Private equity firms and litigation funders have flocked to Arizona to take advantage of its looser rules on law firm ownership and launch national operations.
The elimination of a rule that forbids non-lawyers from owning law firms in the state has invited a wave of outside capital to have a stake in law firms. Of the 76 applications that have been approved for so-called alternative business structures (ABS) since 2020, at least 15 have involvement from private equity or litigation finance.
A few established litigation funders that have created the structures include Pravati Capital, Virage Capital Management, Counsel Financial, Bespoke Capital Consulting and 777 Partners. Private equity firms such as Melody Capital Management and Kayne Anderson also have stakes in firms.
Ninth Avenue Capital, a private equity firm in Missouri, applied for an ABS last year and its principal is Greyson Clymer. Clymer was a founding partner at Melvin Capital, the hedge fund that shorted GameStop and shuttered after losing billions. According to its application, Ninth Avenue will initially focus on mass torts and personal injury and will seek to split the controlling class of interests with Golden West LLC, which is founded by Richard Frankenberg of private equity firm Edgehill Partners.
Ninth Avenue Capital did not respond to a request for comment.
The CEO of litigation funder Pravati Capital formed 1787 legal group last year. It shares a physical office location in Scottsdale with the funder and is owned and operated by Alexander Chucri who is the designated principal for 1787. He owns 80% of 1787 through a Delaware company Arizona Legal Ventures LLC.
Pravati Capital did not respond to a request for comment.
Litigation Funders
A presentation from Texas-based Armadillo Litigation Funding showed that the funder is seeking investors to partner with them on an law firm venture in the state.
In their presentation for investors Armadillo wrote, “Arizona is blazing the way for non-attorney participation, paving a path for innovators and entrepreneurs to help revolutionize (and profit from) the legal space.”
The venture includes Johnson Law Group, a mass tort law firm in Houston that is owned by the same individuals as Armadillo, the ABS Bay Point Legal Partners, and ARCHER Systems settlement administrator.
The presentation outlines how the process would work. Johnson Law Group will serve as lead counsel and will facilitate all client services such as case marketing and acquisition, intake, and medical records retrieval. Armadillo will evaluate the torts for share of the market, injuries, potential timeline to settlement and other factors. It will guide the investment process for selection of matters. The law firm ownership stake occurs through Bay Point. ARCHER Systems will serve as the settlement administrator.
Jeff Manley, chief operating officer at Armadillo, said it’s too early to comment on the venture as the company is still in the process of evaluating and setting up the opportunity.
Outside Arizona
The alternative business structures were meant to bring business to Arizona, but many are using the program to work outside of the state. In particular, mass tort firms have taken to the alternative business structures and use them for lead generation and advertisement nationally.
Other states have altered the rule as well. In 2020, Utah created a “sandbox” for nonlawyer-owned firms that is monitored by the Office of Legal Services Innovation. After a year, if it meets certain thresholds, an entity may be granted an annual license. Washington D.C. allows nonlawyer ownership for individuals who further legal services to the clients. Arizona has gone the farthest by eliminating the rule entirely.
“I don’t think that was particularly Arizona’s intention,” said Crispin Passmore, a consultant to funders, private equity firms and law firms, about whether the program was meant to expand outside of the state. “They’re focused on improving competition and access in Arizona and bringing in new money, new ideas into the practice of law in Arizona.” He added, “There’s a first mover advantage for Arizona because these businesses are coming there and people are working out how to make it a US-wide business.”
The state set up a licensing program for Alternative Business Structures (ABS) and a committee comprised of Arizona lawyers, active and retired judges and business people reviews the applications and recommends approval or denial to the Supreme Court, which then grants or denies the applications. The structures are required to have an Arizona-licensed compliance lawyer, but the investors and other lawyers at the firm can be based elsewhere.
‘Where Magic Happens’
“The interesting issue is an Arizona ABS is authorized to practice Arizona law in Arizona, that’s not a very big market. It’s not New York, it’s not California, it’s not Chicago, it’s not Florida, et cetera,” said Passmore. “The question then is how do you go from Arizona to 50 states? That’s where magic happens.”
Passmore, who consulted with the ABS committee that setup the new structures, now advises those who are applying for an ABS. He said he works within the ethics rules across the US and helps create national law firms. The firms are setup in Arizona, with an investor owning a stake, then the money is used for technology, lead generation, or marketing. When claimants are brought in, the lawyers will then co-counsel with firms outside of the state.
“It didn’t introduce a new concept in terms of funding or financing of a law firm’s business, what it did was changed the way one can provide that funding,” said Boris Ziser, New York based partner and co-head of the finance group and global leader of the litigation funding practice at Schulte Roth + Zabel, who has assisted around a dozen investors who have provided funding through an ABS or through fee-sharing with an Arizona firm. They’ve predominantly been in the mass tort space.
Ziser says that the investor takes a stake in the growth through Arizona, so they are not just receiving a premium on their lending, they’re getting equity in the business. Litigation funding to a law firm is often structured like a loan with interest rates in the teens and twenties. With an ownership stake, lawyers don’t have to face accruing rates when cases last many years, as is common for major mass torts.
“What the Arizona ABS enables the law firm to do is actually funding, or investing, in an equity form rather than debt and that could have a lot of appeal,” said Ziser.
Andy Kvesic, an attorney on the Arizona ABS Committee who also owns and operates alternative business structure Radix Law, says that the program has been good for Arizona by bringing in new businesses and creating jobs. He said that law firms often co-counsel with firms outside of their state and it is not an ABS specific situation.
“I think the ABS program is absolutely helping Arizona and I think beyond that, it’s having benefits nationally as well,” he said.
‘Mass Torts Capital of the US”
Detractors of the litigation finance industry point to Arizona’s alternative business structures as an example of non-lawyers interfering with cases. But Ziser and Passmore both emphasize that lawyers are following ethics laws and are making choices in the best interest of their clients. In the majority of states, non-lawyers cannot own law firms so when these structures handle cases outside of Arizona, it’s important to look at state ethics laws.
“Just because Arizona eliminated rule 5.4, that doesn’t necessarily mean that in other states rule 5.4 won’t apply,” said Ziser. “You just have to look at the conflict laws of that state and the circumstances to which you’re trying to apply it and then determine whether it would be that state’s rule that would apply or Arizona’s rule.”
The US Chamber of Commerce has been an opponent to the alternative business structures and the general prevalence of litigation funding.
“Arizona should not allow hedge funds, litigation funders, and others to set up volume-focused, for-profit claims mills, advertising and collecting claims for out-of-state plaintiffs,” said Page Faulk, U.S. Chamber of Commerce Institute for Legal Reform Senior Vice President of Legal Reform Initiatives. “There is no benefit to Arizona and its citizens in unintentionally making itself the mass torts capital of the United States.”
Kvesic says the structures have created more diversity and innovation in the legal profession and that the regulations in place prevent unethical behavior.
“There are so many mechanisms built in to protect the client, to make sure the firms are operating ethically and pursuant to the professional rules,” he said. “I’m more wary of traditional law firms that don’t have to honor any of these hoops that ABS have to jump through.”
Passmore said what’s happening in Arizona will continue and that he expects more states to take a similar approach. He said that those who don’t like the structures can’t change them but can look for ways to add more regulation.
“Capital is like water, it just flows downhill and it will find a path from where it starts to the sea and if it gets cold and chilly it will freeze,” he said. “Then when it thaws it’s cracked open that small crack into something bigger and before long you’ve got the Grand Canyon with billions of private equity flowing through it.”