Third-party funding: making the right choices
Shopping around is essential is an increasingly competitive market, says Katie Armstrong
Today, the concept of third-party funding (TPF) is understood in basic terms by many, if not the majority of litigators. Most lawyers appreciate that there is a growing market of funders (both occasional and dedicated) willing to invest in cases in return for a share of the proceeds.
A small but rapidly expanding group of
lawyers have been through the process of applying for and arranging funding. In less than a decade, we have gone from theoretical idea to a global market, within which the UK legal sector plays
an influential role.
Unlocking assets
TPF is quite simply a commercial arrangement where the objective of the funder is to obtain a return on their investment risk from successful litigation and arbitration cases. Some funders describe legal claims as 'assets', a term that still divides opinion despite a growing acceptance
that TPF helps unlock income contingent on the success of the claim.
Litigation funders stand as professional investors that offer to fund both the solicitor's legal fees and disbursements on an ongoing basis to pursue a claim, in exchange for a 'success fee' that will be deducted from the proceeds collected (usually damages following an award or settlement out
of court).
The return a litigation funder will seek is usually either (a) a multiple of the amount invested, (b) a percentage of the damages recovered, or (c) some combination of (a) and (b).
The funder will assess the prospects of success, the value, the enforcement potential and estimated timescale before setting a price. Typically the funding arrangement will be staged so, if the case resolves early, a lower success fee will be payable.
A staged success fee reflects the reduced amount of legal costs funded (and time the funder's money is out for). The importance of the cost of that time is an often underestimated factor.
Risky business
The TPF structure will finance the legal costs of a claim on a non-recourse basis (as opposed to a loan) where the funder's only recourse is against the 'proceeds' of the litigation. If the case is unsuccessful, the funder loses their investment.
Any adverse costs will usually be covered by adverse cost insurance (or 'after the event' (ATE)insurance). If not, such costs would be the responsibility of the funder under the terms of
the litigation funding agreement.
The non-recourse nature of the investment is the key to TPF's popularity. It means that impecunious parties are able to access the product because they are not liable to pay anything other than a fee payable solely from the litigation proceeds. However, the fact that there is no need for any collateral (as would be required by a debt facility) explains why the cost of funding is, more often than not, a multiple of the amount invested.
The funders face a high risk that they will lose their money. Such a business model necessitates detailed due diligence prior to the investment being made, with funders routinely spending several weeks and often tens of thousands of pounds in due diligence.
This is why when a funder invests in a case it should speak volumes about the merits of that. After all, an independent commercial enterprise has decided to support the case following a thorough due diligence process.
Attractive alternative
The majority of the funders operating in this market are focused on investing in a small
number of claims (five to 25) per year. They
invest predominantly in large value commercial disputes, where the claim value runs to millions, tens of millions or hundreds of millions.
TPF is most suited to high-value claims against well-resourced opponents where the client does not have sufficient funds to bring the claim. Historically, there has been limited overlap between the worlds of CFAs and TPF.
Huge disputes, especially when in the hands
of large conservative law firms, can carry such significant legal fees that firms simply would not
be willing or able to carry that kind of contingent work-in-progress risk on anything other than
a lightly discounted CFA.
As such, TPF has an important role to play in providing a viable method of funding for very large disputes where it would be difficult to find any law firm to take that level of risk.
It is sometimes speculated that in the new
costs regime, where CFA uplifts are no longer recoverable making CFAs less attractive, people would turn to TPF as an alternative.
This seems unlikely. If we assume that a funder may charge a success fee of several times its investment (say, two to three times), while a lawyer on a CFA can charge a success of up to 100 per cent of base fees, it would still seem more attractive in most cases to use a CFA where possible.
What does ring true is that CFAs and TPF work in harmony on larger cases. A CFA is only ever a partial solution, at best dealing with fees but leaving a gap in the funding of disbursements or more likely only covering a percentage of the fees. This means that the funder still has an important role to play to make the case viable.
Smaller cases
In reality, it is rarely a binary choice between a
CFA or TPF. Many cases simply will not carry the damages potential to make TPF work, whereas a CFA may be just about economic.
When considering a potential opportunity,
a funder will start by considering (on a highly conservative basis) how much the case is
probably worth, in conjunction with the cost
to get the case to trial.
It is an essential element of the funder's assessment to determine whether they can receive a commercially viable return while leaving the claimant with the majority of their proceeds. The costs-to-damages ratio has to be right for a funder to take things forward. Most funders look for a minimum ratio of 1:4.
How then could you approach a case where
the ratio is not enough for a funder? The answer could be partial funding and with some >>
>> ATE insurance cover. Key to containing the overall cost of funding is to keep the level of the funder's investment as low as possible using insurance on the basis that an ATE insurance premium is far cheaper than a funder's success fee.
As such, if a claimant can contribute, say,
30 per cent of the overall budgeted legal costs, these costs could be insured in the event of a loss. This means that the claimant will get their money
back if they lose.
A small sector of the market is establishing
new methodologies for funding smaller cases - effectively by building volume accounts. The lower-value cases tend to settle quicker and more frequently than large cases.
Some funders recognise that funding a lot
of matters at the lower end, with law firms holding good track records, should mean they can afford to charge lower prices than traditional TPF. It
will be interesting to see how this side of the
market develops.
Market growth
Lawyers instructed to seek out external financing options had limited choice when the market for professional TPF started. TPF was hard to obtain
at all. Where it was offered, it would be expensive, often prohibitively so.
The funders were almost exclusively occupied with chasing down massive damages claims in the hands of the impecunious. It was even said that on one occasion a funding arrangement had produced enough of a return for the funder that the principal behind the fund was able to retire to the Hamptons. Much has changed.
Legitimised by Sir Rupert Jackson's review
of civil litigation costs and assisted by various court authorities, TPF has established itself in the mainstream consciousness of the legal community, proving to be a viable and important option to consider when advising clients about litigation costs.
Practical experience has been key to understanding the essentials of a product about which many were previously apprehensive. Media reporting of examples of TPF in live cases (both successful and unsuccessful) has emphasised the existence of a number of reputable funders in the market and built confidence among law firms.
Creative solutions?
Lawyers are routinely and proactively seeking new creative ways to help clients fund their cases and are embracing the flexibility of the product whether the client is insolvent or a cash-rich
FTSE company.
There are now about 20 TPFs operating in the UK, plus countless more internationally including in the US, Australia, Canada, France, Holland and Germany. The market is much more competitive and funding is more accessible than ever.
Many funding arrangements are structured in a very similar away, however, unlike debt-based lending in other areas of asset financing, a modest difference between success fee multiples or percentages can translate into a swing of many millions in terms of the claimant's net recovery.
Therefore, it becomes a vital stage in
the process of obtaining funding to shop
around and to consider multiple funding
offers. This in turn will inevitably ensure that
the eventual arrangement is as cost-effective
as possible and most suited for your client's specific requirements. SJ
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TPF APPLICATIONS: CHECKLIST FOR LAWYERS Consider the suitability of the case
Consider the economics of a potential funding arrangement
Case presentation
Which funders are the right fit for the case? Shop around
Managing timescales
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Katie Armstrong is an associate at TheJudge