Litigation funding: capital gain

Third-party funding is increasingly present behind the scenes in the commercial litigation travelling through the court system. But the past few months have seen a surprising number of cases in which funding itself took centre stage before the court. 

The most high-profile example is the Court of Appeal’s judgment in Excalibur Ventures v Texas Keystone and others [2016] EWCA Civ 1144 earlier this month. However, Excalibur does not show funding at its finest hour. Excalibur secured litigation funding to bring a $1.6bn claim against Texas Keystone over interests in four large oilfields in Iraqi Kurdistan. But when the claim eventually came to trial in December 2013, it suffered a crushing defeat, failing on every point. The trial judge criticised the litigation as ‘speculative and opportunistic’. The case had been brought by magic circle firm Clifford Chance, and was reportedly the first time that the City giant had entered into a conditional fee agreement.

A number of funders had supported the claim, to the tune of £31.75m, including £17.5m stumped up for security for costs. It is notable, though, that none of the funders involved in the claim were members of the Association of Litigation Funders (ALF), the body set up in 2011 for self-regulation of the funding sector. These were inexperienced funders who probably took too much comfort from the involvement of a big name like Clifford Chance.

In the appeal handed down this month, the lords justices were asked to rule on two key points concerning the funding of the claim, both with big financial implications for the wider funding industry. First, the position regarding indemnity costs; and second, a question relating to security for costs. 

Indemnity policy

In Excalibur, indemnity costs were awarded against the claimant to punish it for the way the litigation had been carried out. But this effectively meant that the funders were on the hook for this punitive level of costs, despite the fact that – as Tomlinson LJ acknowledged in the appeal judgment – they themselves had been guilty of ‘no discreditable conduct’. Was that fair?

Tomlinson dismissed the funders’ argument that because they themselves had done nothing wrong, they should not be faced with indemnity costs. He said this only looked at the issue from one perspective – that of the funder – and it ignored ‘the character’ of the action that was funded, and ‘its effect on the defendants’.

Tomlinson also pointed out that making the funder liable for indemnity costs is no different to the way a litigator may find themselves hit with indemnity costs because of the way their lawyers, experts or witnesses chose to behave during the case – even though the litigator was not directly responsible for that behaviour.

On this first point, then, the appeal court made it clear that a funder can indeed find themselves on the hook for indemnity costs, even where they are not at fault. This clearly has the potential to make investing in litigation more risky for funders, because they could be facing a much higher costs bill than expected. But nonetheless, the mainstream funding industry could be described as relatively relaxed about this aspect of the ruling. Indeed, in his judgment, Tomlinson LJ refers to a 2015 Gazette article in which ALF chair Leslie Perrin acknowledges that he is ‘quite happy’ if a case attracts indemnity costs; the funder’s liability should be assessed on the same basis. At the end of the day, it is part of the risk inherent in litigation.

Linked to indemnity costs is the question of how far funders are allowed to go in influencing the way a case is conducted. The ALF code of conduct has strict rules for members, setting out the extent to which they may have an input into the cases they fund. But the court’s attitude to this issue has been something of a grey area. Funders are wary that if they get it wrong – and the court considers they have exerted too much control over the case – they will be guilty of ‘champerty and maintenance’ .

Funders were pleased, then, that Tomlinson LJ has now given some appeal court guidance on this issue, which Harbour’s head of litigation funding Susan Dunn suggests will offer ‘peace of mind’ for the funding industry.

The ALF provided written evidence to assist the court in Excalibur. One issue it raised was the fact that if funders want to avoid indemnity costs, they will need more input into the way the claim is conducted, running the risk that the funding agreement would be considered champertous. Tomlinson said this concern was ‘unrealistic’. 

He added: ‘As the [trial] judge pointed out, champerty involves behaviour likely to interfere with the due administration of justice. Litigation funding is an accepted and judicially sanctioned activity perceived to be in the public interest. What the judge characterised as “rigorous analysis of law, facts and witnesses, consideration of proportionality and review at appropriate intervals” is what is to be expected of a responsible funder… and cannot of itself be champertous.’

He continued: ‘If anything, such activities promote the due administration of justice. For the avoidance of doubt, ongoing review of the progress of litigation… seems to me not just prudent but often essential to reduce the risk of orders for indemnity costs being made against the unsuccessful funded party. When conducted responsibly, as by the members of the ALF I am sure it would be, there is no danger of such review being characterised as champertous.’

