Third Party Funding – An Inside View

Nick Rowles-Davies of LCM was a guest panellist on a webinar jointly hosted by Ince and the UAE branch of the Chartered Institute of Arbitrators. Following is a transcript of Nick’s insights and perspectives as presented on the webinar.

Please click on the link below to access the webinar:

What purpose can third party funding serve in dispute resolution?

Firstly, let’s assume that the basics of third-party funding are understood. Disputes finance, litigation finance, legal finance or third-party funding – are just some of the names used to describe the use of external capital, invested in legal fees, usually for a plaintiff or claimant, in return for repayment of that investment plus a return from the proceeds of a successful action.

The usual proposition for third-party funding is that it levels the playing field between parties to the dispute – the David v Goliath argument. It provides an equality of arms.

But it also provides access to justice – allowing those clients who, but for the external capital, would not have the financial resources to bring their claim.

The main types of investments made by funders are as follows:

1. Single case funding. This is where it all started more than ten years ago, and it remains the mainstay of the funding industry. These once off investments are in matters where the need for external finance is driven out of necessity. The cases are typically high value with large budgets, have good merits and the opposing party has the resources to pay or is insured. This is still where the majority of litigation funding takes place. However, it is expensive for the client because there is a binary outcome, and it is high risk for the funder.
2. Class Actions. A form of single case funding is the financing of class actions. This is an area seen more in Australia but also in Canada, the US and increasingly via the use of Collective Actions in England & Wales.
3. Over time the use of funding for portfolios of cases has become more prevalent, particularly with US law firms. There are a number of ways that portfolios can benefit clients, law firms and insolvency practitioners. The basic proposition is that if you finance three or more cases where the investment is cross collateralised across the proceeds of all or any of the cases then the risk is much lower than in a single case. This method allows for the provision of a solution rather than a standard template for funding and addresses the biggest criticisms of the funding industry from corporate clients, which are:

• • Funders cherry pick and only fund the very good cases that the client would fund anyway.
  • The price is always too high.
  • Funders cannot finance defence cases, declaratory cases or small value cases.
  • Funders do not provide a solution to the issue of annual legal budget.

The use of portfolios to reduce risk has had a consequential effect of reducing pricing to allow corporates to contemplate the use of funding.

4. This is a growing area involving an assignment of a case from an insolvency practitioner, where the funder then becomes the principal and runs the case for themselves.
5. The area of enforcement and asset tracing is a different discipline, but third-party funding nonetheless.
6. There are other areas such as divorce and family matters, but I don’t propose to comment on those areas which fall out of the mainstream of third-party funding. 

The sophistication of the industry and movement away from ‘funding’ to providing ‘capital’

This is what I used to refer to as the evolution of third-party funding into litigation finance.

A small number of funders have been able to evolve and are now able to provide capital and offer financial solutions that are bespoke and not entirely from the same old template that has been rolled out for the last ten years. I have said many times that it is very disappointing that the innovation in this industry has been limited to a few players.

The big change is the move from funding out of necessity to funding out of choice. By that I mean the use of disputes financing by corporate clients who are not at all impecunious. They are making a positive decision to use external capital to finance the legal fees of their disputes.

There are many reasons why this is a good idea for some corporate clients, not least the accounting benefits and avoiding the horrible inefficiency of paying monthly from cashflow for legal bills – and the consequential negative effect on EBITDA or reduction in profits. It also provides certainty of budgeting and the ability to use their own cash on their core business.

Portfolio funding has developed as a solution in response to corporates looking to fund litigation as a positive choice. It allows for the financing of small and large cases, declaratory and defence cases – and it has been a significant change in the market.

Importantly, it addresses the annual tension between CFO and GC over legal budgets.

For example, I created the first corporate portfolio transaction with a FTSE 100 company in the UK in 2014. The very large corporate wanted to address two main issues with its litigation spend:

1. It was primarily using up its budget on defence matters – and hence had no budget to bring claims and was therefore not pursuing matters.
2. It had no control over the timing of when cases would produce cash.

