01 October 2008

A new way to fund litigation

It is a well-known feature of the English legal system that not only are you expected to pay your own legal costs but, should you fail in your claim, you are likely to have to pay a substantial proportion of the other side’s costs as well. This adds an extra dimension of risk to an already risky process and can tip the balance in any cost-benefit analysis undertaking when considering whether to pursue a claim in court. A new source of funding has recently developed that offers those involved in substantial commercial disputes the chance to offset that costs risk entirely.

The declining role of state assistance for individual claimants over the few decades has prompted the growth of alternative methods of funding litigation which, in theory at least, are also available to corporate claimants. Certain types of claim can be covered by insurance policies bought in advance. These can pay a reasonable amount toward your own legal costs, and sometimes, the other side’s costs as well. If the claim has already arisen, there are insurers willing to offer ‘After-the event’ insurance to cover the risk of paying the other side’s costs if your claim fails. That market is particularly well developed for claimants in the field of personal injury claims, a volume market with a degree of consistency of outcome that enables insurers to model their predicted returns. It is not so well developed in the commercial field and our experience has been that cover is not easy to find for large commercial claims.

For the past decade solicitors in England & Wales have been able to offer conditional fee agreements as a way of funding some forms of litigation. CFAs allow the solicitor to charge no fee (or a discounted fee) if the case is lost and a higher than normal fee if the case is won, that higher fee being recovered from the losing party. This is not the kind of contingency agreement that you will find in the US and solicitors in England & Wales are still prohibited from taking a share in money recovered by litigation. CFA usage is similar to after-the-event insurance, it is prevalent in personal injury volume work, but so in the field of commercial disputes.

In some circumstances, the parties to litigation can obtain funding from a third party, as the court refers to those not party to the litigation. Some will put up the funds to enable cases to be run because they are genuinely interested in the outcome (typically directors and shareholders of small companies); others because they want to support a case they see as deserving of justice.

There has now developed a further type of litigation funder which is neither altruistic nor interested in the outcome of the case, but is simply looking to profit from it. Although solicitors are specifically prohibited from taking a share in the proceeds of their client’s litigation, others may now do so. In the past year this type of funding has been given the blessing of the legal establishment in the form of the Civil Justice Council’s Recommendations, in its grandly entitled: “Improved Access to Justice – Funding Options and Proportionate Costs: the future funding and litigation alternative funding structures” June 2007 Recommendations”: “Recommendation 3 – Properly regulated Third Party Funding should be recognised as an acceptable option for mainstream litigation. Rules of Court should be developed to ensure effective controls over the conduct of litigation where third parties provide the funding”.

The fact that someone can contract for a share in the proceeds of litigation is something of a novelty in the litigation market in England & Wales because until 1967 it was a criminal offence in this jurisdiction to “aid a party to bring or defend a claim without just cause or excuse”. This was known as ‘maintenance’ and was regularly descried by the courts as “improperly stirring up litigation and strife” or “Officious and wanton intermeddling”.

If the aid was given in exchange for a promise of a share of the proceeds of litigation, this was called ‘champerty’ and has been condemned by the English courts since 1219 and was still being condemned as recently as 1994 on the basis that there was never a just cause or excuse for champertous maintenance. A quote from Lord Denning in Re Trepca Mining from the early 1960s gives just one example of the risks the judiciary feared: “The reason why the common law condemns champerty is because of the abuses to which it may give rise. The common law fears that the champertous maintainer might be tempted, for his own personal gain, to inflame the damages, to suppress evidence, or even to suborn witnesses. These fears may be exaggerated; but, be that so or not, the law for centuries has declared champerty to be unlawful”.
Even after criminality was abolished a champertous agreement remained unenforceable on public policy grounds.

In the past 10 years however attitudes have been changing; the English court has recognised that the provision of funds by third parties can help to achieve access to justice and the perceived risks of officious intermeddling can be kept in check by responsible legal representation and active court management of cases. Other parties to the litigation can be protected by making the third party funder liable for adverse costs orders. From the provision of funds to pay a security of costs order (in Faryab v Smyth) to payment of experts (in Factortame & ors (2002) and Arkin v Borchard Lines (2005)) the courts have been refusing to rule that agreements for funders to share in litigation as champertous.

