This article was prepared for and first featured on the Finance Director Website in December 2010
The market for Third Party Funding in the litigation world, albeit still in its infancy, has been relatively quickly established in the UK. It represents a unique and exciting area of commercial legal practice where business, law and finance interact at a critical time in the development of legal services. Finance Directors of pan-European companies should take note of these recent developments to stay ahead of the game and appreciate how alternative ways to fund litigation can help their business.
What is Third Party Funding?
Until recently the funding of litigation by third parties with no interest in the dispute had been characterised as ‘maintenance’ and ‘champerty’, principles traditionally viewed as unlawful. However the approach of the Courts has changed substantially from this. Third Party Funding (‘TPF’) is the provision of funds by individuals or companies who have no other connection with the piece of litigation. A funder may provide the full legal costs of the proceedings, part fund, or fund only disbursements and in return would expect to make a financial profit from their investment, with profits calculable in a number of different ways. Harbour Litigation Funding, Calnius Capital and Allianz Litigation Funding are just a few of the leading players in the burgeoning UK TPF market. Juridica Capital Management (‘Juridicia’) is the leader in the U.S.
Although in its infancy and thus too early for European Union (‘EU’), and specifically UK, institutional investors to begin looking at litigation funding, the potential return on investments is incredibly strong within this arena referred to as ‘a completely uncorrelated class’ and ‘one of the most fashionable alternative investments’. Although a complicated, and potentially risky, form of investment at present, its future and strength will ultimately depend on the key players who choose to back it in the coming years. The main considerations to take into account are the prospects of success and the inherent risks involved balanced against the potential investment to be made. Financial institutions are now taking note of these legal developments and expressing an interest as to how their companies can become involved.
The Future of Third Party Funding
Juridica announced at the beginning of 2010 its serious intentions about the UK’s TPF market and earmarked $50 million for local projects, largely as a result of multinational law firm clients who had made the company aware of UK possibilities. Europe, and specifically the UK, is now an attractive marketplace.
In line with the collective redress actions (class and representative actions) currently being proposed and enacted throughout Europe (in particular Italy, Poland and Belgium), private litigation funding has become an extremely topical and live issue within the EU. If regulated properly, effectively and efficiently at an EU level, TPF has the capability of pursuing and arguably attaining the pan-European goal of promoting access to justice for all.
There are four crucial areas for development if the industry is to survive, prosper and achieve the above:
- First, it needs a growing profile within the legal profession. The report identifies that the success or otherwise of third party funding will depend upon the extent to which it is embraced by the legal profession;
- Second, and perhaps more important, it needs a growing profile within the financial community. Whilst there has been plenty of discussion about third party funding emerging as a new asset class, investors have yet to be convinced that it will provide the desired returns even in today’s depressed markets in which many of the traditional forms of investment have failed to deliver. Finance Directors of pan-European companies are in a position to make a real impact here, to diversify their business operations and widen the remit of investments made;
- Third, it remains to be seen how the expected regime of voluntary self-regulation will cope with the three factors identified by Lord Justice Jackson in his report on litigation costs as being vital issues for third party funding. These issues are:
(a) establishing an acceptable voluntary code for third party funders to deal with such matters as capital adequacy the need for funders to have sufficient capital in order to meet their obligations if a case is lost, and the circumstances in which funders can withdraw from cases;
(b) revisiting the question as to whether there should be statutory regulation of third party funders by the Financial Services Authority when the market expands; and
(c) whether the third party funder should be liable in unsuccessful cases to pay the whole of the winning party’s costs (rather than an amount limited to the level of its funding of its own losing party).
- Fourth, whilst third party funding has mostly been involved with commercial claims to date, its future will be governed in part by the extent to which it is capable of developing a different model with regard to consumer claims. This will be particularly interesting when combined with the alternative business systems which will be permitted from October 2011 by the Legal Services Act.
In order to grow in the short term, third party funders would be well advised to increase their profile within the financial communities. In addition, funders could streamline their acceptance procedures, which often take a number of months. The market will also expand if funders adopt a less conservative attitude to investment. Understandably, in the early days it is crucial to prove the financial model to investors and demonstrate the returns which can be made. In time, once the model has been proved, if funders are prepared to relax their acceptance criteria (for example, by funding cases with a 60% chance of success rather than a 75% chance of success), they will be able to expand their portfolios substantially.