Over recent decades, regimes around the world have begun to legalise third-party funding of litigation. Taking England & Wales as an example, the expenses of litigation were not transferrable less than a decade ago. Until that point, the historic principles of Champerty and Maintenance barred a third-party from funding legal cases. But in 2013, Lord Neuberger, the president of the UK Supreme Court, adapted the rules in the name of enabling access to justice, and the litigation funding industry was born. Today, such funding is increasingly available around the world, and in demand from claimants, their lawyers, and investors alike.
Initially, litigation funding was largely reserved for those who simply could not pay legal costs. The typical situation was a ‘David & Goliath’ type case, where a private individual of limited means required support to seek redress from a large organisation who had wronged them. Following the success of such cases, acceptance in other realms grew. Over time, such funding has widened across all areas of the legal spectrum, including to large commercial cases, multinational investment treaties and significant group actions to name but a few. Typically, however, funding operates along similar lines, regardless of the type of case at hand.
This article will outline some of the common features of funding across major markets. Whilst there is some variance based on legal regime, acceptance of funding as a concept and the sophistication of the players present, there are some typical features which exist in most markets. Following an overview of these common traits, we will then outline some of the key elements of the funders process, to assist lawyers in guiding their clients towards the most appropriate funding solution.
Litigation funders only make returns with successful resolution of cases, whether a win in court or an out of court settlement. Their choice of investments is therefore incredibility important to the success of their business model. Well managed funders invest time and resources in building a process to carefully source, vet and manage claims.
Litigation Finance – supporting law firms and their clients
The features of funding vary by geography due to local law. There are however numerous common features which we will outline below including it being non-recourse, payment to funders being derived from winnings, funding usually being claimant side, funding applying to the majority of costs, and the role of the law firm as intermediary. Again, there are nuances by jurisdiction, but the below will hopefully serve as an outline of what is likely to be available in many markets.
Non-recourse funding is core to the litigation finance model. In most situations, this arrangement means the claimant does not bear any risk from taking the funding. Should the claim fail, the funder will cover all of the claimant’s costs. And to ensure that should an adverse costs order be granted, to pay for the other side’s expenses, specific insurance know as After the Event, or ATE, can also be provided, which the funder can also pay for. The claimant therefore passes risk to the funder for all costs.
Payments to funders are typically taken from the claimants’ winnings. This can be calculated by a variety of means. Some situations provide for a ‘multiple’ approach, where the funder takes back their original investment plus say twice their original investment from the winnings the claimant receives. Other options could include a fixed percentage of winnings, particularly on larger cases. Nuances to these typical approaches include time-based weighting, where the level of return to the funder increases with the passage of time, to factor in additional costs to the funders. In some situations, it may be that a hybrid of some/all of the above will be available.
Claimant side funding is the typical model for litigation funders in most geographies. This is due to the greater familiarity of aligning a funder’s investment to returns from damages a claimant might win. In some rare cases, funders may look at defendant side funding, however this is a more challenging proposition to structure. Today it is reasonable to assume that funding for claimants is widely available, but funding for defendants is unlikely to be available in most markets.
The majority of legal costs are typically covered by a funder supporting a claimant. These naturally include the fees charged by the claimant’s law firm. They usually extended also to cover disbursements. These will likely include costs for filings at court, and for court hearings. They may also extend to cover fees for specialist advice, whether accountants or expert witnesses, or additional counsel such as Barristers costs in judications like England & Wales where lawyers generally supplement their work with specialist advocates. Additionally, as mentioned above, costs of insurance for adverse cost orders, to cover the other side’s legal costs should a case be lost, can also typically be included in funding arrangements.
Law firms intermediate between funders and claimants in many situations. Whilst there is a growing trend for corporates to speak directly to funders, especially where a corporate has a portfolio of cases, in most situations it is the law firm that will introduce their client to a funder. Depending on regulations, this may allow for the law firm to take a cut, or commission of the funder’s profits on certain cases, providing that such arrangements are transparently disclosed to the client. In many situations however, law firms prefer to remain separate from the financing arrangements. In some markets, brokers may also assist parties in identifying appropriate funding opportunities for the funder themselves to diligence.
Litigation funders only make returns with successful resolution of cases, whether a win in court or an out of court settlement. Their choice of investments is therefore incredibility important to the success of their business model. Well managed funders invest time and resources in building a process to carefully source, vet and manage claims. Typically, funders will assess cases on six points, conducting diligence on: (1) legal merits; (2) the claimant; (3) damages; (4) case economics; (5) recovery potential; and (6) the legal team. An outline of each ‘test’ is provided below.
