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Litigation and arbitration finance for construction disputes

October 17, 2019
Craig Arnott

Construction disputes are famously high stakes. In addition to the damage to business outcomes that the underlying disputes may present, parties can quickly spend many millions on legal fees and expenses; as well as technical experts and consultants, if and when those disputes progress through the courts or arbitration. Meanwhile, in their pursuit of resolution, those parties’ financial profiles may be significantly impacted—not only because mounting legal costs can drag down balance sheets, but also because pending legal claims may represent hundreds of millions (if not billions) of dollars in captive value that traditionally haven’t been counted as assets.

Third-party financing, which seeks to unlock the asset value of pending legal claims, can change this dynamic. Construction disputes are ideal candidates for this specialized and fast-growing area of finance.

What is litigation and arbitration finance?

With litigation and arbitration finance, a third-party financer provides capital that is collateralized by a pending legal claim. In the simplest arrangements, they provide non-recourse capital that can be used to pay for legal fees and expenses, so that a single matter may proceed. In exchange, the financer is entitled to recoup its investment and gain a return from the settlement or damages, should the claim be successful. In more complex models, the financer may provide capital for multiple matters in a portfolio arrangement, including defending matters as well as claims. Capital may be used to pay for legal and expert fees or expenses, or for other business purposes.

Is it suitable for large construction disputes?

Third-party finance can be helpful to parties engaged in construction disputes for a variety of reasons.

In some instances, a construction claimant may simply lack the financial resources to pursue a single, high-stakes matter. Litigation and arbitration finance provides parties with access to capital, without which they might not have the resources to pursue a fair recovery through the courts or arbitral process. It also levels the playing field in ’David vs Goliath’ scenarios, where smaller claimants face much better-capitalized defendants. Lacking the resources to engage the very best counsel for the full duration of a dispute can put the claimant at a significant disadvantage. Third-party finance removes that obstacle, even when claimants are fully insolvent.

However, litigation and arbitration finance is equally suitable in situations where parties have ample resources to pay their legal bills out of pocket. In many industries, corporations are increasingly using third-party finance by choice, not just necessity. It may simply be a more efficient way to pay for legal costs, whether for respondents or claimants. It also provides a tool to hedge risk, eliminate budget constraints, and monetize pending claims to free capital for other corporate needs.

As such, arbitration finance is particularly important to construction contractors facing disputes. In most cases, any construction company facing a dispute will not only have to absorb legal expenses within existing legal budgets, but must also deal with significant resources being tied up for an indeterminate time. The level of risk within a construction dispute is very high, with significant dependencies on complex technical knowledge as well as significant expense needed to bring the matter to fruition. Here, arbitration finance can support in reducing or eliminating the immediate legal costs of a claim, as well as bearing some or all of the risk associated with bringing the claim in the first place. It can be used to:

  • Manage corporate resources by moving legal costs off balance sheets to a third party and therefore reserving cash for other corporate purposes
  • Manage and mitigate the risk because a third-party assumes that risk on the claimant’s behalf
  • Improve accounting outcomes, because financing legal fees and expenses and moving risk off of corporate balance sheets represent a more efficient, and far friendlier, approach from an accounting perspective

Appropriate matters

The most obvious factor in determining the suitability of a dispute for outside finance is the likelihood of success. Because litigation and arbitration finance is typically provided on a non-recourse basis, and the financier will lose its investment if the underlying matter proves unsuccessful, third-party financers will look hard at the merits of the claim first and foremost. This means that parties seeking financing should be realistic about the prospect of success and prepared to explain the strength of their factual and legal position.

Beyond this basic criterion, matters suited for financing are high-stakes commercial cases with significant value to the business, in which damages or returns are sufficient to appropriately balance the interests of the client, lawyers, and an outside financier. Pricing varies with risk and investment amounts; meaning the amount provided by the financier, not the size of the claim, may range from as little as $1 million for a single case to as much as $100 million for a portfolio of cases. Another consideration is enforceability.

A third-party funder must be confident that if the case is successful, the losing party is creditworthy, has the means to pay, or else has sufficient assets located in a favorable jurisdiction for enforcement.

What should parties look for in a finance partner?

Third-party finance is a fast-growing industry that has attracted many new entrants to the field. Parties seeking financing should be careful to perform their own due diligence in seeking out the right fit for their business and their needs.

Two issues are paramount. First, in transactions when some capital is to be paid in the future, claimants must be confident that capital will be available to them at the point when it is needed. Does the financier have its own capital? If the capital must be called, are the capital sources firmly bound to provide it?

Second, even when capital availability is not an issue—such as when all the capital is received up front—claimants need to focus on the size and structure of their finance providers to assess their stability and incentives, and the materiality of the investment to them. This is important because if a transaction is material to the financier, there are inevitably contractual provisions in the arrangement that will, if it comes under pressure, permit the financier to act in a manner that may be inconsistent with the client’s interests.

As the largest player in the industry, Burford offers significant experience and expertise, as well as capital, to parties seeking financing for construction disputes. We stand ready to help.

This article by Craig Arnott was first published in the September 2017 issue of the Driver Trett Digest.