A few years ago, most solicitors would have had no notion of what third-party funding (TPF) was, and even fewer would have cared. But as banks become ever more reluctant to lend to law firms – and civil litigators begin turning their minds to how they will finance contingency fee arrangements when these burst on to the scene next year – TPF has risen up the agenda. Indeed, in the past two months alone, the topic has featured four legal conferences, with funders invited to explain how their industry works to audiences of distinctly attentive solicitors and barristers.

‘The funding market is picking up dramatically, across the board, on every front,’ asserts Neil Purslow of funder Therium. This is partly due to greater awareness as the industry raises its profile. But the impending Jackson reforms – which will largely reduce the attraction of conditional fee agreements for claimant lawyers, but will also bring in new damages-based agreements (DBAs) – are also fuelling interest. DBAs will give solicitors good reason to want to work more closely with funders. Purslow says: ‘We are seeing a certain amount of discussion about the reforms, but there is anxiety as well. I haven’t heard many lawyers saying, "I just can’t wait to embrace that risk". Some see an opportunity there, but they are nervous about it. It will feed a desire for funding, and we are looking at ways in which we can deliver this.’

DBAs will be linked to damages rather than costs, and so could prove more lucrative – and therefore more tempting – for litigators than CFAs. But they inevitably involve much risk. Part of the attraction of funders is that they can share this risk and meet, for example, the ongoing cost of experts’ and counsel’s fees, or pay all or part of solicitors’ fees as the case progresses. ‘When DBAs come in and lawyers can take up to 50% of the damages in commercial cases, that leaves room for a law firm to [share this] with a funder,’ says Leslie Perrin, chair of funder Calunius Capital. ‘This really means the law firm’s working capital requirements, which have to be paid. The law firm will have to pay its people, and it will have to pay its rent.

‘Any firm that is going to pursue an aggressive DBA strategy will have to find some funding. That might be litigation funders, or it might be banks; but since [the collapse of US law firm] Dewey, banks are running for cover where law firms are concerned, and they will run shy of aggressive business models.’

Lower-value cases

One of the commonly heard criticisms of TPF is that it is only available for the big commercial cases, worth at least two or three million in damages. While there have been some attempts to widen its scope, this is a very tough nut to crack. Matthew Amey, director at broker TheJudge, explains: ‘It’s all about ratios. The quantum has to be big enough in relation to the level of costs needed to realise that value. The value of the costs will go up with the value of the claim, but it will not go up one for one. So the ratio gets more workable as you get bigger.’

But Amey says the funding market is trying to respond to the demand for funding in smaller cases. Last year, fund manager Thomas Miller launched ‘alternative’ funder Caprica, which targets lower value claims worth at least £50,000. The fund is aimed at financing large volumes of claims capable of a degree of commoditisation. Frits van Kempen, of Thomas Miller, says the fund’s portfolio is growing ‘steadily’, and is financing a scheme for bringing breach of patent claims.

But demand for funding at the lower end is expected to increase considerably once the Jackson reforms end recoverability of after-the-event insurance premiums next April. Amey predicts that clients will want ‘mix-and-match’ funding, for example, to cover just the ATE premium or other disbursements. ‘But the only way it works for the funder is with volume. Funders will need to relax their due diligence criteria in proportion to the amount being funded, so that they have a much larger spread of risk. The challenge is that you need to get a lot of deals done.’ That leads on to what may be the next frontier in TPF – developing a much closer relationship with select law firms, so as to fund a book of their litigation. Funders have very different ideas about how they might go about investing in a group of a firm’s cases. But it is something that they are all considering, and most have already begun discussions with law firms.

Matthew Reach, head of legal review at funder Argentum, says: ‘Everybody is on board with it, it is just a case of picking the right firm… And it could go further than funding a portfolio’. Reach says that funders will be particularly looking at lawyers within a firm, and how committed they are to winning cases. He points out that solicitors who want to work with funders to maximise their use of DBAs will need to adjust the way they think about cases; the key question on every case will be, will this litigation be a good investment in three or so years’ time?

