The class action against Royal Bank of Scotland that recently hit the headlines was an interesting case for investors in more ways than one.

As well as shining a spotlight on the bank’s dealings with shareholders before its taxpayer bailout, there is another reason why investors watched with interest as it finally drew to a close last month.

It was one of the highest profile cases yet to be funded through third party commercial litigation funding. This emerging asset class is rapidly gaining traction, and investors and their advisers are increasingly keen to understand the dynamics behind it and the opportunity it represents.

A growing market

Commercial litigation funding is where a third party provides the financial resources to assist a claimant with expensive commercial litigation or arbitration cases in return for an agreed share of the proceeds of any successful claim.

This can range from international corporate disputes to shareholder class actions to smaller claims involving tax, trusts, intellectual property, competition, professional negligence or insurance, and more.

Crucially, commercial litigation funding should not be labelled as ‘ambulance chasing’ – funders will not usually invest in cases relating to areas such as personal injury or divorce.

It is a growing market with significant potential, not least because there is a clear need. The costs of pursuing cases can be prohibitive and uncertain, which often deters claimants from pursuing meritorious claims.

At the same time, law firms are not always able to take on cases on a conditional fee arrangement basis. As a result, litigation funding for UK and international cases is becoming more mainstream and London is now well-established as a global centre for legal dispute resolution. Some estimates put the size of the market at around $3.5 billion (£2.7 billion), a tenfold increase since 2009.

A key reason for its popularity is that it is an uncorrelated asset. Cases are resolved by the courts, irrespective of what is happening to asset prices in the wider economy.

Its ability to reduce overall portfolio risk while boosting returns, decreasing exposure to public market volatility and providing insulation against wider economic factors, which could impact other assets, is a major attraction.

Another compelling factor is that potential money multiple returns are similar to private equity, but are expected to be generated within a shorter timeframe.

Although the lifespan of a portfolio may be several years, the investment horizon for each case can vary greatly; once several cases within a portfolio are concluded, periodic distributions may become available.

International arbitration cases may take several years, but other types of cases can take only weeks or months, and claims frequently settle quite quickly after funding has been received. Funding can be provided at any point – even mid-trial.

A handful of key players

The market is maturing, with a handful of key players dominating in the UK, making it hard for new entrants to gain a foothold. Among them are Therium Capital Management – which is funding major shareholder actions against Lloyds and VW later this year – and Burford, which is listed.

Approaches vary, with some funders focusing mainly on high end international claims and others making a volume play, specialising in smaller cases. Funders may also differ in the types of cases they take on. Other players in the market include Harbour and Vannin Capital.

The fact that most of these leading market participants are private funds poses a challenge for individual investors, family offices and niche institutions looking to access the asset class. There is a huge amount of institutional interest now, which means smaller investors often get crowded out.

Their only options are to invest in a quoted commercial litigation funder (of which there are currently very few), but this means exposure to markets, undermining the uncorrelated nature of the asset. Or they will need to access an existing manager direct, as our clients have been able to do collectively, via a co-investment relationship we have established with Therium.

What to look for

Assuming investors can get access, what should they look for in their due diligence process? Essentially, commercial litigation funders should:

• Have well-established relationships with law firms

Law firms are the source of case flow. They are keen to ensure that cases can be pursued and their costs are met, so litigation funders’ professional conduct, ability to deliver and speed to fund are therefore often just as important as terms

• Be able to demonstrate specific expertise and a robust track record

In this highly specialised area, expertise is everything. This kind of investment should only be undertaken by a dedicated commercial litigation funder. Understanding the risks and conducting thorough case due diligence is vital to success.

• Be capable of building a diverse portfolio of cases

Cases have a roughly 50/50 success rate at trial, though a proportion will settle early, so a diverse portfolio is essential. Funders need a robust pipeline of prospects from which to select the strongest cases.

Commercial litigation funding provides investors with exposure to a non-cyclical, alternative asset, unrelated to stock market movements or economic developments, which can deliver attractive risk-adjusted returns.

For high net worth investors, the main challenge is gaining access via high quality market participants, as availability becomes more limited with growing demand. For those who can find a route in, the rewards – both financial and in terms of enhanced portfolio diversification – should be well worth it.

Claire Madden is a co-founder and managing partner at private equity and specialist funding business Connection Capital.

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This article first appeared in the December 2016 edition of Litigation Funding magazine.

The conventional view under English law is that the funding costs of High Court litigation cannot be recovered from a losing party. In Essar Oilfield Services Limited vs. Norscot Rig Management PVT Limited [2016] EWHC 2361, the High Court, applying the Arbitration Act 1996 (the ‘Act’) to an English-seated International Chamber of Commerce (‘ICC’) arbitration, held that the arbitrator had not exceeded his powers in determining that the losing party, Essar, should pay the funding costs of the successful party, Norscot.

Does Essar signal the beginning of a new age for funded claimants? What implications does the decision have for funders financing both international arbitration and litigation? How will the funding market react?

