In a much watched case, the Second Circuit Court of Appeals has ruled that New York's anti-champerty statute (Judiciary Law §489) does not preclude a purchaser of defaulted sovereign debt from suing on that debt even if the purchaser bought the debt with the intention of suing to enforce its claims (Elliot Associates L.P.V. Bancode la Nacion, 1999 U.S. App. Lexis 26370 (2d Cir October 10, 1999), rev'g. 12 F. Supp. 2d 328 (S.D.N.Y. 1998)). A federal district court ⁽¹⁾ had held that the purchaser could not sue where it purchased the debt with the intent of rejecting the negotiated Brady settlement available to all holders, it knew the issuer would not agree to special deals for recalcitrant holders, and it intended to sue to collect the debt. Judiciary Law §489 makes unenforceable (with certain exceptions) claims purchased by (i) a person or partnership engaged in the collection or adjustment of claims or (ii) a corporation or association, with the intent and for the purpose of bringing an action or proceeding thereon.

The district court had applied a "strict construction" analysis of the Judiciary Law, currently favored by the U.S. Supreme Court, to conclude that a purchaser who buys a claim with the specific purpose of suing violates the statute. The court rejected all policy arguments and attempts to limit the statute to its alleged historical purpose. In particular, earlier versions of the statute had been aimed at the practice of attorneys' purchasing small claims in order to sue on them and obtain an award of attorneys' fees. Such a limited interpretation effectively would have nullified the statute.

On appeal, the Second Circuit concluded that the statutory phrase "with the intent and for the purpose" of suing was ambiguous, thereby opening the door to outside interpretive sources. Rejecting the option of certifying the question to New York's highest court for resolution, the Second Circuit based its interpretation both on earlier state court decisions interpreting the statute and on certain policy arguments. Obviously desiring to restrict the champerty defense as much as possible, so as not to interfere with the exploding secondary market for defaulted obligations, the Court of Appeals purported to rationalize a series of antique and modern state court decisions interpreting predecessor (and more narrow) anti-champerty statutes in order to distill the rule that assignments of claims are permissible so long as the principal purpose is to obtain a return on an investment and the intent to sue is merely incidental in the sense that suit will be resorted to only when necessary to collect the claim.

The Court divined that New York courts had limited application of the broadly worded statute to cases where suing was the primary, not a collateral, purpose of purchasing the claims. On that view, the primary purpose of Elliott had been to collect on the claim -- not to sue. Suing was merely the necessary means for collection. The Court bolstered its decision with "policy arguments" to the effect that upholding the champerty defense would increase financing costs and impair the marketability of sovereign debt.

Where does this case leave the champerty defense? Champerty, although seldom upheld, can be a powerful defense. It can turn a simple summary judgment motion on a note, which should be resolved in a few weeks or months, into a multi-year litigation, putting the claim purchasers' business practices and intent on trial.

The Elliott Associates decision does not necessarily change this. First, it governs only cases in the federal courts. It has no binding effect on New York State courts. Secondly, the decision does not purport to give a complete catalogue of the situations covered by Judiciary Law §489. There remain a number of New York State court decisions that uphold the application of the champerty defense in various situations. While the purchase of a mortgage with the intent to bring a foreclosure suit in order to obtain payment or ownership of the collateral has long been immune from challenge, other situations are less clear. Assignments that require the assignor to commence enforcement actions are suspect and subject to challenge. Assignments in which the assignor retains a financial interest are also vulnerable. Assignments in which it appears that the purpose is to finance litigation are questionable. Indeed, any assignment where it is arguable that the specific intent to commence litigation is a significant factor may be subject to attack unless the assignee can establish a primary business purpose other than litigation. Accepted reasons include an investment motive, desire to acquire the collateral securing the obligation or the fact that the assignment was an incidental part of a larger commercial transaction, such as a sale of a business.

¹ Elliott Associates, L.P. v. Banco de la Nacion,12 F. Supp. 2d 328 (S.D.N.Y. 1998).