By Cheng-Yee Khong and Tom Glasgow, IMF Bentham
Cheng-Yee Khong and Tom Glasgow of IMF Bentham examine the new regulatory environment for third-party litigation funding in Singapore and Hong Kong.
Asia-mena Counsel: Last year’s article provided the basics of third-party funding and an overview of the funding landscape in Asia. Have there been any legal developments for funding in this region?
Cheng-Yee Khong / Tom Glasgow: The 2017 legislative changes in Singapore and Hong Kong to permit third-party funding in prescribed dispute resolution proceedings have provided certainty and guidance for parties, legal practitioners and funders in the dispute resolution industry.
In March 2017, Singapore abolished civil liability for the common law tort of maintenance and champerty and established a new regulatory framework to allow third-party funding for international arbitration and related proceedings, including court proceedings and mediations. Helpful, non-binding guidelines have been issued for funders, legal practitioners and arbitrators by the Singapore Institute of Arbitrators, the Singapore Law Society and the Singapore International Arbitration Centre respectively.
The regulatory regime has been designed with flexibility and party autonomy in mind, with relatively light statutory regulations focusing primarily on lawyers and law firms practising in Singapore. This approach, combined with its popularity as the seat of choice for international arbitration, has led to an emerging market for third-party funding in Singapore.
The first funding agreement under the new statutory framework was reported in July 2017. IMF agreed to fund its first international commercial arbitration in Singapore in February 2018, and there are more cases in the pipeline.
In June 2017, Hong Kong abolished maintenance and champerty for arbitration and related proceedings, including court proceedings, emergency arbitrators and mediations. The amendments apply to third-party funding of arbitration proceedings seated in Hong Kong, whether domestic or international, and in respect of work done in Hong Kong on arbitrations seated elsewhere.
It is hoped that the legislative amendments will come into effect this year, once a code of practice for funders is issued. IMF has received enquiries for funding in Hong Kong, which can move forward once this last piece of the jigsaw falls in place.
Any recent industry trends?
The costs barriers and associated risks of litigating are high in modern international arbitration as expenses are compounded by the international nature of the dispute requiring multi-jurisdictional and often specialist legal teams, as well as arbitrator costs, institutional fees and hearing costs. It comes as no surprise, therefore, that international arbitration has seen a rise in the use of third-party funding by parties with lesser means, or those who wish to level the playing field against a larger opponent.
However, dispute resolution finance is no longer just for those who are unable to pay. Sophisticated, well-resourced companies are increasingly seeking dispute finance: firstly, as an effective means to manage the costs and risks associated with complex commercial disputes by transferring all or part of these costs (including potential adverse costs) to the funder. Secondly, as a cashflow management tool and a means of raising corporate finance. General counsel and financial controllers have tight budgets and are increasingly seeking relief from burdensome litigation or arbitration costs to allocate funds elsewhere. More generally, a business may wish to leverage the value of its contingent litigation or arbitration assets by seeking funding in the form of a capital advance, with no corresponding balance sheet liability.
These advantages are amplified when applied across a portfolio of disputes. In a portfolio, the funder’s investment can be cross-collateralised — linked to the overall performance of the portfolio rather than individual claims — and correspondingly risk is diversified. The reduction in risk may reduce the cost of capital to the funded party. A portfolio arrangement also allows greater flexibility to fund defence costs, as the funder can recover its costs and any return from the revenue generating claims within the portfolio. This means that businesses can obtain funding not only for bringing claims but also for defending claims brought against it.
Similar arrangements can be structured to support a law firm’s portfolio of contingency or success fee cases in jurisdictions such as US and China, where firms are permitted to act on this basis. The funder will assist the firm to meet its regular overheads as well as case-specific disbursements, in exchange for a share in the contingency or success fee generated by the firm.
What is the best way to select a funder?
Funders are not interchangeable. One important thing to keep in mind is that a dispute-financing relationship typically lasts two to three years until the resolution of the case, and will need to survive all the usual complications associated with any complex commercial dispute. This means that parties seeking funding, along with their lawyers, should look for a funding partner that has the track record, the financial resources and the know-how to serve as a trusted adviser and a partner who can go the distance when an unexpected turn in the case requires revisiting the litigation budget. Choosing a funder based on competitive pricing, whilst attractive at the outset, may not be the wisest choice when issues arise and remain unresolved, leading to delays and additional costs.
When choosing a funder, it is important to consider not just the funder’s track record for success, but also how long it has been in business to determine whether it has addressed thorny issues. Important factors to look for include whether the funder has been involved in disputes with funded parties or their lawyers; who will be dealing with the case at the company; whether interactions with the company will be with an individual who will approach the deal like a banking transaction, or a seasoned litigator who understands the fundamental nature of the litigation / arbitration at issue and can add value as it progresses. The source of the capital being provided is also important — is it readily available to draw down or does the funder need to make capital calls or go through other hoops to access it? IMF Bentham is comprised of experienced dispute resolution specialists who understand the cadence of the proceedings and how to handle obstacles along the road to resolution. IMF Bentham also has capital on-hand to fund legal fees, costs and even working capital and debt satisfaction for funded parties as soon as its diligence process is completed.
In addition to gauging a funder’s reputation, history and capital capabilities, the most successful funding arrangements are achieved when there is a mutuality of trust and respect between the funder, the funded party and the lawyers. Anyone considering dispute financing should have these goals in mind when first approaching a funder, to determine whether the funder is the right fit. It is imperative that all parties involved have a successful multi-year partnership with all interests aligned.
