The third way
6 February 2012 | Updated: 6 February 2012 8:55 am
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Third-party litigation funding is a relatively new model, but it is likely to become more mainstream in the next few years
Litigation funding is slowly beginning to take off and gain acceptance among lawyers and clients. This week’s panel discusses what needs to be addressed to ensure the market is well-run and provides litigants with the certainty they need when accepting third-party funding.
What kind of cases appeal to third-party funders?
Jeremy Morgan QC, 39 Essex Street: At present, most funders are interested in high-value claims. They need to invest a fair amount of resource in the assessment and monitoring of a claim even if the actual legal costs they incur are left out of account, as well as needing to ensure they cover their exposure to costs and return a profit.
An important difference between England and Wales and other jurisdictions where third-party funding has been successful, such as Australia, is the ability of a funder in England to lay off risk under the existing law. With recoverable conditional fee arrangements (CFA) success fees and after-the-event (ATE) premiums, it is possible in theory for a third-party funder to lay off either all or most of the risk of being ultimately liable for either own-side or adverse costs onto solicitors and ATE insurers.
If a third-party funder succeeds in doing so, it has no risk but might have to fund the cashflow necessary to pay disbursements, provide security for costs and so on. I believe, though, that the model I have described is more theoretical than real, as solicitors and counsel are reluctant to bear the entire risk of their fees in third-party funded cases, and tend to prefer to work on a no-win low-fee CFA model. That means the funders have to take the risk of the low fees (the amount of fees payable regardless of whether the case is successful or not) as well as ATE premiums if the third-party funder seeks insurance but the insurer is not prepared to offer a self-insuring premium.
Following the implementation of the Jackson reforms this will change and the third-party funder will have to accept real risk in all cases.
The only way third-party funding could secure an adequate return in low-value cases would be by backing group litigation with a large number of low-value claims or by delegating a lot of decision-making to solicitors and effectively acting as an insurer for the solicitors’ business.
Colin Wynter QC, Devereux Chambers: Third-party funders will only be interested in cases in which there will be a good prospect of success and a correspondingly good prospect of recovering damages of sufficient magnitude to have made the funder’s acceptance of the cost of risks profitable.
Marginal cases will not find funding unless the damages potentially available are enormous and a funder’s profits from other cases make investment in such weaker cases commercially viable.
Roger Mallalieu, 4 New Square: Third-party funding is, at least in the terms described here, a business. The key factors that appeal to third-party funders are therefore that the case is for monetary relief and of an adequate size, and that there is sufficient prospect of a return on the investment. An additional key factor is the ability to accurately gauge the risk, in particular the exposure to adverse cost.
Litigation funding of this type is therefore likely to remain primarily the province of the larger commercial cases to which it is inherently better suited. A large corporate entity is likely to be viewing its claim as a commercial matter and is better able to accept and appreciate the commercial benefit of its case being funded by another party in return for a share of the damages. In contrast, large PI or clinical negligence cases are less suitable. The reward for the funder would of necessity amount to a substantial inroad into the sums required to provide for the claimant.
Group litigation cases might appeal too, although the nature of such cases and, in particular, concerns with regard to protecting the interests of a large number of individual claimants who may not have the commercial or litigation expertise of those who would normally look to use litigation funding, raise particular problems.
Simon Twigden, partner, Enyo Law: Cases that have a monetary judgment and a liquid result. Essentially, there needs to be some form of payment at the end of the case that is higher than the amount the funder has invested.
Funders will typically look to fund cases with a value of over £1m as a minimum, although some will fund for less and others will require a higher starting point, say £3m.
Unfortunately, most funders are looking for that ’slam dunk’ case, where they are almost guaranteed a significant return on their investment. There should be more of a portfolio approach, with a wide variety and number of cases funded.
David Engel, partner, Addleshaw Goddard: The easy answer is cases with a good prospect of success and a massive claim for damages. Traditionally, third-party funders have been attracted only by multimillion-pound claims, where such funders would be hoping to be paid approximately one-third of the damages obtained by the claimant, or three times their investment in the case, whichever is greater.
These days, however, we are seeing more innovative funding models whereby third-party funders are more willing to look at other ways of obtaining a return on their investment. As a result of this change in approach from some of the new entrants to the litigation funding market, a wider range of cases may appeal. Indeed, there is no reason why almost any commercial litigation should not be of interest to them subject, of course, to decent prospects of success.
Are litigants nervous about accepting third-party funding?
Wynter: To the extent that the funder will have some degree of control over how the case is fought there will be anxiety on the part of litigants. Much will depend on the precise nature of the contractual arrangement between litigant and funder.
With commercial litigants simply seeking to rid themselves of the administrative burden of litigation there may be no real concern, as they are well able to look after their own interests. In the case of less sophisticated litigants there is a danger of them having little choice in the selection of their lawyer. Since such funding acts in a way that is similar to legal expenses insurance - a field in which the insured is given the freedom to choose his or her own lawyer - it would be discordant if a funder was not similarly required to grant similar freedom of choice.
Mallalieu: Although it has been available for a number of years and has been successfully used in a number of cases, litigation funding remains in its relative infancy. It is also unregulated. The recently introduced voluntary code and the creation of the Association of Litigation Funders is an improvement in this field, as is the growing reputation of a number of litigation funders who are able to point to a good record in this field, including meeting their obligations where cases are unsuccessful.
Moreover, while there is increased use of litigation funding, many solicitors have little or no practical experience of its use and accordingly are unaware of its benefits (and potential disadvantages) and of how it operates in practice.
The method by which third-party funding operates means that the litigant with the benefit of such funding will always remain the party that is prima facie liable to be subject to an adverse costs order if the litigation fails. Of course, part of the funding arrangement will normally be for the funder to provide complete or partial indemnity. However, concerns as to the lack of legally binding capital adequacy requirements on the part of such funders (in contrast to insurers) and the risk of a funder being able to withdraw from funding (and the future indemnity) in circumstances contrary to the funded party’s interest mean that the party considering using third-party funding may have substantial concerns as to how great a reliance can be placed on either or both the funding and the accompanying indemnity.
Such matters inevitably create a wariness on the part of litigants and their advisers. This is probably not helped by the general upheaval in the world of litigation funding as the Jackson proposals head towards implementation. The voluntary code of conduct is only a partial answer to some of these concerns.
Twigden: Not usually - most will have sought it out to hedge their risk, although some clients will not want to part with what could be a significant amount of their award to a funder and will find the idea of funding unpalatable.
There is also a real reluctance in the corporate world to move their litigation matters off-balance sheet, effectively transferring all the cases to a funder. If this was done internal litigation departments could become profit centres rather than overheads. However, this is an approach that is not being taken up by the majority
Engel: I am not sure whether nervous is the right word, but it may be true to say that in the legal and financial departments of corporate Britain there is not currently a high level of awareness and/or understanding of the third-party funding options available and their relevance to mainstream commercial litigation.
There is something of a time lag between perception and reality. I think litigation funding providers and lawyers have some way to go in raising awareness of the options available.
What would boost confidence in this burgeoning market?
Morgan: There is some evidence of new investors wanting to get in on the act of what seems like a profitable model, so I doubt that further boosting is necessary. To the extent that those newcomers are basing their plans on the existing system where it is at least theoretically possible to make good profits with very little risk, they will have to reassess their business plans when Jackson is implemented.
As for users, I believe there is a fair amount of confidence in existing third-party providers, but there must be doubts about the future. The Jackson reforms will make many providers of ancillary services look to new fields for profit, and third-party funding will be one of these. My own view is that the existing provisions for capital adequacy and the regulation of business practices are insufficient to adequately regulate the move of such organisations into a field as sensitive as third-party funding, and more will eventually be required to boost confidence in this model.
Wynter: A drawing together of the principle of freedom of choice of lawyer, similar to that available to legal expenses insureds, and consistency in the terms of contractual arrangements between litigant and funder, including a principle that, other than for acting as funder and obtaining the consequential benefits in the event of successful litigation, the funder stays remote from the conduct of the litigation.
