Whipping up a storm

This is not a good time to be a litigation funder. Over the past few years, the industry has been beset by problem after problem. 

Economically, the investment environment is not what it was. Litigation funding thrived in a low-interest world where it was hard for investors to make a decent return in more mainstream, less risky investments. But that is no longer so.

What’s more, litigation funding faces competition from other investment options that are not only more predictable, but do not require the same degree of patience before reaping the rewards. As Malcolm Hitching, partner at City firm Macfarlanes, explains: ‘One longstanding issue which has come to the fore in the last year or two is the so-called “duration risk” of investments. Investors assumed they would be investing in litigation assets that would be likely to yield a return in three to five years. The reality is that has not been the case. The court process is now typically taking longer than anyone would initially have foreseen.’

Against this difficult backdrop came the fateful Supreme Court ruling in PACCAR ([2023] UKSC 28), dealing a dramatic body blow to the industry. Before PACCAR, litigation funders had their cake and ate it, with a choice of two ways of getting paid: as a percentage of damages, or a multiple of the sum they invested. Most litigation funding agreements (LFAs) allowed the funder to take whichever of the two options worked out best for them.

This has all changed since PACCAR, because the Supreme Court decided that LFAs involving a return based on a share (or percentage) of damages must be classed as damages-based agreements (DBAs). That makes all such LFAs invalid in opt-out collective proceedings before the Competition Appeal Tribunal, because DBAs are not permitted in those cases. Outside of this, an LFA based on a percentage would need to comply with the Damages-Based Agreements Regulations 2013 in order to be valid; but that is not technically possible. Susan Dunn, founder of Harbour Litigation Funding and chair of the Association of Litigation Funders (ALF), explains why: ‘It’s because DBAs are not intended for third parties, they’re intended for lawyers. So if you look at the reading of the DBA regulations, funders can’t make them fit because we’re not the lawyers on the case. You just can’t draft an agreement that works with the terminology of the DBA, because they’re designed only to be used by a representative who stands to gain money from the case that they’re running for the client. So you can’t make [LFAs] compliant.’

All this put an abrupt end to the practice of funders calculating their return as a percentage of damages. In the immediate aftermath of PACCAR, funding agreements were urgently renegotiated and the industry switched to basing returns solely on a multiple of the sum invested in the case (‘the multiple approach’). Now that they no longer have the option of taking a sizeable percentage, however, the multiple that funders use has increased, and funding has become more expensive since PACCAR.

The vast majority of LFAs were successfully renegotiated, helped by the fact that where a case was ongoing and the funder’s financial support was still needed, it was in everyone’s best interests to reach an amicable solution. Elena Rey, partner at Brown Rudnick, comments: ‘I was very pleased with how the market dealt with the PACCAR decision, because parties very quickly came to the same solution, which was to amend the funding terms and to work on amended funding structures.’

Where cases have already concluded, however, or where the parties do not need any more cash from funders, the balance of interests is somewhat different. Battles have been raging behind closed doors, with clients or former clients challenging the enforceability of their percentage-based LFAs and either refusing to pay up or demanding their money back. As LFAs usually provide for such disagreements to be resolved through arbitration, however, these disputes are confidential and it is hard to get a sense of just how many are ongoing, and what the outcomes are.

A sequel to PACCAR?

If the PACCAR ruling was the equivalent of a zombie horror movie for funders, then they need to brace themselves for what could be a terrifying sequel, coming soon to the Court of Appeal (CA). A hearing in Alex Neill v Sony Interactive Entertainment could herald a real apocalypse for the industry, because the validity of the multiple approach – on which the vast majority of funding agreements are now exclusively based since PACCAR – is under challenge. The CA hearing groups together a number of appeals from the CAT that all require a definitive answer on the question of whether LFAs based on a multiple should be classed as DBAs, rendering them unenforceable. A stay on these appeals, imposed while PACCAR -related legislation looked imminent, was lifted in February,  and the hearing will take place by 31 July.

'I would be surprised if multiples were not upheld… the market has considered all different possibilities of how to adapt since the PACCAR ruling came out, and this was regarded as the safest approach'

Elena Rey, Brown Rudnick

So why might the multiple approach amount to a DBA? In LFAs calculated as a multiple of the sum invested, the funder’s fee cannot be more than the full amount of damages. Defendants argue this creates a connection between the funder’s fee and a (100%) share of the damages; and so a DBA is born.

