Managing risk: using third party funding to pay the costs of litigation and international arbitration

Written on 13 Jul 2016

What is Third Party Funding (TPF)?

TPF is non-recourse lending provided by professional investors or hedge funds to claimants in order to fund the legal costs of bringing claims. It covers solicitors’ and barristers’ fees, court fees, experts’ fees and general disbursements. TPF is for payment of the costs of a claimant, however it is sometimes possible for a defendant with a counterclaim to obtain TPF.

TPF is potentially available for litigation and arbitration claims and for claims brought overseas as well as in the UK. It is potentially available for a wide range of claims for monetary damages, including claims for breach of contract (for example, for supply of goods or services, joint ventures, or investments), for civil fraud, for construction or infrastructure projects, for infringement of IP rights and for claims relating to property rights.

TPF can be used in combination with ‘after the event’ insurance, which covers the risk of the claimant having to pay the defendant’s legal costs if it loses the case. When used together with TPF, the claimant can substantially eliminate the cost risk of pursuing a commercial dispute, at a price.

The price of obtaining TPF is that the funder will receive an agreed payment, a “success fee”, if the claimant recovers damages from the defendant. Of course, if the claimant loses the case or is unable to recover payment of damages, the claimant has no liability to pay the funder and the funder will not receive a return on its investment in the costs of the litigation or arbitration.

The market for TPF

The origins of TPF date back about 20 years. But it is only in recent years that the market for TPF has taken off. This growth has been made possible by a shift in modern English law (notably the case of Arkin v Borchard in 2005) to recognise that, provided there is no impropriety or overly officious meddling in the case by the funder, TPF is a legitimate and lawful way of funding litigation. TPF has, moreover, received judicial approval as a means of improving access to justice.

The upshot is that TPF is now part of the mainstream of the disputes market. The UK has an Association of Litigation Funders (ALF) and a Code of Conduct, and the US has a similar regime.

What situations are suitable for TPF?

From the claimant’s perspective, TPF is most useful where good claims are not being pursued out of concern for the upfront cost of funding the claim and the risk of having to pay the defendant’s costs if the claim is unsuccessful. TPF is also useful for businesses that allocate relatively modest budgets to legal departments, or would prefer not to use cash reserves to fund claims.

In considering whether or not to seek TPF for a particular dispute, there are three main factors that will determine whether the dispute may be suitable for TPF and, if so, the level of success fee that a funder may be looking for:

  • the merits of the claim;
  • the realistic quantum of the claim, as compared to the budget required to fund the claim; and
  • the enforceability of an award of damages against the defendant.

The merits of the claim are important. Self-evidently, funders will not be prepared to fund a claim that is unlikely to result in the claimant succeeding and recovering damages. There is no set measure or percentage for the likelihood of success, but in our experience funders typically look for at least a 60% chance of winning the case.

The funder is likely to insist upon a minimum return, which will be a multiple of the funds committed by it for the case. On top of this sum, it is common for funders to be paid a percentage of the damages recovered. We have seen percentages ranging from 10% to 40%, depending on the quantum of the damages claim and risk factors.

What this means exactly in terms of the amount of damages that is left for the claimant is of course a function of the amount of the damages and the anticipated costs of pursuing the case. It therefore means that a claim needs to have a certain minimum value in order for TPF to be financially viable. There is no set minimum value for claims and different funders focus on different claim values. However, we would say that funding really only makes sense where the claim value is in the millions.

Funders will also look at the likely enforceability of the award, which will have an impact on the overall costs, the likelihood of a successful recovery of money and the length of time that the funder’s capital will be tied up. The enforceability will therefore depend on both:

  • the creditworthiness of the opponent; and
  • the jurisdiction in which the defendant’s assets are located and whether there exist treaties for enforcing damages awards in that country.

Taking all of these risk factors into account, the funder will decide whether it is willing to fund the dispute and if so, the level of return it will be looking for. The funder’s success fee is a matter for negotiation: there is no standard formula or amount, no minimum and no maximum. But it is true that the TP funder will be looking for a high return on what is generally regarded as a high risk investment in litigation. The lower the chances of success, the lower the ratio of damages to costs, and the lower the chances of enforcing an award of damages, the higher will be the return that the funder will be demanding.

What will the TPF arrangement involve?

Along with the level of success fee, the most important question to decide in the funding agreement will be what constitutes success? There is also no set standard for what “success” means – this will need to be spelled out in the funding agreement. Obtaining judgment for damages against the defendant and then actually recovering payment of the damages will be part of the answer. But what level of damages constitutes success, either after trial or following a negotiated settlement?

The parties will also need to reach agreement on the funder’s level of oversight of the case. There are 3 main aspects to this:

  • budgetary – making sure the costs budget is kept to;
  • regular reporting about progress of claim; and
  • settlement.

Most funding agreements provide that the claimant shall not settle the claim without the funder’s consent. But, apart from settlement, the funder will not exercise control over the conduct of claims; control will remain with the claimant. This is because if the funder has control of the claim, the court might find the funder liable to pay the defendant’s costs if the claim is unsuccessful or, in extreme cases, might find the funding agreement void under the public policy doctrine of ‘champerty’.

The TPF agreement will also provide that, if the merits of the claim change adversely, for example an unexpected piece of evidence emerges, the funder will have the right to terminate the funding agreement and close the facility.

Comment

The legal costs of bringing claims can be high and the outcome of litigation or arbitration inevitably involves an element of uncertainty. There is therefore an element of risk involved in bringing any claim. But if you have a good claim, not pursuing it could mean losing the chance to realise a contingent asset.

For the right claim, TPF can be a very good way of balancing the risks associated with the costs of claims with the objective of recovering compensation for wrongs done to your company. We therefore advise our clients to consider TPF before deciding not to pursue claims out of concern for the legal costs involved.

We have worked with funders and can advise on TPF options for a particular claim, how to select a funder and the process of obtaining funding.