An asset preservation order in respect of a dispute between litigation funders Therium and OmniBridgeway and their funded client, Bugsby, has caused some heated debate. Bugsby, it appears is seeking to argue that the funders’ litigation funding agreement is no longer valid in light of PACCARand as such they have no entitlement to recovered proceeds. As was common in many funding agreements, the funders’ return seemingly included both a multiple and/or percentage-based calculation, the latter creating the PACCAR issue in this instance.
This case is the first of potentially many to arise in light of PACCAR. It’s understood that the funding agreement entitled the funders to receive the amount they had funded multiplied by three, plus 5% of any damages in excess of £38 million. The dispute now centres on the implication of the percentage component. Essentially the question is, given PACCAR, whether the whole agreement becomes enforceable or the impact is limited to just removing the offending percentage clause, as Therium/Omni argue is more just.
Media reports suggest the underlying case for which funding was sought settled for £28m. Yet, according to Bugsby’s lawyers, the funders are seeking to claim rights to £36m. Without knowing the terms of the funding agreement or other specifics, it would be unlikely for a funder’s return entitlement to exceed the amount recovered, since there will ordinarily be a waterfall to determine how the proceeds will be distributed in circumstances where the damages recovered are insufficient to pay all stakeholders.
Therefore, assuming the argument is actually over the £28m damages recovered, and since the 5% success fee entitlement apparently only applies to damages in excess of £38m, the funding fee at stake is presumably limited to the multiple based calculation. Based on the description of a three times multiple, we can surmise the amount paid by the funders to finance the case must have been at least £9m (possibly higher if the three times multiple is inclusive of the principal paid). We’ll come back to that.
How are funders and funded parties responding post-PACCAR?
Post PACCAR, many funders with funding agreements in England and Wales which included a percentage component will have been scrambling to renegotiate. How successful those negotiations are will likely be determined by where the case is in its lifecycle and the current relationship between the parties.
Cases at an early stage should involve comparatively painless re-negotiations, since the parties are in a relatively equal state. The claimant will require the performance of the funder to finance the case to hopefully generate proceeds. All the original justifications for why they sought funding in the first place will still likely be apparent (lack of resources, concern about the litigation risks etc.).
At Erso Capital, we sit in a somewhat enviable position given we’re just entering our second fund and many of our investments relate to cases that are still in a relatively early stage. Accordingly, our exposure to PACCAR issues has been limited. For the avoidance of doubt, that’s more luck than judgment – we like other funders, didn’t see PACCAR coming.
There are several scenarios where PACCAR becomes more problematic, and likely more contentious between parties:
- Cases where there has been a materially positive development e.g., mediation, settlement offers have been made by the defendant to the claimant, such that the claimant is buoyed by the likelihood of a positive outcome/imminent settlement.
- Matters which have been fully litigated and are pending a judgment/award.
- Scenarios like Bugsby where the settlement has already taken place but proceeds not yet distributed.
In scenario i), one can well imagine negotiations occurring for larger than normal haircuts to the funder’s return ahead of a mediation or settlement negotiations. Scenario ii) is trickier, since the case could still lose, but very little further funding maybe necessary, if any, should the award prevail. So while the funder would like to renegotiate the agreement to bring certainty, the claimant will wish to keep their powder dry until the award is handed down. If the case loses, then they won’t likely question the enforceability of the agreement (especially is there is an adverse costs indemnity). If it wins they’ll potentially raise PACCAR. Finally, scenario iii) is arguably the hardest of all to reconcile in the current state. In many instances the funder/claimant relationship is a one-off arrangement with no go-forward business interest between the parties. This heightens the risk of each becoming entrenched to protect their position in order to maximise any possible leverage.
Are funders the bad guys here?
Most can at least understand the sentiment that PACCAR could potentially be seen as creating a windfall scenario for a claimant. The funders have borne the risk on the capital, financed the case and are ultimately at risk of losing everything, despite having enabled a successful outcome for their counter-party. Iit’s easy to vilify a litigation funder: aren’t they are essentially sharks, earning huge returns on their capital? Alas, that’s often far from reality. As the funding market has matured, the underlying capital has become increasingly institutionalised, so the greedy shark caricature is increasingly being mis-directed at all mainstream investors, including all of us via our pension funds.
But let’s step back. Assume it’s correct that in Busgby the funders had invested at least £9m into the case. They obviously stood to lose that investment had the case lost. Bugsby is a commercial entity. When it negotiated with the funders at the outset of the case, they were obviously doing so either from a position of need or choice. That is, they either couldn’t self-fund and take on that kind of litigation cost risk or they commercially chose not to.
