Legal Briefing

Cash-poor but claim-rich companies adopting the third way – international insights on third-party funding

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Disputes | 02 October 2018

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Third-party litigation and arbitration funding is increasingly more prevalent, as a result of it being embraced by a greater number of jurisdictions and the funders themselves having raised a vast amount of money to invest in claims. Third-party funding can benefit both under-resourced growing businesses as well as established and profitable companies, allowing them to cover the legal costs of potentially complex proceedings. This article examines the growth in the legal finance market and considers potential risks which funded parties need to bear in mind.

The spread and growth of third-party funding

In its modern form, third-party funding started in Australia in the 1990s. Funding has spread around the globe since then; in addition to Australia, it is also now well established in England and Wales, and the US, and recent legislative changes mean that certain types of disputes can now be funded in Singapore and Hong Kong.

In recent years there has been something of a domino effect in terms of jurisdictions relaxing their rules on funded cases. Many courts and arbitration bodies are becoming increasingly comfortable with the involvement of funders in disputes, and jurisdictions are keen to attract the business of funders and remain competitive as venues for dispute resolution. By way of example, the Cayman Courts recently approved a third-party litigation funding agreement, thereby opening the door to third-party funding in this prominent offshore jurisdiction.

There has also been an influx of capital from investors, attracted by the potential for high returns promised by funders, which has driven the staggering recent growth rate of the global legal finance market. A 2017 report by Thomson Reuters suggested that the assets of the top 20 UK litigation funders totalled £723m. Globally, if market estimates are believed, tens of billions of pounds have been injected into third-party funders’ businesses in recent years. This growth has encouraged new players to the market and funders to diversify their client base and product offerings.

Key facts about third-party funding

Funders are legally sophisticated and understand a wide breadth of claim types, with each funder having a varying risk profile and appetite. In general terms, most funders tend to offer:

  • single case funding (upfront, non-recourse finance for legal fees in litigation or arbitration proceedings (or for a stage thereof) in return for a multiple of two to five times their investment or 25% to 40% of the amount recovered (whichever is higher));
  • portfolio funding (to underwrite several similar cases, often at a lower rate than would be available for a single case or where the merits of a group of cases are weaker than would normally be acceptable to funders, but losses may be absorbed by gains elsewhere in the portfolio); and/or
  • corporate finance, for general use within a business, secured against litigation or arbitral proceedings (often called the monetisation of claims or judgments).

Some funders are also open to financing defendants in actions, but the economics of the defendant model is much less clear given that, in many cases, the defendant to a claim will not recover a monetary sum unless it has a counterclaim.

Funders will perform detailed due diligence on the merits (including jurisdictional obstacles) and the economics of a claim (including its value, the nature and length of the proceedings and the opponent’s creditworthiness). Many of the major funders have high-calibre and experienced practitioners sitting on their investment committees to ensure that investment is limited to cases with strong merits.

A question for a company considering funding is whether it is willing to give up some of its potential returns in exchange for taking the risk off its balance sheet.

Funded parties are required to enter into comprehensive agreements governing the terms upon which finance will be provided. When a funder participates under a typical non-recourse funding agreement, the funder will normally have no control over the litigation or arbitration. Most funding is on a ‘non-recourse basis’, meaning that if the case is lost, the funded party does not have to repay the investment. Some funders offer a sliding scale, under which the proportion returned to the funded party decreases the longer the case takes to be resolved. The precise costs position differs depending on the type of dispute, but the funder often requires the funded party to agree to pay for an after the event insurance policy, to insure against the risk of an adverse costs order should the claim fail.

Issues when considering funding

A gateway question for a company considering funding is whether it is willing to give up some of its potential returns in exchange for taking the risk off its balance sheet. A company should also consider and seek to address in the funding documentation issues around privilege and potential conflicts of interest.

As noted above, funders will require information about the claim. Proper arrangements, such as a confidentiality or non-waiver letter, must be put in place between the funder and the funded party in order to ensure that confidentiality is maintained in any documents and other information supplied to the funder and privilege is not waived.

While both the funder and the funded party have a financial interest in the dispute, their interests may not be identically aligned. For example, a funded party may wish to maintain a commercial relationship with its opponent and be more willing to settle. Equally, there may be issues of wider significance to the party’s business, such as the reputational impact, which may incentivise the business not to settle pre-trial. It is therefore prudent for a party to discuss with the funder its commercial objectives when negotiating the funding agreement.

Any funding agreement should address potential conflicts of interest which may occur during the claim. One potential area of tension between the funder and funded party concerns settlement. While funders cannot direct a party to accept or decline a settlement offer, funding agreements typically require claimants to act reasonably when considering such an offer and may require referral to independent counsel. A funded party needs to understand exactly when a funder can terminate a funding arrangement, as the withdrawal of funding may significantly impact the funded party’s ability to continue with the claim. A funded party should therefore ensure that it receives legal advice when negotiating the terms of the agreement and that it complies with all such funding terms.