We solved the first issue by providing finance across a portfolio of matters which would allow the funding of defence and claimant cases. We were also able to monetise pending matters to provide lump sum payments at agreed points – thus providing a solution for budgeting and timing.

Portfolios for law firms are of equal importance (as they are for insolvency practitioners). The ability to lay off risk and improve cash flow management on a contingent caseload has helped many law firms globally.

A law firm tends not to have a balance sheet. The value is in Work In Progress (“WIP”) and the cases being run. For law firms that have a significant contingent case load – namely cases where they are paid only on success at the conclusion from the proceeds of a case – the use of funding can alleviate some of the cash flow issues.

Additionally, the use of a funder can transfer some of the risk. If a law firm wishes to increase the number of contingent matters that it is running it can do so by partnering with a funder.

How does that work? There are several ways to do it. Usually – for every contingent case in the law firm’s portfolio the funder makes a monthly payment of an agreed percentage of the law firm’s WIP and any disbursements or expenses.

In return the funder receives a repayment from any case in the portfolio that is successful along with the agreed uplift. The funder would usually cross-collateralise their invested funds so that if a case loses, the amount invested is repaid from the next winning case. That reduces the risk of capital loss which in turn reduces the price to the law firm for the financing.

The solutions-based approach is important. Every transaction we do is bespoke and based upon the unique set of needs and the circumstances of our counterparty. Some simply want the provision of cashflow, some need to monetise. Disputes financing is becoming ever more sophisticated as a corporate finance tool.

Current trends and where third party is funding moving in the future, whether globally or in the MENA region

Starting with the global perspective it is certainly accurate to say that there is a growing acceptance of disputes financing in most jurisdictions and there is an increasing speed of change – an acceleration.

Singapore and Hong Kong have enacted legislation to increase the ability to use third-party funding and the direction of travel is very much in favour of its use.

A number of the key disputes hubs around the world have come to realise funding is here to stay and that it is helpful to have access to capital for use in the financing of disputes whether it be in New, York, London or Singapore.

We have seen three global effects from the pandemic in the last 9-12 months. These are:

1. Those corporates who are in the midst of a dispute have had to reconsider whether they have the continuing budget for the dispute – should they continue.
2. Those corporates who have been contemplating entering into a dispute are now rethinking the budgetary needs of doing so.
3. Those law firms who are acting for these corporate clients have realised that they need to provide an alternative solution to those clients. That alternative solution has mainly been the use of litigation finance. This has led to a growing understanding that the use of litigation finance can be of benefit to the law firms as well as to the clients. This has created an acceleration in the education and acceptance of litigation finance amongst those law firms and has changed some of their thinking.

The effect of this is the better understanding of what disputes financing can do for law firms. It is taken as read that all of the law firms pitching for specific corporate clients are very good lawyers. But what we are seeing is an increasing use of disputes financing as a business development tool.

Where there is a need to change the narrative and to set themselves apart from the competition, the smart lawyers are turning to disputes funding. It is no secret that there is a growing demand from in house counsel for their external lawyers to provide alternative and innovative solutions as regards fees. Disputes finance can assist with that.

In the MENA region specifically, there is a significant increase in knowledge and understanding of disputes financing – particularly in the UAE. There have been significant strides taken since I financed my first DIFC case in 2010. Indeed, there have been practice directions on the use of funding in both DIFC and ADGM.

We have seen, and will continue to see, the use of finance in construction matters. But there is an increase in usage outside of the construction sector, whether that be for general commercial matters, insurance subrogation work or disputes between hotel owners and operators. No doubt there will be increased interest in non-performing loans and bank debt portfolios as well.

In Dubai we are seeing similar patterns to the global trends in regard to understanding how the use of disputes funding can be a business development tool and that will drive closer ties between funders and law firms.

In short, funding is very much becoming established in the MENA region as it is elsewhere and whilst it is not the answer to every problem it is certainly continuing to prove a useful tool for disputes lawyers and their clients.

Please click on the link below to access the webinar: