Australia: A Developing Trend – Disputes Funding For Corporates

Last Updated: 10 November 2017
Article by Philippa Murphy

WITH COMMENTARY FROM PETER CASH PARTNER AND LEADER OF NORTON ROSE FULBRIGHT'S AUSTRALIAN LITIGATION TEAM

According to global law firm Norton Rose Fulbright, and as evidenced by the firm's 2016 Litigation Trends Annual Survey, the use of third party funders in commercial (and other) litigation is transforming how major litigation is run in Australia. At Vannin Capital, we are witnessing those transformations first hand.

The Survey* (the largest survey of corporate counsel on litigation issues and trends, with 606 respondents across the globe) highlights an upward trend in virtually all of the metrics relating to litigation and the broader disputes area. In particular, it identifies an increasingly litigious environment, more regulatory disputes, more class actions, more IP disputes and increasing costs of litigation amongst the top ten most important litigation trends observed by respondents in 2016 Survey.

It is within this business environment that corporate stakeholders are more focused than ever before on managing corporate risk. In-house legal teams are increasingly expected to achieve more with less, and the prospect of embarking on costly litigation to recover damages is increasingly unattractive.

In response, corporate clients are seeking out Alternative Fee Arrangements (AFAs) with 60% of the respondents of the Survey using AFAs in 2016, up from 56% in 2015. The use of AFAs is a well-trodden path and traditionally AFAs were offered through blended rates, capped fees, fixed fees, contingent/ conditional fees and/or "success" fees in some jurisdictions.

Prior to joining Vannin Capital, in my role as partner at law firm Baker McKenzie in the dispute resolution team and as head of the firm's Asia Pacific Risk and Crisis Management Practice Group, this was increasingly a well versed and often vexed topic with clients. Typically, the favoured approach was blended rates and fixed fees for different phases of the litigation. There were opportunities to introduce dispute/litigation funding as a viable alternative funding model, but it wasn't commonplace and clients didn't always understand the opportunities presented to the business. This is changing in corporate Australia.

Our observation is that the emphasis on AFAs, coupled with a rising understanding and appreciation of the benefits of dispute resolution funding, is driving an increase in demand for third party funding solutions from corporate clients (from large multinational corporations to family-owned businesses). This in turn is enabling law firms to successfully run high-value commercial litigation and arbitration without the need to discount hourly rates and to create real value for their clients.

Dispute resolution funding therefore is extending its use from the traditional and well-established area of assisting impecunious plaintiffs (e.g. liquidators) to bring meritorious cases that would otherwise not be run, to assisting many large corporations which can afford to run litigation but which see an opportunity to secure the benefits without the risk.

Below, we outline the key benefits to all businesses (poorly or well-capitalised) that third party funding can provide:

Risk shifting – in much the same way that insurance and other hedging products are used in commerce, the benefits of dispute resolution funding in effectively shifting the entirety of litigation risk from the claimant to a third party, are clear.

Unlocking value – each potential claim is an asset of the company. In a world where growth is scarce, the importance of extracting value from all available company assets has never been higher.

Reduced drain on legal budget – with the costs of running the claim now outsourced to a third party, the legal budget can be more effectively deployed on core activities. Any overrun in the cost of conducting the claim will not be for the account of the business.

Time savings – management and legal team time can be used more effectively on other activities relevant to the business.

Improved settlement prospects – The fact that Vannin is involved can send a powerful message to the defendant that many legal minds (including an independent QC engaged by Vannin and former judges who sit on our investment committee) consider that the case has a strong chance of success. Involving a funder can give the other parties reason to pause and reassess their defence and their own advice on prospects.

Expert assistance – as a funder, Vannin also brings to bear its considerable experience in managing disputes and can add real value by providing strategic input before the proceeding is issued and as the case progresses.

These observations are supported by Peter Cash, partner and leader of Norton Rose Fulbright's Australian Litigation Team:

"I have seen substantial corporate clients make decisions not to pursue what I considered to be very meritorious claims simply because they were uncomfortable with the potential distraction to their in-house legal team of having to manage the litigation process." He adds that "the fact that in-house teams are typically comprised only of transactional and regulatory lawyers can mean that the involvement of a litigation funder such as Vannin, which has specific expertise in managing litigation and liaising effectively with external counsel, will provide considerable efficiencies in the conduct of the litigation."

MAINTAINING OR INCREASING MARKET VALUE

For businesses that elect to fund a major dispute themselves, the value of the company will inevitably be reduced.

Because the amount of the funds spent on a claim need to be expensed through the P&L, this has a direct impact on EBITDA, the impact of which is multiplied by the prevailing P/E multiple enjoyed by the company. Further, cash spent on pursuing the claim is not then available for strategic growth initiatives, thus having an additional depressive impact on EBITDA.

By utilising TPF, directors can pursue meritorious claims with no financial risk and still benefit from cash receipt should the claim be successful.

For public or private shareholders, the use of TPF therefore has the immediate benefit of maintaining and even increasing shareholder value.

TAKING THE NEXT STEP

Educating clients and lawyers on the basics of dispute resolution funding is critical. In a very basic sense, lawyers need to recommend dispute resolution funding to clients and clients need to understand how it works and what the benefits to the business are before they will access it. In addition to the aforementioned benefits of businesses using dispute resolution funding, here are some key practical points:

  • Dispute resolution funding is essentially a form of finance and risk transfer.