What are the steps to obtain financing?
We recommend reading IMF’s concise guide to funding, which sets out three key steps to finance a case and the basics of dispute resolution finance. A detailed description of the process from initial enquiry to funding follows.
Non-disclosure agreement (NDA)
Once the preferred funder is selected, the next step is to reach out with a general description of the case and the funding amount sought. Funders will invariably require a NDA before any substantive discussions occur. This is critical to the diligence process because it evidences the intent of the parties to maintain confidentiality and privilege over shared information.
Once a NDA is executed, parties should expect to have a more robust, but still preliminary, conversation with a funder about the case. In general, a funder will look for:
- a simple explanation of the case;
- where the case is pending (to verify there are no champerty or other restrictions in the jurisdiction);
- the anticipated funding amount sought; and
- the ideal funding arrangement (ie, whether the party is looking for working capital, legal fees, costs, or a combination of the three).
During these initial discussions, a funder will look to ensure that the matter meets its basic parameters. For instance, IMF Bentham typically requires a realistic damages estimate that is at least 10 times the proposed funding amount and a liability theory supported by documentary evidence. Typically, a party seeking funding will approach a funder with lawyers already engaged. In situations where a party seeking funding has not already retained a lawyer, funders are commonly willing to assist with making introductions and referrals if the matter satisfies the funder’s minimum criteria and the merits appear strong.
From the initial discussions, a funder should be able to generally understand the claims, the amount needed to fund the case to completion and a reasonable estimate of potential recovery. This information allows a funder to gauge its level of interest in moving forward. If that interest is strong, a funder will typically issue a term sheet that outlines the economic terms of the proposed investment and provides for a due diligence period to fully assess the merits of the case and related issues. For IMF Bentham, the term sheet is non-binding except for an exclusivity period, which generally lasts 30 to 45 days.
Funders require exclusivity because the diligence process is time-consuming and may require bringing on an outside expert to analyse the specific area of law at issue. Certain funders attempt to lock up parties with exclusivity requirements as early as the NDA stage, and often ask that parties reimburse them for costs incurred (eg, outside legal advice) as part of the diligence. IMF Bentham, in contrast, only requires exclusivity after the parties tentatively agree on terms. We also incur due diligence costs without seeking reimbursement from the party.
A funder’s term sheet will invariably describe its proposed return structure. Returns typically (but not always) increase over time as the funder continues to invest risk capital in the litigation. There is no single way to establish up front what an acceptable return will be if the case is successful, and approaches vary widely. But it is often calculated as a multiple of the disbursed funding amount, a percentage of the litigation proceeds, or the greater of the two. One thing to look for is whether a funder proposes to take a multiple of the committed funding amount (as opposed to the amount deployed as of the date of any resolution). Often committed funds are not fully drawn upon if the proceedings do not go the distance, in which case committing to paying a multiple of the committed amount is inadvisable. IMF Bentham’s business is focused on certainty and fairness. As such, we welcome early resolutions of the matters in which we invest — if fair to all concerned.
Parties should also look at the proposed return priority structure. Generally, a funder will require a first-priority position to receive, at minimum, the return of its principal. If the claimant’s lawyers have agreed to a full contingency arrangement and the funding is for working capital, the lawyers may want input in such an arrangement. Addressing issues like these sooner rather than later will benefit all parties and help facilitate the positive relationship necessary to make a dispute financing partnership work.
Preparing a matter for funding
Funders put each potential investment through rigorous diligence, which typically takes 30 to 45 days. Given that a typical case might last over two years and involve a commitment of a few million dollars, a funder’s in-depth review is essential. This process includes meeting with the party seeking funding, reviewing relevant documents, and possibly hiring outside experts (especially if the case revolves around a highly-specialised area of law).
Parties should prepare for this process early. Funders will ask for pleadings that best summarise the legal and factual arguments from each side, and documentary or other evidence that both supports the claims and refutes any facially strong arguments from the adversary. A legally sound and objectively measurable theory of damages — even if preliminary — is important, and a pre-litigation damages analysis conducted by the lawyers or their consultants is a huge plus from a funding perspective. Funders will invariably seek access to the legal team to discuss liability and damages issues in depth. If the case involves a niche practice area that requires the funder to engage outside expert consultation, parties should ask whether this additional expense will be borne by the party or the funder when negotiating the term sheet. IMF incurs all such costs as part of its diligence process.
Preparing for and assisting with a funder’s diligence process may be time-consuming but it can be very helpful to strengthen the merits of the case, including identifying and shoring up any perceived weaknesses. Funders often reduce a case to somewhere north of its “worst-case scenario” and seek an explanation of the best arguments available. Lawyers are often very appreciative of the process because it forces them early on to analyse the pitfalls in the case, identify the best evidence available, and crystallise counter-arguments sooner than they otherwise would do in the litigation process.
While each case presents a unique set of issues, funders at a minimum look for the following in any investment opportunity:
- a cogent liability theory supported by documentary evidence, indicating strong prospects of success;
- a sound damages theory that results in sufficient damages to cover the funder’s return, the lawyers’ contingency stake (if any), and (in IMF’s case) enough remaining for the funded party to recover at least 60% of any award or settlement; and
- a high likelihood of collectability.
Being frank, realistic and dispassionate during the diligence process is important. Dispute finance is a multi-year partnership. Thus, it is best for everyone involved if the funder has the essential information to make an accurate underwriting decision. Once an investment decision has been made, parties can expect to finalise and execute a funding agreement.