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Litigation Funding
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Litigation or third party funding

Historically, the English law principles of “maintenance” and “champerty” have prevented the funding of litigation by third parties. The underlying justification for this was to avoid third parties profiting from litigation in which they had no legitimate interest. As part of the desire to improve access to justice, the judiciary in Australia has adopted a more pragmatic approach to third party funding and has recognised the role it has to play in civil litigation and access to justice. Third party funding is therefore permitted notwithstanding that it gives the funder a share of recoveries from the litigation, provided the funding agreement does not give the funder an unreasonable return or the right to control the litigation.

What is third party funding?

Third party funding is where someone who is not involved in a dispute provides funds to a party to that dispute in exchange for an agreed return from any recoveries. Typically, the funding will cover the funded party’s legal fees and expenses. The funder may also agree to pay the other side’s costs if the funded party is so ordered, and provide security for costs. Its application can extend beyond litigation and arbitration to all forms of dispute resolution, and it is available for a variety of commercial disputes.

As the use of third-party funding has increased, so have the number and range of institutions that are prepared to finance litigation and arbitration. In addition to specialised third party funders, insurance companies, investment banks, hedge funds and law firms have entered the market.

As the market has developed, the range and sophistication of funding products and structures available has broadened. There is no one size fits all and the description above is funding at its most basic. Third party funding, or “litigation funding” as it is commonly referred to, has evolved. In addition to funding one-off cases, litigation funding is being used for a broader range of purposes, with the proceeds of the litigation being used as collateral.

When is funding appropriate?

Recent innovations in the products available have made litigation funding appropriate in more situations than was previously the case. However, if looking to fund on a one-off case basis, the following is a useful preliminary checklist:

• funders are unlikely to provide funding for cases that do not involve a claim for damages. Given that funders receive their return by reference to recoveries made, they are primarily interested in claims with an award of damages or compensation as an outcome. As such, funding is generally only available to plaintiffs or defendants with a counterclaim;
• funding litigation is a high risk investment, and funders will require a certain investment to quantum ratio.
• funders will require good prospects of success. They will undertake their own separate analysis and due diligence of the claim and only fund it if they have confidence in it and the way it is being advanced;
• funders will want to know if the target (ie. the defendant or respondent) is able to meet the claim, costs and interest. The funder will want to know where assets are situated; enforcement risk is a key concern. If situated in jurisdictions where enforcement is difficult, that may deter some funders. Other considerations, including whether the target will fight to the bitter end, may also influence the funder;

Advantages and disadvantages

A potential party may approach a funder for various reasons:

• necessity: Litigation and arbitration can be expensive. If a claimant does not have the means to pursue a meritorious claim, funding may well be its only option;
• Risk management: Claimants with the funds to litigate or arbitrate may want to lay off some of the risk associated with costly proceedings, and be prepared to give up a proportion of any recoveries to do so. It also enables a company to invest that money elsewhere. In addition, the funded party is relieved of costs pressures and cash-flow issues associated with the legal costs of the dispute;
• Validation: Funders are only interested in good claims. They will therefore conduct extensive due diligence and carry out their own analysis of the merits before agreeing to provide funding. This objective analysis may assist the claimant to shape its case strategy, and may also encourage early settlement once the other party is made aware that the claim has the backing of a funder; and
• Levelling the playing field: Where a claimant with little means is faced with a defendant with substantial or unlimited resource, having a funder’s support helps level the playing field.

However, there are also disadvantages to using third party funding:

• a successful claimant will generally have to pay a significant proportion of his or her recoveries to the funder;
• although funders are generally prohibited from taking undue control or influence in a litigation matter or an arbitration, there may be some loss of autonomy on the part of the funded party (in particular when considering settlement) as funders may reserve the right of approval of the settlement; and
• substantial costs can be incurred when packaging the case for presentation to a funder. These will have been wasted if the application for funding is unsuccessful. Even if successful, funders are not usually liable for any costs incurred before the funding arrangement is put into place, including the costs of packaging and the negotiation of the funding arrangements (see below).

Useful Tips

Approaching a funder: practical tips

Finding a funder
Third party funding is a developing market with new funders entering all the time. When choosing a funder, it is important to ensure that a funder has sufficient capital to meet all liabilities that could arise. Proper due diligence as to financial standing and reputation should be carried out.
Packaging the claim

If you think you have a claim that is appropriate for funding, and just want a “preliminary feel” for whether a funder would be interested, most funders are prepared to discuss a case informally over the telephone.

If the funder is interested, the next step will be to “package” the claim so that the funder can carry out a full assessment of the merits. Typically, a funder will require:

• key documents and evidence so that proper case analysis can be carried out either by in-house experts or external counsel;
• any legal advice and opinions given by the legal team and counsel. This should cover both liability and quantum – the funder will need to be satisfied of the value of the claim;
• information on the defendant’s position. A funder will investigate this independently as it is crucial for them to be confident of recovery. However, useful information includes financial viability of the respondent, location of any assets, and their attitude towards disputes; and
• a detailed budget, including the number and cost of any expert witnesses likely to be required, and a timeline setting out the anticipated process up to trial.

The funder will then conduct extensive due diligence in order to satisfy itself of the merits of the case. Factors that will influence its decision are listed above. Timing will depend on the complexity of the case and whether the funder conducts the due diligence in-house or has to seek assistance from external counsel.

Calculating the funder’s return

The funder’s return, and the way it is calculated, will always be tailored to the particular case. Funders adopt different approaches to pricing and various factors will be taken into account, including: the size of the expected damages, the likely length of the matter, and the level of risk.
The way the return is calculated will vary between cases and funders. It could be calculated according to a fixed percentage share (typically between 30 per cent to 50 per cent of recoveries), a multiple of the funding to be provided (usually a multiple of three or four), or a combination of both. Funders are becoming more innovative in their approach; for example, some funders are prepared to take an equity share in the claimant company (where the only asset is the claim). The funder’s share of the proceeds can also be staged depending on when success is achieved or by reference to the extent of the damages recovered.

Issues to consider when dealing with a funder

Privilege and confidentiality

A funder will need to be provided with confidential information as early as the “preliminary chat” stage. It is therefore sensible to enter into a non-disclosure agreement at this early stage.
Packaging a claim for third party funders will invariably involve sending privileged documents and legal advice. Does sending these confidential documents to a funder constitute a waiver of privilege? Under Australian law privilege can be protected by entering into a non-disclosure agreement with a funder or agreeing that any documents are sent to the funder on a restricted waiver basis.

Exclusivity

At some point an interested funder will ask for exclusivity. This usually occurs just before the funder is about to incur significant costs in reviewing a case. If a funder relies on external assistance to assess the merits of a claim, exclusivity may be required at an early stage. Although understandable from the funder’s point of view, it could be disadvantageous as it would prevent other funders from looking at a case, and there is no guarantee that the particular funder will decide to fund at the end of the due diligence process. Caution should therefore be exercised before agreeing to exclusivity.

Reporting requirements

As to the level of involvement of funders in the matters they fund, in general, most funders will adopt a “light touch” approach. The funders will be conscious of the need to remain at arm’s length, otherwise the arrangement could be found to be unenforceable. In addition, funders will have too many cases to be actively engaged with any one of them. Funders will therefore only require limited reporting, usually on a quarterly basis or at key stages of the litigation or arbitration.

Regulation of third party funding

Any litigation funding scheme entered into on or after 22 August 2020 will be subject to the requirements under Chapters 5C and 7 of the Corporations Act 2001 (Cth). In particular, the scheme must be registered under Chapter 5C (provided it has more than 20 members or is promoted by a person who is in the business of promoting managed investment schemes) and must be operated by a “responsible entity”, being an Australian public company that holds an AFSL authorizing the entity to operate the scheme. The responsible entity is subject to obligations under s 601FC to, among other things:

• act honestly and in the best interests of members;
• exercise the degree of care and diligence that a reasonable person would exercise if they were in the responsible entity’s position; and
• report breaches of the Act to ASIC.

The responsible entity will also be subject to the obligations that apply to all AFSL holders, including to do all things necessary to ensure that the financial services are provided efficiently, honestly and fairly; to take reasonable steps to ensure that its representatives comply with financial services laws; and to have adequate risk management systems in place.