Third Party Funding/Litigation Financing: Setting the Law Straight

The Author, Siddhant Ranjan Trivedi, is a 4th Year, B.B.A. LL.B., student at IFCAI Law School, Hyderabad. He is currently interning with Jasra & Jasra Law Offices.

Abstract: 

Third party funding is not new. Originally designed to support companies that did not have the means to pursue claims, its use has broadened to the extent that it has become a feature of the litigation landscape in several jurisdictions. Funders also look at international arbitration, attracted by the high-value claims, perceived finality of awards, and the enforcement regime provided by the New York Convention. The last few years have seen a marked increase in funding activity, initially focused on investor-state arbitration, but now spreading to commercial international arbitration. However, unlike in national litigation where disputes are decided by court appointed judges, the use of third party funding in private arbitration, with party-appointed arbitrators, has given rise to various ethical and procedural issues. 

Third party funding is where someone who is not involved in an arbitration provides funds to a party to that arbitration in exchange for an agreed return. Typically, the funding will cover the funded party's legal fees and expenses incurred in the arbitration. The funder may also agree to pay the other side's costs and provide security for the opponent's costs if the funded party is so ordered. As the use of third-party funding has increased, so have the number and range of institutions that are prepared to finance litigation and arbitration. In addition to specialised third party funders, insurance companies, investment banks, hedge funds and law firms have entered the market. In this project we explain what third party funding is and the practicalities of securing it, and then go on to outline the issues it gives rise to. 

Introduction:

A fundamental assumption for Third-Party Funding (TPF) or litigation financing is to fund a litigation or arbitration in favour of the claimant/counter claimant to an interest in the monetary judgement (if successful). Contracts for international arbitrations, commercial contracts, mishaps, class action cases etc. may be covered with a calculated likelihood of monetary victory. The funders may be any entity interested in the claim monetarily but who has no personal connection to the controversy. The frequently cited benefit of TPF is that the parties who do not seek judicial forums otherwise will have better access to justice for themselves. The TPF has been placed on a global map of international arbitration and commercial litigation, including major countries such as Australia, England & Wales, Hong Kong and SingApril, to mention a few. This essay seeks to give a bird's eye view of TPF regulations in other jurisdictions and how a growing arbitration powerhouse such as India may use the same methodology. In many countries the financing of unrelated lawsuits in accordance with maintaining and champering principles was formerly forbidden for third parties^[1]. While maintenance consists of a third party giving financial support for the maintenance of the dispute, champerty as a maintenance form permitted an unrelated third party, in exchange for a portion of profits, to pay some or all of the litigation costs.

The law of Torts in India, which started itself in the United Kingdom, is the source of this theory. In the case of a person not interested in the claim or related to the complaint, maintenance shall be provided financial assistance in pursuing a legitimate suit in the court to any party to the dispute, and Champerty shall provide the same person for the financial contribution to the result of the legal proceedings. This is a common legal competence theory and because of moral and ethical considerations, was judged contrary to public policy. Maintenance is a kind of Champerty^[2]. The parties undertake Champerty for litigation funding because investors are generally corporate businesses that are looking for returns by way of damages. In India it is unlike England and Wales, Australia, Hong Kong and Singapore that the maintenance or champery bar has never been established initially and without legislation. In the case of the inalienably discriminative, inappropriate and not malicious purposes of the claim, the Privy Council in Ram Coomar Condoo v Chunder Canto Mukherjee^[3] diminished the standard of champertous agreements which were undermined by the common law principle of government policy, and held that such agreements would potentially reject Indian public policy.  It was deemed to be extensive and unreasonable and created for unsuitable objectives such as gambling in litigation and oppression by promoting unfair lawsuits should be considered against public policy. The Court repeated this concept in BCI V. A.K. Balaji^[4], and found that lawyers in India cannot fund litigation on behalf of their customer but that the third parties are not likely to finance and get repayment for the case. 

Applicability:

In India, Champerty law has been resolved, however the apex court does not provide Third-Party Finance the opportunity to arbitrate. However, the states of Maharashtra, Gujarat, Madhya Pradesh and Uttar Pradesh have made significant adjustments to accept the third party litigations, as provided for in their respective Civil Procedure Code of 1908 under Order XXV of Rules 1 and 3. An agreement is essentially a contract of the litigant with the sponsors, and hence the Indian Contract Law of 1872 governs the contract. Furthermore, every foreign finance transaction under the Foreign Exchange Management Act, 1999 is examined (FEMA). Apart from such regulations, any arrangement or compliance relevant to that foreign investment shall fall under the sector or industry-specific rules or laws. 

