Third-party funding: a saviour to the distressed claimant who needs to litigate but is strapped for cash
Juris Corp, Mumbai
Juris Corp, Mumbai
Juris Corp, Mumbai
The financial crisis caused by the Covid-19 pandemic has led to several unconventional innovations in business operations such as working from home.
The crisis has meant that chasing up on recovery of various debts, both financial and operational has become more pressing than ever. However, the financial crisis means that businesses maybe strapped for cash and unable to wait for realisation of legitimate claims through litigation. Some businesses may even find it hard to fund expensive litigation for worthy claims. In such situations, third-party funding (TPF) may provide desperately needed funds, ensuring the realisation of claims on which a business’s very survival businesses might hinge.
What is TPF?
TPF refers to the provision of funds to parties in a dispute, by an unrelated third party having no connection to the dispute itself. In exchange for providing funds, the third party receives a share in the recovered/awarded amounts, if the funded party succeeds. TPF is also known as litigation financing.
The third-party funders normally adjudicate the value of a claim, its likelihood of success or failure and, accordingly extend funds to the claimant. TPF covers various costs incurred in dispute resolution to realise claims. Such funds normally constitute non-recourse capital, ie, if the litigation/arbitration is unsuccessful, the funder has no recourse to recover its investment from the funded party. On the other hand, if the litigation/arbitration is successful, the funder will receive an agreed share from the claim amount.
TPF can be applied in litigation involving contracts, international commercial arbitration, class action suits, antitrust matters, insolvency proceedings, and other matters where the financial and monetary pay outs are substantial.
TPF operates with the support of lawyers, quantum assessors/ experts and other skilled parties for evaluating and assessing a claim being considered for funding. Several third-party funders may also require the claimant to obtain certain insurance products to cover costs of litigation. The funders require full disclosure of information related to the claim for the purpose of determining conflicts of interest and risk assessment.
TPF in India
TPF is not new to India, where its laws have long recognised the concept of TPF. Order XXV Rule 1 of the Civil Procedure Code, 1906, (CPC) as amended in the states of Maharashtra, Gujarat, Madhya Pradesh, and Uttar Pradesh allows for the impleadment of third-party funders, thereby recognising TPF’s existence and legality. Bombay High Court, in its Notification No P0102/77 has amended Order XXV of CPC to include TPF unders as parties to proceedings being funded.
Gujarat and Madhya Pradesh have also adopted similar amendments. Uttar Pradesh on the other hand, has included Rule 2 under Order XXV of CPC, stating that costs for funding litigation may be secured from third parties.
The Supreme Court of India, in the matter of In Re: Mr ‘G’, Senior Advocate of Supreme Court of India v Unknown, has recognised the legality of TPF, holding that an advocate’s agreement with his client for recovering proceeds from the success of his client amounts to professional misconduct. However, a contract of this sort with third parties (not lawyers), would be unobjectionable and legally enforceable.
This introduces an important caveat to TPF, namely that lawyers are not allowed to fund litigation while representing a party. This is laid down in Rule18(fomenting litigation),Rule20(contingency fees), Rule 21 (share or interest in an actionable claim) and Rule 22 (participating in bids in execution, etc)of the Bar Council of India Rules,1975(BCI Rules).Otherwise, it maybe concluded that TPF agreements (not excluding lawyers) are undoubtedly legal.
Although otherwise legal, TPF agreements must stand the test of not being unacceptable, overpriced or against public policy. In Nuthaki Venkataswami v Katta Nagi Reddy, the Andhra Pradesh High Court, found a TPF agreement providingfor3/4th share of the claimant’s property to the funder should the claim succeed, to be so extortionate and unconscionable, as to bein equitable.
‘There appears to be no restriction on third parties (non-lawyers) funding the litigation and getting repaid after the outcome of the litigation.’
Additionally, in an interesting development, the Court, in AKBalaji (supra)throws light on an exception carved out for lawyers in TPF, observing that funding of litigation by advocates is not explicitly forbidden, but reading of Rules 18 and 20 to 22 of BCI Rules suggest that advocates are not permitted to fund litigation on behalf of their clients.