‘It will be a learning curve, and no one knows how steep it will be. There will be a transitional period where funders will hold the hand of law firms,’ says Reach. ‘We would need to understand the way that cases are being reviewed. We would never give carte blanche that we would fund whatever the firm was doing on a DBA. [But] It might start with shadowing a specific group of cases, where we have a right of veto. Ultimately, it will lead to giving solicitors more autonomy. We are speaking to a number of firms about how that might work.’

In terms of structure, Reach suggests a number of possibilities: ‘It could be giving the money as a loan, or taking an equity stake and becoming an alternative business structure; it depends what is more tax-efficient.’ Harbour Litigation Funding recently revealed that it is in talks with three law firms about taking on a portfolio of their litigation. Its head of litigation funding Susan Dunn explains the thinking behind this: ‘We have a £3m minimum [of damages] per case. ‘But if you have [similar] cases which are below the £3m, you can go through a process of evaluating one, and approving it, and then as each new one is added, you would delegate authority to the law firm [to approve it for funding]. You might say to the firm, "tell us what the differences are".

‘You could allocate, say, £3m to £5m to that particular type of case, and the law firm could draw down up to that limit.’ From the funder’s perspective, there is one major danger inherent in any deal which gives law firms a greater role in assessing cases on their behalf: adverse selection. Under the DBA regime, law firms may choose to fund the strongest cases themselves, and only engage funding where the case is more risky. ATE insurers have long complained that they find themselves selected against in a similar way. Dunn says: ‘Adverse selection is always the first thing on my mind; I wonder, are we being given something that no one else wants?’

She adds: ‘So [in a portfolio funding arrangement] we would always take all the cases like that, not just some; to the extent that the client wants funding, that is. Say you had 60 claims in a particular area, with 40 clients wanting funding and 20 who wanted to self-fund. We would make sure we did all of the 40; it is not a question of the law firm keeping the 10 best cases.’

Finding similarities

One of the difficulties with funding a batch of a firm’s litigation is that, in the commercial arena, firms do not tend to have large numbers of identikit cases. Indeed, commercial litigators will probably regard each case as a one-off. But that does not necessarily mean that there is no scope for introducing a streamlined funding process where there is a close relationship with the law firm.

Ross Clark, chief investment officer at US funder Burford, which entered the third-party funding market six months ago through a tie-up with UK after-the-event insurance business FirstAssist, says: ‘This is certainly something that we’ve been talking about internally, and we are very interested in. I lose track of how many of our [insurance client] firms have talked to us about that. It could be a short-cut procedure that we could use and access more of their business.’

Clark suggests that while commercial cases might be quite heterogeneous, they may still share common characteristics that could make them eligible for a slightly lower level of due diligence from the funder. This might make funding a viable option for cases of a lower value than currently, if the firm is providing enough of them. ‘It is hard to know where the threshold is; perhaps cases worth hundreds of thousands, or possibly tens of thousands. It could work.’ Clark suggests that where cases reach a certain level of merit, have the right relationship between costs and damages, and involve solvent parties, they could be eligible for a lighter-touch due diligence by the funder, once it has assessed the law firm itself, and its processes.

‘Once you have established what checks the lawyer did in making sure that the other side has money, you could then tick this box and move on; whereas in a firm where there is no relationship [with the funder,] you would need to spend more time on it,’ he says. Likewise, Clark adds, if one knows that the lawyer’s own budgeting mechanism works and they are good at recovering their own fees, ‘you tick the box and move on’.

‘It is about making things more efficient, to get into markets that are not thought of as traditional funding markets. But you would need the firm to have some kind of stake in the litigation themselves; for example, some form of DBA or CFA arrangement.’