Certain legal developments in the Indian landscape have recently prompted an increase in instances of third-party funding. A recent amendment to the Specific Relief Act 1963 has made specific performance of a contract a compulsory relief, as opposed to a discretionary relief that may be conceded by the court if there is no financial remedy accessible. Further, in infrastructure project contracts, the court shall not accord an injunction in a suit where it would deter or delay the continuance or completion of the project. Even though the Arbitration Act makes no particular mention of third-party funding, the recent amendments to the Arbitration and Conciliation Act 1996 have introduced fast-track arbitrations, as well as stricter and shorter deadlines for the passing of awards. Critical reforms such as a robust framework for dispute resolution, an overhaul of the arbitration regime, enforcing contracts and setting up of commercial courts can ensure smooth implementation of third party funding in India.

Lastly, if an arbitration is being funded by a foreign third-party funder or if the funder is seated in India – whereby there is remittance of foreign exchange from India – then the provisions of the Foreign Exchange Management Act 1999 (FEMA) will be pulled in. 

This does not explicitly classify third-party funding as either a current or capital account transaction. There is uncertainty regarding how such funds will interact with the regulatory regime, particularly since both these transactions are seen distinctively under FEMA rules and regulations. The Delhi High Court, in NTT Dokomo Inc v Tata Sons Ltd^[5]. and Cruz City 1 Mauritius Holdings v Unitech Limited^[6] observed that – in contrast to its archetype rule, the Foreign Exchange Regulation Act (FERA) 1973 – FEMA itself neither restricts foreign exchange transactions, nor does it render them void if there should be any procedural non-compliance. In these commercial times, it is inalienable that awards passed by foreign seated arbitral tribunals are honoured. Regardless of whether there is a lay regulation that provides some sort of hindrance in execution, it ought not be called as opposed to the public policy of India. In both these cases, awards were enforced by the Indian Court.

How May the Arbitration of Third Parties be Pursued? 

It is desirable if parties may establish an arbitration budget or if a budget limit is provided. It may not be viable for the funders to invest if a budget continues to change. The budget must be reasonable, comprehensive, forward-looking and thorough. This depends largely on the case's merits. However, the truth is not ideal. What can be the result of a conflict cannot be anticipated in advance. A party can estimate litigation expenses roughly since there is no doubt that there are changes. In this case, the donors must adapt and help to modify the budget that has already been agreed upon. At the same time, the litigant must monitor the packaging and negotiating cost of the financing agreement, as this happens prior to a settlement between the parties and the costs are the litigant's only responsibility

• Independence of Arbitral Tribunal : The arbitrator's independence is one of the key aspects for the successful implementation of the arbitration procedure. According to the recommendation of the 246th Report of the Law Commission of India, the Arbitrator was obliged to make public a past, present, direct or indirect relationship with any of the parties of the arbitration in the new provision in paragraph 5 in accordance with Section 12, 1996 and in 2015, amended. Any relationship not previously revealed or not authorised in writing by the parties may frustrate the whole arbitration process. Due to the assumption of influence on the arbitrator and the procedures themselves, the award won might be contested and thrown aside. The financing party should thus not be associated with the Arbitration Tribunal or must get a statement from the Arbitral Tribunal and the other parties' approval.

The financing structure should regulate the extent to which investors have influence or intervention. Funder typically adopts a "light-touch approach" and keeps up with the procedure, but it saves the settlement from numerous conflicts by establishing its area of authority. It also includes a method to decide how to agree when both cannot reach a consensual settlement accord.

Regulation of Litigation Financing: 

There are currently no clear standards or regulations for regulating third-party funding in India. This notion is still in its infancy in India, thus a complex regulation is not possible and is needed. Sophisticated governments across the globe create measures to self-regulate this idea and enable companies to develop through risk-based investment. In India, as the government has just said, it is on the path to becoming a developed country. A self-regulatory route in its baby stage will therefore be more practical.

Need for Third Party Funding in India: 

TPF is not alien to the Indian legal market^[7]. Many a mukadma (case) have been bought and sold in the unorganised market by opportunistic investors and desperate litigants, often resulting in the transfer of the very asset that is the subject matter of the litigation. Formal arrangements built on risk-reward share on an arm's-length basis, as discussed in this paper, are however yet to come of age in India. In 2015, the Supreme Court in Bar Council of India v. AK Balaji^[8], clarified the legal permissibility of TPF in litigation and observed that “There appears to be no restriction on third parties (non-lawyers) funding the litigation and getting repaid after the outcome of the litigation.”. As on date, there is no legislative instrument that regulates such funding. However, the (Indian) Code of Civil Procedure, 1908 as amended by a few Indian states including Maharashtra, Karnataka, Gujarat and MP, expressly acknowledges the role of the financier of litigation costs of a plaintiff and sets out the situations when such financier may be made a party to the proceedings. TPF has also received favourable reference in the report of the High Level Committee to review the Institutionalisation of Arbitration Mechanism in India (2017). 

Limitations under existing legislative framework 

It is well established that lawyers in India are expressly barred from funding litigation when representing the disputing party or accepting a success based fee. This could bear an inherent structural limitation for funders that typically seek contingency fees of legal counsel as a core factor to an investment decision to ensure alignment of interests. Additionally, whether a TPF arrangement falls foul of public policy would depend on the terms of the arrangement including the funder’s stake in the award, if determined to be extortionate. Another limitation that is yet to evolve is the permissibility of foreign investment in third party funding of disputes in India.