TPF in Indian arbitration
The Arbitration and Conciliation Act, 1996 (the Act)remains silent on the concept of TPF. However, the issue of TPF’s legality in arbitrations had been resintegra for a very long time. The issue had recently arisen before the Bombay High Court in the matter of Norscot Rig Management Pvt Ltd v Essar Oilfields Services Ltd, where one of the objections raised while opposing the execution of the foreign arbitral award is that the TPF arrangement entered into by the petitioners is barred in India, being champertous. The matter is lis pendens. The final order may shed light on the position of TPF in arbitration.
Advantages and drawbacks
TPF can be a great equaliser in litigation, taking away the advantage one party has over another by virtue of being more affluent. TPF frees up and provides desperately needed capital for the funded party. It can also be used effectively by the claimants to hedge their risks. Indeed, corporates may view TPF as a valuable source of corporate finance.
Its advantages to the legal system are manifold. TPF improves access to justice and prevents deep-pocketed parties from muscling out their weaker opponents by bringing financial pressure to bear. It may filter out unmeritorious claims as funders are likely to fund claims which have higher probability of success.
However, TPF if not documented appropriately, may affect the litigant’s autonomy. The perceived risk is that TPF may reduce the incentive for an out of court settlement and consequently increase the likelihood of litigation. In addition, conflict of lawyers’ ethical obligations to maintain attorney-client privilege and its applicability to third-party funders is something which needs be dealt with.
These issues and risks can be mitigated by having carefully-drafted TPF agreements. Ensure that they can withstand a challenge on grounds of being opposed to public policy or unconscionable. Also, be clear on both the party and the funder’s demarcating rights, and provideclearapportionmentofdecisionmakingpowerstopreventconflict.
TPF invariably involves funding by foreign investors as India’s appetite to deploy capital in such matters has yet to develop. This, plus an inherent aversion to what maybe painted as hard-hearted behaviour, runs risks of the lower courts striking it down. In fact, many lawyers have been heard to have expressed hostility.
The current scenario
TPF in India is still emerging, with very few instances of it taking place. However, the field has seen a surge in recent times. In 2018, M/s. Patel Engineering Ltd assigned its actionable claims to its wholly owned subsidiary, Hitodi Infrastructure Ltd, 51 per cent of the equity which is held by an investment company.
A year later, in 2019, Hindustan Construction Co Ltd it referred to having obtained litigation funding by transferring its interests and rights in various claims, worth INR20bn (approx. US$272.78m) to a special purpose vehicle (SPV) owned by an investor group for a sum of INR17bn (US$231.87m).
TPF in India has been hindered for years due to the lengthy and burden some pace of litigation and bottle necks in the judicial system. However, the landscape has gradually changed to become more favourable to third party litigation. The latest round of amendments to the Acthas made arbitration more effective.
The Commercial Courts Act, 2015 also has greatly affected recovery in India. Another development which is likely to increase TPF in India is the latest amendment to the Consumer Protection Act, which empowers consumers to initiate class-action lawsuits and opt for mediation. This has increased its potential in India.
Currently, claimants in various disputes ,facing a liquidity crises and having been hit by the Covid-19 pandemic, are likely to opt for TPF. If entered into with skilful structuring, TPF arrangements could change the face of dispute resolution in India. Litigation financing is a good way for claimants to free up capital and deleverage, without having to wait for litigation to conclude. It could also effectively hedge their risks. For funders on the other hand, the return on the investment may be massive, resulting in a ‘win-win’ situation.
 Rajat Jariwal, Divaspati Singh and Sukanya Hazarika, ‘Why litigation financing is witnessing a sudden surge in popularity in India’, CNBC TV18, 26 September 2020, available at: https://www.cnbctv18.com/legal/why-litigation-financing-is-witnessing-a-sudden-surge-in-popularity-in- india-4429011.htm, last accessed 2 October 2020.