Third-party funding is growing in popularity, but powerful critics allege that it fosters an ‘unhealthy’ litigation culture. Rachel Rothwell reports.
Third-party funding is an industry that divides opinion.
Its proponents argue that external investment in litigation helps genuine claimants to enforce their rights, lending them equality of arms with big defendants – and giving them certainty over how much the litigation is going to cost them. But its detractors – the biggest and most vocal enemy being the US Chamber of Commerce – insist that the industry fuels an unhealthy litigation culture. There is one thing, however, on which both sides agree – third-party funding is a sector that is growing rapidly.
According to the US Chamber, the funding industry has expanded by 743% in the last five years, with £1.5bn of known assets now under management. There are currently around 15 litigation funding companies, and new funds are launched around every six months. Those involved in the industry include private equity funds, hedge funds, family offices and some listed funds.
As Matthew Amey, director of funding broker TheJudge, explained last month at the Law Society’s commercial litigation conference, one new source of funding is coming from law firms themselves – with firms putting their cash into an entity which then acts as a funder. ‘The US law firms in particular see the UK as fertile ground for them to operate as funders,’ Amey noted.
As the funding market grows, funders are beginning to specialise more, serving particular market segments such as competition law, patents or insolvency.
Speaking to funders, all seem to agree that applications for funding have surged over the past year. Rosemary Ioannou, senior counsel at Vannin, says: ‘I joined Vannin almost exactly a year ago, and in that year we have seen an exponential rise in approaches for funding. That has been from law firms across the board – magic circle, US, boutique firms, national firms – and also from barristers, and clients directly, both in the UK and internationally; and for both litigation and arbitration. The breadth of cases and jurisdictions is growing very substantially and very quickly, and clients are often large, well-established, well-capitalised claimants.’
Ioannou cites insolvency and investment arbitration as two key growth areas, as well as a rise in breach of contract disputes (a funder’s bread-and-butter). Another burgeoning area, particularly for funders that operate internationally, is enforcement work – whereby funders buy judgments and take on the enforcement risk.
Ioannou adds: ‘Hong Kong has recently recognised that funding should be made lawful in arbitration. That, to me, demonstrates that dispute resolution centres around the world are now becoming alive to the importance of funding to their industries.’
Funders are also playing a growing role in supporting class actions, as illustrated by Bentham Europe’s announcement last month that it is funding a shareholder action in Germany against Volkswagen, over the emissions scandal. Also in Germany, funder Burford has just revealed a €30m deal with claimant firm Hausfeld, known for its class actions work, to fund German competition claims and open an office in Berlin. In the UK, the new ‘opt-out’ regime for competition claims is likely to lead to more funded claims in this area.
Burford’s deal with Hausfeld reflects a new development in litigation funding, with some funders now investing in a book of cases, rather than each individual claim.
Burford is providing finance to corporate entities to fund, for example, a portfolio of defence cases; and it now does more of this type of funding than it does one-off, individual cases. From a funder’s perspective, this is a much more efficient way of providing finance – cutting down on the extensive legwork involved in funding individual claims. The cases come directly from the in-house legal teams, and the companies involved are AIM-listed, publicly listed and private.
Burford’s managing director Nick Rowles-Davies says the funder has repositioned itself, moving from ‘funder’ to ‘financier’. He says Burford is also working with law firms to help them respond to clients’ expectations that they should take on more risk: ‘There are some big-named London firms who have said to us, we can’t do work at a massive risk, but we are actually being challenged by some boutique law firms that are prepared to take on more risk. So we are saying to them, if you want to spend, say, £2m a year for the next five years, we can finance that – and the client, law firm, and funder all share the risk.’
Would Burford go a step further, and invest in the law firm itself? ‘We are looking very carefully at that,’ Rowles-Davies responds, ‘and talking to a number of law firms to see if there is something there. It’s a natural progression.’
Traditionally, third-party funders have served only high-value claims, with a minimum dispute value of at least £3m and often much more. But that is changing.
Call for statutory regulation
In November 2011, the Association of Litigation Funders was set up to provide self-regulation of the funding industry. It currently has just seven members, who must maintain at least £2m of capital and abide by the ALF’s code of conduct, which includes a requirement not to control the litigation.
But critics of the funding sector, including the high-profile US Chamber of Commerce, have repeatedly called for statutory regulation. A spokesman for the Chamber told the Gazette: ‘The current reliance on a voluntary organisation of funders, ALF, to regulate the industry is completely insufficient. The industry has grown dramatically since 2009… If a member firm violates the voluntary code of conduct, the worst that can happen is that they will be booted out of the organisation. That would not prevent the funder from continuing to finance litigation. It is past time to consider government oversight of a financial services industry of this size and scope.’
He added: ‘An oversight regime should assure at a minimum that funders have sufficient capital to live up to their commitments, should regulate the conflicts of interest that riddle litigation financing, and should provide sanctions – with teeth – against misbehaviour.’
ALF chair Leslie Perrin (pictured) points out that a number of ALF members are already regulated by the Financial Conduct Authority and /or various offshore financial commissions, and notes that funders’ counterparties are ‘overwhelmingly’ experienced commercial organisations or individuals, rather than consumers.
Burford’s Nick Rowles-Davies insists that the ALF does a good job, but adds that funders do not fear statutory regulation. ‘If the government said we should be regulated, why should we worry?’ he asks. But he points to the fact that no government regulator has so far shown any interest in taking the funding sector into its remit. ‘The problem is, no one wants us,’ he says. ‘I suspect that is the real reason why we have not been regulated.’
In the past few years, a small number of funders have attempted to tackle a part of the market where the need for financial help is greatest, but the economics are toughest – the lower-value sector. Since the Jackson reforms of April 2013, winning litigants have been unable to recover the costs of success fees and after-the-event insurance from their opponents. This has made it even harder for small clients to bring litigation, increasing the need for third-party funding while at the same time making it harder for such claims to be economically viable for funders.
Currently, three funders offer finance for lower-value claims: Augusta, which was the first to enter this end of the market two years ago, and will generally be looking to provide at least £50,000 of finance; Burford, which launched its specialist ‘Sprint’ product for lower-value claims in February, providing finance from £25k to £500k; and now Acasta, which launched a product offering a minimum investment of £10,000 in July.
Mark Beaumont, director at ATE and funding broker Annecto, says demand is growing in this part of the market. He explains: ‘More businesses are looking at funding for lower-value claims, because now there are actually solutions in that area. What people want above all is certainty. If they go to a lawyer and the lawyer says, “well I don’t know how much this is going to cost, it may be £100,000, or it may be double that”, they can’t go back to their finance director with that. But they might be prepared to spend a certain amount, provided they have certainty. So a business might be quite prepared to put in the first £50,000 and not pay a penny more, with the lawyer on a CFA and insurance in place, all sharing the risk.’
The challenge at the lower end, where the damages pot is not that big, is to keep the cost of providing funding as low as possible. As with funding for larger cases, the lower-value funders require claimants to take out after-the-event insurance. Burford’s ‘Sprint’ product is administered by ATE and funding broker TheJudge. It keeps costs down essentially by relying on the due diligence of the ATE market to decide whether a case has sufficient merit.
Augusta has developed a streamlined, web-based process for applying for funding, and is aggressively pursuing case volume. Its managing director Louis Young says the funder is now dealing with eight or nine cases per month; though he admits that it recently had had a ‘flat spot’ while it reorganised its financing. Young says that Augusta’s original ‘short-term mezzanine investors’ will remain as equity investors, but the funder has ‘some serious players’ lined up to provide further finance.
Overall, Augusta has 90 or so matters in the pipeline and has received around 17,000 notifications in two years. The funder has relationships with a variety of law firms, including Freeths and Gordon Dadds, and some 860 firms have access to its database. It also has a network of 160 or so introducers, including independent financial advisers, accountants and tax consultants, who are paid a brokerage fee upfront. In addition, it markets itself to institutions with access to small and medium-sized enterprises, such as the Institute of Directors and an association of travel agents.
The third and newest player in the lower-value field is Acasta Europe, an insurer majority-owned by Fred Done, founder of Betfred. This summer, Acasta launched two arrestingly named funding products, ‘Sparkle Capital’ and ‘Sparkle Lite’, both of which are tied to its ATE insurance.
Acasta’s legal director David Kearns explains: ‘Acasta is a Gibraltar-based insurer, and one of our [main] licences is for Class 17 legal expenses. Post-Jackson, there is less need for ATE in personal injury and disease claims, and a growing area [for us] is commercial ATE. We recognised that, as a relatively small player, we needed to offer something special, and funding must be a part of our offering.’
Sparkle Capital is for larger claims, where damages will typically be a few million pounds, and funding might be up to £1m. Sparkle Lite is for lower-value claims, which might mean damages of £1m, and funding of £400,000 or so. But the minimum investment amount can be as low as £10,000.
Unsurprisingly, the drastic rise in court fees, which must be paid upfront, has proved a boon for lower-value funders. Kearns says Acasta has already funded court fees in several cases where the prospects looked good, and it wanted to provide the ATE cover but needed to finance the court fees in order to get the case into court.
There has been plenty of good news in the third-party funding industry, then, with strong demand from clients and new finance coming into the sector. But it has not all been plain sailing.