The award arose from an attritional ICC arbitration that had commenced in 2008. Norscot claimed sums due to it as the operations manager of a rig. Essar asserted an extremely large counterclaim for damages for alleged breach of contract.

The arbitrator, Sir Philip Otton, found emphatically in favour of Norscot on its claims and dismissed Essar’s counterclaim. He was excoriating in his criticism of Essar’s conduct both before and during the arbitration. Essar ‘had set out to cripple Norscot financially’ by resolutely refusing to make payment, flouting its agreement to pay crew wages and withholding payments to suppliers. Norscot’s managing director had been compelled to re-mortgage his home for the best part of US$1m. Throughout the arbitral process, it had become a battle between ‘David and Goliath’.

Sir Philip found that Norscot’s ‘impecuniosity was deliberately caused, or substantially contributed to, by Essar‘, and that the former ‘had no alternative, but was forced to enter into..litigation funding’. The funding cost to Norscot was return of capital plus the greater of three-times the sum advanced or 35% of the proceeds. Sir Philip accepted that this cost was reasonable, having heard evidence from a broker, James Blick of The Judge. In exercising his discretion to award costs against a losing party (s. 63 of the Act), he construed ‘other costs’ in s. 59 (1) (c) of the Act as including the cost of litigation funding. The effect was to expose Essar to indemnity costs and an additional liability of £1.94m, being the sum owed to the funder who had advanced c. £647,000 to Norscot.

Essar applied to the High Court under s. 68 of the Act to set aside the award. Essar argued that the words ‘other costs’ in s. 59 of the Act did not cover litigation funding costs. Sir Philip’s alleged error in so determining did not simply amount to an error of law, but, it was averred, a serious irregularity under s. 68 (2) (b) of the Act.

Sitting as a deputy High Court Judge, His Honour Judge Waksman Q.C. dismissed the application:

1. he held that even if Sir Philip’s construction of s. 59 (1) (c) of the Act was wrong, it amounted to an error of law, not an excess of power under s. 68.
2. he ‘unhesitatingly’ concluded that Sir Philip’s construction was in fact correct. He held that as a matter of language, context and logic, ‘other costs’ could include the costs of obtaining litigation funding, given that they were related to, and for the purpose of, the arbitral proceedings. It was entirely a matter of discretion whether a tribunal awarded such costs in any given case; and
3. he held that in any event, pursuant to s. 73 of the Act, Essar had waived its right to challenge the award both by its pre- and post- award conduct.

Judge Waksman expressly distinguished the position under the Civil Procedure Rules (r. 44 et seq.), in which there is no parallel provision to that of s. 59 (1) (c) of the Act enabling a court to order a losing party to pay ‘other costs’ (in contradistinction to legal costs) of the successful party.

THE IMPLICATIONS

Arbitration

Essar has piqued the arbitration world. Jamie Curle, a partner with DLA Piper LLP, commented: ‘Inevitably there will be an increase in the number of applications by successful claimants in funded arbitrations seeking recovery of funding costs following the decision in Essar. Indeed, following the decision it would be surprising if those acting for funded claimants did not consider making such applications; whether they will be successful will of course depend on the facts of a given case and the conduct of the parties’.

The wording of article 37 (1) of the 2012 ICC Rules paves the way to an application, as indeed does (expressly) the ICC Commission Report of 2015 (para. 87). Similar wording is found in other arbitral rules too, such as the 2010 UNCITRAL Rules (art. 40), and Article 61 (2) of the ICSID Convention, to mention but two.

A more egregious set of circumstances than Norscot is perhaps hard to imagine. However, one can see how successful claimants in investor-state arbitrations who have had investments expropriated by governments could make a persuasive case for their funding to be picked up in a costs award, a fortiori where the acts complained of have caused the claimant’s impecuniosity.

But do hard cases make bad law? Some commentators have suggested that the outcome in Norscot is unjust, that it is a strong deterrent to arbitration, and is even potentially damaging to the third party funding industry (Duarte G. Henriques, BCH lawyers).

With respect to fairness, while those commentators accept that the actual costs of the arbitration paid for by the funder are potentially recoverable (cf. Kardassopoulos & Fuchs vs. The Republic of Georgia ICSID case no ARB/05/18 and case no ARB/07/15), they maintain that the uplift or success fee ‘is neither a party’s cost, nor the damage suffered by the funded party…[but is] a result of a contract privy to the funder and the funded party’ (Henriques). The ICCA – Queen Mary Task Force on Third Party Funding in International Arbitration (Draft Report Nov. 2015) describes the success fee as a ‘trade-off’ between the funded party and the funder, an agreement ‘not linked to arbitration proceedings as such’ and accordingly a cost that ought not to be payable by the unsuccessful party.

Suggestions that Essar gives rise to uncertainty amounting to a deterrent to arbitrate are, with the greatest respect, misconceived and overly defendant/respondent focussed; there is little certainty in the outcome of an arbitration per se.

