Litigation funding: Redressing the balance?
This article was originally published by Middle East Economic Digest (MEED) on 7 September 2020 and is reproduced with permission from the publisher.
Inequitable risk allocation eroding profit margins; late payment creating a cash flow crisis; and an unparalleled level of scope changes has created a construction industry with a culture of chronic cost and time overruns, disputes, and mounting financial losses. COVID-19 has brought further delay and disruption to projects and the inevitable fights as to who bears the cost.
The industry has been slow to change and, until the playing field is levelled between the stakeholders, that is set to continue.
Attempts to redress the balance through the pursuit of arbitration or litigation claims has sadly been an (expensive) necessity for contractors in the past, but the present priority is survival. Expending significant cash and time on costly disputes is something which industry players of all sizes can ill afford.
Enter stage left the litigation funders. Litigation funding has been around, in one form or another, for many years, and some of the larger funds have now accumulated decades of experience. Their business model is simple: they agree to provide non-recourse financing, mainly to claimants, to fund their claims, in return for a percentage of the winnings. This gives claimants ready access to capital to pursue legitimate claims and removes the cost from their balance sheets, a key priority for CEOs and CFOs alike.
When claims are funded, the client retains full control over the dispute resolution process; the funder simply provides the funding, though it will be involved in setting the budget and strategy as a pre-condition. If the claim is unsuccessful, the funder loses out. Usually, it will also have obtained adverse costs insurance to cover the other side’s costs if the client loses, so that the client should never have to pay a penny. This eliminates the downside risk for the client. In return for taking on this risk, the funder takes an agreed percentage of the winnings if the claim is successful. The percentage depends on a number of factors, and one of which is whether the client has more than one claim to be funded, in which case the funder will be able to offer better terms, since it is able to spread its risk across a number of cases.
Why is this of particular relevance to the Middle East construction industry? For five reasons:
First, litigation and arbitration funding is permitted in the Middle East’s various jurisdictions. In some jurisdictions (such as the DIFC and ADGM), it is expressly permitted and there are provisions made for its use; in the onshore jurisdictions, while care needs to be taken when structuring the funding, there is no prohibition on funding.
Second, while funders have traditionally focused on markets such as the United States, Europe and Australia because of their size and the perceived predictability of their legal systems and enforcement regimes, they have become far more interested in the Middle East in recent years. This is due to: the sheer number and size of disputes; the existence of the DIFC and ADGM courts (whose regimes are very similar to the common law courts of England); the increasing track record of successful enforcement; and the prevalence of arbitration. Having taken on cases in the Middle East, many funders have made successful recoveries and have, to some extent, grown comfortable with the onshore litigation system. Many have established offices here, particularly in Dubai. Funders are here, and they are looking to commit their funds.
Third, funders are generally interested only in larger claims. Since construction-related claims tend to be substantial, the nature of the industry lends itself to litigation funding.
Fourth, while funders do fund single claims, their preference is to spread risk across a portfolio of claims so that, if one claim fails, they are still able to recoup their costs from others. Bundling up a portfolio of claims allows the funder to offer more favourable funding terms to clients. The significance for the construction industry, where many contractors have numerous claims at any given time, is obvious: and for this reason litigation funders are increasingly interested in offering portfolio funding solutions to players in the construction sector.
Finally, while the perception is that litigation funders have focussed on banks and their non-performing loan portfolios or impecunious or insolvent clients, the reality is that funders have been funding construction claims for a long time, and the sector is one of the key drivers for their growth in the Middle East. As highlighted in the MEED/DLA Piper Report “Time for Change” (November 2018), the region’s construction industry faces a number of systemic issues, which drive the region’s projects into developer/contractor and contractor/sub-contractor disputes.
Against a backdrop of global economic uncertainty, new funders are continuing to enter the market. For example, DLA Piper recently entered into a non-exclusive arrangement with publicly listed disputes financier Litigation Capital Management, and a new DLA Piper-dedicated funder, Aldersgate Funding Limited, to offer our clients access to GBP150 million for funding large-scale litigation and arbitration. Funders such as LCM and Aldersgate are seeking to take the market to the next level, with best-in-class funding terms and with investment in construction claims a key focus. With cost constraints often cited as a major impediment in deciding whether to pursue litigation, this is an example of a law firm taking action to provide more efficient and innovative solutions to clients that enable them to take recourse in a market where they are otherwise facing cost-reducing measures and a lack of available capital.
Litigation funding could mean the survival of industry players, provide a much needed push towards redressing the balance, and act as a catalyst for reactivating change.