The Need of Third Party Funding: 

The post-Covid world is witnessed in the form of breach or frustration of contracts between parties to a multitude of trade disputes. In the sphere of infrastructure, energy, construction, insolvency and corporate undertakings, the bulk of the conflicts are expected to emerge as the Government of India expands investment in the infrastructure and energy sector under numerous contractual arrangements. India would invest $1.4 trillion over five years on the infrastructure sector to become a $5 trillion economy, with India forecasting to become the third biggest infrastructure industry economy by 2022-2023^[9]. The DFI, a lending platform for Rs. 5 Lakh Crores in Infrastructure Projects is also being established by the Government of India^[10].

The government may even end up having several arbitration disputes with foreign corporations with these big assets and get their investments locked in litigation. A smart company that operates on a risk-return basis can prevent Investment Companies and Public Sector companies from consolidating their investment in arbitration and allowing them to continue to function without losing their cash. If companies can find someone to support their legal proceedings in the private sector, too, they should certainly go for them. Loans or other forms of debt might be a bad choice since the cost of financing is high and the domestic cost of the company is reduced. Due to the restricted resources of firms, expansion plans will remain in place. The financing of litigation allows the company to use its earnings for its organic expansion. It does not influence the enterprise and risk is transferred at a reduced price to a third party.

Notable gaps in the Indian Market: 

Indian litigation is an ever expanding market with increased commercial activity. While there is a demonstrable demand for structured and professional TPF to facilitate the pursuit of viable claims, a few sticky areas of concern are: › Class actions suits or representative claims which provide high likelihood of exemplary damages that attract funders have not gained traction in India. Further, there is hardly any precedent in India for grant of exemplary or ‘blockbuster’ damages for commercial disputes. › Funders often use historical data to carry out a risk-assessment analysis before taking up a case. Such relevant data is a work in progress in India and will take a few years to consolidate. › Factors like roster changes during the progress of the case lead to an inherent unpredictability in the system that is not conducive to risk assessment. › Funders often prefer sharing the risk of their investment with lawyers appearing for the funded party, by requiring the lawyers to work on a contingency fee basis. This aligns the incentives of the lawyers and funders. This practice is impermissible in India.

Conclusion: 

The introduction of third-party litigation finance in India has to be studied so that enabling such a system to prosper creates a new asset class that not only provides outsized profits, but also may lead to extra liquidity. There are certainly concerns about such a complex law and notion in India that would develop and mature. Since domestic rules differ from place To place, for convenience, this might lead to forum shopping. Secondly, the risk of over-regulation is constant when an unsustainable structure makes it difficult to pursue such restrictions. Since the notion of third-party finance is new and developing, the operational flexibility is clearly evident. Indian law does not dissuade any third-party funds from joining the commercial market via legislative measures. As long as contracts of third parties financing are not against state policy, or in any way illegal, India should handle the financing of third parties by using diverse methods established by leading arbitration jurisdictions. The report of the high-level commission for the review of the arbitration mechanism's institutionalisation in India states:

'The passage of legislation encouraging the development of these jurisdictions as arbitration centres, made a substantial contribution. For example, recent revisions to the Civil Law Act allowing third party funding for arbitration and related processes have been adopted in Singapore. Similarly the third party payment for arbitration and mediation was legalised in Hong Kong lately. The Bar Council in Paris also expressed its support for the financing of third parties.

Innovative Risk Transfer Arrangements 

Funding arrangements for defendants involve cases where the defendant does not want to bear the upfront costs of litigation, but will pay out-of-pocket, a share of the perceived value of a successful defence, upon dismissal of the claim. Increasingly, defendants not only want the litigation-related expenses funded, but also the risk of an adverse decision transferred. For this, the market is evolving instruments that provide insurance and other arrangements (like “After the Event (ATE) Insurance”) that transfer the risk of a dispute for an upfront price paid by the party. 

Increasing legislative sanction for Third Party Funding

Beginning with Australia, many countries are moving away from the outdated common law concepts of champerty, barratry and maintenance, and have legalized third party funding. Most recently, Singapore introduced the amended Civil Law Act and the Civil Law (Third-Party Funding) Regulations, 2017 making third party funding in international arbitration and related proceedings legal. On the same lines, Hong Kong enacted and amended its legislative framework to enable third party funding in arbitration and mediation.

Litigation, in a way, is counter-cyclical to an economy. The present slowdown in the economy is bound to affect businesses engaged in high volume and low margin industries. These businesses could be well inclined towards using external capital rather than their own while engaging in necessary dispute resolution.

Overall, India’s time is now to open its doors for TPF in both arbitration and litigation, which will go a long way in making India a hub for effective and expeditious dispute resolution.

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