It is now possible to say that a commercial arrangement by which an otherwise disinterested third party provides funding to enable a civil claim to be brought in return for a share of the spoils is not necessarily going to offend the principles of champerty.

This has prompted a very rapid growth in a new market for third party funding of litigation. There are still only a handful of players in this market in this jurisdiction: some have come from jurisdictions such as Germany where they have traditionally had no issue with principles of champerty; others are hedge funds, funds set up specifically to invest in litigation. There are also a number of brokers, some of which have been in the business of finding insurance to cover litigation costs and are now moving into the field of finding investors in litigation, tapping into the ‘spare’ funds held by HNWI and Family Offices.

The novelty is that litigation is now regarded as an investment. Litigation that your average company might regard as an unacceptable risk is attractive to hedge funds because its return is entirely uncorrelated to the other risks that they hold. They see large returns to be made. In such a nascent market, it is too early to talk of standard terms or even standard structures. One thing to be clear on though is that we are definitely not talking about a loan – the funding is, absent any breach of warrant, non-recourse.

Generally, the third party funder contracts directly with the claimant and agrees to pay all the claimant’s legal fees including expenses, experts fees, counsel’s fees, etc and usually any adverse costs orders made against the claimant in the event the claim fails or indeed as the claim proceeds. In return for taking on this liability the third party funder will be given a share of any winnings. The share required in return varies and commonly is stepped according to the time it takes to achieve the winnings. Typically it is between 40% – 60% of the damages awarded. So in return for agreeing to give away a large proportion of their damages the claimant can obtain complete protection against costs and effectively cap the downside risk.

Not every case will be of interest to the funder. Some are only interested in cases likely to recover millions of pounds – others will look at smaller cases. Typically they are all looking for cases with good prospects of recovery which will generally be assessed by reference to similar factors: good merits (as judged by the client’s lawyers); a substantial sum to be recovered in relation to the costs to be covered; a defendant that is good for the money; not too many risk factors; and some prospect of quick recovery.

It is early days for this market. The exact point at which the public policy of preventing ‘officious intermeddling’ will override the public interest of facilitating access to justice has yet to be established. How much control will the courts allow a third party funder to take? On the one hand we have a retired judge on record expressing the opinion that those who pay the bill, should expect to have a say in how the money is spent. On the other, we have concerns expressed about the lack of court control, the lack of any requirement to disclose the funder’s involvement In one case last year, Franses v Al Assad, the judge expressed concern about a party’s legal representatives failure to draw the court’s attention to the fact that information about another party’s financial affairs obtained by the third party funder had almost certainly be obtained by unlawful means.

Will the third party funders encourage litigation to be brought which would not otherwise be brought? In Franses v Assad  the applicant was compelled to make clear that the litigant was instructing the solicitors to bring the application before the court and not the third party funder. A high profile case being funded by a key player in the market was recently struck out by the Court of Appeal and an appeal to the House of Lords is anticipated. If that appeal fails it will be interesting to see how the market reacts.

Of particularly concern is that fact that there is no regulatory scheme applicable directly to litigation funders. What if their funds run out? Moves are afoot to put forward a self-regulatory code of conduct.

If the altruistic funders of the type that Neil Hamilton attracted could be classed the “white knights” of litigation then third party funders might be compared to an entire mercenary army backing up your pursuit of justice. Like a mercenary army, they will turn out for the promise of a good pay day and potential victory. And like mercenaries, they are essentially disinterested parties. Their interest is in the profit they can gain and not in any other outcome that the litigant may be interested in, such as vindication, exoneration, apologies, retribution, or simply establishing the truth.

Having said that, if you have a clear case on liability, an ultimate defendant still in possession of the money but the route to the money requires an expenditure which you would rather not or cannot afford then there is at least a possibility of trading a part of your hoped-for winnings in return for the funding of your legal costs. That is something worth considering before dismissing a claim as uneconomical to pursue.


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