This clarification over how far funders can legitimately get involved in reviewing the case has been very much welcomed by funders. But even more welcome is Tomlinson’s open acknowledgement of the concept of third-party funding as a legitimate practice. Burford Capital’s CEO Chris Bogart notes that the judgment is a ‘complete acceptance of litigation finance funding as an integral part of a modern justice system’; something that has become ‘mainstream’ and is no longer ‘novel, esoteric or controversial’.

Security test

The final aspect of the Excalibur appeal – relating to finance advanced not for the ongoing expense of the litigation, but as security for costs – did not go the way the industry would have liked, however.

As it stands – and the Excalibur appeal has done nothing to change this – funders currently benefit from a principle known as the Arkin cap. The cap, which stems from a 2005 Court of Appeal case, limits a funder’s liability for adverse costs to the same amount that it has invested in litigation. Say, for example, a funder has advanced £1m towards a case, which loses at trial. The funder loses the £1m it has already invested; and it will be liable for up to £1m in adverse costs – but no more than that, because of the cap.

The cap itself is the subject of some controversy, and Tomlinson LJ noted in his judgment that there are ‘those who consider that the Arkin cap is unduly generous to funders who, some think, should have their exposure left at large’. But he also observed that in this instance, the appeal court had not been asked to ‘revisit’ the cap.

The issue before the court was whether money provided for security for costs should count towards this cap. If it does, that increases the amount that funders will end up having to pay out. The funders put forward a host of arguments as to why security for costs sums should be excluded from the Arkin cap – but Tomlinson slashed through them. He concluded that, fundamentally, the provision of court-ordered security for costs – without which a case cannot proceed – should not be treated any differently to other payments made by the funder, which are all essentially the costs of pursuing the litigation. This could prove an expensive decision for the funding industry. 

Recovery position

The Excalibur ruling came hot on the heels of another significant decision for the funding industry; this time more positive. In Essar Oilfield Services Ltd v Norscot Rig Management Pvt Ltd [2016] EWHC 2361 (Comm), HHJ Waksman upheld an arbitrator’s decision that, in the context of an ICC arbitration, a successful claimant could recover not just the usual legal costs, but also the cost of the third-party funding that it had been forced to incur in order to bring the case. These amounted to nearly £2m, provided by Woodsford Litigation Funding. 

The ruling means that in the international arbitration context, losing a dispute with a funded claimant could suddenly become much more expensive for defendants.

Woodsford’s chief investment officer Steven Friel holds the judgment up as ‘an arbitral and judicial sanction for litigation funding, from a leading arbitrator and a member of the judiciary’. He adds that this was a classic ‘David v Goliath’ situation, in which third-party funding plays a vital role in helping less powerful claimants gain access to justice.

Norscot had brought a claim against Essar for money owed to it as the operations manager of an oil rig, only to find itself hit with a huge counterclaim alleging breach of contract. The arbitrator, Sir Philip Otton, found emphatically in favour of Norscot, dismissing the counterclaim and criticising Essar’s conduct of the litigation, which had resulted in Norscot’s managing director needing to remortgage his home, and had been an attempt to ‘cripple Norscot financially’. 

In this case, the paying party’s conduct was heavily criticised by the arbitrator, and the third-party funding received by Norscot was essential to enable it to bring its claim. So the question is, will funding costs be recoverable in less extreme circumstances? 

Neil Purslow, director at funder Therium Capital Management, says: ‘It will be very interesting to see how this case develops. It has been decided on a set of facts, and we will have to see how far the court is willing to go. But people will test the limits.’

For Friel, if funding costs do indeed become widely recoverable in international arbitration, this could affect the settlement dynamics of this type of dispute significantly.

He says: ‘When I was in private practice as a litigator, at a time when CFAs and after-the-event insurance premiums were recoverable, you only had to write to the other side to tell them that you were about to enter into a CFA, or you had already entered into one and there was about to be a step up, and that really focused the defendant on settlement. That is the impact.’

Identity crisis

A criticism sometimes levelled at the funding industry is that it lurks in the shadows, without proper transparency over which cases are funded, and who is active in the market. But there is a steady trend towards greater openness. Funder Augusta Ventures, for example, publishes a running total on its website of the number of claims it has backed and the level of finance it has committed since it set up in January 2014; while listed funders such as Burford publish financial results with details of their investments. 

