Funding the fights

With litigation funders having established their own industry regulator and starting to move into arbitration cases, there are more reasons to believe that third-party funding is here in a big way

Leslie Perrin, chairman of litigation funder Calunius Capital, remembers the atmosphere in New York during the autumn of 2008 when he was attempting to raise money for Calunius’s inaugural litigation fund. Tumbleweed was rolling down Wall Street and Citigroup’s share price was plunging by the second. It was an inauspicious time for raising capital.

‘It was incredibly difficult as banks’ capital values were being annihilated. There was a definite sense that Armageddon was at hand,’ says Perrin. Four years on and Calunius now has a healthy £40m litigation fund and a portfolio of cases that makes it one of the premier third-party funders in the industry.

Perrin is also chairman of the Association of Litigation Funders of England and Wales (ALF), a body set up last year to bring greater credibility and transparency to the world of third-party funding. A key aspect of the ALF is its code of conduct, which was recommended by Lord Justice Jackson during his Civil Litigation Costs Review in 2009 and has strictly defined rules on capital adequacy, termination of funding and control of cases. In essence, it is designed to ensure that third-party funders commit to a case for its duration and do not seek to take control of the dispute or settlement negotiations.

‘Law firms won’t have the same adverse cost risk as
funders and won’t be subject to the same capital adequacy requirements.’
Annabel Thomas, Enyo Law

‘The Association will be increasingly important,’ says Woodsford Litigation Funding director Jonathan Barnes. ‘It brings some transparency to the market and helps identify the serious and reputable players, which benefits the sector and the Association’s members. Members must have their own capital so litigants and solicitors can be sure they are dealing with a funder and not a broker speculatively trying to put a deal together.’

What vexes ALF members most is the number of so-called litigation funders that actually have no money, but effectively act as broker between investors and the claimants seeking funding for their cases. Calunius itself acted as broker until it raised its first fund in December 2010, but Perrin says that it was open and transparent about what it was doing: ‘We were very clear that we were broking. That is sometimes not made clear.’

TheJudge is a prime example of a genuine broker that is in the business of helping claimants and their lawyers to find the most appropriate funder. With an increasing array of eager funders out there going after a relatively small sector of the dispute resolution market, TheJudge has found itself playing a pivotal role in getting claimants and solicitors in front of the right third-party funders. ‘One of the problems with third-party funding is understanding who has the appetite for what type of case. It is this initial level of knowledge that a broker can bring to the table,’ TheJudge director Matthew Amey comments. The funding community has evidently embraced TheJudge and it and ClaimTrading are currently the only broking members of the ALF.

 

Changing landscapes

With greater comfort and assurance provided by the ALF and code of conduct, funders still face an uncertain period leading into 2013. As part of Lord Justice Jackson’s civil justice reforms, contingency fees are to be introduced in April, enabling solicitors to earn their fees through damages-based agreements (DBAs) with clients. It raises the prospect of solicitors no longer requiring funding for specific cases, as they will have the opportunity of running a dispute and hoping to take a share of the damages. Furthermore, the liabilities and restrictions on funders appear to outweigh those felt by solicitors. Barnes explains: ‘Funders and lawyers will be doing exactly the same thing – facilitating claims that would otherwise wither on the vine. However, first, funders will bear an adverse costs risk and lawyers won’t. Second, funders will have capital adequacy tests far more stringent than any bank (post-crisis) and any after-the-event (ATE) insurance company. Lawyers won’t have any capital adequacy requirement.’

Even so, as a naturally conservative profession and with constant cash flow challenges, solicitors are unlikely to charge after the DBA market en masse and take on sizeable financial risks. Most firms are likely to favour partial DBAs with funders providing a key role in financing counsel fees, disbursements and insurance premiums, in return for a share of the damages or a multiple of their funding commitment.

