An Issue over the Application of New York’s Champerty Law

08/20/12

On Thursday, Manhattan Supreme Court Justice Shirley Kornreich stayed the dismissal of a case upon champerty issues and ordered the parties to conduct discovery for deciding the issue. In the instant case, now-defunct German bank WestLB AG, sought the dismissal of the claims of Justinian Capital and Reed Smith upon the grounds that the claims violated New York's champerty law. The champerty law in New York bars individuals or companies from purchasing an interest in a claim or debt for the sole purpose of bringing litigation.

Conventionally, the state courts of New York have been reluctant to find champerty violations since entities that by debt, often do so knowing that litigation is inevitable. In general, courts interpret the champerty laws to allow a party obtain a debt instrument for the purpose of enforcing it, even though litigation may be the only means of enforcement. However, in Thursday's ruling, the judge held that the state law does block a company or law firm from purchasing a claim with the sole purpose of collecting fees on the litigation.

Justice Kornreich wrote “While allegations of champerty have been rejected in similar cases, this case appears to be unique … In fact, it appears that the Court may be presented with a question of first impression: whether a company (Justinian) may partner with a law firm (Reed Smith) to purchase debt instruments where the primary motivation for doing so is to make money from the litigation. This Court believes that the answer, under New York's current statutory scheme, is no.”

In 2010, Justinian Capital and Reed Smith purchased a number of mortgage-backed securities from two investment vehicles in the Cayman Islands for $ 1 million. The purchase was made at a time following the recession when the notes were virtually worthless. Then Justinian filed a lawsuit against the German bank managing the notes for fraud and financial malfeasance.

However, the sale agreement between Justinian and the original owners of the notes included conditions that Justinian would pay between 80 and 85 percent of any settlement or litigation damages to the previous owners, and will itself keep the remaining 15 to 20 percent.

The judge said the conditions in the sale agreement raise the suspicion that the deal was simply a method of, “subcontracting out this litigation to Justinian.” However, she held, “The relevant inquiry is whether Justinian bought the instruments as a bona-fide investment (which would properly include the ability to enforce rights through litigation) or if the purchase was merely pretext for conducting litigation by proxy in exchange for a fee … The latter is classic champerty.”