But while claimants often choose to let their opponents know that they have a litigation funder standing behind them, this disclosure was considered optional until the issue came before the High Court this October, in Wall v Royal Bank of Scotland [2016] EWHC 2460 (Comm). In what the judge Andrew Baker QC described as a ‘test case’, the court ruled that the claimant must disclose the identity of its litigation funder, so that the defendant could apply for security for costs against it.

Friel says: ‘The Wall case – which saw an individual claimant forced to disclose to a big bank the identity of its litigation funder – could potentially have a chilling effect on access to justice. The English litigation landscape is already very bank-friendly, and the likes of RBS don’t need more ammunition with which to discourage potentially meritorious claims. 

‘That said, at Woodsford, we are relatively relaxed about disclosure of our involvement in cases. We believe it sends two strong messages to the defendant. First, that the claim is a good one. Second, that the defendant will not be able to deploy the common defendant tactic of seeking to use costs escalation as a way of causing the claimant to go away.’

But he adds: ‘Of course, it could lead to another defendant tactic emerging – wasteful satellite litigation aimed not at resolving the dispute, but at trying to scare off the funder.’

Purslow has mixed feelings about the Wall ruling. He says: ‘We would normally take the view that it’s the client’s decision whether to disclose funding. Whenever they do so, it is usually a positive. 

‘As a well-capitalised funder, we don’t regard it as any problem, but there are public policy reasons why there should be no requirement to disclose funding. For example, if it were a non-professional funder, or a smaller, undercapitalised funder, the defendant might draw inferences from that. 

‘But you have to remember that the court is sitting on top of everything that you do. You can’t rely on contractual rights to stay in the shadows and we certainly wouldn’t want to.’

Purslow adds that while it is one thing to disclose the fact that a case is being funded, and the identity of the funder, it would be wholly unacceptable to have to disclose the terms of the funding, its limits, or the funding documentation.

What, then, does the future hold for the litigation funding industry?

Maurice Power, managing director at Ferguson Litigation Funding, suggests that economics will drive further capital into the funding market: ‘With interest rates forecast to stay low for the foreseeable future, and the returns from investing in litigation funding having zero to do with the state of the economy or the state of the global markets, investors will view this as a lucrative addition to their investment portfolio.’

Indeed, if any evidence were needed of the popularity of litigation funding as an investment, one need look no further than the ease with which funder Calunius raised £100m last month, from the same investors from whom it raised £50m in 2014.

While third-party funding is well-established in the UK, the US and Australia, its reach is now extending further, with new jurisdictions taking baby steps in opening themselves up to the industry. Most notably, last month the Hong Kong Law Commission published a report expressing support for the use of third-party funding in arbitration, with legislation now set to be introduced to abolish barriers to arbitration funding in Hong Kong and to introduce light-touch regulation. Meanwhile in Singapore, legislation is expected early next year to open the doors to third-party funding, again limited to arbitration.

But one place stubbornly bucks the trend: Ireland. This April in Persona Digital Telephony Ltd v The Minister for Public Enterprise, the Irish courts held that the third-party funding of a claim by Harbour amounted to champerty and maintenance, and was therefore unlawful. The issue has been leapfrogged to the Irish Supreme Court, with a decision expected some time next year.  

Dunn says: ‘The High Court decision was disappointing as litigation funding is something that Irish lawyers and their clients are looking for. But we always take the view that we want to be completely transparent and talk to the court about it. When we’ve done that in every other jurisdiction, they have always said yes.’

Friel, who is qualified as a solicitor in both England and Ireland, adds that there was ‘nothing surprising’ in the High Court’s decision, as any change to the rules on champerty and maintenance would always need to be achieved either through the Supreme Court, or by legislation. But he is confident that the court will recognise global trends and endorse the use of third-party funding.

From the perspective of funders and the clients that use them, the future is certainly looking positive. Even Excalibur, which went against the funders on the two important costs issues at stake, contained a gift for the sector – with funders seizing on the fact that Tomlinson began his judgment by stating ‘third-party funding is a feature of modern litigation’.

For an industry that only ever wanted to be accepted as ordinary, Tomlinson’s rather mundane opening line – and the recognition it conveys – is music to the ears of funders. 

Rachel Rothwell is editor of Litigation Funding magazine