Third-party litigation funding has yet to really take off, despite being around for five years. While a mature market is still some way away, litigation specialists are finally seeing that self-funding is not the only way forward.
Big-ticket disputes in the public sphere and funded by a third party are rare. The biggest case in the UK to date came in 2008 and featured an £89m negligence claim brought by Stone & Rolls against audit firm Moore Stephens. The dispute was driven by Norton Rose’s Sam Eastwood for client Stone & Rolls and was funded by IM Litigation Funding. The case was thrown out by the House of Lords as part of its grand finale in 2009, gifting a massive victory to Barlow Lyde & Gilbert client Moore Stephens.
In August this year, Calunius Litigation Risk Fund, a $60m private fund based in Guernsey, announced that it would be putting a ‘substantial investment’ into a multi-million-euro claim made by Elvis Presley Enterprises in Germany against Arista Music, demanding proper payment for Elvis’s sound recordings in Germany.These examples aside, public mentions of third-party-funded cases are few and far between. In the litigation funding community, some feel the Stone & Rolls case did the market considerable damage. The net result of the failure of the first major funded case in the UK was that it ‘scared the horses’. It had the twin effects of putting lawyers off considering what they saw to be a failed strategy, while the funders themselves became naturally more cautious as a result.
‘In the rare instance where a case looks to be a sure thing, why wouldn’t you try to fund it yourself?’
‘Stone & Rolls is certainly part of the reason why we haven’t seen more cases using litigation funding in the UK to date,’ says Richard Myrtle, managing director of specialist after-the-event insurance brokers Universal Legal Protection. Many funders perceive that a lack of understanding or even suspicion of how third-party funding works is holding solicitors back from recommending it as an option to their clients. While there is optimism among funders, with the launch of a new code of conduct for litigation funders and the Association of Litigation Funders on 23 November, the journey is still upwards.
On the flip side, many solicitors feel that too many funders are looking for the huge payout, slam-dunk cases.
And, if these cases are so certain of being successful, why would a claimant not fund a case themselves? As the King once sang, we’re caught in a trap.
Avoidance of risk
Many litigation funders take up a very low percentage of the cases that are brought before them. Harbour Litigation Funding, one of the early pioneers of the industry, funds just 8% of the cases it sees, and that’s about the average.
‘We’re very selective,’ says Neil Purslow, founding director and chief investment officer at Therium Capital. ‘We’re funding around 6% of the cases offered to us.’
This selective approach is putting some solicitors off considering third-party funding for their clients’ disputes. A litigation partner in the City sums up the lack of appetite among some quarters of the legal profession: ‘There is not enough risk being taken by the funders to take on cases; they are looking for too much certainty, which you’re never going to find in disputes. In the rare instance where a case looks to be a sure thing, why wouldn’t you try to fund this case yourself and collect all the damages?’
The funders argue that they are there to take the cases on but are always going to be prudent about the kinds of matters they accept. In assessing a case for funding, many of the decision-making criteria are purely subjective. As Purslow says, instinct plays a big part. ‘Most of this is about appraising the unknowns as well as the knowns,’ he says cryptically.
‘In North America it’s still considered by some in the legal profession as a dirty little secret and people are still sceptical of the whole thing.’
But Nick Rowles-Davies, a solicitor who is a consultant at Vannin Capital, a third-party funder backed by Isle of Man private equity firm Bramden Investments, argues that the cases are out there to be funded, it’s just that the UK market isn’t mature enough. In explaining why the time was right for Vannin to officially launch in June this year, he says: ‘It’s an under-populated market, which is why it is so attractive. There are far more cases out there than there is money available, if you look across Europe as a jurisdiction. The problem is that in the UK, funding isn’t something that is well known among lawyers and they don’t inform their clients about it so it’s an effort to educate them.’
This point is echoed by another relative newcomer. Jonathan Barnes was a partner at DJ Freeman and Lewis Silkin and is now a director at Woodsford Litigation Funding. Woodsford Litigation Funding is backed by Woodsford Consulting, the family office of a wealthy European family. He says that understanding the barriers to third-party funding from a law firm perspective is critical.‘
There was anticipation in some quarters of a great surge of third-party funding, but I would start to question that in the short term,’ he says. ‘My understanding is that litigation lawyers are busy right now, so it’s tough to find the time to build up a complete understanding of third-party funding. Do lawyers feel confident enough about the evolving funding market to guide clients through it?’ Funders need to recognise the practical issues and help lawyers work through them.