Indeed lawyers, funders and insurance providers may well team up to exploit the DBA environment and share the risk accordingly. ‘There could be direct competition between solicitors and third-party funders,’ says Addleshaw Goddard Manchester partner John Gosling. ‘Solicitors acting under DBAs and third party funders will in theory be in competition for cases.  But not every law firm will be prepared to take the loss of cash flow and potential loss of their entire fee income on a major piece of commercial litigation run under a DBA.  I think firms will want to take slightly less risk. There may be some competition with third party funders, but on the bigger cases there will be roles for solicitors, funders and insurers.’

‘The ALF will be increasingly important. It brings
some transparency to the market.’
Jonathan Barnes, Woodsford

Annabel Thomas, a partner at boutique litigation firm Enyo Law, agrees: ‘Potentially, there’s going to be competition between law firms and funders. Law firms won’t have the same adverse cost risk as funders and won’t be subject to the same capital adequacy requirements. However, I do think there will opportunities for firms to team up with funders on DBAs.’

In essence, both solicitors and funders agree that firms are largely going to avoid taking on the entire risk of a DBA. ‘Third-party funding takes a set of skills and a portfolio approach because you can’t win every case. Solicitors could take that approach, but I don’t think they will want to take that risk,’ suggests Vannin Capital’s Nick Rowles-Davies.

The appetite for risk among solicitors is clearly meagre. When Addleshaw Goddard launched a new litigation funding solutions product called Contro£ in 2007, which was based on ATE insurance, conditional fee arrangements and third-party funding, it expected the rest of the market to do the same. ‘We expected everyone else to follow suit, but they didn’t,’ says London partner David Engel.

Evidently the legal profession in the UK is still slowly coming to terms with alternative fee arrangements and many firms are still ignorant of the options available to clients. One leading funder speaks of a firm that excitedly announced ‘innovative’ funding arrangements for clients this year, but on further examination it turned out it was actually just offering conditional fees on a no-win no-fee basis. It was not exactly novel.

Despite this evident ignorance of alternative funding arrangements, 2013 is poised to be a pivotal year in raising awareness of options such as third-party funding and the new contingency fee regime, with Jackson’s reforms set to become law.

Richard Fields is a US attorney and chairman of the board of directors of Juridica Capital Management, a litigation funder that was listed on the London Stock Exchange’s Alternative Investment Market (AIM) in 2007. He says that the longstanding presence of contingency fees in the US has allowed third-party funding to get greater traction than perhaps in the UK and other parts of the world. He explains that Juridica frequently funds cases involving major Fortune 500 companies that have very healthy balance sheets, because these organisations recognise that litigation can boost revenues and needn’t be a financial risk.

‘The UK model of third-party funding appears to be more about smaller companies seeking funding because they don’t have money,’ he says. ‘It’s not so much major companies looking to lay off risk. In the US, it is different because major companies have been using contingency fees for a long, long time.’

Antoinette Pincott, a partner and forensic accountant at StoneTurn Group, says that there is still a huge cultural difference between the US and the UK, which limits the potential demand for third-party funding: ‘In America, litigation is a business strategy as much as any strategy. We just don’t have that psychology here in the UK.’

However, UK solicitors are increasingly recognising that third-party funding no longer only applies to impecunious claimants and that it is increasingly recognised as a mechanism to drive forward claims that may otherwise be rejected by conservative boardrooms and in-house-counsel. Marc Keidan, a partner at Cooke, Young & Keidan, explains: ‘In-house counsel on the whole just don’t like the unpredictability and risks of litigation. They like to be able to report to the board and say “this is the potential upside and this is the potential downside, and here are the figures”. Legal budgets are increasingly tight in the FTSE 350, so one can understand why litigation funding might be attractive to in-house counsel. They give away some of the upside, but they are relieved of the ongoing burden of funding the costs and the downside risk is covered by ATE insurance.’

 

Persistent concerns

Litigation funders or third-party funders still suffer from widespread scepticism and ignorance about their worth in dispute resolution. Some of the more affluent funders complain that there are numerous organisations out there that claim to have money to finance cases, when they are actually operating as a broker between investors and solicitors. Naturally, concerns are raised over these so-called funders’ ability to meet their financial commitments, including liquidity constraints caused by investors who are reluctant to part with cash and require constant updates as to the status of the case.

