Participation of lawyers in litigation funders

Market overview

With increasing digitalisation, Germany’s legal services landscape is undergoing major changes and, since the recent “dieselgate scandal” in particular, the field of collective redress actions has been in a state of flux. In recent years, an increasing number of legal tech service providers have emerged; their business model is to collectively pursue claims in mass lawsuits using various class action models (which have now been recognised by the highest courts). Litigation funding is often included in the package offered. Litigation funders cover the legal and court fees for claimants, thus bearing the cost risk associated with the litigation. In return, in the event of success, the claimant pays the litigation funder a share of the proceeds obtained from the opponent. This contingency fee usually amounts to 20-30 % of the judgment awarded.

Litigation funding often involves collaboration between lawyers and litigation funders. However, we also see lawyers occasionally acting on behalf of litigation funding companies that finance the mandates the lawyers are acting on. The extent to which such cooperation is permissible will be discussed in this article.

General prohibition for lawyers to earn contingency fees

Lawyers in Germany are generally prohibited from agreeing a contingency fee with their clients, unlike in the US, where lawyers often act on a success basis; they are not permitted to base their fee on the outcome of the case or receive a share of the amount awarded.

In 2006, the German Federal Constitutional Court (Bundesverfassungsgericht) ruled that this general prohibition of contingency fees is incompatible with the freedom of profession and thus unconstitutional. In 2008, the legislator amended the prohibition clause of section 49 (2) of the German Lawyers Act (Bundesrechtsanwaltsordnung) and, for the first time, introduced exceptions to the prohibition in sections 4a and 4b of the German Act on Lawyers’ Fees (Rechtsanwaltsvergütungsgesetz). 

To strengthen consumer protection and put lawyers on an equal footing with legal tech companies, the legislator provided for further exceptions with the German Legal Tech Act (German Act to Promote Consumer-Oriented Offers in the Legal Services Market of 21 August 2021 (Gesetz zur Förderung verbrauchergerechter Angebote im Rechtsdienstleistungsmarkt, Federal Law Gazette I p. 3415), permitting the agreement of contingency fees in a limited number of cases. Beyond these strictly defined exceptions, the ban on contingency fees has remained in place in order to protect the independence of lawyers (section 43a (1) of the German Lawyers Act), in the interest of a well-functioning administration of justice and to protect clients from being exploited.

Circumventing the prohibition through participation in litigation funders

If a lawyer works with a litigation funder that finances a case the lawyer is acting on, the lawyer will, in the event of success, indirectly receive a share of the amounts awarded. The lawyer would receive this amount in addition to the fee agreed with their client.

Court rulings regard these additional payments from the litigation funder’s success share as a success-based fee, the receipt of which is prohibited under section 49b (2) of the German Lawyers Act. This does not apply if the prerequisites for exceptionally permitting the agreement of a contingency fee under section 4a of the German Act on Lawyers’ Fees are met. The protection of a lawyer's independence enforced by the prohibition is jeopardised if lawyers explicitly agree on a contingency fee with their clients. If lawyers participate in the proceedings with a company that finances the litigation of their clients, their independence is equally at risk (Higher Regional Court of Munich, judgment of 10 May 2012 - 23 U 4635).

Legal consequences of a violation or its circumvention

According to earlier court rulings, the involvement of a non-lawyer (i.e. a litigation funder) as an unlawful circumvention of the prohibition of contingency fee agreements rendered the litigation funding agreement between the client and the litigation funder null and void. The reason given for this was that the lawyer’s status as an independent judicial administration body was deemed incompatible with the agreement of contingency fees and the agreement of a success share in a litigation funder in which the litigating lawyer participates. Litigation funding agreed upon this way constituted and evasion of the prohibition and, thus, voided the transaction (Court of Appeal of Berlin, judgment of 5 November 2002 - 13 U 31/02 and Higher Regional Court of Munich, judgment of 10 May 2012 - 23 U 4635/11). 

In 2014, however, the Federal Court of Justice ruled that a fee agreement between lawyer and client remains effective even if the prerequisites for the conclusion of a contingency fee agreement are not met and that the legal consequences are governed by section 4b of the German Act on Lawyers’ Fees, according to which lawyers may claim their fee only up to the amount of the statutory fee. 

The lower courts also considered this judgment of the Federal Court of Justice in view of the legal consequences if a lawyer participates in a litigation funder. In 2015, in a case in which shareholders of a law firm were silent partners of a litigation funder, the Higher Regional Court of Munich, also referring to the Federal Court of Justice’s rulings, held that a violation of section 49b (2) of the German Lawyers Act did not render the litigation funding agreement null and void. However, clients were entitled to demand from their lawyers the amount that the lawyers had collected as a contingency fee through their participation in the litigation funder (Higher Regional Court of Munich, judgment of 31 March 2015 – 15 U 2227/14). 

Given the wording of section 4b of the German Act on Lawyers’ Fees, it may also be assumed in this context that, the lawyer is entitled to the statutory fee only. If, for example, the lawyer has agreed with his client on an hourly fee exceeding the statutory fee, the lawyer ought to have to give the client his contingency fee obtained through his participation in the litigation funder and the difference between the fee actually invoiced and the statutory fee.

Participation in litigation funders through partners of a foreign LLP

So far, courts have not decided whether the prohibition of contingency fee agreements under German law also applies if lawyers practising abroad have a share in the success while, at the same time, being partners of a law firm which pursues the claims in Germany. 

Since the major reform of the German Lawyers Act in 2022, professional duties also apply to law firms where several lawyers work for professional practice companies (Berufsausübungsgesellschaften). In principle, professional practice companies now also require admission by a German bar association and, upon admission, become members of the admitting German bar association. This reflects the reality of the legal services market, where legal services have been increasingly offered by professional practice companies and not by individual lawyers.

The professional duties also apply to foreign companies such as the Anglo-American Limited Liability Partnership (LLP) which provides legal services in Germany through branch offices. This is only permitted if the branch office has lawyers, and the legal services on German law are provided by lawyers, who are admitted to practise law in Germany.

If a partner of a foreign LLP’s German branch office who is admitted to practise abroad works with a litigation funder that finances the litigation conducted by the German branch office, a question arises as to what extent the German law prohibition of contingency fee agreements is violated. 

Since the commitment to German professional law is established by membership in a German bar association, the bar membership is inseparably linked to the resulting submission to practise German professional law. Foreign partners of a German branch office are also obliged to comply with German professional law therefore a violation of the prohibition of contingency fee agreements is likely to arise in this case as well. As a result, clients could claim back the success fee a partner admitted abroad receives through his participation in the litigation funder as well as the hourly fee if the fee exceeds the statutory fee from the branch office as the contracting party.

Conclusion

A structure whereby a lawyer works with a litigation funder and thus ultimately participates in the litigation which is indirectly financed by the lawyer through payments out of the litigation funder’s success share, constitutes an unlawful circumvention of the prohibition on contingency fees. This also extends to lawyers admitted abroad who are also partners of a foreign LLP’s German branch office. In both cases, the lawyer or law firm circumventing professional law must give back any hidden contingency fees paid and, if applicable, fees exceeding the statutory fee to the client.