Out-Law Analysis 4 min. read
16 Mar 2022, 10:58 am
Third-party funding (also known as litigation funding) has matured over the last few years to the extent that it is now a common funding mechanism for dispute resolution around the world, particularly in the field of infrastructure and energy sector disputes.
Due to the unique nature of third-party funding as non-recourse finance, whereby a losing client has nothing to pay, it has come to be seen not only as an opportunity to pursue claims when cash-flow is at a premium but as a risk management tool for sophisticated businesses, and more recently a significant source of capital for companies with a range of legal claims.
The increased use and availability of third-party funding may indeed be one reason for an observed uptick in disputes during the past year, along with underlying causes such as Covid-19 and its impact on the supply chain.
There is also a trend for a move away from single case funding, with claims increasingly being used as an asset to release funding to defend other claims – or to finance other parts of the business.
Funders have traditionally financed single claims, but unless a case has around a 60% chance of success, funders will not take a risk on funding that claim alone. Additionally, if the quantum is low, the economics of the funding may not stack up on a single case basis.
In response, a solution which is now gathering momentum in the construction industry is portfolio funding. A contractor’s portfolio of claims can be monetised to fund the cost of several disputes –for example four or five large arbitrations or 25 low-value debt claims.
Head of Construction & Energy, Augusta Ventures
In a portfolio we look to offer the client capital in addition to the raw cost of the claims – it can be a simple source of cash for a business
Portfolio funding is more attractive for the funder, as it cross-collateralises risk across multiple potential outcomes. The funder is more likely to receive a return, cover its outlay and make a profit, whilst the company takes the benefit of improved cashflow and reduced risk.
The portfolio funding approach also enables a company to deploy funds on disputes where it is a defendant, provided the funder is satisfied it will make a return on its investment from the proceeds of claims in the wider portfolio).
“In a portfolio we look to offer the client capital in addition to the raw cost of the claims – it can be a simple source of cash for a business,” said Andrew Roberts of Augusta Ventures. Accessing additional capital is more viable in a portfolio context where there are multiple claims, Roberts explained, because the funding is lower-risk and therefore less expensive.
For construction companies this means portfolio funding can be a holistic solution for all legal disputes on a particular project, even if some will not result in proceeds for the funder. It also means the scope of funding can be expanded to cover other expenditure, such as working capital.
Third-party funders offering portfolio funding will value the claims and decide how much they can put at risk against that portfolio ‘asset’. The funder’s share of any proceeds will be relative to the amount they contribute and time it takes to recover. If a contractor is prepared to give the funder a bigger share at the end, they can take more capital at the beginning.
Companies are more rapidly viewing third-party funding as a commercial risk management tool which allows them to take legal costs off their balance sheet.
On a practical level, the steps involved in obtaining funding include first, an anonymised general discussion about a case. Once a funder has indicated that the case has funding potential, the client enters into a non-disclosure agreement to protect legal privilege in information that would be shared with the funder.
Companies are more rapidly viewing third-party funding as a commercial risk management tool which allows them to take legal costs off their balance sheet
The funder will then review a legal opinion from the lawyers, covering the key facts and legal issues of the dispute, quantum, and an indicative budget for conducting the claim. If the claim meets the funder’s criteria – generally, whether it has a good chance of success and whether both the client and funder will be happy with the prospective financial return – the funding will be agreed in principle.
The funder then carries out legal diligence on the claim. The lawyers may at this stage be required to provide additional information or clarification on certain issues, including preliminary reports on quantum and detailed budgets.
Once the claim has also been approved by the funder’s investment committee, a funding agreement can be executed and funds released.
Clients may have to (or choose to) disclose the fact that they have taken third-party funding during the running of a case. For example, the new International Chamber of Commerce arbitration rules require disclosure, as do the new DIAC Rules, and cases before the High Court of England and Wales. This can send a strong signal to the other side, since the fact of funding is indicative of a case with good prospects of success and one that has been independently reviewed.
Those unfamiliar with third-party funding may have concerns about the funder’s level of involvement in the case. However, the funder treats the claim as a contingent asset and does not exercise any control over the law firm’s practical management of a case, although it will track spending and monitor key updates.
The funder will know and trust the legal team involved. While a funder will generally prefer that a claim settles amicably, it leaves it up to the lawyers to provide advice to the client on strategic decisions.
Regular reports to the funder on the progress of the case is not an onerous requirement for the lawyers, so long as communication between the two is effective and collaborative. It can be useful for clients to have another sounding board in maintaining a sensible and commercial approach to the dispute.
Co-written by Seema Bono of Pinsent Masons.
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