Many lawyers believe this argument is unlikely to succeed. Rey suggests: ‘I would personally be surprised if multiples were not upheld… the market has considered all different possibilities of how to adapt since the PACCAR ruling came out, and this was regarded as the safest approach, not just by funders, but also by king’s counsel and lawyers who advised them. I think that’s a good indication of multiples being within the legal framework.’

'If the Court of Appeal finds that LFAs using a multiple are creating a DBA, that will be a massive shock to the industry'

Jenny Morrissey, Harcus Parker

The difficulty is that while it may be perfectly likely that the Court of Appeal will uphold the multiple approach, no one can be sure; and if it does not, the ramifications will be huge. As Neil Purslow, chair of the International Legal Finance Association and chief investment officer at funder Therium, puts it: ‘The Court of Appeal case is very, very significant. It shouldn’t go wrong, but if it does, it’s PACCAR 2, and risks causing irreparable harm to the funding industry and the availability of litigation funding in this jurisdiction.’

Jenny Morrissey, partner at Harcus Parker, adds: ‘If the Court of Appeal finds that LFAs using a multiple are creating a DBA, that will be a massive shock to the industry, because all the newly negotiated agreements [since PACCAR] will also fall foul…  It would prevent single [case] funding, because how on earth do you calculate your return? The traditional funding of funder to claimant would be blown out of the water. And just think about the costs that have been spent dealing with PACCAR. The costs that would then be spent dealing with this – one would think that the government might have to sit up and pay attention at that point, because fundamentally, it’s impacting the ability of claimants to access justice.’

'It would be difficult for funders to keep laying out millions of pounds funding claims if they really thought their agreements were at serious risk of not standing up'

Julian Chamberlayne, Stewarts

Whatever the Court of Appeal decides, that will not be the end of the matter, as one side or the other will inevitably appeal to the Supreme Court. This will require permission to appeal, but given the significance of the issues, that seems unlikely to be refused.

Julian Chamberlayne, partner at Stewarts, predicts that if the Court of Appeal does rule against the validity of the multiple approach, ‘we will all have a horrendous period waiting for it to get up to the Supreme Court’. He adds: ‘In the meantime, there’s every chance there will be a hiatus. It would be difficult for funders to keep laying out millions of pounds funding claims if they really thought their agreements were at serious risk of not standing up. They can’t just keep shovelling money in if they’re at serious risk of not getting their money back, let alone getting the return on it.’

In the alternative, if the Court of Appeal upholds the multiple approach, Chamberlayne suggests it would be ‘business as usual’ while the issue made its way to the Supreme Court. By which time, the Civil Justice Council (CJC) will have published the recommendations from its review of litigation funding, due this summer. It is also possible that the government will have signalled an intention to legislate. If there is no sign of any PACCAR legislation before the multiple question reaches the Supreme Court, however, then the funding industry should be very worried. In PACCAR itself, the highest court took a very black-letter approach to the wording of regulations and paid no regard to the real-world consequences, which were for government to deal with. There is no reason to think it would change that approach. 

State of uncertainty

According to Law Society research, the UK legal sector generates £44bn in turnover for the UK economy. But there are growing signs that the fallout from PACCAR is having a damaging impact. Burford Capital, for example, with a $7.5bn litigation portfolio, recently said it was shifting some dispute resolution activity away from London to rivals such as New York due to continuing ‘uncertainties’ in the UK.

Hitching comments: ‘If you are a funder, why would you invest in a single case opportunity in England and Wales at the moment? Litigation is a risky enough investment as it is. If there were extra risk layers on top to say that, if we win, there’s actually no certainty that we’re even going to get our money back – quite apart from the return – funders are going to say, quite rightly, we’re going to put our money somewhere else.’

He adds: ‘Surely as an economy, what you should be after is growth. What is happening at the moment is the opposite of growth, it is precluding investors from investing into the UK economy.’

Macfarlanes partner James Popperwell points out that the full effect of PACCAR is not yet visible. He says: ‘The interesting question is, what is the effect of PACCAR on new funding, subsequent to July 2023? At the moment we’re still seeing cases that were funded pre-PACCAR playing out… But give it another 12-18 months, and we should see whether the new cases being filed in the courts are going to be on the rise, or on the decline. There are already signs that it’s looking like a downward trajectory… This is certainly in part affected by uncertainty in the litigation funding market affecting English cases.’

Dunn adds that the negative effects of PACCAR are real, not theoretical. She reflects: ‘In an uncertain world, when you’re trying to raise money as a funder, the more uncertainty there is, the more difficult it is to raise money. Without question, funders across the piece are finding it challenging to raise money.’

