Disputes funding in the COVID-19 pandemic environment
Global | Publication | June 2020
The COVID-19 global pandemic is forcing businesses of all shapes and sizes to pursue alternate sources of funding to ensure the advancement of pending claims, to bring new claims arising out of the pandemic and to enhance cash flow where possible to survive. Understanding the range of dispute funding options available is critical to assess whether and, if so, how such funding can be leveraged to help a business weather the current COVID-19 environment – and what is yet to come..
COVID-19’s impact on solvency
Many businesses have experienced a dramatic reduction in cash flow and working capital as a result of the recent global economic shutdown. Insolvency is on the rise, as is bankruptcy. Whilst some losses experienced during this period will lie where they fall, many have already and will continue to give rise to disputes. A meritorious claim in the hands of a nearly insolvent company may well be a vital part of its return to financial health. Similarly, a meritorious claim in the hands of a bankrupt party may represent the only asset capable of ensuring a meaningful recovery for creditors.
In Canada, third party funding (TPF) (also known as disputes funding or litigation finance) was on the rise prior to the COVID-19 pandemic. A recent judgment of the Supreme Court of Canada has cemented the availability of TPF in Canada to help unlock the value of claim assets for companies in distress and their creditors (by confirming that third party litigation funding agreements can be approved as interim financing in bankruptcy proceedings (9354-9186 Québec inc. v Callidus Capital Corp., 2020 SCC 10). The timing of the Court’s release of this judgment has proved providential, as businesses dramatically impacted by the recent economic shutdown seek out alternative sources of financing to weather the pandemic.
How can disputes funding help address the solvency crisis?
TPF generally speaking is the process whereby a third party funder, which has no direct interest in a dispute, funds the legal costs for one of the claimants. It is rare for defendants to obtain funding, although sometimes this is made available, for example, as part of funding a portfolio of claims and defences. TPF often works alongside its insurance brethren, before the event (BTE) and after the event (ATE) legal costs insurance, which insure the risk claimants face of adverse legal costs. Many funders require funded parties to obtain such insurance and, in some instances, also require their external legal counsel to work on a conditional fee arrangement (CFA) in order to share some of the risk.
TPF is usually provided to claimants on a non-recourse basis, meaning that if the claim is unsuccessful, the funder loses its investment and has no recourse against the funded party. If the claim is successful, the funder recovers its investment as well as a success fee (usually calculated as either a multiple of the sum invested or a percentage of the damages awarded, whichever is the higher). Many funders also offer products designed to alleviate strain on working capital. For example, a business with a meritorious claim or holding a judgment/award may “monetize” the claim or judgment/award. This involves a funder advancing payments in tranches or a lump sum to the business, usually consisting of non-recourse capital, and securing its return by taking an interest in the claim or award/judgment. Funders have already reported an increase in requests for this type of funding since the outbreak of COVID-19.
BTE legal costs insurance covers the risk of the legal costs of a potential litigation or arbitration in exchange for a premium paid in advance, while ATE legal costs insurance covers the risk of the legal costs of litigation or arbitration after a dispute has arisen. Businesses that had BTE insurance in place prior to the outbreak of COVID-19 may be better positioned to manage their disputes risk arising out of the pandemic than those businesses with no such protection in place. BTE will commonly fund the following costs of bringing or defending a claim: the insured’s lawyer’s fees, disbursements (including expert witness fees), court/tribunal costs, and adverse costs. For those businesses without any BTE insurance in place and already facing disputes arising out of the pandemic, ATE insurance may offer some protection. This type of insurance provides cover against an adverse costs award or against non- recovery of a litigant’s own costs up to the limit of indemnity, and is usually paid for by a contingent premium (that is, a premium paid only if the claim succeeds).
What is required to secure disputes funding?
Although most third party funders disclaim the application of any particular formula in sizing up a potential case, there are several common factors that funders consider material to accepting (or not) a matter. Many of these factors are not impacted by the COVID-19 pandemic.
One of the key factors is proportionality of costs to likely recovery of damages. Some third party funders maintain minimum claim value thresholds in order to ensure that any recovery is adequate to cover both the funder’s return and a meaningful return for the claimant. In some jurisdictions, this may be necessary to ensure the enforceability of the funding agreement (see e.g. Schenk v Valeant Pharmaceuticals International Inc, 2015 ONSC 3215, but see also Seedlings Life Science Ventures, LLC v Pfizer Canada Inc., Fed. Ct. Docket T-608- 17, Order and Reasons (September 12, 2017, 2017 FC 826)). They will also factor in any other elements that affect this ratio, such as likely counterclaims.
Third party funders also seek to fund only meritorious claims. The merits of a case and any counterclaims are likely to be assessed from several different angles, including the stability and predictability of the laws of the jurisdictions that are potentially applicable to the claim (including the governing law of the dispute as well as laws of the forum or seat of arbitration). An absence of documentary evidence or fact witnesses who are able and willing to testify can also lead to an adverse assessment. Indeed, funders generally tend to prefer claims where there are not significant facts in dispute, as this adds to the complexity of the matter and complicates the assessment of the likely outcome. A claim that is premature, or conversely at too advanced a stage, may also be assessed as having less merit than a claim that is about to be commenced or still in its early stages.