The issue of cessation of funding mid-way through litigation is also of concern. A principle of ’in for a penny, in for a pound’, save where dishonesty or concealment by the litigant has led to a change of prospects, should also be a requirement.
Mallalieu: Practical experience on the part of litigators and the courts will be key. Only when there are repeated examples that can be pointed to, to illustrate and emphasise that there are a number of reputable funders in the market, can market confidence grow.
Greater transparency will also assist and the voluntary code is a positive step in the right direction, although the absence of a mandatory code backed by regulation can only create uncertainty.
Finally, the lack of any legally binding capital adequacy requirement can only lead to wariness, regardless of funders’ acceptance of the requirements of the voluntary code. It is difficult to understand, particular in light of the turmoil in financial markets in recent years, why the Government would allow what is in essence an investment activity to continue without this basic minimum legal safeguard.
Twigden: Without a doubt, greater transparency. The market has come a long way in the past five years, but for the most part funding is still not completely understood. It can also be difficult to recognise the difference between those funders that have money to spend and those that are just acting as intermediaries.
Greater information about the successes and failures of funded cases would help to boost confidence. If people were to witness funders paying out on losses it would increase confidence and credibility.
Engel: Ultimately, confidence is likely to be boosted only after a record has been established of the successful funding of litigation by third parties.
The big challenge is to explain to companies involved in big-ticket or even medium-sized commercial litigation how third-party funding can be an attractive financial proposition, not least by providing certainty as to the financial exposure, even where the claimant may be able to fund the litigation from its own financial resources.
What impact will the introduction of contingency fees and ban of referral fees have on the third-party funding market?
Morgan: The introduction of contingency fees will allow solicitors to compete directly with third-party funders on similar terms.
Smaller firms will not be competing in the same market and I suspect that even large firms offering contingency fees may want to lay off some risk by sharing the risk and reward with a third-party funder. I do not believe that referral fees play much of a role in the existing market, but abolition will put pressure on organisations that depend on referral fees from other sources to move into this market.
Wynter: Contingency fees would incentivise the legal market to take on stronger cases at the risk of no reward because the potential rewards would be so great. Had I conducted even two or three of my larger and stronger cases on a contingency basis I would by now have retired to the Bahamas and be fishing for marlin instead of writing this. More seriously, contingency fees, because the legal market would with alacrity pick up and fight the stronger cases, would effectively wipe out or at least seriously damage the funding market.
Mallalieu: The introduction of contingency fees will provide what is likely to be a viable alternative source of funding for claims of substantial value. It must be borne in mind that third-party funding is presently only one potential way of funding cases, alongside alternatives such as conditional fees, and contingency fees will provide another. Each has benefits and disadvantages. The availability of a range of alternative forms of funding should be an improve-ment, although it will undoubtedly increase the burden on solicitors to understand and advise on the various alternatives.
It is not immediately apparent that the proposed ban on referral fees will have any direct impact on the availability or use of third-party funding. The proposed ban on the inter partes recovery of ATE insurance premiums may have a greater effect in encouraging businesses that would have been prepared to fund their own cases to consider litigation funding as a way of spreading the risk.
Twigden: Where contingency fees have been in use there is already a culture that makes litigation funding more palatable. CFA arrangements can be incredibly complicated and time-consuming to create for each particular matter. Success can mean different things to different people, and it would be far easier for both law firms and clients if they had a clear and transparent billing arrangement.
With regard to referral fees it will make little difference, as you are talking about low-value, high-volume work as opposed to litigation funding which is high-value, low-volume.
Engel: The introduction of damages-based agreements may see lawyers more willing to fund their clients’ litigation from their own working capital. However, given the high cost and risk profile of funding high-value and complex commercial litigation it seems unlikely that any firm would be willing to fund more than a handful of its clients’ cases in this way at any one time.