Of greater weight, and practical import to funders (and funded claimants), are the potential consequences with respect to disclosure of the funding, a further point raised by Henriques.

Given the potential additional liability, there is a persuasive case for the early disclosure of funding, and Essar may see claimants voluntarily disclosing that they are funded at an early stage, but what of the extent of the disclosure? Should the funder be identified? Should the terms of the funding be revealed? Quite possibly, but would this hand the defendant/respondent a strategic advantage knowing the precise amount of the funding – it could encourage frivolous applications in order to exhaust a claimant’s ‘war chest’. Indeed, one might consider that a well-resourced defendant/respondent equipped with knowledge of the funding per se would be able to assess the extent of its potential downside based on the broker’s evidence as to market pricing in Essar as accepted by the arbitrator (and implicitly by Waksman Q.C.).

Is this damaging to funding? Not so according to Jamie Curle: ‘Essar confirms the growing relevance of third party funding to claimants in arbitration and its inexorable march into the mainstream. Indeed, advisers ought to be talking to their clients about funding both in the context of litigation and arbitration at an early stage’.

Litigation

The common law draws a distinction between notional interest on costs incurred (which is recoverable) and actual interest (or funding costs) on borrowed money (which is not). Costs experts argue persuasively against retention of the status quo. Indeed, Norscot’s Bar team argued against the distinction in the arbitration, a point whose ‘force and logic’ Sir Philip Otton agreed with ([33] 2016 EWHC 2361). Alas for funded claimants, Motto vs. Trafigura [2012] 1 WLR 657 is the last common law word on the matter, but watch this space.

Funding – pricing

Sir Philip heard from and accepted the evidence of a reputable broker (James Blick at The Judge) who explained that the terms agreed in Essar were in his view reasonable and in line with pricing in comparable cases (size, economics, timings etc). To that extent, the decision could be said to be a useful marker for both claimants and funders as to what is a reasonable funding return. But will Essar herald the beginning of commoditised pricing? Not in the considered view of Mr. Blick:

‘I don’t think we can say that this means 3x is standard pricing. A difficult case and only one funder willing to support it seeking a 4x, 5x or more return for doing so wouldn’t in my view be unreasonable. On the other hand, a case with very attractive features and a short timetable for resolution may attract offers well below 3x, meaning that 3x may be too high. Ultimately, the market should dictate what a reasonable pricing structure may be; we are a long way away from funding becoming sufficiently commoditised to enable us to talk seriously about standard market pricing.’

By the same token, it is unlikely that funding costs will necessarily reduce overnight merely because Norscot was able to recover them.

Legal firms are successfully suing Spanish banks for abusive loans to renewable energy development over the past decade.

Therium announces new portfolio funding model

Innovative portfolio funding model launched with first law firm.

Therium Capital Management Limited, the litigation and commercial arbitration funder, has launched a ground-breaking portfolio funding arrangement with the litigation team of private client legal practice Harcus Sinclair and Harcus Sinclair Limited (HSL). Under the portfolio funding model, Therium works with a selected law firm to pursue cases for its clients. Therium establishes a dedicated entity with the firm for that purpose, pooling risk and sharing in returns. The entity can be tailored to suit the needs of the firm, whether covering the whole firm or specific practice areas or geographies. Funding can be provided for both litigation and arbitration, including group litigation.

This new funding approach enables law firms to share risk and reward with Therium on the funded cases, promoting a closer alignment of interest between law firm, client and funder. “We have enjoyed a long and successful working relationship with Harcus Sinclair across a number of cases and are delighted to initiate this new portfolio funding model with them which is the first arrangement of its kind” says Neil Purslow, founder and chief investment officer of Therium. “We are talking to many law firms about the potential that this model offers for their business.”
Harcus Sinclair is known for its practice in acting in group litigation relating to financial services. HSL acts for Claimant Group in the high profile claims against Lloyds Bank arising out Lloyds’ acquisition of HBOS in 2009.

Therium deploys litigation funding to support a wide range of claimants, including the investors in the Lloyds / HBOS litigation. The benefits of this portfolio model are many: for the client, the litigation or arbitration can be fully funded, relieving the client of the cost burden of pursuing the claim. As the law firm shares in the risk of the case and the return, it is
incentivised to achieve a successful result. The model also provides the law firm with cash flow, enabling it to manage its financial exposure and undertake a wider range of contingent work.
“This is an innovative development in litigation funding and demonstrates Therium’s understanding of our needs as lawyers,” comments Damon Parker, founding partner and Head of Litigation at Harcus Sinclair.

Therium was one of the first litigation funders in the UK market. Since its launch in 2009, it has consistently been at the forefront of developments in litigation funding, such as pioneering the use of insurance within its structures to manage risk. Therium funds across a wide range of cases including for group actions, intellectual property disputes, anti-trust / competition cases and in international arbitration, and in industry sectors such as financial services, technology, energy and natural resources.

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