The competence of legal counsel retained by the party seeking funding is another important factor. A meritorious claim in the hands of counsel with no prior experience in the subject matter may lead to the rejection of an application for funding. Funders are often staffed with former dispute resolution lawyers who are familiar with leading members of the legal profession in different fields. They will also have an eye to how counsel historically have analysed and presented the merits of claims to funders, potentially preferring those with a track record of presenting meritorious claims.
However, in the present environment, many funding decisions are likely to turn on the third party funder’s assessment of the likelihood of recovery of any judgment or award for damages, including the defendant’s solvency. The same phenomenon that is causing businesses to seek out disputes funding is forcing funders to proceed with caution and to closely scrutinize not just the present solvency of the defendant but its likely future solvency as well. Predictions of global economic recession suggest that businesses that have survived the COVID-19 crisis will not necessarily be out of the woods once pandemic restrictions have been lifted. More generally, the third party funder will assess the ease of enforcement, including who and what the defendant is (e.g. commercial or state entity), their historical approach to satisfying adverse judgments or awards, and the type and location of assets against which enforcement would need to be made.
The nature of the funder and its source of investment capital is also a factor in its investment appetite, as discussed below.
What are the chances of getting funding?
According to commentators, in any given year, more applications for third party funding are rejected than accepted. In the present period of economic uncertainty and disruption, this is unlikely to change. Businesses in certain sectors suffering from multiple shocks, such as oil and gas, may face a greater challenge in making the case for third party funding due to uncertainties such as the price of oil. This uncertainty may make it more difficult for funders to gauge the merits of a claim, in particular the value of any likely recovery and the solvency of the defending party, whether a private company or a state, and therefore likelihood of recovery of a judgment or award.
Similarly, changes in law in response to or in connection with the pandemic may impact a funder’s merits assessment. States may adopt changes to the legal framework applicable to a contract or an investment, leading to uncertainty in respect of the status of a company’s rights and their vindication. Inconsistent judgments or awards on contract interpretation, such as in respect of force majeure clauses and other doctrines such as frustration of contract, may also create uncertainty.
For companies seeking to pursue TPF, careful consideration of the above factors and due diligence prior to applying for funding will assist in ensuring a company’s best chances of success. Legal counsel with experience in TPF and the type of claim being considered can help guide a company in weighing its options and preparing its best case for funding, as well as identifying appropriate funders. The nature of the funder and how and from where their investment capital is raised is another key piece of the puzzle. Funders backed by private equity and those who have just completed significant capital raising rounds are more likely to be actively pursuing opportunities for investment and may therefore have a higher risk tolerance.
As many third party funders are seeking to shift their investments to portfolios, there may also be an opportunity for multiple claims to be included within a portfolio. Portfolios enable funders to spread their risk by cross-collateralizing claims: the more diverse the claims, the lower the risk to the funder. The criteria for this type of funding is similar to the criteria discussed above in respect of individual claims but within a portfolio, a funder may be more willing to take on a higher risk claim if it is balanced by a diverse set of other matters, lowering the overall risk presented to the funder and potentially lowering the cost to the funded party. There is also the potential of including defences in addition to claims.
Companies with a claim or claims subject to English law should also be aware of a recent decision over-turning the ‘Arkin cap’ (Davey v Money  EWHC 997 (Ch)) which had operated to limit a funder’s liability for adverse costs in litigation to the amount of funding contributed. Going forward, funders are likely to price the risk of a large adverse costs judgment into their litigation funding structure, potentially making TPF too expensive for some would- be funding applicants, or to insist that ATE insurance be in place as a condition of funding. There is no such liability in the arbitration context given that funders are not parties to the proceedings and therefore beyond the tribunal’s authority.
Last, but not least, claimants seeking funding must also undertake their own careful due diligence on potential funders, in particular looking at where their capital comes from, the level of capital adequacy and if and how funds are ring-fenced for particular claims. Generally, some capital is paid in the future on a rolling basis, so claimants must be confident that the capital will be available to them when needed. The terms of funding should also be carefully negotiated to ensure for example that the funder is firmly bound to provide the capital and to reasonably limit the opportunity and terms on which they may exit the funding arrangement.
Careful consideration of proposed funding terms, once a successful application for funding is made, is essential not only to ensure funding can and will deliver the relief a company needs but also to address other matters as well. For example, it is critical that a funded party understand how and when payment of the funder’s fee and investment will be made. It is also important that the funder and funded party agree an appropriate level of involvement for the funder (legally as well as practically) throughout the matter, including in respect of any settlement discussions. Issues of privilege and confidentiality must also be carefully considered both at the outset when funds are sought as well as during the subsequent funded period.