of legal fees.

The result of this transaction is the creation of a new sort of financial instrument — litigation bonds — which look on the surface to be a great deal for both sides. Lawyers get cash now to invest in more lawsuits and political favors, and the investors get a guaranteed stream of income for less than a third of its future value. High fives all around?

Well, the trial lawyers ought to be happy. They can use the up-front cash to finance new class action lawsuits, or harass industries into settling for enormous sums. The money the plaintiffs' bar rakes in will easily top the discount rate they agreed to in this deal.

However, before stamping a "triple-A" rating on these litigation bonds it would behoove the investors to take a hard look at the threats to the income stream that is supposed to support their value. The reality is that these lawyers could experience an onslaught of challenges to the exorbitant fees that many expect to collect for their work on the tobacco settlement.

Whatever the legal theory or legislative vehicle used to recoup those fees for the states to which they belong, all of the challenges will focus in some way on the obscenely excessive size of the fees. So far, the state bar associations have ignored their own rules against lawyers charging excessive fees, but it's a bad bet that Congress, the courts, or the new Administration will all give tobacco suit lawyers a free pass.

President George W. Bush targeted unethically excessive lawyers' fees in his campaign. Bush embraced a simple, but ingenious reform. Under current federal law, an excessively compensated fiduciary of a charity must return the over-payment or pay the U.S. Treasury. The Bush proposal would extend this restitution rule to tobacco lawyers and lawyers in other mass or class actions who owe a analogous fiduciary duty to the clients they represent.

President Bush has just fired a shot across the bow at the tobacco lawyers' juggernaut. Last week, in his first budget as President, he officially included his tobacco fee restitution proposal. Specifically referring to his own campaign promise, Bush's budget assumes "additional public health resources for the States" from the recoupment of excessive legal fees from tobacco awards. The Bush proposal is elegant and powerful. Where these legal fees are both obscenely excessive and unethical, it would force the return of the excess to the states.

We can expect the trial lawyers to fight the Bush restitution proposal in every venue. But even if they block or delay this proposal, they are not out of the woods. The ethical rules and other laws they have ignored are too much a part of our legal system and culture. Here are some other possibilities to consider:

• Courts could nullify the contracts the lawyers had with the states on various grounds and order the lawyers paid on an hourly rate with some enhancement for risk and uniqueness of the work. This would undoubtedly reduce the hourly rates tobacco settlement lawyers are receiving, which range up to $40,000 and even $100,000 an hour.
• Courts could rule that the agreements with the states violate antitrust laws because competitors were excluded, or for other reasons, and either block the fees or order damages — even treble damages.
• Courts could find that the conduct of the attorneys violated their fiduciary duties in a host of ways — from failure to disclose the true risk of the cases, to negotiating a settlement that put lawyers in a stronger position than the states regarding payment of fees.
• The Bush Administration could act to recoup excessive fees for the states, based on Health Care Financing Administration regulations requiring competition when hiring lawyers to recoup Medicaid costs from third parties.
• Courts could order full restitution, punitive damages and even criminal penalties if bribery, bid rigging or payoffs were involved in the lawyers' contracts with the states. In fact, two federal grand juries are hearing evidence in Texas where the current state attorney general is determined to keep the state from being fleeced by the outside counsel hired by his predecessor.
• Findings of criminality in the Texas case could begin a ripple that could taint tobacco attorney fee contracts in other states. Findings of so-called predicate acts of criminal conduct could subject some participants to penalties under RICO.

Bond attorneys instinctively zero in on facts that may jeopardize the investors they are hired to protect. While trial lawyers may dismiss the possibilities discussed here, bond counsel should not. The stakes are too high for them and their clients.

Will any of these scenarios happen? Surely, legal counsel for these new institutional partners of the big time class action bar have considered at least some of these possibilities and their potential consequences. To be sure, there are complicating issues of standing, statutes of limitation, and political will. But have the stockholders been put on notice of all the risks involved in gambling on the hypothecation of such a stream of income — a stream that could be vulnerable to such a myriad of attacks? Wouldn't it be ironic if the securities litigation bar made a killing suing the investment banks that helped make billionaires out of their tobacco lawyer brethren?

The issue in such suits would be simple. Were the challenges to these fees foreseeable - even inevitable? And therefore, can anyone be a bona fide purchaser and thereby shielded from liability when the true owner — in this case the states — shows up to claim the goods? The rules of caveat emptor and bona fide purchaser could produce draconian outcomes for the unwary investor. To anyone considering these investments, "buyer beware" is good advice.

James Wooton is president of the U.S. Chamber Institute for Legal Reform.