    Under a Litigation Funding Agreement (LFA) Vannin will pay on behalf of the claimant all of the costs associated with the claim, in return for a fee to be deducted from any damages recovered (together with recoupment of Vannin's costs). Vannin's funding is non-recourse to any of the other assets of a claimant and there is no obligation to make any payments to Vannin unless there is a recovery from the funded legal claim.

    The LFA will also provide that Vannin will indemnify the claimant for any exposure that it might incur as part of the claim (e.g., having to pay the defendants their costs if the claimant is unsuccessful). In this sense, a LFA should achieve a complete transfer of financial expense and risk from the claimant to Vannin.
  • Entry into a LFA does not change the underlying legal relationships.

    The claim remains the property of the claimant, who continues to provide instructions to their chosen lawyers for the conduct of the claim. Vannin's standard LFA provides for a regular flow of information to Vannin from the lawyers with conduct of the claim, regarding the status of the claim and budget tracking. Vannin is also entitled to have input in relation to key strategic decisions, but does not conduct the day-to-day running of the claim.
  • Vannin's LFA also incorporates an ability for the funded corporate claimant to terminate the funding arrangement in certain prescribed circumstances.
  • Vannin's involvement can be tailored to suit each case.

    If the claimant is comfortable and prepared to manage the external lawyers throughout the case, then Vannin's involvement can be minimal. Alternatively, if the claimant would prefer Vannin to have a more active role in managing the case, Vannin is happy to do this and there is no additional charge to the claimant in those circumstances.
  • Vannin's pricing can be tailored to suit each case.

    An appropriate pricing structure can be agreed with the claimant in each case. For example, this could involve a fee based on:

    • Percentage of gross recoveries
    • Flat fee (minimum amount)
    • Multiple of invested amount (i.e., costs)
    • Hybrid of the above
  • In all cases, Vannin will structure its fee so that a significantly lesser rate will be payable in circumstances where prompt settlements are achieved. We have set out below some examples to demonstrate how the numbers look in practice for a funded and unfunded example.
  • The LFA also provides that all information exchanged between Vannin and the claimant will be kept strictly confidential – legal professional privilege will therefore be maintained (i.e., subject to common interest privilege).

    Being a private company, Vannin is not required to publicly disclose the details of any of the investments it makes or the outcomes of the cases it funds. In contrast, dispute resolution funding firms which are listed on securities exchanges are generally required to disclose details of each case funded and the ultimate results of their investments in those cases (being market sensitive information).

    However, it's worth noting that as a professional third party funder, we as a general rule, favour the fact of funding and our identity to be disclosed. Whether and when the fact of funding and our identity is disclosed normally comes down to a strategic decision made by the claimant and their lawyers. With that decision being made in the interest of their dispute, the strategy being pursed in respect to it, and whether it advances the broader interests of their organisation.

Dispute resolution funding can be tailored to the situation and also the appetite for risk mitigation. If we continue to experience more litigious environment as highlighted by Norton Rose Fulbright's Survey, then it is critical that companies are engaged with professional disputes funders who can provide such a financing tool. It is also extremely important to start conversations as early as possible to investigate if funding is a suitable option as an appropriate risk and cost management strategy.

SCENARIO: HYPOTHETICAL $20M CLAIM BEING BROUGHT BY A COMPANY AGAINST A CONTRACTUAL COUNTERPARTY FOR BREACH OF CONTRACT

UNFUNDED FUNDED
Assuming that the claim cannot be resolved without commencing proceedings, it might be expected that legal fees for the plaintiff could reach $2m by the end of a contested trial and adverse costs exposure (i.e. payment of the other side's costs if the claim is unsuccessful) could be in the order of $1m.

An unfunded plaintiff commencing proceedings in respect of this claim would likely need to provision for a total exposure of up to $3m, which could be expected to increase if the claim was unsuccessful (following a trial). Further allowances would be required for any subsequent appeals.

In addition to the above figure, there will be substantial additional costs for lost management time, in-house legal time spent actively managing the case and the opportunity cost to the business of the expenditure/ provisioning committed to the case.
AMOUNT
SETTLEMENT SUM $13,000,000
Reimbursement to Vannin of legal costs – estimated spent to date: $(1,000,000)
Reimbursement to Vannin of costs of providing claimant's adverse costs indemnity – typically 25% of the cover amount given the time at which settlement occurred: $(250,000)
Payment of Vannin's fee – likely to be around 25% of the gross settlement amount given the time at which settlement occurred: $(3,250,000)
ESTIMATED TOTAL TO CLAIMANT $8,500,000
In the Funded example, the client receives about two thirds of the settlement amount, which could be achieved with zero financial cost or risk to the claimant. In this scenario, shareholders have seen no impact to EBITDA or value and management have been able to concentrate on growing the underlying business. If the client had self-funded, they would have received $3.5m more, but only by risking $3m in direct costs plus substantial indirect costs.

* Norton Rose Fulbright's 2016 Litigation Trends Annual Survey can be viewed at http://www.nortonrosefulbright.com/files/20160915-2016-litigation-trends-annual-survey-142485.pdf

Originally published in Funding in Focus, Issue 4 - 2017

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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