Litigation funding—introduction to funder's perspectiveWhat is litigation funding?Litigation funding, also commonly referred to as litigation finance or third party funding, is where a third party pays all or part of the costs and legal expenses associated with pursuing a claim.Claimants typically seek funding to cover all their disbursements and legal expenses in accordance with an agreed budget under a funding agreement.Funding can, however, also be made available for discrete costs, for example, to cover one or a number of disbursements such as ATE premia, experts, outside counsel, or arbitration costs.Most commonly, third party funding is provided on a non-recourse basis, which means that:•if the claimant makes no recovery, it will not have to pay anything to the funder and the funder has no recourse to the claimant for its lost investment•if the claim is successful, the funder will be entitled to a success fee. This is taken from the damages actually recovered, in accordance with the terms under a funding agreement, see Practice Note: Litigation funding application processWhy use third party funding?The reasons for seeking third party funding will vary from client to client and claim to claim.Significant factors for many claimants include the ability to:•de-risk financial exposure•optimise alignment of interests•manage external legal spend•unlock value by treating legal claims as an asset classDe-risking financial exposurePursuing a claim Involves many uncertainties, eg duration and cost of proceedings; outcome with respect to liability, quantum, and recovery; and exposure to adverse costs.Third party funding can be used to transfer these risks from the claimant to other parties.Even meritorious claims are not always successful and the utilisation of third party funding provides a claimant with assurance that in the event of a loss, it will not be liable to pay the funder for the costs of having brought the claim.Similarly, third party funders will usually be happy to pay for insurance against adverse costs exposure, which de-risks the client from having to pay the other side’s costs in the event the claim is successful.Optimising alignment of interestsMany clients have long sought alternative fee arrangements to hourly rates, with a view to creating greater alignment between the fees they are billed and the outcome-based value to their business. Third party funding, by nature of being non-recourse, ensures that the claimant only pays in the event of a win.Similarly, third party funding can be utilised to increase innovation around fee structures and risk sharing between funders and law firms, which are increasingly prepared to defer part of their fees in exchange for an uplift in the event of success.Properly managed, third party funding can be used to increase the sharing of risk and reward between the claimant, its law firm and the funder to optimise the alignment of each party’s interest in achieving a positive outcome.Managing external legal spendLegal departments, like any other, have to operate within the constraints of their budget (or otherwise seek additional budget for unanticipated legal spend, as may arise with a substantial legal claim). Clients are increasingly looking for a menu of options when deciding how to finance legal claims.Budgetary constraints can also lead to difficult decisions with respect to law firm selection, for example where pricing may be a determinative factor. Third party funding can be used to facilitate a client’s preferred choice of firm by sharing some or all of the costs.Unlocking valueSome clients are increasingly viewing legal claims as an asset class. The burden of meeting the costs of pursuing these claims can lead to meritorious claims not being pursued, or being pursued later than might otherwise be the case. This can leave valuable assets on the table.Certain sectors, for example, in the private equity space, are increasingly looking to third party funding to monetise and/or de-risk claims in their portfolio companies.Separately, some claims, however meritorious, would not be brought without third party funding where claimants are impecunious or have otherwise suffered losses that individually are relatively small but collectively are very substantial, for example in relation to opt-out claims before the Competition Appeal Tribunal. For this category of claimants, third party funding will generally be the only means of pursuing their claims.What factors do funders consider as part of their assessment as to whether to invest in a claim?Different funders have different investment criteria, however, most funders will want to ensure:•there is a clear path to recovery:◦funders are commercial businesses that ordinarily only make a return upon the actual receipt of payment by the claimant from the defendant(s)•the proposed investment is financially viable:◦funders treat legal claims as an asset class and need to assess the basic economics of their investment in the event of success◦at a minimum, this requires an understanding of the amount of their investment (the budget), and the amount of damages likely to be recovered•merits:◦as funders typically extend finance on a non-recourse basis, they only stand to get paid if the claim is successful◦funders therefore need to impose minimum requirements on the prospects of success in respect of any claim before they can invest in itFor more detailed information, see: What funders look for—checklist.What pricing terms are commonly found in funding agreements?One of the advantages of third party funding is the flexibility available to clients from being able to negotiate bespoke funding agreements. A result of this flexibility is that funding terms will vary between cases.In terms of pricing, it is fairly common for a funder’s fee in the event of success, to be based on a return of capital plus a multiple. Historically, there was a consensus in the funding market that litigation funding agreements were not damages-based agreements (DBAs) and did not, therefore, need to comply with the relevant legislation governing DBAs. However, in Paccar Inc v Road Haulage Association Ltd, the Supreme Court held that where a litigation funding agreement provides for the third party funder’s return to be calculated by reference to a share of the damages, the agreement is a DBA and must therefore comply with the relevant legislation in order to be enforceable. For a more detailed discussion of the Paccar judgment, see Practice Note: Damages-based agreements (DBAs).Most third party funders will set out the pricing terms in an indicative term sheet (subject to diligence and contract), at an early stage in the application process. Subject to successfully passing diligence, the pricing terms will then be incorporated into the funding agreement.Funding agreements will typically contain a waterfall provision that prescribes the order in which various interested parties (which, in addition to the claimant and funder, can also include insurers, the law firm, and external counsel), are paid from the recovered amounts.Are third party funders regulated?Third party funding is permitted in the UK, where the role of third party funders in promoting access to justice is widely recognised. Similarly, many other jurisdictions also permit third party funding.The Association of Litigation Funders of England and Wales (ALF) is an independent body that has been charged by the Ministry of Justice with delivering self-regulation of litigation funding in England and Wales.In order to be a member of ALF, funders must abide by its Code of Conduct which sets out various standards, including with respect to:•access to capital, ie having immediate access to capital under the funder’s control, rather than having to raise funds when presented with a credible case•capital adequacy, ie maintaining adequate financial resources at all times in order to meet the funder’s obligations to fund all of the disputes it has agreed to fund, and to cover aggregate funding liabilities under all of its funding agreements for a minimum period of 36 months•termination and approval of settlements, ie behaving reasonably and only withdrawing from funding in limited specific circumstances•control, ie adhering to restrictions preventing the funder from taking control of litigation or settlement negotiations and from causing the litigant’s lawyers to act in breach of their professional dutiesFurther details about ALF, a copy of its Code of Conduct and a list of funders who are members of ALF can be found on the ALF’s website.Do third party funders require ATE insurance to be in place?When funding litigation in the UK or other fora in which costs follow the event, many third party funders will require the claimant to obtain After The Event (ATE) insurance to protect against the risk of adverse costs in the event the claim is unsuccessful.Any upfront premium for ATE insurance will ordinarily be paid for by the third party funder as part of the funding under the funding agreement. Any deferred premium is usually paid out in the event the claim is successful, in accordance with the waterfall provisions under the funding agreement.Sometimes, a funder may provide a funder indemnity to the claimants, which may be backed by an ATE policy.For more information on ATE Insurance, see Practice Note: Costs insurance.