It is not just the funders that are affected. As Popperwell explains: ‘We’re not just talking about the funding of cases, but also the funding of law firms, which is playing an increasingly important role in the litigation landscape today. That funding enables those law firms to offer their own DBAs or CFAs. But if this uncertainty affects the funding to those law firms, the funders can’t offer those deals…. we’re in a situation that is not so different to what we had pre-Jackson reforms, when we had no DBAs and very little third-party funding. We had CFAs, which were widely recognised to be disproportionate in their effect. And that’s where we find ourselves today; it seems like CFAs are the only certain, viable way of funding a large commercial case in England. We’ve wound the clock back.’

ThePACCAR question forms part of a broad-ranging review of litigation funding being carried out by the CJC. Funders hope that when it publishes its recommendations this summer, the council will urge government to take separate, prompt action on PACCAR, rather than dealing with it as part of the broader reforms, which will take longer. Under the previous government, justice secretary Alex Chalk had spearheaded a short Litigation Funding Agreements (Enforceability) Bill to do just that, but this fell victim to the general election. The Labour government has so far declined to follow suit, indicating that it will deal with PACCAR once it has considered all the issues in the CJC’s review ‘in the round’.

Hitching warns that legislative action on PACCAR may come too late: ‘If it is another 12-18 months before anything really happens, there may be very little left by way of capital that really wants to deploy in this sector in this country. It’s a finite resource… PACCAR is a really significant dampener on the litigation funding market in this jurisdiction and we would urge that the government deals with it speedily.’

Opponents of the previous LFA bill argued strongly against its retrospective effect, which they say is unjustified and goes against legal norms. Retrospectivity is very significant for funders, as without it they will still be vulnerable to challenges over past agreements. At a recent CJC consultation event, Mr Justice Simon Picken, co-chair of the CJC review, gave funders cause for hope. Listing a whole range of findings that the review might potentially make, he included a potential conclusion ‘that third-party litigation should be viewed as a [DBA] but that the position should only apply to post-PACCAR agreements, and that any agreements entered into pre-PACCAR should not be understood to be damages-based agreements’. This at least suggests the CJC has not ruled out recommending retrospective legislation.

Under review

With the CJC currently scrutinising the funding industry, many in the market were shaking their heads last December at the timing of a rare public spat between a funder and a class representative. The £200m settlement agreed between Walter Merricks CBE and Mastercard, in a claim once valued at £10bn, led to funder Innsworth Advisors challenging the settlement agreement in the CAT, without success. ‘It was a bad coincidence that this came up just at the time when [litigation funding] is right under the spotlight [and] issues like funder control are being considered,’ remarks Chamberlayne.

'Why should a cap be imposed between sophisticated contracting parties? Why should any restriction be imposed?'

Malcolm Hitching, Macfarlanes

As well as questions over how funder conduct should be regulated (see box), two further issues are lurking within the CJC review that make funders particularly jumpy. The first is whether funded parties should have to disclose that they are backed by litigation funding; a move currently being considered in various US states and elsewhere to bring greater transparency. Funders worry this would hand an important tactical advantage to opponents and argue that the same rules should then apply to disclosure of defendants’ insurance.

The second controversial issue is whether funder returns should be capped. This highlights the different situation faced by consumers as opposed to commercial parties. Hitching reflects: ‘Why should a cap be imposed between sophisticated contracting parties? Why should any restriction be imposed? It strikes us as wrongheaded that one should try to impose restrictions in those circumstances. But flip it around, and if there are consumers, then it is more understandable. If a consumer wanted to borrow money, for example, they would be protected by the Consumer Credit Act. The CJC may say that is a sensible comparator… there could be some kind of consumer protection.’

He adds: ‘I’d caution very seriously against interference when it comes to freedom of contract between sophisticated parties… It would be perverse to go against centuries of tradition in this country that essentially says, if you are a sophisticated contracting party, you can agree what you like. That has made it a very attractive place to do business.’

Overall, the CJC will need to strike a careful balance to achieve the right level of control over the funding industry while ensuring that it can still do the job it is needed for.

‘Litigation is so expensive in this country that very few people can afford it,’ remarks Hitching. ‘If funding drops away as an option, that will be a bad outcome. There will be a lot of people who won’t be able to bring their cases, and won’t be able to even think about accessing justice.’

 

Rachel Rothwell is editor of the Gazette’s sister publication, Litigation Funding