(1) Legal Merits. The starting point in assessing any case for funding is to consider the legal merits of the situation. Funders may employ independent lawyers or have legal experts on staff to consider which laws apply, how they may have been broken and causation, linking the defendant to the case. A dispassionate approach is required here by all parties involved. Many cases fall away due to not having a strong enough legal basis, as funders have no interest in supporting claims which are lacking in legal merits.
(2) The Claimant. Funders will seek to diligence the reputation and behaviour of the potential claimant. The ideal client is one who is reasonable and dispassionate, and can evidence that they are acting rationally, rather than emotionally in seeking to pursue action. Many claimants will passionately believe they have been wronged and therefore deserve access to justice. A funder however will only seek to support those claimants who are likely to be reliable counterparties throughout any action.
(3) Damages Calculation. Assessing the financial dynamics of a case is fundamental to the success of the funders’ business model. The starting point is a realistic assessment of damages. This may involve seeking expert input from valuation specialists to assess what the real value of damages is, which is often below what the claimant initially seeks. Care has to be taken to estimate a likely award through litigation or settlement.
(4) Case Economics. This realistic damages figure must be compared to the costs of running the action through to trial, include legal and expert fees. And finally, a profit for the funder must be accounted for. Should all of these costs, when deducted from realistic winnings, leave a fair return for both claimant and funder, cases may progress to further diligence. Many funders will say a minimum fair return for a claimant is 60% of realistic damages.
(5) Recovery Potential. Many cases possessing strong legal merits and other positive factors are unfortunately not suitable for funding if recovering damages is difficult. Factors considered here will include the jurisdiction of the matter, the location of any assets against which recovery would be made and the overall financial health of the defendant. In some situations, specialist forensic accountants will be employed to trace assets and verify recovery is possible.
(6) Legal Team. In most cases, a funder is contracting directly with the claimant. In order for the funder to ensure that the claimants’ interests are protected, the funder will want to ensure that the lawyers supporting the claimant are appropriate to the case. In most situations, this will be so, but in some circumstances, it may be necessary to supplement the legal team with additional experts or specialist counsel to provide additional brainpower for the matter.
Many cases put to funders are suitable for pursuit in the court. But only those which pass the tests mentioned above are likely to attract funding. First and foremost, funders will want to ensure they only support highly meritorious cases. An assessment of the nature of the claimant will follow to ensure rational behaviour. Importantly, the economics of the case will be considered to ensure that all parties will receive an appropriate return from funded actions. With this in mind, consideration will also be put to the recoverability of damages from the defendant. And the funder will also want to ensure that all parties interests are protected with the appropriate legal team in place. Should these tests be passed, funders will be more likely to consider supporting particular cases.
When the modern litigation funding market emerged a decade ago, it was typically focussed on supporting small claimants against larger defendants. The societal value of this, as a means to promote access to justice, has not eroded as the business has expanded to cover larger commercial claims and even the most sophisticated multinational actions. As the market has expanded, so have the ‘pockets’, the resources available to funders. Estimates vary, but a figure of $20bn globally would not seem out of place. And as the equity markets have fallen due to Covid-19, many investors are seeking access to litigation funding as an uncorrelated, strongly yielding asset.
With access to funding growing, claimants of all types may seek to work with their legal counsel to secure funding for claims. The non-recourse nature of this funding, particularly today amidst continuing certainty, will appeal to many who may wish to shift risk off balance sheet. The opportunity to de-risk, remove the need for cash payments of costly legal bills and instead have the opportunity of a windfall gain has attracted claimants in large numbers.
As demand for funding increases, so has the sophistication of funders. In some markets, such as the UK, mature players have come together to form a self-regulatory body know as ALF – the Association of Litigation Funders. This body sets basic standards for the conduct of funders and should assure all parties that ALF members have sufficient capital for claims they take on, and will operate with appropriate transparency.
Claimants seeking access to this precious resource should however come prepared for the diligence and rigour with which well managed funders operate. Questions will be asked about the legal merits of a case, through to the actual value of damages and the potential for recovery. And both the claimant themselves and their legal teams will be scrutinised to assure funders that they are working with appropriate counterparties. Should all these tests be passed, litigation funding is a highly attractive and increasingly available resource for claimants seeking redress.