Many businesses with strong claims are hesitant to pursue their legal remedies because of the high costs and significant risks of litigation and arbitration. This problem is particularly acute where the potential defendant has robust financial assets at its disposal. An increasingly available option for such businesses is third-party funding through a litigation funding agreement.

What Is Third Party Funding?

Third-party funding is an arrangement where a commercial funder, or a number of funders, finance claimants engaged in litigation or arbitration, as an investment. Typically, the funder will only realize a return on its investment if the claim is successful or the parties work out a favourable settlement, in which case the funder receives a share of the proceeds. Generally, third-party funders are interested in funding claimants. However, funding for defendants is becoming increasingly available as well.

Over the past several years, third-party funding has grown rapidly, in the contexts of international arbitration (including investor-state and commercial disputes) and class actions. The trend is beginning to penetrate the Canadian market. Canadian resource sector companies investing abroad are particularly interested in this option.

Historically, the concept of third-party funding ran afoul of the common law doctrines of maintenance and champerty. Maintenance is when a non-party to a lawsuit funds or “maintains” it with an improper motive, such as meddling where it has no legal interest. Champerty, a sub-species of maintenance, is where the maintainer shares in the profits of the lawsuit. However, in modern times, third-party funding is not considered maintenance or champerty. But funders must still be careful not to take complete control of the proceedings on behalf of the claimant.

How Does Third Party Funding Work?

Potential claimants (and their counsel) and third-party funders are actively seeking each other out. Once they make contact, the first step, generally, is for the funder to conduct due diligence on the potential claim, i.e., does it look like a good investment? This requires the potential claimant to provide the third-party funder with access to relevant records (including potentially privileged information – discussed below) to assess the strength of the claimant’s legal position, the potential amount of a successful result and the prospects of enforcing a court judgment or arbitral award.

Similar to the venture capital process, if the third-party funder believes that the claim (and the claimant) are fundamentally sound, then it will provide the necessary capital to fund the proceedings (and sometimes even the claimant itself, to assist it with its operations throughout the duration of the proceedings). A typical agreement will describe the claimant’s relationship with its legal counsel, the treatment of legal advice received by the claimant, the manner in which the claimant will instruct legal counsel, and the availability and timing of resources to conduct the proceedings. It will also generally prohibit the claimant taking any actions which may impair the success of the claim. As mentioned above, third-party funders should not have control of the conduct of the claimant’s case. Rather, the claimant should instruct legal counsel in much the same way as if the dispute was internally funded. However, funders will often expect to be involved in assessing critical issues, which could include the choice of legal counsel, the choice of an arbitral tribunal in arbitral proceedings and any potential settlement. Funders may also request the right to provide input on key strategic decisions, but claimants and their counsel should always retain the final say and control.

A third-party funder’s return may range from 20% to 50% of a successful outcome. It is unlikely that the fee limitations on contingency agreements in legislation apply to third party funding agreements: a “contingent fee agreement”, as defined in, for example, the British Columbia Legal Profession Act, must be between a lawyer and a client. A litigation funding agreement is generally between  a third-party funder and the client. However, until this has been confirmed by courts of the jurisdiction in which the agreement is to operate, funders and claimants should be aware that a court may exercise its inherent supervisory jurisdiction to assess whether a funding agreement is “fair and reasonable” in all of the circumstances. This is particularly relevant in the class action context (where unique public policy considerations are often at play), but less of a concern in an international arbitration context

Who Are Third-Party Funders?

Following the 2008 financial crisis, corporate legal budgets contracted, allowing the arbitration and litigation finance industry correspondingly to expand. In a recent Wall Street Journal article, the United States litigation market, taking into account the money spent by plaintiffs and defendants, was estimated to be around $200 billion. Although the Canadian market is considerably smaller, many arbitration and litigation funders are positioning themselves to gain access to a piece of it.

The bottom line is that arbitration and litigation funding, although still considered a niche market, is expanding globally. For example, in 2012 investment bank Credit Suisse Group AG created  a legal finance group, which has since raised over $200 million in capital. Mike Smith, co-founder of Calunius Capital, one of the world’s most reputable funders, estimates that the six best-known third- party funders have raised over $1 billion since 2007, with over half of that used to fund arbitration rather than litigation.

The Future of Third Party Funding

There is no legislative regime in Canada that regulates the disputes funding industry. This  is consistent with the remainder of the world, where the industry remains almost completely unregulated. Indeed, litigation funding agreements have received very little judicial consideration in Canada and elsewhere. However, a recent decision of the British Columbia Supreme Court confirmed the validity of such agreements under that Province’s class action legislation. The  Court addressed, among other things, whether communications between the claimant and the funder, including the agreement itself or portions of it, were protected by privilege, and confirmed that they were, although some parts of the agreement, such as the amount of control the funder may have over the litigation, may be subject to disclosure to the opposing party in certain circumstances.

In Ontario, the Superior Court has taken a different approach on the issue of privilege in the class action context, holding that litigation funding agreements are not privileged at all because they should be completely transparent and not allowed to operate clandestinely, due to public policy concerns relating to the purpose of class proceedings. The Ontario Court, however, appears to support the validity of such agreements in general.

In light of the divergent authority on the issue of privilege, counsel should be cautious and take particular care to ensure that confidential information is provided only through highly structured and controlled processes, recognizing that the potential funder requires enough information to be able to evaluate of the risk and potential reward the case presents, and that the claimant may be unable to proceed with its case at all without the assistance of third-party funding.

Litigation funding agreements appear to be here to stay and the funding of disputes by third parties is likely to be big business for the future. Businesses assessing the viability of pursuing potential claims should not overlook this option.