Funding Litigation – the good, the bad and the ugly
Following developments in the law surrounding the funding of litigation, litigation funding has started to emerge as a new asset class. However the centuries-old disapproval of the concept of making a market in litigation still resonates and care must be taken in structuring and managing such arrangements to avoid risks of unenforceable security or of becoming responsible for the costs of an opposing party.
Litigation funding's slow progress from criminality to virtual necessity
Historically English law refused to recognise and enforce arrangements under which third parties funded or 'maintained' litigation coming under the headings of 'maintenance' and 'champerty'. 'Maintenance' is the improper support of litigation in which the supporter has no legitimate concern without just cause or excuse. 'Champerty' is an aggravated form of maintenance and occurs when the maintaining party pays some or all of the costs of a party in return for a share of the proceeds of the action or suit. These common law rules against champerty and maintenance were based on public interest in protecting the purity of justice. Originally maintenance and champerty were both crimes as well as torts.
The Criminal Law Act 1967 (CLA) abolished the crimes and torts of maintenance and champerty, but section 14(2) of the CLA left intact the rule that a contract which breached the rule against maintenance and champerty would be contrary to public policy and therefore unenforceable.
Further modifications to the common law position were made by the Courts and Legal Services Act 1990 ('CLSA') (as amended by the Access to Justice Act 1999 and the Legal Aid and Sentencing and Punishment of Offenders Act 2012 (LAPSO 2012)). This legislation permits CFAs (i.e. an agreement with a person providing advocacy or litigation services which provides that his fees or expenses (or any part of them) are payable only in specified circumstances) provided they comply with the prescribed regulations (s.58 of the CLSA).
Subsequently legislation was introduced to permit DBAs (i.e. an agreement between a representative and a client providing that the client will make payment to the representative if the client obtains 'a specified financial benefit' (usually damages paid by the losing side). The Damages–Based Agreements Regulations 2013 define a representative as the person providing advocacy services, litigation services or management services to which the DBA relates.
Maintenance and champerty live-on
So the current position is that CFAs and DFAs are expressly permitted within a particular scope. However, outside the above statutory provisions, the common law continues to apply, although its scope is now more limited. Modern authority recognises that to amount to maintenance or champerty, a funding agreement must disclose an element of impropriety, such as "wanton or officious" meddling, disproportionate control or profit, or a clear tendency to corrupt justice (e.g. there is a temptation to inflame damages).
Similarly, an assignment of a chose in action will be valid and enforceable - if the assignee has a 'genuine commercial interest' in the assignment. If this is not the case, the assignment will be void and unenforceable as 'savouring of maintenance'.
Modern authorities give some guidance as to the factors that the court will take into account when assessing the validity of any agreement. These factors include:
- the extent to which the funder controls the litigation. Examples of excessive control might include: taking or influencing strategic decisions, seeking to interfere on the solicitor/client relationship; or controlling or meddling in settlement negotiations
- the level of communication between the funded party and the solicitor. Ideally, the solicitor should be independent of the funder, and alive to the possibility of conflict of interest
- the extent to which the funded party is provided with information about, and is able to make informed decisions concerning, the litigation
- the amount of profit the funder stands to make
- whether or not there is a risk of inflaming damages. This is more of a risk in the case of contingency agreements
- whether or not there is a risk of distorting evidence (e.g. it is unlikely that an agreement whereby expert witnesses were paid on a contingency basis could ever be upheld as valid)
- whether or not the funder is regulated.
An agreement whereby a third party funds litigation is less unlikely to be struck down by the courts as offending rules against maintenance and champerty than before unless the funder attempts to exercise control over the litigation or stands to recover disproportionate sums in which case the courts can and will hold the agreement to be unenforceable.
Can a funder become liable for the defendant's costs?
