Litigation Financing is the idea of a third party independently providing funds to parties to a dispute in exchange of a portion of monetary rewards recovered from the proceedings. This kind of funding helps unlocks the value of legal claims even before they can be recovered before a court or tribunal. Many a time access to justice is blocked because meritorious claims are hindered by high costs of litigation. Litigation funding aids parties realize the full potential of their claims and deter protracted litigation. This funding not only encourages parties to access top legal talent and not settle for anything less than the worth of their claims, but investors availing this new asset class can gain outsized returns compared to other investment avenues with moderate time for realization of liquidity. Litigation funding has become a fairly commonplace practice in jurisdictions like USA, UK and Singapore, and has outperformed1 private equity and hedge funds as an asset class.
In India, the full potential of this 'Third-Party Funding' (TPF) has not been tapped into, however, recent legal developments and changing attitudes in the infrastructure and Engineering Procurement Construction (EPC) sector towards entering into such alternative arrangements with investment companies can prove to be a lucrative transaction for all players to such a deal.2 This article seeks to analyze the legal and ethical constraints of such funding as well as pros and cons posed to investors
LEGAL PERMISSIBILITY OF LITIGATION FINANCING
The Supreme Court has observed3 that "There appears to be no restriction on third parties (non-lawyers) funding the litigation and getting repaid after the outcome of the litigation." Amendments to the Code of Civil Procedure, 1908, (Order XXV Rule 3) enacted by Maharashtra, Karnataka, Gujarat and Madhya Pradesh, also clarify that the court may direct the financier to become a party to such proceedings where it is bearing litigation costs for the Plaintiff. There is, however, a lack of regulatory mechanism to oversee disclosure of such investments and the structure via which such investments might be concealed. It should be noted that lawyers cannot fund the litigation costs of a party that they are representing4 ; in fact, lawyers cannot engage in a business of this nature et al.5
The following changes in different statutes can lead to a rise in instances of Litigation Funding:
- Amendments to Section 10 and Section 11 via the Specific Relief (Amendment) Act, 2018 which reduced the court's discretionary powers to stay applications for specific performance of contracts, by making enforcement a mandatory rule.
- Insertion of Section 20A via the Specific Relief (Amendment) Act, 2018 which prohibits injunction by a court in infrastructure projects which may impede/delay the fruition of such a project.
- Tighter timelines for passing an award under the Arbitration and Conciliation (Amendment) Act, 2019.
The prime reason for acceptance of TPF in EPC sector has been the enactment of Insolvency and Bankruptcy Code which has simplified the process of initiating insolvency resolution proceedings against defaulters within a time-bound 270-day deadline. Since one of the grounds for filing an insolvency application against a company is an adverse arbitral award regarding a debt owed by such a company to its creditor, it has become essential for debt-ridden companies in the EPC sector to resolve their shortterm liquidity by accepting capital injunctions.
The medieval English legal doctrines surrounding prohibitions on maintenance, champerty and barratry which could have deterred the practice of litigation financing have since been deemed obsolete by the American courts which recognized the need of the hour being access to justice and legal representation which is facilitated by such financial considerations.
One aspect of such indulging such investors which might prove contentious is that such investors are not barred from funding the litigation expenses of the opposite party. Coupled with the fact that most investment deals proceed only after the assets of the party have been securitized in favour of the investor, this can spell that in the event of a loss in court the party can have everything to lose but the investor can walk away with substantial returns. To address such concerns surrounding conflict and transparency, India also needs to enact something similar to USA's Litigation Funding Transparency Act or Singapore's Civil Law (Third-Party Funding) Regulations, 2017.
STRUCTURING A LITIGATION FINANCING DEAL
Financiers invest in disputes involving commercial contracts, international commercial arbitration, class action suits, tortious claims like medical malpractice and personal injury claims, anti-trust proceedings, insolvency proceedings, and other like claims that basically have a calculated chance of winning considerable monetary awards. Therefore, claimants make the best recipients of TPF as they may accrue a substantial award or settlement in case of a successful outcome.
It is usually the litigating party which approaches the investor with its case for a possible injection of TPF capital. This is followed by an assessment process of the party's claims, merits and due diligence on part of the investors before such a deal is approved. While the deal may seem lucrative to the litigating party, they have to hammer out difficult clauses regarding the degree of influence/control that the investor shall have over the legal representation and the share that it shall claim from the final award.
- A TPF can be structured in three ways:
- The party holds the proceeds from its claims in a trust, in which the investor is one of the beneficiaries.
- The party assigns the proceeds from its claims to the investor.
- The party assigns the claims in itself to the investor.
EPC behemoths, Hindustan Construction Company Limited (HCC) and Patel Engineering, have entered into versions of the third form6 , by assigning all their beneficial interests and rights in a pool of claims and arbitration awards to an SPV controlled by a consortium of investors led by BlackRock and a subsidiary with majority equity owned by Eight Capital, respectively.
Regardless of the entities involved, the transaction is in nature of a contingent contract, where the gains the investor makes are dependent on the success or failure of the assigned claims. The obvious disadvantage is that the financier makes no return on the investment if the party loses the case. Further, any sort of compensation to such an investor may not be possible as the EPC Company is usually in a situation of financial distress.
Meanwhile, structuring the transaction as a loan seems absurd as the losing litigant shall be obligated to repay a debt in form of paying the entire amount invested, upfront. Additionally, a debt involves a maturity period and interest rate, while claims expected by a thirdparty funder are always fixed. Even if the investor decides to initiate insolvency proceedings against the party as a financial creditor, there is always the looming risk of 'haircuts' (write-offs), which are typical of any corporate insolvency resolution process.
Therefore, structuring a litigation financing deal through assignment of benefits to an entity created solely created for the purpose of channeling funds seems like the safest choice for all players involved.
Investors usually depend on historical data while analyzing the Return on Investment (ROI) and in the absence of such data, when it comes to TPF in India, investors have to rely on wisdom of legal experts while determining the outcome of a case. Additionally, the permissibility of foreign investment in third-party funding of disputes in India, is still an evolving area.
1. Emily Cadman, 'For the World's Super Rich, Litigation Funding Is the New Black', Bloomberg.com (28 August 2018)
2. Manoj K Singh, Rajdutt Shekhar Singh, 'High yield, low risk: Why India's litigation finance market catches the eye of global funders', CNBCTV18.com (14 May 2019).
3. Bar Council of India v. A.K. Balaji (AIR 2018 SC 1382)
4. Section I, Rules (Bar Council of India) u/s Section 49 (1) (c) of the Advocates Act, 1961.
5. Section VII, Rules (Bar Council of India) u/s Section 49 (1) (c) of the Advocates Act, 1961.
6. 'HCC raises Rupees 1,750 Crore in litigation funding deal', Livemint (27 March 2019).
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