Third Party Funding: Freeing claims and adding value

While there are those that consider TPF encourages unmeritorious claims, others argue that it provides access to justice for claims with a good chance of success that would otherwise be denied a legal remedy on account of a parties´ financial inability to pursue legitimate legal action. 

It may also provide a means to convert what would otherwise be an accounting expense that reduces operating profits into free cash and therefore a real receivable on the asset side of a balance sheet. TPF pays the costs of litigation or arbitration, increasing the profitability of the company, which can then allocate cash to other projects. 

A positive evaluation by an independent third party investor may provide senior management with added comfort and confidence in determining whether to pursue a claim. 

In this article the authors intend to demystify this complex area by providing a 14-point guide to TPF:   

1. What are TPF agreements?

Seen primarily as being of Anglo-Saxon or Common Law derivation, TPF agreements are being used more and more throughout the world. They are not new. In fact, they have been in existence since the early 1990s. While they were used originally more in litigation proceedings, they are increasingly common in both commercial and investment arbitration. 

Essentially, TPF agreements involve a third party investor with no connection to the dispute covering part or the full cost of the legal and ancillary expenses, such as expert fees, of litigation or arbitration. They do so after carefully evaluating the merits of each case. In return, if successful, the third party funder takes a percentage of the final amount awarded to the funded party and/or a multiple of the amount invested by the third party funder.

2. What kind of claim is covered by TPF agreements?

Many different kinds of claims can be covered by a TPF agreement. TPF agreements have been entered in a wide variety of disputes, including breach of contract claims, trust claims, insolvency and fraud related claims, professional liability claims, intellectual property and patent infringement, business defamations, shareholder/company disputes, tax disputes, anti-trust/competition claims, class actions, and investor-State and commercial arbitration.

3. When is it appropriate to use a TPF agreement?

Most typically, TPF can used in the following situations:

• The claimant has been so damaged by the defendant that they cannot afford the litigation/arbitration process.

• The claimant is solvent and could potentially afford the litigation expenses, but it wants to focus on running its business and avoid wasting its time and resources in the litigation/arbitration process.

• The claimant would like to generate cash quickly and is willing to sell the rights to the claim for a lump sum.

• The claimant is insolvent and may have neither the money nor the ability to pursue a claim.

4. Who can benefit from TPF agreements?

The claimant can be either an individual or a company. Although TPF is primarily aimed at claimants, it may be also available to respondents in funding a counter-claim and/or defending a claim.

5. Are TPF agreements legal?

This depends on the law and professional regulations of each jurisdiction. For many, until relatively recently, it was not possible for a third party without an interest in the proceedings to fund or invest in the same proceedings. 

In order to promote increased access to justice, the law and professional rules have now changed in many jurisdictions to allow this. It is important to have a clear understanding of what is permissible. In Spain, TPF is considered legal and more and more clients are becoming aware of its advantages. 

6. Are only parties with limited or no finance eligible?

No. Increasingly, even well-funded or solvent parties are considering TPF as a means of spreading or "hedging" the cost and risk of litigation or arbitration. 

7. What is the cost?

There is no cost associated for third party funding. Indeed, even the cost of negotiating the terms of a third party agreement may be recoverable. Hence, it is common to refer to such agreements as "No win, no fee" agreements.

8. What do the funders receive?

Much will depend on the complexity and level of risk associated with the dispute. The greater the uncertainty, the greater risk. The greater the risk, the greater the level of potential recovery for the third party funder. 

Typically, where a third party funder is operating on a on a contingency basis they might expect to recover 25-50% of the final amount awarded. Where a third party funder is operating on a multiplier basis, then a recover in the event of a successful outcome might be a multiple of 5-10 times the level of the investment plus the return of the original investment. 

Under exceptional circumstances, it is even possible to recover the TPF costs.

9. Who controls the proceedings?

This has been a somewhat controversial area in recent times with many questioning the role of the third party funder in managing the proceedings and determining and driving strategy. In practice, it is the party and its counsel, working in close consultation with the third party funder that retains control of the proceedings, including in relation to settlement negotiations. 

10. Who are the funders and where are they located?

They are now many more funds available to clients beyond the original specialist litigation funders. They are located all over the globe, but mainly in North America, Europe and, to a lesser extent, the Asia-Pacific region.

While there may be common characteristics and requirements between the third party funders, they also vary considerably. It is vitally important to ensure the best deal that the third party funders are properly identified and engaged with. Much will depend on the expertise, standing and credibility of the legal team presenting the opportunity to the third party funder. 

11. What factors do the funders take in considering a claim?

The key considerations that third party funders take into account when considering a claim, include:

• Is the claim a commercial dispute?

• The amount of the dispute

• The solvency of the defendant. Is the defendant creditworthy?

• The complexity of the dispute

• The probability of winning the claim. Are the legal merits good?

• The costs estimate

• The ratio of claim value to costs

• The experience of the legal team

• The jurisdiction of the dispute

• The feasibility of enforcement

• The procedural timetable 

12. What is the process to obtain funding?

Generally, the first step is for the legal team will need to prepare a detailed proposal setting out the background to case, the merits of the claim (including jurisdiction, liability and quantum), and an outline estimate of costs.

Next, a list of potential third party funders will need to be identified, with or without the assistance of a TPF broker. The prospective third funders will enter into a non-disclosure agreement and undertake an initial review of the claim, with the input of their own in-house or external counsel and other advisers. If interested, the third party funder may provide outline terms of business. 

A short list of prospective third party funders is then prepared with a few to refining the outline terms of funding. Once a third party funder is selected, detailed negotiations are undertaken and the funding agreement is finalized. The whole process can take from a matter of a few weeks to up to six months.   

13. Is funding also available to enforce a judgment or an award?

Yes.  As these are separate proceedings to the main merits proceedings, this will generally need to be negotiated separately. The easier the likelihood of a successful enforcement, the more preferential are likely to be the terms of the TPF agreement.

14. Are there other products available to fund proceedings?

Yes. There are a number of insurance products both before and after the event, as well in relation to the enforcement of judgments and awards.

The rise of TPF is nothing short of revolutionary. It has transformed the legal landscape. What was for centenaries impermissible in almost all jurisdictions is now a thriving in many parts of the world and providing greater access to justice. 

The ever increasing cost of contentious proceedings is a perennial problem that clients across the globe struggle to deal with. TPF provides an effective means of address. However, knowing who the main players are in the TPF market, how best to negotiate such agreements and understanding the potential pitfalls to avoid are all factors that any party and its advisers will need to be well aware of in order to make the most of the opportunities offered by TPF.  

In our view, the scope for the use of TPF remains relatively untapped. In many parts of the world, such arrangements remain at the very least unaccepted or completely prohibited. This would seem to give a competitive advantage to those parties that may be able access such a resource over those parties that that not able to. Such a situation of inequality does not seem sustainable. We anticipate further expansion of the use of TPF and for barriers to its use to come down as parties and their counsel have a better understanding of the options available to them.

INTERNATIONAL ARBITRATION NEWSLETTER - APRIL 2018