• New York's Highest Court Narrows Restrictions on Transfer of Claims
  • January 4, 2010 | Authors: Linda T. Coberly; Joseph A. DiBenedetto; Michael J. Friedman; Steffen Johnson; Gene C. Schaerr
  • Law Firm: Winston & Strawn LLP - Chicago Office
  • The New York Court of Appeals ruled on October 15, 2009 that transfers of legal claims do not violate New York’s champerty statute even where the transferee intends to enforce the claims in court, so long as the purpose of the transfer is not to profit from the costs of the resulting litigation.  New York’s champerty statute (Judiciary Law § 489) prohibits the purchasing of legal claims “with the intent and for the purpose of bringing an action or proceeding thereon.”  The Court’s decision provides comfort to financial institutions who buy or sell distressed debts or other obligations, reducing concerns that the buyer’s ability to enforce such debts in court could be restricted by New York champerty law.  More broadly, the decision might provide new fluidity to the distressed debt market.

    The dispute in Trust for the Certificate Holders of the Merrill Lynch Mortgage Investors v. Love Funding Corp., 2009 NY Slip Op. No. 07323 (Oct. 15, 2009), centered on a $6.4 million loan that the defendant Love Funding originated in 1999 and sold to Paine Webber, with the representation that the loan was not presently in default.  Paine Webber in turn resold the loan to Merrill Lynch Mortgage Investors, Inc. (“MLMI”), again with the same representation that it was not in default.  MLMI in turn securitized the loan, setting up a trust (the “MLMI Trust”, the plaintiff here) to collect interest payments for the benefit of the security holders.

    It later emerged that the original borrower on the loan had lied on its application, and that the loan had in fact been in default each time it was sold.  The MLMI Trust sued Paine Webber for breach of its representation that the loan was not in default.  The suit was settled, with the MLMI Trust agreeing to dismiss its claims in exchange for an assignment of all of Paine Webber’s legal claims against Love Funding, the originator and original seller of the loan.  The MLMI Trust then brought this action against Love Funding, and Love Funding asserted a defense that the MLMI Trust’s acquisition of Paine Webber’s legal claims through the settlement agreement was in violation of New York’s champerty statute, Judiciary Law § 489.

    Following a bench trial, the U.S. District Court for the Southern District of New York ruled in favor of Love Funding on its champerty defense.  The district court found that to demonstrate that the transaction was champertous, Love Funding had to show that the MLMI Trust’s primary purpose for, if not the sole motivation behind, entering into the settlement was to sue on the assigned claim.  The district court found that Love Funding had met this burden by showing that the assigned legal claims were the sole consideration the MLMI Trust received in return for dismissing its claims, and by presenting evidence that the MLMI Trust was expressly contemplating suing Love Funding while the settlement was being negotiated.

    The MLMI Trust appealed, arguing that a finding that it had accepted the assignment with the intention of suing Love Funding was insufficient as a matter of law to constitute champerty.  The Second Circuit found the existing body of New York champerty law insufficiently clear to determine whether the MLMI Trust’s argument was correct.  The Second Circuit accordingly certified the determinative legal issues to the New York Court of Appeals for resolution.

    On October 15, 2009, the Court of Appeals rejected the district court’s conclusion, holding that the MLMI Trust’s acquisition of Paine Webber’s rights, even with the intent to use them to sue Love Funding, was insufficient as a matter of law to establish a violation of Judiciary Law § 489.  The Court of Appeals cited several of its own nineteenth century rulings holding that champerty rules were limited in purpose to preventing attorneys from purchasing claims for the purpose of profiting from the costs of bringing the lawsuit, and did not bar purchases of claims “for the honest purpose of protecting some other important right of the assignee.”  The Court emphasized “the difference between one who acquires a right in order to make money from litigating it and one who acquires a right in order to enforce it” and concluded that the purpose of the champerty statute is to prohibit parties from “stirring up” claims which would otherwise not be prosecuted in order to generate costs.  It “does not apply when the purpose of an assignment is the collection of a legitimate claim.”

    Applying this rule to the facts presented, the Court observed that the MLMI Trust held “a pre-existing proprietary interest” in the loan before the assignment, and then held that if the MLMI Trust’s purpose in acquiring Paine Webber’s rights was to use them to enforce the MLMI Trust’s pre-existing rights, even if such enforcement could only be done in court, the transfer did not violate Judiciary Law § 489.  The Court also held that the MLMI Trust’s additional acquisition of Paine Webber’s rights to have Love Funding indemnify it for its prior litigation expenses did not constitute champerty.

    This ruling is significant in that it narrows the scope of New York’s champerty rules.  Before this decision, an investor’s acquisition of another’s legal rights, with the knowledge that such rights were likely to be only enforceable through litigation, would have raised red flags as potentially champertous.   The Court of Appeals has now made clear that the mere expectation that the claim to be acquired will be litigated is not enough to run afoul of the champerty statute.  To violate Judiciary Law § 489, the acquisition must also be for the purpose of profiting from the process of litigation, rather than profiting from the vindication of the underlying right.

    This ruling is not, however, a blank check sanctioning all potential claim transfers.  The Court of Appeals emphasized that its holding relied upon the MLMI Trust’s pre-existing rights to the loan, which meant that the Trust was not a complete stranger to Paine Webber’s claims against Love Funding.  A party purchasing a claim with which it has no pre-existing relationship may not be similarly protected.