Access to justice is not always equally achievable for all parties, considering the expenses attached to seeking relief through legal proceedings, in most cases litigation or arbitration. The parties to litigation or arbitration proceedings may not be in a position to cope with advance costs, and most significantly attorney fees. This may be due to financial distress, or a party may prefer not to allocate its available funds to lengthy legal battles. The parties’ desire to retain control of their exposure to loss while proceeding with a dispute resolution process has led them to seek outside financing. The third party funding (“TPF”) mechanism enables an impecunious party to pursue a claim thanks to financing provided by a non-party financial institution, in return for a share of the potential dispute resolution proceeds.
Besides reducing the parties’ exposure to loss when resolving disputes, TPF brings financial institutions an attractive investment opportunity that is not subject to global market fluctuations or any other external financial variable. TPF has thus witnessed a swift development, now reaching a USD 10 billion market value globally. Lawmakers have however failed to keep pace with the growing popularity of TPF, giving rise to controversies around the disclosure of the funder’s identity, and the nature and validity of the funding agreement.
TPF is no way nascent and has been used since the early 90s, mostly for litigation and in mainly common law jurisdictions, but was rarely practised in Turkey until recent years. TPF is not a regulated concept in Turkish dispute resolution, and the Turkish Court of Appeal (Yargıtay) has not expressed any opinion on this mechanism to date. Based on the freedom of contract principle, however, there is no restriction for TPF agreements to be entered into under Turkish law. On the other hand, recent economic difficulties arising of fluctuations in the Turkish Lira and high inflation rates have created a demand for external financing in dispute resolution, causing unprecedented hype around TPF in the Turkish market.
TPF can be available not only for commercial or investment arbitration proceedings with a Turkish element, but also for litigation before domestic courts. The fairly high cost of litigation proceedings in Turkey can certainly drive the need for a third-party funder. Bringing a monetary claim before Turkish courts requires the payment of a filing fee equal to 6.831% of the amount in dispute to initiate the proceedings, one fourth of which must be paid at the outset by the claimant party. A USD 10 million claim would for instance lead to almost USD 170,000 in filing costs. Therefore, even large-scale corporations may need to secure funding to proceed with their case. This is even more true of bankrupt companies with high-stake cases, which frequently attract the funders’ attention.
Once approached, the funders conduct serious due diligence on numerous aspects of the claim at hand, such as the parties’ solvency, their respective arguments and defences, the likelihood of enforceability and collection, etc. This enables the financial institution to determine whether and to what extent the case is likely to be accepted by the arbitral tribunal or the state court. Experience shows that funders look for no less than a 70% likelihood of success. Once the funding is approved, an agreement as to the financial terms of the TPF must be reached between the funder and the funded party. Funders calculate the return they expect from the award proceeds depending on the likelihood of success, complexity and expected duration of the proceedings. In commercial arbitration proceedings, funders generally expect a return of three times their initial investment (funding), whereas the ratio is much higher in investment arbitration cases, which give rise to lengthy proceedings. The parties may also simply agree on a lump sum payment to the funder.
In most cases, the party to be funded would be in a financial bottleneck and perhaps bankrupt. If there is any risk, due care must be given to the authority to sign the agreement on behalf of the bankrupt party, and to the distribution of litigation or arbitration proceeds considering the other creditors of the bankrupt company.
Under Turkish law, once a company is declared bankrupt, the powers to represent the company are transferred to a trustee in bankruptcy, who acts on behalf of the bankruptcy estate. The trustee is allowed to execute new agreements binding the company, provided that the agreement is necessary to the liquidation or serves to increase liquidation proceeds. Although there is no clarity under Turkish law as to whether TPF can be provided to a bankrupt company, funding agreements may be argued to meet these criteria, considering that liquidation proceeds may increase if the proceedings lead to an award in favour of the company.
It is important to note, however, that the bankruptcy trustee’s decision to enter into a TPF agreement may be challenged by the company’s creditors, so that it is strongly advisable to reach out to these creditors and obtain their prior consent. Once the agreement is signed, the funder will be deemed a privileged creditor and will rank above the other creditors of the company, except for secured creditors. The funder’s cut from the litigation or arbitration proceeds will be included into the bankruptcy estate and can only be recovered once the liquidation process is completed, unless the creditor’s assembly or the bankruptcy trustee agree to a provisional distribution of proceeds.
With TPF culture beginning to spread in Turkey, further regulation of this practice may be expected in the near future. Recent legislative developments, such as laws to encourage the use of mediation and arbitration, have certainly shown that the country is committed to adopting tools that improve access to efficient dispute resolution mechanisms. TPF could well become another useful component in that toolbox.