Do lawyers know enough about the third-party market? The answer, according to Rowles-Davies, is often no. He argues that one in three firms knows nothing about litigation funding. ‘I’m regularly shocked by the lack of knowledge displayed by solicitors about litigation funding. Even when some firms have some knowledge of the market, it is often incomplete or wrong, which makes it difficult to properly explain the funding options open to a client.’
The growth and acceptance of the third-party litigation funding model has certainly required more of a learning curve for the legal profession than most litigation funders would have anticipated five years ago,’ says Louis Young, chief executive of Argentum Investment Management Limited, a third-party litigation fund manager.
One of the main points of confusion is a suspicion of how much influence a funder will have in the running of the case. If it’s their money making the show possible, surely they can push for a case to settle if they want, even if the claimant wants to press on?
Not quite. The principles of ‘maintenance’ and ‘champerty’ prohibit funders from exercising undue influence on the running of a case and the law is quite clear. Should a funder cross this line by ‘wanton or officious meddling’ it will not be able to enforce its litigation funding agreement.
Despite the law being explicit, funders believe that many law firms are still wary of the risk that funders will dictate the running of the case. But as Purslow points out: ‘When we’re funding cases, people are often surprised about how little control we exercise. Our interests and the claimants’ interests are very closely aligned and we’ve never had any problem there.’
Another area of confusion and false assumption is that most of the clients that use larger law firms will happily self-fund litigation and have the means to do it. Banks and major corporates, for example, will not need litigation funding and so the Magic Circle and larger litigation practices have no need to consider this option for their clients. However Matthew Amey, director at litigation risk broker TheJudge, says there are quite clear examples of where litigants have sufficient funds themselves for litigation, but choose to use third-party funding creatively.
‘Lawyers that run high-end cases don’t think their clients need to consider funding but what we are seeing now is companies using litigation funding strategically to take costs off the balance sheet,’ he says.
The lack of transparency in litigation funding hardly helps the cause. As so few funded cases make it all the way to court, there is no real track record to point to as proof of the ability of funders to pay for large and successful cases. Many disputes that settle are bound by confidentiality agreements, which makes any kind of marketing about success impossible. Add to that the fact that a fair number of funders, particularly those who raised capital on the public markets, are unable or unwilling to disclose who their institutional financial backers are. This all combines to create a shroud of secrecy over the entire industry.‘
Litigants and funders generally assess each case for publicity,’ says Leslie Perrin, chairman of Calunius Capital. ‘There are generally more reasons to keep something confidential than reasons to seek publicity.’
But the appetite is definitely there to fund cases and many small-to-medium-sized companies don’t have the cash to take on the big boys in disputes, so funding is the only option. As such, many funders report that a sophisticated understanding of how funding works and the options open to clients are evident among the more entrepreneurial style of law firm. This is particularly true of the swathe of high-quality litigation boutiques that have sprung up, namely Quinn Emanuel Urquhart & Sullivan, Enyo Law, Stewarts Law and Cooke, Young & Keidan.
Law firms can help themselves by thinking about the case they are pitching to a funder and the key elements of correct budgeting and likelihood of recoverability.
‘Funders tell us that they have the budget for the right case but, naturally, critically judge cases presented to them,’ says Jane Colston, a commercial litigation partner at Stewarts Law. She doesn’t believe a lack of understanding over maintenance and champerty rules decreases the likelihood of lawyers considering third-party funding for clients, ‘especially for the sophisticated firms like ours,’ she says.
That said, law firms can help themselves by thinking about the case they are pitching to a funder and the key elements of correct budgeting and likelihood of recoverability.
‘We’ve been running for over 12 months now and so far we’ve not been that impressed by some of the cases brought to us,’ says Barnes.
‘Some lawyers still focus too narrowly on the merits of a case; they don’t think enough about recovery. Often the enforcement route can be just too murky.’
Jane Jones, review director at Argentum, sums up solicitors’ reluctant attitude to third-party funding thus: ‘Lawyers may be suffering from litigation funding fatigue. There has been a lot of talking about it, but when the industry was in its infancy the infrastructure, systems and processes simply didn’t exist to service those cases that were put forward. In many cases the “funders” were intermediaries who did not actually have funds themselves, and those funders that had raised their own capital were so few and far between that they were able to cherry pick cases and charge highly. Things have moved on considerably now, but those lawyers that tried litigation funding once and had their case turned down, or whose chosen provider failed to live up to its promises, may be falling into the category of “once bitten, twice shy”.’
