Is litigation funding compatible with Shariah principles?

This article was originally published in the December issue of Butterworths Journal of International Banking and Financial Law and is reproduced with permission from the publisher.

In recent years, there has been an exponential growth in litigation funding entering global markets. According to some sources, it is estimated that in the UK alone the litigation funding market is currently in excess of USD5 billion, whilst amounting to almost USD40 billion across Europe. With the pandemic increasing financial defaults and distress (such defaults expected to only increase further following the lifting of various national insolvency moratorium regimes), coupled with a desire from creditors not to potentially “throw good many after bad”, many in the Islamic Finance sector have begun to consider litigation funding and whether it is compatible with Shariah principles. This article explores the principles of litigation funding, why it is becoming increasingly attractive and whether it is compatible with Islamic Finance principles.

What is litigation funding?

Litigation funding (also known as third party funding) is where a funder agrees to pay (usually on a non recourse basis) the costs of litigation or arbitration, in return for a share of any recoveries made if the litigation/arbitration is successful. If the litigation is unsuccessful, the funder loses the capital it has invested.

Why is litigation funding becoming popular?

There are a number of reasons why litigation funding is becoming increasingly popular. First, it enables a party to pursue litigation/arbitration without deploying its own capital, preserving cashflow within the business. In the current climate, this is particularly attractive where businesses are under financial pressures to keep costs off the balance sheet. It also enables a client to pursue (and potentially monetise) multiple viable claims as they arise. Second, it is particularly attractive to certain claimants (for example, insolvent estates) who have a good, meritorious claim against a creditor but may not otherwise have the financial means to pursue the claim. Third, it is ideal for certain high-value, cross-border disputes such as non-performing loan portfolios or complex fraud and asset tracing disputes where the costs of litigation/ arbitration are likely to be high and there may be uncertainty in relation to any potential recoveries. These high value, often “difficult” cases are ideal for funders whilst taking the perceived risk away from clients of potentially throwing “good money after bad”. Fourth, it removes a significant traditional impediment to pursuing litigation/arbitration, ie the risks of having to pay (at least your own) legal costs for an unsuccessful claim. A funded case puts that risk entirely on the funder/legal team. Finally, the client retains ultimate control of the litigation and the terms of settlement (if any).

Is litigation funding compatible with Shariah principles?

Islamic Finance is premised on the fundamental principle that one party should not exploit another due to an unequal bargaining position, ie the rich should not use their position to take advantage over the poor. It is a financial system, therefore, that seeks to create a just and equitable society. It is for this reason that interest (riba) is prohibited. Instead, parties are encouraged to work collaboratively, sharing risks and profits/losses.

In many respects, litigation funding is entirely aligned with Shariah principles. First, it potentially provides access to justice to a claimant that may otherwise have been deprived from pursuing a meritorious claim purely on financial grounds. Funding focuses on the merits of a claim rather than the financial pecuniosity of a client. Second, the funder assumes the risk of the claimant's costs if the litigation/arbitration is unsuccessful. Equally, if the claim is successful, the parties share in the profits together. There is therefore no guarantee of a fixed return to a funder. Third, the litigation funding model is remarkably similar to a classic Mudarabah structure, ie one where the funder provides the capital (rab al maal) and the client provides the labour/instructions (mudareb) and, in return, the funder earns a fee/share of the profits according to a pre-agreed ratio.

The fact that litigation funding may also deter “bad behaviour”, for example by discouraging one party from engaging in highly risky/ speculative behaviour, or discouraging deliberate defaults on repayment obligations (on the assumption that a counterparty may not otherwise have the financial means to pursue the debt), is entirely compatible with the spirit of Shariah principles of creating a just and equitable society.

The incompatibility, if any, is likely to arise in relation to any potential claim for interest, or the funding of a claim for a prohibited matter (eg in relation to gambling, armaments, alcohol etc). However, this is no different to a non-funded case. Both funded and non-funded cases would need to comply with the underlying principles of Islamic Finance.

Practical tips

• The funding agreement is key. Ensure the role/risks of parties is clearly set out, together with the pre-agreed ratios.
• Carve out any claim for interest and/or non-Shariah compliant investments.
• Seek out early advice from an Islamic Finance litigation specialist.