The law against "champerty" and its implications to debt buyers.

Champerty is an age-old legal doctrine, codified in New York State by New York Judiciary Law § 489, that in very general terms prohibits agreements to purchase legal claims with the intent to sue for profit. A corporation or association that violates this law in New York may be fined $5,000, and a person, co-partnership, corporation, or association that violates it may be found guilty of a misdemeanor.

So, why aren't more debt buyers being accused of violating champerty laws? They appear to buy alleged debts just to sue on them?

A recent New York Law Journal article, entitled The Narrow Application of the Champerty Doctrine, surveyed the state of the champerty law in New York. The article summarized two Court of Appeals cases, and four subsequent cases. All but one of these cases declined to find champertous conduct.

In Bluebird Partners v. First Fidelity Bank, 94 NY2d 726, 731 NE2d 581 (2000), Bluebird purchased second series certificates from a bankrupt airline, and later sued the second series trustee for breach of fiduciary duty. One defendant asserted the defense of champerty. The Court of Appeals began its opinion by noting that the original purpose of the doctrine was "to prevent or curtail the commercialization of or trading in litigation." In declining to find the existence of champerty, the court in Bluebird observed that its decision was "consistent with the limited scope of the champerty doctrine as it originally appeared and developed in the Anglo-American legal system." The court concluded that, "in order to constitute champertous conduct in the acquisition of rights ... the foundational intent to sue on that claim must at least have been the primary purpose for, if not the sole motivation behind, entering into the transaction."

The second Court of Appeals case[1] held, in short, that there can be no champerty when the party which acquires the debt already has a pre-existing interest in the debt, which is not the case with debt buyers that purchase defaulted debts from, for instance, banks or lending institutions.

Of the four subsequent Commercial Division cases which have interpreted the champerty doctrine, the one most informative for the purposes of this blog is Justinian Capital SPC v Westlb AG, 37 Misc3d 518 (2012). In Justinian, plaintiff, a holder of collapsed Class B notes, sued the issuer for breach of contract and multiple other claims. The defendants claimed that the plaintiff had structured the purchase of the notes solely to bring the litigation, and did not in fact actually own the notes. In this case, the court held that the question before it was whether a company may partner with a law firm to purchase debt instruments where the primary motivation for doing so is to make money from the litigation, and it concluded that to do so would be champertous.

Crucially, the court noted, "New York draws a distinction 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. The latter motivation is permissible; the former is not."

New York courts appear to be influenced by debt collectors' assertions that they first use other methods to collect (calls, letters) before they sue.

The Justinian court went on to observe that "the ancient prohibition of champerty must be reconciled with modern financial transactions," and stated that New York courts have been correct in their reluctance to find claims champertous, because the "financial industry is critical to New York's economy, and its courts are rightly wary of fomenting uncertainty in its vibrant secondary debt markets by exposing purchasers of debt instruments to charges of champerty."