Third-party funding is not new; however, it is about to enter a period of unprecedented global growth – notably in Spain and Latin America. The measures implemented by governments in response to COVID-19, coupled with the rapid economic downturn and ongoing uncertainty arising from the pandemic, have created the perfect storm. The outlook may seem bleak, but third-party funding offers a ray of hope for beleaguered boardrooms looking to maximize cashflow in this unpredictable period.

Companies are finding themselves under increasing cash flow pressure. On the one hand, CEOs need to keep businesses running, but on the other hand they are experiencing late payments and increased contractual defaults. While some governments have implemented measures to help companies (notably with regard to supporting salary payments for furloughed workers), business interruption in all its forms is resulting in drastic cutbacks in spending to preserve cash. Legal departments are placed under immense pressure to do more work in-house with less budget.

An obvious means of saving is to cut back on legal spend by not pursuing legal claims, with in-house counsel reluctantly accepting that good claims may have to be put on the shelf, at least for the time being. It is exactly in this situation that companies need to be asking themselves if they should be partnering with a third-party funder to turn their claims (assets) into cash.

1. Third-party funding myths

First, one myth needs to be dispelled. Third-party funding is often viewed as a product for insolvent companies and class action claimants, and that using funding is a sign of weakness in a legal dispute. Nothing could be further from the truth. Today, third-party funding is a multibillion dollar market. It attracts banks, multinational companies and other listed and highly solvent companies who recognize the benefits of using funding to free up cash for the business that otherwise would have been deployed in legal spend.

Litigation funding has been around for many years, and a number of reputable funds have emerged. The business model is simple: the funder agrees to pay the legal fees incurred by a company (typically as claimant) to pursue a claim. This finance is non-recourse, which means if the company loses the litigation, it bears no cost and any adverse costs order is typically covered by an insurance policy that is often part of the funding package (after-event insurance). In return, if the company wins, it pays over a percentage of the winnings to the funder. Not all funders are equal on this last point, and clients are advised to shop around.

In short, litigation funding is a risk-free product for the company. The funding provides ready access to capital to pursue legitimate claims, while removing cost and risk from the balance sheet – a sure way for in-house counsel to bring delight to the faces of CEOs and CFOs alike.

Time to dispel another myth: legal claims are often brought against long-standing commercial partners, and clients fear that using third-party funding will mean they have less control over the claim. The truth is that 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 overarching strategy. In many jurisdictions, the funder is, in any event, prohibited from exercising any greater level of influence, given rules on champerty.

2. What is the relevance of third-party funding to Spain and Latin America?

There are five main points:

First, the funding of litigation and arbitration is permissible (or unregulated) in many jurisdictions. The market is growing at a rapid rate, and funding is increasingly a topic being discussed in boardrooms.

Second, while funders have traditionally focused on markets such as the US, UK and Australia because of their size and the perceived predictability of their legal systems and enforcement regimes, they have recently become far more interested in Latin America. This is because of a variety of factors: the volume and value of many of the disputes in Latin America; a developing track record of successful enforcement; and the exponential growth of arbitration as a means of resolving disputes.

Third, funders have adapted their business model. While high-value claims remain attractive, funders are increasingly willing to consider portfolios of lower value claims. This broadens the offering available in the funding market and allows funders to spread risk across a portfolio of claims.

Fourth, rising litigation costs in Spain and Latin America, particularly in large, complex or cross-border matters, often compel companies to abandon or settle good claims at a major discount. Funding provides these companies the opportunity to access first-class legal services and pursue good claims without the cash flow constraints and downside risk of a potentially unsuccessful outcome. It frees up the litigation spend for other priorities such as legal technology or even new legal team hires.

Finally, and relatedly, every global economy has been adversely affected by COVID-19. Boards of directors are seeking opportunities to ensure profitability for shareholders. Relying on litigation funding increases profitability by reducing cost, with the upside of a potential inflow of cash.

3. Litigation as a business tool

Against a backdrop of global economic uncertainty, new funders are continuing to enter the market. For example, Litigation Capital Management (LCM), a long-established funder, which is listed on London’s AIM exchange, recently entered into an arrangement with DLA Piper and a new DLA Piper-dedicated funder, Aldersgate Funding Limited, to launch a GBP150 million litigation fund, whose reach and investment goals are global. 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 and financial services claims a key focus. With cost constraints often cited as a major impediment in deciding whether or not to pursue litigation, this is an example of a law firm listening to clients and providing them with efficient and innovative business solutions. Litigation funding is now a key tool in the armory of companies across all sectors, which helps them navigate these turbulent economic times and focus expenditure on core business activities.