It’ll cost you
While criticisms by law firms over funders’ attitudes to risk persist, the funders themselves counter this by arguing that often the approach taken by law firms in estimating costs is so poor that even a sound case becomes ineligible for funding because the budgeting is so unrealistic. One oft-quoted ‘oversight’ example involves the sudden need for a highly expensive silk on a case who wasn’t even on the radar during preliminary discussions. In fact, one funder likens lawyer cost estimates to that of your average builder. An escalating and unforeseen price tag is now almost elevated to joke status.
According to Purslow at Therium, which is one of the more established UK funders, costs in litigation funding are obviously a critical issue. The whole rationale for investing time or money in a case can be undermined completely if costs are not managed. And it’s not always the fault of the parties’ budgeting that is the problem.‘
While we do see examples of inadequate budgeting, litigation costs also do have an inherent degree of unpredictability which has to be absorbed somewhere – either by the law firm, the client or the funder, or a combination of all three,’ he says.
He adds that often the problem is not so much the budgeting as the level the costs could potentially reach. ‘We see cases which could become simply become uneconomic to run given the magnitude of potential costs and sadly we see too many examples of cases being allowed to become uneconomic because of the defendant using the costs deliberately to try to reduce the litigation to a zero sum game,’
he says.‘The courts do seem to be getting better at preventing this but at the moment there is still no substitute for an early (and necessarily pessimistic) appraisal of the costs and addressing that issue up front. However, as a funder, part of our role is to scope out the project at the outset with the lawyers and client and between us make provision to make the ongoing running of the case stable, however it twists and turns.’
Many solicitors feel that too many funders are looking for the huge payout, slam-dunk cases
Changes already in the pipeline may work in favour of all sides in civil litigation. A costs management pilot scheme began operating in the Technology and Construction Court (TCC) on 1 October and will run until 30 September 2012. It is an extension of an earlier voluntary pilot that was run in the Birmingham TCC during 2009 and follows Lord Justice Jackson’s civil litigation costs review. The pilot will encourage all parties involved in a case to draft detailed cost plans at each stage of proceedings, with the court having the authority to approve the costs or demand a revision. The days of the litigation cash cow may be coming to an end.‘
Cases will run over budget, that is a fact of litigation, but steps can be taken to minimise that risk,’ says Jones. ‘We ensure that a costs expert is brought in, at our expense, at the very start of the case to advise upon the budget being put forward for the case, and to monitor the litigation spend throughout. Most lawyers find the advice invaluable not only for providing an accurate funding budget, but also in maximising their own costs.’
Worse than poor budgeting are instances where disputes lawyers are not really thinking about the likelihood of recovering damages and costs from an insolvent defendant. The majority of the funders and brokers interviewed for this piece confirmed that while it isn’t a widespread issue, instances where litigation teams haven’t even thought about recovery of damages or enforceability of costs are common.‘We’ve actually said to people that if you have a certain kind of case, the first thing to do is not to spend money on an analysis of the legal merits, but spend money on an analysis of where the money is,’ says Purslow.
Positive signs
Despite this misalignment of interests between disputes lawyers and funders over when, how and if to fund a case using a third party, and the lack of major cases in the public eye that have received this funding, the outlook for the industry is very positive. The problems in the UK, relative to other jurisdictions, are minimal.
John Rossos is a Toronto-based former investment banker who co-founded Canadian litigation funder BridgePoint Financial Services in 2005. He is planning to expand his business into the UK market, and feels that attitudes towards third-party funding on this side of the Atlantic are considerably more developed than in North America.‘The UK is the most advanced market in the world right now,’ he says. ‘With the Legal Services Act there are no longer any restrictions on how law firms may fund cases.
‘In North America it’s still considered by some in the legal profession as a dirty little secret and people are still sceptical of the whole thing.’
He adds that in the UK, he feels that not only law firms but also claimants themselves are much more savvy about the options available to them and the potential that litigation funding can offer. He points towards the arrival of a code of conduct for litigation funders as a final stepping stone towards having a mature, regulated market.