Financial sector disputes
One area where demand for funding is growing is in banking and financial disputes.
Janine Alexander, financial services disputes partner at City firm Collyer Bristow, says clients in this sector now know much more about funding. ‘Awareness is increasing generally as more funders come into the market. The volume of information disseminated by them overall about litigation funding has increased exponentially in the last five years or so,’ she says.
‘Funders are now getting more sophisticated in their analysis of potential claims “pools” and at targeting information to potential claimants – for example where there is a banking scandal leading to potential claims by businesses. Many clients who come to us are now often already aware of particular funders who are interested in their type of claim and the broad structure of their offering. Whereas a few years ago, a general awareness of the existence of funding as a concept, and perhaps the names of a few major players, would have been more typical.’
She adds: ‘For banking and financial disputes there are now fewer barriers to using funding, because some funders will offer “seed funding” for initial factual and expert investigations, which can be expensive but are critical to assessing the prospects of complex claims. Also, some funders are now more willing to rely on the judgement of solicitors based on a “risk-sharing” model where solicitors act on a discounted CFA. This again helps open up claims that might otherwise be prevented by the cost of time resource required for extensive due diligence.
‘But the key remaining barrier is cost. Clients are often unwilling to give up so large a proportion of their damages, so if they can afford to fund a case with good prospects themselves, they prefer to do so.’
One setback last year was the costs judgment in Excalibur Ventures v Texas Keystone et al  EWHC 3436, which was seized on by critics. The second was the controversy surrounding funder Argentum, which had been one of eight (now seven) members of the Association of Litigation Funders. Following allegations of irregularity surrounding one of its investors, Argentum left the ALF, and was also delisted from the Channel Islands Securities Exchange. It has since dissolved.
Has the storm surrounding Argentum had a negative impact on the funding sector? Not according to Rowles-Davies, who says: ‘It was an unfortunate set of events, and no one would want that in their industry. But other than the occasional question, I’m not sure it has had any effect at all. The industry has grown so much. In 2010 it was considered something of a ‘dark art’, and now it is almost mainstream.’
The Excalibur judgment related to an epic $1.6bn claim by Excalibur Ventures against Texas Keystone, over interests in four large oilfields in Iraqi Kurdistan. Excalibur’s claim was dismissed after a 57-day trial and the judge was highly critical of the way its solicitors (Clifford Chance) had conducted the case.
In October 2014, the funders in the case – who were not ALF members – found themselves subject to indemnity costs; despite not having been responsible for the way the claim was conducted. The judge also held that the £17.5m provided by the funders as security for costs should count towards the so-called ‘Arkin cap’.
Under the Arkin rule, a funder is only liable to pay adverse costs up to the amount that it actually invests in the litigation. But this was not previously considered to include the amount it put up as security for costs. That issue is being appealed, but if it is not reversed it will have a big impact on the funding industry.
Leslie Perrin, chair of both the ALF and of funder Calunius Capital, says: ‘The Excalibur judgment is a tremendous learning experience for funders, because it specifies how they should review cases before they invest – that is, thoroughly – and makes it clear that funders cannot abandon the cases that they have invested in; they have to continue to monitor them, without controlling them.
‘That is one of the difficulties. How do you keep monitoring cases without controlling them? I think the ALF code of conduct gets the balance right, and people in judicial functions accept that [the ALF code] is a balanced account of the current state of maintenance and champerty.’
But Perrin admits that he has ‘worries’ about some of the costs aspects of Excalibur. ‘The ALF will be making an application to be heard in the Excalibur costs appeal next year,’ he says, ‘to assist the court with insights into the current practice of funders.
‘Personally, I am quite happy that if the case attracts indemnity costs, then the funder’s liability should also be assessed on that basis. The part that concerns me is the security for costs.
‘If you put money into court, that is considered to be funding, when it is [actually] a payment on account of a claimant’s costs. Plus, these days, security of costs is often provided by insurance, and the cost of that is not the same as the value of it. There is a lot of difficult stuff in there.’
But while Excalibur contained an unwelcome development on security for costs, it could have been much worse. What the judgment did not do was to question the validity of the precious Arkin cap. That protection is hugely valuable to the funding industry. Lord Justice Jackson wants to see it removed.
In summary, this thriving industry is not worried about the prospect of government regulation, or the criticisms levelled at it by defendant representatives such as the US Chamber (see box on statutory regulation, above). But if there is one thing that will make a funder wake in a cold sweat at night, it is the thought of losing that Arkin cap.
Rachel Rothwell is editor of Gazette sister publication Litigation Funding – the essential guide to financing and costs. To subscribe call 020 7841 5551 or visit the website