During this short era of third-party funding, a number of funders have also pulled out of the market. In November 2011, Allianz ProzessFinanz withdrew from funding cases in the UK and Europe, though it continued to honour its funding commitments, including the headline Innovator One professional negligence case against Collyer Bristow. The court ruled that the firm was not in breach of the Financial Services and Markets Act (FSMA) regarding its advice on tax-efficient investment products known as Innovator Schemes.

IM Litigation Funding, the funder behind the landmark third-party funding case Moore Stephens v Stone Rolls in 2009, is also no more, with Woodsford essentially absorbing it in 2012.

‘In America, litigation is a business strategy
as much as any strategy. We just don’t have that
psychology here in the UK.’
Antoinette Pincott, StoneTurn Group

Third-party funding has come under fire from a number of quarters. The US Chamber of Commerce’s Institute for Legal Reform (ILR) recently attacked third-party funding in the UK and indicated that it ‘should be discouraged in all circumstances’ as it could lead to a plethora of frivolous claims. Big businesses make up a substantial proportion of the ILR’s membership and they are understandably concerned about being on the receiving end of claims that would otherwise never get off the ground. Yet the funders are adamant that the ILR and other sceptics are completely wide of the mark and that funding unmeritorious claims would essentially amount to business suicide.

Sceptics also point to the narrow proportion of cases that apply to typical funding models. A constant complaint is that funders want an extravagantly high proportion of the damages in the event that the claimant wins the case. Many solicitors blame the lack of real competition among funders, causing the proportion of damages that they typically seek to not come down far enough. Often claimants just don’t feel that the financial rewards are worth all the inevitable effort that has to go into supporting the case. Geoff Steward, head of the contentious intellectual property and arbitration departments at Macfarlanes, explains: ‘It can be a lot of pain for businesses with senior personnel having to commit a lot of time to a case. If the funder wants 50% of the damages, then it has to be a fairly hefty claim for management to sacrifice that amount of time.’

The introduction of the ALF and its code of conduct has gone some way to assuaging the fears of solicitors, particularly the concerns around funders committing to a case throughout its lifecycle. It brings credibility and transparency to a segment of the legal market that has suffered from scepticism and ignorance. Neil Purslow, founding director of Therium Capital Management, one of the founding members of the ALF, says that it has had an immediate effect on the business: ‘London is becoming a hub for third-party funding because nowhere else has an association and a code of conduct. People come here because there is a market. We are seeing cases from the US, Canada, Holland, France, Australia and New Zealand.’

A central part of the code of conduct is the strict capital adequacy requirements that the funders must abide by and the limited circumstances in which a funder may withdraw from a case.

In essence, once a funder has committed to a case, it must stand by it, the lawyers and the litigant. In this regard, funders have proved largely reliable, as evidenced by Allianz’s willingness to continue to finance the Innovator One case even after it had decided to withdraw from the litigation funding business in the UK and Europe. ‘Allianz stopped writing new business, but it continued to fund the commitments that it had. There was no question that it would turn away from its contractual commitments to fund ongoing cases,’ Perrin comments. Perrin’s colleague Christian Stuerwald joined Calunius as head of underwriting from Allianz back in 2009. Perrin says that funders must face up to the size of their liabilities, and by and large there have been no headline horror stories about funders pulling out of sticky cases. He says that this is a key component of ALF membership in that capital adequacy requirements ‘force funders to face-up to the size of the liabilities they have overall’. He admits that this was one of the principle concerns of the Civil Justice Council when assessing the third-party funding market.

With the ALF in place, there still remains some scepticism about the paltry number of members and the lack of serious competition among the established funders. On this issue, there are positive signs. Argentum Litigation Services, Augusta Ventures and Redress Solutions were admitted in November to the ALF, a body that is clearly willing to accept new members and not just preserve the reputation of an elite few. Its board of directors includes Calunius’s Perrin, Susan Dunn at Harbour Litigation Funding and Woodsford’s Tim Mayer. Membership applications are sent direct to counsel, who confirm to the board whether the funder actually holds funds to invest.

