What is third party funding and how has it become a significant financial tool in Asia?
Third party litigation finance is an arrangement in which a litigant (or in some cases counsel representing the litigant) receives funding from a company that is not a party to litigation or arbitration proceedings in exchange for an agreed return. Capital is used by the litigant either to finance the fees and expenses of the dispute or for more general business purposes. The return is usually taken from recovered sums of any award or judgment. The asset value of the dispute is used to secure capital from the third party.
The use of external capital to finance litigation isn't a novel concept in Asia. As early as 2009 the Hong Kong courts acknowledged the role of specialized legal finance providers in funding claims bought by liquidators on behalf of insolvent estates. But the legal finance industry really witnessed a step change at the beginning of 2017 when Singapore passed legislation to allow third-party funding—a term that's now commonly used to encompass a huge range of legal finance activities—for international arbitration proceedings seated in Singapore and Hong Kong. Then, at the beginning of 2019, Singapore implemented similar reforms in related court and mediation proceedings.
Third-party funding has continued to generate interest among legal practitioners and litigants, not only in Singapore and Hong Kong but also in other jurisdictions in the region, including mainland China, India and South Korea where companies have long been participants in foreign dispute resolution proceedings.
What are the advantages for claimants using third party funding in Asia?
The use of funding has traditionally been associated with impecunious plaintiffs needing funds in order for disputes to proceed. However, there's been a shift globally towards using litigation finance as a more specialized form of corporate finance, resulting in the development of different kinds of products to support corporations managing the inherent uncertainty of commercial litigation and arbitration. Disputes create problems for companies that litigation providers like Burford can help solve by providing capital that businesses can use to offload the risk and the cost of pursuing meritorious claims.
At Burford, we work with a huge range of businesses, from startups to Fortune Global 500 companies, and our solutions are very flexible. The variety of financing options available continues to broaden and become more sophisticated as the legal financing market matures.
Fees and expenses financing
Lawyers are most familiar with financing of fees and expenses for single cases, where capital is provided to pay for the costs and expenses associated with litigation or arbitration. The funder will only receive its invested capital and entitlement upon the recovery of the money from the respondent either through settlement or enforcement of a successful judgment or award. The funder's entitlement is commercially negotiated and essentially reflects an assessment of the merits of the case as well as the risk profile. It also considers the economics of the case: At a very high level, that's how much money is required versus how much money is expected to be obtained at the end of the proceedings, like the damages or the quantum of any award.
Portfolio financing is used to fund multiple actions and claims and gathers many matters into a single funding structure. The capital can be used to fund the legal costs associated with the underlying matters or could be used as operating capital for the law firm or company. Again, because the capital is typically provided on a non-recourse basis, the funder assumes the downside risk and will only earn its investment back in the event of a successful resolution of the dispute. The matters within the portfolio can be a mix of claims, or a mix of affirmative as well as defense matters. In a portfolio structure, because risk is cross-collateralized amongst multiple matters, pricing is generally more competitive.
Monetization enables a litigant to convert a portion of its claim, uncollected judgment or award into cash. In essence, a funder can accelerate money from the underlying matter without the client waiting for legal processes to resolve.
Monetization is becoming an increasingly common product in Asia because companies often fight long, hard battles to get a positive judgment or award, and those judgments are only as valuable as the paper they are written on. If the losing party refuses to pay, companies have the additional expense of pursuing enforcement, which can take several years.
Companies can choose to monetize a portion or the entirety of an award or judgment, and can monetize a significant portion of an ongoing claim. Claims often represent considerable latent value to companies, but they carry a huge amount of uncertainty as to both outcome and timing. Because they're illiquid, traditional capital sources historically haven't been able to assign asset value to them, but legal finance providers like Burford have the experience and expertise in assessing the value of those assets and helping companies to unlock that value through monetization.
We can provide capital as a lump sum upon investment or in tranches that can be used either for legal expenses or other corporate purposes, for example, capital investment into the business. As with the more traditional legal finance options, the capital provider bears the risk of loss if the enforcement and collection is ultimately unsuccessful.
What kind of cases are appropriate for financing?
Not all cases are suitable for third party finance. Different funders have different commercial models, economic parameters and risk appetites. There are some threshold questions that we consider at the outset when we're first looking at a case, and we seek cases that meet a set of criteria.
Firstly, the merits must be strong: Because litigation finance is non-recourse and funders receive returns only when cases succeed, funders must be persuaded that the claim has good prospects of success. Therefore, we carefully assess the facts and legal merits. That generally starts with the draft pleading or a detailed written summary of the claim that's been prepared by legal counsel which covers the perceived strengths and weaknesses of the claim.
Secondly, we consider whether counsel has been engaged, and if so, who. Most commercial funders value cases that are led by experienced litigation counsel who have successful track records and a strategic approach. During our review of a claim, we will generally want to confirm that counsel has being retained and that they have performed an initial analysis of factual background of the case.
Jurisdiction is also a relevant consideration. Most commercial funders will invest in matters filed or expected to be filed in domestic courts, and that can be in either common law or civil law jurisdictions or administered by an internationally recognized arbitration center. If the majority of the enforceable assets are located in an unpredictable jurisdiction with an inefficient domestic court system, then it may raise concern not only as to the likely recoverability of the proceeds, but also the duration to recovery. If you're trying to enforce an award in a particularly challenging jurisdiction, then that can sometimes take over five years.
A key part of our assessment will be the creditworthiness of the respondent, the size of the assets and where the assets are located. If the respondent is insolvent or has illiquid assets, the value of which don't meet the damages claimed, then it's quite unlikely that a legal finance provider will make an investment.
Capital requirement is also important. Companies, law firms and funders get the best value when the economics of the case give rise to sufficient upside for all parties. Since the funder takes the return from the proceeds of the successful judgment or award, commercial funders will assess cases carefully to ensure that economics make commercial sense given the funding amount and the likely recovery. This is a balancing exercise, and thus sometimes even a meritorious case does not meet criteria for funding because the economics just won't bear the additional involvement of a funder.
The last consideration is damages. Normally at the outset, we like to see damages that are supported by solid evidence of loss and that are large enough to ensure that there's sufficient upside for all parties so that they can support the funder's investment, with the client keeping most of the litigation proceeds if the case goes well. The ratio of investment to expected recovery varies depending on the case and on the funder.
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