These developments could result in the deployment of new models for the funding of litigation. For example, it may be that funders are willing to fund law firms in respect of a basket of litigation cases, essentially by providing working capital to the firm, as an alternative model to funding on a case-by-case basis.
How will the market evolve in the next five years?
Morgan: The $64,000 question. I expect the market to expand, with the introduction of new funders, but also to need more regulation imposed.
Wynter: A lot will depend on the Jackson reforms and the extent to which they are implemented. A major assumption of the Jackson reforms is that there will be available reasonably priced legal expenses insurance. In the ongoing case involving Webster Dixon, the losing insurer is contending that the effect of the Commercial Court having endorsed the existence of the insureds’ freedom of choice of lawyer will be to increase the costs of such insurance, perhaps to a level where it is no longer viable. If that happens the way will be clear for funders to move into the vacated terrain.
Mallalieu: It is difficult to say, but third-party funding is now rightly seen as a viable alternative in appropriate cases. The sensible assumption is that there will be a significant growth in the use of such funding. The introduction of contingency fees represents an added challenge, but should perhaps be more properly viewed as simply providing another tool in the armoury of those considering the appropriate method of funding for a case.
The market is still young and one or two bad cases could easily damage confidence. Equally, third-party funding is unlikely ever to become a suitable funding choice for all types of litigation. However, it is no longer seen as the new kid on the block.
Twigden: The market will continue to evolve, hopefully with greater transparency. There will certainly be more players in the market and law firms will become better educated as to the working and benefits of funding, which should in turn see the use of it increase. However, the massive gains made by funders in the early days will most likely decline, although it will remain a profitable business.
Some investment banks have created litigation funding departments/pools, and it will be interesting to see how active they will be in the market especially as, in the current climate, a lot of litigation involves financial institutions.
Engel: We will see a growing acceptance and use of the various litigation funding options available to claimants in high-value, complex commercial litigation. In addition, there may well be a convergence between the hitherto separate providers of funding for litigation, such as lawyers, insurers and third-parties. We may see traditional third-party funding and ATE insurance provided by the same entity, and/or risk transfer and risk sharing on a more equal basis between parties, lawyers, insurers, and external funders.
The funder’s reaction
Christian Stuerwald, partner, Calunius Capital
The message from the panellists in this feature is that litigation funding is really coming of age with regard to complex commercial disputes. In fact, it
is clear such cases constitute the only real market for litigation funding at the moment.
There are two sources for these cases - small- and medium-sized enterprises that need access to justice against economically much stronger parties and uber-solvent entities that want simply to manage the business risk presented by large-scale litigation.
In the near future general counsel will want to use litigation funding to turn their legal departments from cost centres into profit centres. We are already seeing this. By way of example, Calunius is presently funding cases for the estate of Elvis Presley and for one of the largest engineering companies in the world.
Corporates hedge their risks in all other areas of their activity by hedging currency risk or taking out insurance policies. Why would they not do it with regard to the inherently risky business of dispute resolution?
The code of conduct recently adopted by the newly formed Association of Litigation Funders in England and Wales should improve transparency in the market, if only because it distinguishes between funders, who have direct access to funds and are subject to capital adequacy requirements, and intermediaries, who do not.
Everyone is interested in understanding and predicting the interface between the activities of litigation funders and law firms availing themselves of damages-based agreements (DBAs). One question is why law firms, if they decide to compete with litigation funders via these contingency fee arrangements, should not
be exposed to the same capital adequacy requirements as funders. Some are advocating ’Solvency 2’ for law firms.
The code of conduct for funders sets out a high ethical standard in relation to how disagreements with counterparties over settlements and terminations are to be dealt with.
Many believe that the code’s treatment of these issues is a model that could be followed to deal with law firms’ disagreements with their clients in the context of DBAs. Standard form DBAs, anyone?
Then there is exposure to adverse costs to consider. As a matter of law, litigation funders can be held responsible for adverse costs in the cases they fund. Law firms should start to think how they will cope with the adverse costs risk they will have to bear and how that might affect their capital adequacy.