 

New arenas

Despite the many concerns about the growing role of third-party funders in litigation, many of the more successful and well-capitalised funders are developing broader horizons. Their business models depend on broad portfolios of cases with the understanding that a win rate of more than 50% can deliver satisfactory profits. Anecdotal evidence indicates that most funders achieve a significantly greater success rate than half.

Calunius recently announced that it had invested in CDC Cartel Damage Claims, an organisation that takes on multiple cartel cases. In addition, it was recently reported that Harbour was in talks with law firms about investing in a portfolio of commercial litigation cases through an alternative business structure (ABS), but not as part of a wider investment in a firm. It indicates that the funders are now finding ways of accessing volume as well as value. Most of the larger third-party funders have traditionally targeted damage claims of over £1m to ensure that they are able to recover a satisfactory return on their own efforts and expenses, but these new models will open up a segment that falls into the mid-market or commodity sector.

Beyond litigation, funders have become particularly active in the arbitration world, a sphere that gives them exposure to high-value cases and defendants that can be relied upon to pay damages should they lose the case. Investment treaty arbitration cases are a particular area of interest for funders, given the financial security of state or government defendants.

Robert Volterra, an arbitration and international law specialist, founded London-based law firm Volterra Fietta in 2011, having previously been a partner at Latham & Watkins and Herbert Smith. Volterra says that investment treaty arbitration claims in particular have become an area of real interest for third-party funders. He says the attraction stems from the fact that the arbitration awards are much easier to enforce against governments than other commercial entities. ‘Countries do not go bankrupt, at least not in the same way as commercial organisations and individuals. There can be challenges to enforcing awards against countries, but you always know where they live and can find where their available assets are held,’ he explains. ‘An arbitration between X and Y company is all well and good, if Y company has assets, but what if Y has no assets or is liquidated? That happened in one commercial arbitration case when I was sitting as an arbitrator. There are complications in commercial arbitrations which you don’t have with governments.’

‘The change is that we are not just talking
about doing it, we are actually spending
£40m a year on litigation.’
Susan Dunn, Harbour Litigation Funding

Volterra admits that the majority of his cases do not require funding, but that there is still a large proportion of claims that could fade away without it. ‘Some time back, we won a third-party funded case where the investor had a sizeable claim but could not be bothered to chase the claim. The company was owned by people who were the salt of the earth and had built this company from scratch with their bare hands. The owners were wealthy and had moved on after the expropriation; the company was soon focused on its investments in other countries. When approached about making a claim by their local counsel, they responded that they did not want the headache of pursuing litigation or putting more money into what they considered as a failed project. When third-party funding was proposed, the owners agreed to proceed with the claim. Basically, they said: “if we do not need to throw good money after bad, knock yourself out; we will support the case with documents and testimony; we will be happy to be compensated for the expropriation; but otherwise do not want anything to do with it.” In the end, it worked out happily for everybody on the claimant side.’

Volterra explains that for many companies, the mere fact of taking the costs of running a claim off their balance sheet outweighs the funder taking a large share of the damages. ‘For some companies, maintaining cash flow and getting litigation costs off their balance sheet is very attractive. It can be more advantageous to get the accounting loss of the claim off balance sheet than to get the full amount of the damages back,’ he says.

Sean Upson, a partner at City firm Stewarts Law, says that some 20% to 30% of the firm’s caseload involves some form of funding, whether it be third-party funding or a conditional fee agreement. He expects this to grow as clients get comfortable with the concept: ‘There is an increasing appetite for looking at funding. We’re working on a confidential arbitration involving a large corporate that could have afforded the legal fees but didn’t want all the risk on their balance sheet.’

Lorraine Brennan, managing director of JAMS International, an organisation that promotes mediation and arbitration, says that arbitration can be expensive at the start of proceedings and this can often put off even the most worthy claims. She explains that third-party funders can fill that void: ‘Certain [arbitral] institutions require large up-front filing fees that might make it prohibitive for a claimant to proceed with its case. So in the sense that a third-party funder would enable such a party to bring a case, I would say there is a place for them.’