Ben Hawkins, managing director of Commercial Litigation Funding Ltd, adds that not all funders will be able to transfer due diligence responsibilities at present. He explains: ‘Funders will need to look at whether the constitution of their existing investments will allow for the flexibility needed; you can’t necessarily delegate any arrangements to the lawyers. There will be new funding rounds, on different terms.’

Conflicting interests

But while there are good reasons for solicitors and funders to build closer relationships, tensions still remain between the two. While solicitors acting under a CFA or DBA may appear to share the same interest in winning as the funder, Reach points out that this is not necessarily so. ‘Even though a solicitor wants their client to win, their interests are not aligned. Solicitors are still being paid [for] most of what is going on’. The solicitor’s hourly charge-out rate can roughly be divided into three aspects: overheads, the solicitor’s salary and partner profit.

‘What we find is that the solicitors will normally put 33% at risk, to postpone the profit element of their fee… But I have the sense with a lot of firms that they are willing to lose this. The fee-earner can still hit their target on the non-deferred part [by working more hours]. It can never be fully [transparent] unless you know exactly what firms are spending on their running costs etc.’

Reach also gets frustrated by lawyers’ attitude to the funding process: ‘I know that as a solicitor in private practice, I hated filling in forms for the ATE insurance. But if a funder is providing, say, £1m of funds over a 12-month period, you should be willing to give them a monthly update that’s a few pages long. A solicitor will sell a case to you over the telephone, because they want to show their client that they can obtain funding for them. But I find that as things progress, and you start to do due diligence – for example, if you want to cross-examine the witness to make sure that the case will stand up in court – they start to get offended, and they act like you are a real nuisance.’

Others feel that many lawyers lack enthusiasm for TPF because they are already doing well under hourly rates. ‘The problem in London litigation is that so many firms are just sucking on the banking and insurance industries, and they don’t really have an entrepreneurial approach to litigation. They are in a comfort zone and don’t want to take risks,’ Perrin says.

The shadow of regulation

The funders’ new umbrella body, the Association of Litigation Funders (ALF), celebrates its first birthday this month. But its existence has not silenced calls for statutory regulation of the industry. The most vociferous and vocal critic of TPF is American trade body the US Chamber of Commerce, which will publish proposals next spring outlining precisely how regulation could be imposed on the sector, and considering which would be the most suitable regulator to handle this. Scévole de Cazotte, vice-president of international initiatives at the chamber’s Institute for Legal Reform, says: ‘This industry has been in place for several years now. Let’s put some rules in place that are enforceable. The code is exactly that; just a code… It is like saying to funders, "now try to behave".’

But Perrin, who is chair of the ALF, argues that regulation is unnecessary and would ‘kill’ the industry, which is still very small. Indeed, he notes that, having assembled what he claims to be the ‘main players with money to invest in litigation’, there are only nine funder members. As most had to amend their funding agreements in order to comply with ALF’s code, he asserts that the association has already raised the level of ‘fairness’ at which the industry operates.

In the coming year, ALF plans to widen the number of funders participating on its board, and welcome more solicitors into its membership. Six law firms have joined as associate members so far, but Perrin expects this to eventually become ‘hundreds’. As the funding market grows, the expectation is that it will become easier for solicitors and clients to take advantage of funding. Because of the inherent risks involved, TPF will never be cheap. But – much as funders like to deny it – there is growing talk of prices coming down.

Amey says: ‘Provided that the ATE market holds up following the Jackson reforms [and funders do not have to step in to carry this additional risk], then TPF will continue to gain traction, and I could well see the price of funding come down as more and more funders enter the market.’ He adds that competition could push funders to become more imaginative about the kind of cases they take on. ‘I think eligibility levels for funders have traditionally been set at a very high level,’ he says. ‘The due diligence threshold has been quite high, and it will come down. After all, funders are not making money unless they get their funds out of the door.’

Rachel Rothwell is editor of Litigation Funding magazine, which provides in-depth coverage of costs and the financing of litigation. For subscription details, tel: 020 7841 5523.