A voluntary code of conduct for litigation funders has been on the cards since 2007 when the Civil Justice Council (CJC) said that ‘properly regulated’ third-party funding was a credible option in mainstream litigation. This baton was picked up by Jackson in his litigation costs review, where he recommended that a ‘satisfactory voluntary code, to which all litigation funders subscribe, should be drawn up. This code should contain effective capital adequacy requirements and should place appropriate restrictions upon funders’ ability to withdraw support for ongoing litigation’.
The CJC launched a consultation on the code in 2010 before pulling together a working party to consider the responses and draft a final version of the code for approval in October 2011. That working party included, among others, outgoing Irwin Mitchell chairman Michael Napier, Calunius Capital chairman and former Osborne Clarke managing partner Leslie Perrin and Harbour Litigation Funding’s co-founder Susan Dunn.
‘We are now seeing companies using litigation funding strategically to take costs off the balance sheet.’
With the code and an Association of Litigation Funders unveiled at the end of November, those interviewed for this piece universally welcomed both. The fact that the code will put in place minimum standards for capital adequacy for litigation funders is crucial in ensuring the credibility of the industry and weeding out rogue elements.
Many trying to fund litigation on a case-by-case basis, who simply are not in a position to provide the funds when they are needed, are tarnishing the industry as a whole. Not all funders are completely transparent about their role – whether they have direct access to funds or act as intermediaries who will have to raise capital themselves from another third party in order to fund a case.‘
The main factor preventing the growth in numbers of funded cases is that so few funders actually have any money to invest,’ says Perrin. ‘Many brokers pretend to be funders but do not have any money.’With funders being accredited under the new code, many believe that law firms and claimants will feel infinitely more comfortable about choosing the right funder for the right case.
‘Once the code comes through, and I’m optimistic that it will deliver, it will create an English model for third-party litigation funding that will be recognisable internationally,’ says Amey. ‘The aim is to create a recognisable product and capital adequacy is part of that.’
Some fear that the capital adequacy requirements under the new code will be too stringent, playing into the hands of the bigger, more established players and pricing some start-ups out of the market. However, Myrtle of Universal Legal Protection believes: ‘It is important to set high standards to avoid the unscrupulous damaging the reputation of the industry as a whole.’
Young at Argentum feels that regulation of funders will only increase in the future. ‘Those funders who are establishing themselves with a long-term view to the market would be wise though to expect that at some point the asset class will come under the regulation of a statutory body,’ he says. ‘When this will happen depends upon how fast the market can be grown and how we conduct ourselves in the interim. In our opinion it would be better happening sooner rather than later as it will be those funders with robust case selection processes, adequate capitalisation, and good corporate governance practices that will make the transition.’
Closer together
Jackson’s litigation review has also brought forth another significant development, which may bring law firms and third-party funders closer together. Jackson recommended the introduction of damages-based agreements, or contingency fees, into UK law. Contingency fees will become lawful in the UK if the Legal Aid, Sentencing and Punishment of Offenders Bill legislation is passed. The legislation is intended to implement a number of recommendations in the Jackson Report. The Act will also abolish the recoverability of success fees and after-the-event insurance premiums and introduce damages-based agreements. The net result is that funders may be sharing more of the risk with law firms, which will be more concerned with achieving the right result commercially without significant billings to rely on.
Reaction to this development is mixed. ‘I don’t think damages-based agreements are going to change things that much, they are not going to become that widespread,’ says Purslow. ‘Conditional fee arrangements aren’t that widespread in commercial litigation now and I think contingency fees are dangerous for law firms, more dangerous than CFAs, bearing in mind law firms will face uncertainty not only over when they get paid but also over how much they’ll get paid. There will be some firms that do it, and do it successfully, but I think there will only be a handful.’
However, Barnes at Woodsford Litigation Funding believes that damages-based agreements could bring law firms and funders together and align interests better.
‘Lawyers may be able to fund cases on a contingency fee basis next year, which could take them in a whole new direction,’ he says. ‘However, I doubt whether firms will have significant capital available to invest like that, as profits are not usually retained in the business and because lawyers will not want to carry adverse costs risk. But there may well be “joint ventures” between law firms and funders in the future whereby the funder shoulders much of the ongoing cost and the lawyer has a much bigger potential upside than currently.’
With alternative business structures just around the corner, closer financial harmony between law firms and funders is a distinct possibility, as long as champerty doesn’t become an issue. The industry is still very much in its infancy and is at least ten years from becoming mature.
During that time, it is imperative that funders do all they can to educate law firms on why and how litigation funding could be the only way disputes teams bring in significant cases in the long term. LB