Third-party funders have certainly discovered this place. Calunius’s portfolio of third-party funded claims now includes more arbitration than litigation cases. This includes funding Toronto-listed Rusoro Mining’s challenge of the Venezuelan government’s nationalisation and expropriation decree in September 2011, which related to its mining concessions. Rusoro is listed on the TSX Venture Exchange in Canada with significant mining interests in Venezuela. Freshfields Bruckhaus Deringer is representing Rusoro. The recent re-election of Venezuelan President Hugo Chávez is expected to lead to a series of other investment treaty arbitrations given his lengthy record of high-profile expropriations.

Vannin’s Rowles-Davies says that arbitration cases are enormously attractive for funders: ‘It is a massive opportunity because the fees upfront to appoint a panel are in most cases quite high and a lot of arbitration regimes don’t have adverse costs. Running an arbitration can be very expensive and unless you are a very big organisation, it is not easy to deal with that. The main reason that arbitration is ripe for funding is that the value of the dispute tends to be very high.’

Funders have also found the arbitration community more willing to embrace third-party funding than their litigation colleagues, in part because arbitration is itself a growth industry and an increasingly viable alternative to litigation. Perrin says that Calunius’s experience with arbitration specialists has been extremely positive: ‘The people in arbitration practice around the City of London are more entrepreneurial than their litigation brethren. There is a greater readiness to seek funding for things like ordinary commercial arbitrations, International Chamber of Commerce (ICC), London Court of International Arbitration (LCIA) or bilateral investment treaty (BIT) disputes.’

Steward at Macfarlanes agrees that third-party funding could have a natural affinity with arbitration because of the forward-thinking mentality of those involved. ‘I have yet to act on an arbitration where third-party funding has been in place, but I can see it being more attractive to funders than litigation. Parties who have arbitration clauses are generally prepared to take a more experimental approach to disputes and may be more willing to be more creative in funding the cases,’ he explains.

Steward also believes that arbitration is more predictable than litigation, and so third-party funders can be more confident of achieving a return on their investments. ‘Arbitration tends to be more document heavy and relies less on an adversarial approach and the cross-examination of witnesses. The issue of witnesses letting you down on the day is less present in arbitration than in litigation,’ he says.

Among Calunius’s impressive arbitration portfolio, it is also funding Oxus Gold’s arbitration proceedings against the Republic of Uzbekistan, over its Amantaytau Goldfields joint venture in the Kyzylkum desert, an area which has one of the richest gold reserves in the world. Hamid Gharavi, founding partner of Paris-based Derains & Gharavi is representing Oxus Gold.

Previous high-profile arbitration cases that have received the support of third-party funders include the Kardassopoulos and Fuchs expropriation case against the Republic of Georgia. The claimants were funded by Allianz and received a judgment award of some $100m. At the request of the Georgian government, Israeli businessman Rony Fuchs travelled to the Black Sea resort of Batumi in October 2010 to finalise the settlement of the dispute. But on arrival he was arrested for alleged bribery and eventually sentenced to seven years in jail. The case was colourful from beginning to end with the war between Russia and Georgia being waged in the background. Karyl Nairn and Timothy Nelson, partners at Skadden, Arps, Slate, Meagher & Flom, represented the claimants. DLA Piper and DLA Piper Gvinadze & Partners acted for the defendants.

Arbitration may indeed be a growing area of interest for third-party funders, but there are still reservations about its suitability for their business models. Cash flow issues appear to be the primary issue, because of the upfront costs and the length of proceedings.

Woodsford’s Barnes explains: ‘Any cost that’s incurred sooner rather than later will depress an investor’s return. Arbitration has its advantages, but one of its big problems is delay. A recent Berwin Leighton Paisner report found that while many awards are published within a year of final submissions, the majority of respondents said that this applied to less than 50% of their cases.’

Therium’s Purslow agrees that arbitration is an attractive market for third-party funders because it gives them exposure to bigger cases and a higher strata of law firms, yet it can be problematic for their funding models. ‘We see arbitration coming to us from very large law firms, but the costs for arbitration can be very high with arbitrators’ fees included and the issue of costs is often addressed early on,’ he explains.

 

Further traction

This gradual acceptance of third-party funding across the world is piquing the interest of the global investment community. Harbour’s latest fund is a huge £120m, building on the £60m it raised in its inaugural fund in 2010. It is currently running 38 cases ranging from competition claims to tax and breach of trust disputes, according to Dunn, its head of litigation funding. ‘The change is that we are not just talking about doing it, we are actually spending £40m a year on litigation. We are an incredible purchaser of legal services,’ Dunn says.

Unlike many other investments that depend on the fluctuation of the global markets, the third-party funding arena is completely insulated from economic variations. Success depends purely on backing a winning case and achieving satisfactory returns. ‘Third-party litigation funding is very high risk and not everyone will be successful,’ Barnes comments. ‘However, if a funder backs the right claims the returns can be commensurately high. Secondly, we like the uncorrelated nature of the underlying asset, which shouldn’t be underestimated in the “risk on/risk off” investment environment post-financial crisis.’

‘One of the problems with third-party funding
is understanding who has the appetite for what
type of case. ’
Matthew Amey, TheJudge

Celebrated fund manager Neil Woodford of Invesco Perpetual acquired big stakes in Juridica and Burford Capital when they were listed in 2008 and 2009 respectively.

Funders believe that there should be very few limitations to the expansion of third-party funding, other than the size of claim required to achieve a satisfactory return on investment. But even so, with funders looking at ever-more innovative ways of taking on multiple cases, such as Calunius’s investment in CDC Cartel Damage Claims, there is an acknowledgement that they are not merely concerned with the high-value cases. Indeed, many admit that the Legal Services Act and the advent of ABSs in the legal profession, means that there are even more avenues for investing in a portfolio of cases, whether that be funding a law firm or a segment of its dispute resolution matters.

According to Ross Clark, Burford’s chief investment officer in the UK, the funder has developed a streamlined application process and a standard set of terms that can be applied to lower-value cases. Clark says that it enables the fund to do things quickly without the need for intensive ‘brainstorming’ and overly ‘bespoke’ pricing models. He explains that this enables Burford to play in the lower-value market as well as the bulge-bracket sector. ‘We just have the question of finding a lawyer who thinks about it in the right way and a lawyer who is going to take a decent size of the risk themselves,’ Clark explains.

Purslow admits that third-party funding is not just about chasing after the headline and high-value cases. ‘We run a portfolio and we manage our risk downwards,’ he says. ‘We are not chasing the huge shiny damages award. Litigation is a place to invest, not to gamble. It is about making good investment decisions and making consistent returns.’

Macfarlanes’ Steward also wonders whether funders will ever make a successful leap into supporting defendants, because at present they are focused on supporting claimants. ‘In theory 50% of the market is ruled out,’ he explains. ‘There is the potential to evaluate what a successful defence of a claim is worth to a business and in theory a funder could come up with a fee proposal based upon that value. But it is certainly not the focus of the funders at the moment.’

Rowles-Davies says there has been a huge step-change in interest and acceptance of third-party funding over the last year, very much driven by the endorsement it received from Jackson and the transformational effects of his reforms on the dispute resolution market. He says: ‘The market place has very much expanded because of the rise in awareness of solicitors and clients. There is a huge difference in awareness compared to 12 months ago.’ He says Vannin is now seeing about 40 cases a month compared to 12 to 15 cases a year ago.

Purslow concurs, suggesting that the third-party funding market is still very much in its infancy, but that in the longer term, it can have an extraordinarily profound effect on the dispute resolution segment: ‘The market has funded only so many cases. No-one knows where the limit is, but we are definitely nowhere near it.’ LB

chris.crowe@legalease.co.uk