The SDNY recently dismissed a lawsuit by Phoenix Light against U.S. Bank on champerty grounds. That is, the court found that the assignment of claims to Phoenix Light was illegal under New York’s champerty law and thus Phoenix Light did not have standing to bring the claims.
This decision relates to a structure that arose out of the last financial crisis and the attempts of bondholders to create entities for the purpose of bringing claims. In this case, the owner of the claims kept the bonds, assigned the claims to Phoenix Light, and (and this is the critical point) Phoenix Light litigated them, but any recovery was to go back to the owner of the bonds. This last point is in our view what caused the arrangement to violate the champerty statute. The plaintiff had no interest in the lawsuit other than to get paid to bring it. The proceeds went to someone else.
So this dismissal is specific to the structure under which Phoenix Light was suing and does not say much about other RMBS litigation.
This decision is something to keep in mind during the current financial turmoil. It may be that there will be investors who, like the assignor in Phoenix Light, will want to get things off their books and farm out the task of suing on bad investments. Two key points from my point of view are:
- If you are in an investment structure that is failing, consider sooner rather than later whether you have a claim against an indenture trustee, investment manager or similar entity. A lot of things are happening right now that are not the fault of the trustees or similar entity that manages financial structures. And no doubt many people are doing all they can (or at least all the indentures or management agreements require them to do). Still, one lesson learned from the last financial crisis is that it is better not to wait years to figure out if someone has failed properly to perform their duties and to do something about it.
- There is a right way and a wrong way to create an SPV in which to park bad assets. Here, litigators such as us and John McFerrin-Clancy, with whom we often work on structured finance matters, can help you. As the Phoenix Light decision illustrates, sometimes an ounce of prevention is worth a pound of cure.