There is a new and burgeoning market of specialist funding companies offering money and expertise to help businesses large and small unlock the value tied up in their legal disputes.  These funders are known as Third Party Funders (TPF) and they will pay for expensive legal costs on behalf of an entity or individual pursuing a commercial claim in the courts or via an arbitral tribunal in return for a share of the proceeds of the action.  The funders will enter into a Litigation Funding Agreement (LFA) in order to provide the funds and the critical feature of these agreements is that the funding is non-recourse.  If the funded party asserting their claim with the funders backing is unable to make a recovery from their adversary, the Third Party Funder will lose their investment in the case.

Specialist litigation funders and their investors view the claims that companies and individuals have (whether flowing from the breach of a contractual obligation, a tortious wrong doing or any other cause of action) as an asset, albeit one that has not manifested itself unless and until there is a settlement with the opponent or an enforceable judgement is delivered.  It is that uncertainty which has allowed TPF to develop because the funders are not only offering liquidity but importantly they are also accepting risk.  Traditional lenders may recognise the value in pursuing a legal dispute to produce a return but they have been reluctant to lend against litigation proceeds as a security for the loan because of the inherent risks in legal proceedings.  Third Party Funders are set up to cope with taking such risk, thereby providing businesses an opportunity to outsource the expense of litigation in the absence of solutions emanating from banks and traditional lenders.

Third Party Funders set their pricing to accommodate the risk of receiving a lower than expected investment return or worse still losing the amount of capital they deployed in the case.  To understand the pricing, it is important to consider the numerous risks they are assuming when agreeing to fund legal costs under an LFA, which include:

  • The claimant fails to obtain a successful settlement or judgement, which would include a discontinuance of the claim following negative advice from the legal team or unexpected adverse developments.
  • The judgement awarded is for a sum that is lower than expected
  • The prospect that despite obtaining a valid judgement, the claimant’s award is not enforceable.  This may arise because the opponent has insufficient funds to pay or has moved assets to less favourable jurisdictions.
  • The possibility that the case will take longer than anticipated to reach recovery, particularly because of appeals, applications for split trials, unexpected interim hearings or enforcement proceedings.
  • The increased cost of funding generated by orders for security and cross-undertaking in damages are made by the court which leads to incurrence of “dead capital” because the money has to be put aside by the funder for the action to continue.
  • The risk of satellite or consequential litigation involving the Third Party Funder directly and potentially exposing them to the other side’s legal costs (adverse costs).
  • The significant (and often under-estimated) risk that a case may become uneconomic to pursue whilst the case is being funded for any of the reasons above and many more.

This list is by no means exhaustive and perhaps goes some way to explaining traditional lenders have left a gap for specialists to inhabit.  It will explain why the funders demand a multiplier return.  Typically, the cost of TPF is the higher of a percentage of the proceeds or an underpinning multiple of x3-4 of the amount of funds committed. 

In fact, there are dozens of different return structures that can be tailored to all manner of situations taking into account the variables between cases on the listed factors above.  It is a highly sophisticated product and with the help of the lawyers and specialist brokers, elegant solutions can be created to keep the funder’s fee proportionate to their risk.  The challenge for the Third Party Funding industry is not so much about price although increasing competition is driving prices down.  The real challenge it is to be recognised as a mainstream option to corporates with claims.

The concept of seeking third party capital to support the legal department into turning 180 degrees from being a cost centre into a profit generating centre, takes a progressive General Counsel, Financial Director or external legal adviser to recognise the contingent assets the firm could monetise with little or no cash drain from the business.  By using TPF, frozen legal budgets can stay frozen whilst legal dispute resolution can accelerate using the company’s preferred legal counsel.

Professional Third Party Funding is an international business, with funders based in common law and civil law countries.  It is an industry on the rise globally and no more so than in international commercial arbitrations and investor-state arbitrations.  However, Third Party Funding is not the only way for a corporate to employ outside capital assistance to realise a litigation asset.  There is also After the Event insurance (ATE).

ATE insurance is a highly sophisticated insurance product that can engineer support to Third Party Funding agreements (as well as operate in isolation).  Whilst ATE does not fund legal expenses as and when they are billed, the insurance does provide an indemnity for legal costs in the event the legal action is unsuccessful.  The policies act as a loss mitigation tool which can form the basis for companies to deploy their own capital if a Third Party Funding option is not desired or available.

ATE insurance developed in the UK and is being exported to other common law jurisdictions with increasing success, mainly because the product has historical covered adverse costs albeit it has been adapted to cover own side’s fees and disbursements over time.

An attractive feature of the ATE offering is that the payment terms for the ATE premium are usually deferred and contingent upon success, similar to the non-recourse nature of Third Party Funder’s payment terms.  However, the biggest attraction is that the premiums tend to be described as a fraction of the cover provided rather than as a multiplier – making it an cheap and efficient way for a business to transfer risk where the business is capable (and his willing) to fund the litigation themselves.

We are entering into a Golden Age for claimants who desire assistance from outside capital providers, whether via TPF or ATE.  Those in-house counsel who recognise the benefits have the chance to innovate and monetise their litigation assets in a way that does not detract from the quality of the legal services they engage. This article was published by Corporate Livewire.