The leading modern English authority on these arrangements is the Court of Appeal decision in Arkin. In this case the provision of expert evidence in support of the claimant's case was funded by a professional funder in return for 25% recovery up to £5 million, and 33% thereafter. The successful defendants appealed for orders making the funders liable for their costs. At first instance, Colman J found that the funders took no part in decisions regarding the management of the litigation and did not attempt to control it. The Court of Appeal concluded that the funder was nevertheless liable for costs up to the amount of its own contribution, but that to impose liability over this limit would represent too great a risk for third party funders.
Can a funder take security over a CFA or DBA?
Another issue to consider is whether a funder can obtain security from the solicitors over their rights under a CFA or DBA.
In principle, there is no reason why an arrangement by way of security cannot be taken in respect of CFAs and DBAs provided the law firm complies with the requirements of the SRA Code of Conduct. The Code includes the requirements that:
- those providing legal services must only enter into fee arrangements with clients that are legal.
- a law firm must not allow its independence to be compromised (e.g.by giving control over its practice to a third party which is beyond the regulatory reach of the SRA) and act in the best interests of the client
- a law firm must keep the affairs of its clients confidential unless (amongst other things) the client consents
- a law firm must avoid conflicts of interest and in particular a law firm must not act if there is an own interest conflict or a significant risk of an own interest conflict
- a law firm must have systems and controls to assess whether financial interests prevent it acting in the best interests of the client on fee sharing
- a law firm must ensure that its independence and professional judgement are not prejudiced by virtue of any arrangement with another person
- a law firm must ensure that its clients' interests are protected regardless of the interests of an introducer or fee sharer
- a law firm must ensure that clients are in a position to make informed decisions about how to pursue their matter
- clients are informed of any fee sharing arrangement that is relevant to their matter.
In a recent case (Jones v Spire Healthcare Ltd (unreported)) 11 May 2016, a circuit judge (overturning a district judge's decision) ruled that a CFA for a claim was validly assigned from one firm of solicitors to the other and that both the benefit and the burden were assigned as they were inextricably linked. It followed that there was a retainer allowing for recovery of pre-delivery and post-delivery assignment costs of the litigation.
Code of Conduct for Litigation Funders
In 2011 the Civil Justice Council introduced a voluntary Code of Conduct for Litigation Funders which was updated in 2014. It applies to members of The Association of Litigation Funders of England and Wales in respect of funding the resolution of disputes within England and Wales. Briefly, the Code sets out certain conduct requirements of funders, including ensuring that the funded party receives independent legal advice on the terms of the funding agreement and requiring the funder not to influence the funded party or its legal counsel. It also imposes certain capital adequacy and auditing requirements on the funders and sets out certain requirements relating to the contents of funding agreements.
CFAs and DBAs are not regulated by the Financial Conduct Authority ("FCA") unless:
- it is consumer credit - which it will not be so long as the borrower is not an individual or two-man partnership; or
- if the agreement is not on its proper construction a loan agreement, but amounts to some form of contract for differences.
The issues for litigation funders to navigate can be summarised as:
1. Avoiding the risk of the CFA or FSA being set aside on ground of maintenance or champerty. Avoid this by:
(a) not seeking to exercise control over the litigation;
(b) avoiding taking excessive profit from the outcome of the litigation; and
(c) avoiding the possibility of the evidence being distorted.
2. Avoiding the risk of a costs order being made against the funder. This is not easy, because if the funded claimant loses, it is probable (under the Arkin principle) that the funder will be held liable up to the amount of its own contribution, even though it exercises no control over the litigation. If it did exercise control, the funder's liability could be unlimited. One way round the issue might be for the funder to take out after-the-event insurance to cover this potential risk and require the funded party to pay the premium.
3. Given that there are no restrictions on a funder creating security on a CFA or DBA, a funder can obtain security over such agreements if it recognises that the solicitor will need to comply with the rules under the SRA's Code of Conduct (especially those relating to the law firm remaining independent and keeping to clients affairs confidential).
4. If the funder is lending to an individual or two-man partnership, the funder will need to consider consumer credit legislation.