Negotiation of a funders’ return is not generally a complicated financial arrangement for most commercial counterparties. The funder’s return is normally incredibly straightforward : a multiple on the amount actually invested by the funder, a percentage of the amount awarded, or some combination of the two, as appears to be the case in Bugsby.
Those rushing to vilify the funders may have overlooked a key point here. According to press reports, the Bugsby case was originally pleaded for £366m. That is, when the parties were negotiating the terms of the LFA, they were doing so in the expectation of the case being worth damages in the hundreds of millions. It seemingly therefore settled for circa 1/13th of its original value. At the outset of negotiations, the funders’ multiple probably didn’t seem unreasonable, but the claimant may now think differently given is insufficient to clear the funder’s multiple in the waterfall. If the worst case for a claimant is a complete loss, the second-to-worst case scenario is that.Arguably there is no difference in those two outcomes from the claimant’s perspective, but at least in the low settlement scenario the claimant has a chance of negotiating something with the funder (i.e., the funder agrees to some haircut in their multiple to allow the claimant to recover something out of the award).
Whilst the settlement amount is less than 1/13th of the original amount pleaded, it’s probably safe to assume the amount the funder committed under its LFA was not 1/13th of the total commitment amount. It’s understood in fact that Busby was in fact only awarded £15m at first instance, resulting in both sides appealing, before the defendant ultimately settled for £28m. It’s therefore highly likely that the full original funding commitment was deployed, if not more (e.g., given the cost of an appeal preparation, possible budget overruns etc.).
The irony of the PACCAR decision
And here’s the irony of the implication of the PACCAR decision. In removing the percentage-based option from the funder’s toolkit, it has in fact amplified the risks of the Bugbsy scenario occurring. The multiplier return for the funder is a somewhat blunt instrument, it’s there to protect the funder’s return in the very scenario that materialised in Bubgsy, where the quantum value in the case is decimated. It’s highly unlikely that any funder would enter into an LFA transaction if they genuinely thought their success fee multiplier wouldexceed the likely damages award/settlement amount. It’s typically there as a floor protection. Funders want a claimant to be motivated when bringing their case and to feel engaged commercially e.g., help control costs where possible and have a commercial view towards settlement.
Assume in Bugsbythe multiplier didn’t exist, and the funders’ entitlement was instead a flat percentage of, say, 45% of the damages awarded. In terms of the waterfall, the Claimant would at least be entitled to the lion’s share of the available damages (i.e. £15.4m assuming they keep 55% of £28m) . However, were the settlement say, £200m, the funders might now be achieving a circa 10 times return on its investment of £9m, and the greedy funder argument would be made again. A funder’s multiple, whilst a blunt instrument, is at least capped whereas a percentage is not. On a simplistic level, as a claimant, if your case does particularly well, you’ll likely prefer a multiple, whereas if the case achieves a low-end recovery, then you’ll likely have preferred a percentage calculation with the application of hindsight.
Those championing PACCAR might ultimately be precipitating more situations like Bugsby, since funders may need to apply multipliers as standard and potentially at a higher level, in some scenarios, to reflect the fact they can no longer share the fortunes in the particularly high recovery scenarios. The difficulty with high multiples, other than the risk the claimant doesn’t achieve any recovery at all, is that it reduces the settlement potential for a dispute, since the claimant needs to clear an ever-increasing damages hurdle in order to walk away with some recovery. This can only lead to more cases going to trial than is necessary, which isn’t in any parties’ interest. With legal budgets themselves only getting higher, that issue is compounding further with costs inflation.
The reality for funders
Bugsby/PACCAR aside, a general reality for most funders is this: cases will typically take longer than expected to resolve, budgets will often overrun (creating top-up requests), damages will often be lower than expected and a far greater than expected volume of cases will ultimately progress to trial. The upshot is that making money in the funding market is far from certain. Scratch below the surface and you’ll see countless funder casualties. Funders aren’t immune from the wider economic impacts either. Once upon a time investor prospectuses would laud the ability to achieve “uncorrelated returns” but in today’s climate, the impact of rising interest rates has created challenges. Investors can now achieve high bond returns from more “traditional” investments with the rising interest rates. 24 months ago, there appeared to be a new funder launch monthly. Now the media reports are littered with disputes surrounding funders, funders closing shop or selling their entire asset positions – hardly markers of a market awash with fantastical returns.
In summary therefore, while we accept our view will be regarded as self-interested, our comments should highlight that issues involved are more nuanced than the headlines might suggest. A market without funders is unlikely to be a good market for claimants, claimant lawyers or even defendant litigation lawyers. Unfortunate economic outcomes like Bugsby will materialise; such is the nature of the economic risks in litigation, but that shouldn’t automatically lead to calls that the market is broken and needs immediate regulation. Judicial intervention through PACCAR has just made things more inflexible; so arguably the market does not need more rigidity right now.