Third-Party Litigation Funding: A New Paradigm After Covid-19

by Bernardo Saravia Frías

Introduction

Iustitia est constans et perpetua voluntas jus suum cuique tribuendi. According to Ulpian´s famous definition, justice is the constant and perpetual wish to render to everyone his due.

Since Roman times, it is the essential assumption that should govern any dispute settlement mechanism, especially the arbitration one: two parties intend to resolve a dispute subject to fundamental principles applied by an impartial and independent authority.

Third party litigation funding (“TPLF”) challenges the basis of the system. Financial support is provided to claimants who lack the resources to pursue a claim. The claimant is thereafter superseded (fully or partially) and the very reason for a claim to proceed is outlasted by the prospect of a positive financial outcome.

Financing claims can be legitimate, even if the third-party funder is exclusively looking for a profit, as long as the basic premises associated with the idea of Justice are not surrendered. Justice is a core value of our social organization (especially in a globalized world) and not a mere business.

TPLF affects the basic principles of any legal proceeding: bona fide and due process.

Lack of regulation gives rise to unfair advantages which have nothing to do with the nature of the infringed right and the claim to restore it. Irregularities introduced into the classic procedural relationship are so significant that they seriously undermine confidence in the functioning of the whole system (both judicial or arbitral) .

The purpose of this paper is to assess the main challenges posed by the TPLF and the need for its regulation, which becomes especially relevant in the face of the post-Covid-19 global economic depression. A foreseeable scenario of private and sovereign defaults will provide with huge investment opportunities for third-party funders.

The problem that will challenge the world with some degree of novelty is old and known to the Argentine Republic. Its experience provides valuable insights on the subject. This country has dealt in numerous international arbitrations with the presence of litigation funders that interfered in the normal development of the processes. That is why some of the claims against Argentina will be used as a reference to exemplify legal and economic issues brought by TPLF lack of regulation.

As a conclusion we propose certain regulations to overcome the major flaws in TPLF practice in order to preserve due process and good faith principles at the most relevant fora.

Crisis as an opportunity to regulate the TPLF industry

For some time now, but with special emphasis over the past two years, the Argentine Attorney General Office has pushed TPLF regulation in international litigation as a priority.

Current international context invigorates the issue: an unprecedented global economic recession will be followed by massive disputes involving private parties and sovereign States, raising sheer opportunities for TPLF.

After 2008 financial crisis, TPLF industry, in which lawsuits and arbitrations are traded as a negotiable value, became enticing due to the very high prospect of returns.

The crisis is now deeper and the opportunities for the TPLF industry will grow accordingly. Following the Covid-19 recessive scenario, numerous conflicts will develop becoming assets to funders.

Private sector will face financial restrictions and cash-flow issues that will turn into multiple contractual breaches, many of which will end in legal claims or commercial arbitrations.

Problems are doubled for sovereign States: (i) the huge increase in public spending to mitigate the effects of Covid-19 will rise the possibilities of sovereign defaults, especially in emerging countries, generating a public debt market with assets in sale available to the TPLF industry; and (ii) emergency regulations to cope with the crisis may affect contracts and private investments, giving place to legal claims and investment arbitrations.

TPLF has to be regulated. To be clear, we are not seeking to forbid TPFL industry, but to establish a legal framework that ensures the transparency and legitimacy.

The game must be fair; its rules, clear. This is the time to accomplish it.

TPLF industry. Burford Capitals LLC and “Petersen” case

The main actors of TPFL industry are:

Bentham IMF Limited, registered in Australia and listed on the Australian Security Exchange since 2001. It is defined as the global leader in financing international disputes. In 2019, it merged with Omni Bridgeway, a Dutch fund that, according to its own description, specializes in financing high-value claims and executing judgments against States worldwide.

Juridica Investments Limited, registered in Guernsey, England, in 2007 and listed in the Alternative Investment Market of the London Stock Exchange.

Augusta, founded in England in 2013, is the UK's largest fund in terms of the number of cases it funds.

Harbor Litigation Funding Limited, registered in England and Wales in 2007. It specializes in providing financing for complex disputes with high financial risk and class actions.

Burford Capitals LLC (“Burford”), registered in Guernsey in 2009 and listed on the Alternative Investment Market of the London Stock Exchange. It is defined as the world leader in legal financing with subsidiaries on four continents.

In this paper, we will highlight certain actions taken by Burford in claims against Argentina. Its performance is paradigmatic: (i) it has a long history in funding disputes against Argentina; and (ii) acquired a main stake in Petersen Energía Inversora, S.A.U. et al v. Argentine Republic et al. (the "Petersen Case"), the most significant international claim for the country.

A summary of the Petersen Case and Burford's participation

Petersen Energía Inversora S.A.U. and Petersen Energía S.A.U. (both "Petersen") claim damages for alleged breach of contract, arguing that Argentina and YPF S.A. (“YPF”) would have violated YPF’s Bylaws when expropriating 51% of the shares of the company owned by Repsol YPF S.A. without making a tender offer to the rest of the shareholders.

When the Argentine Government took control over YPF's operations and launched the expropriation of 51% of its shares in 2012, Petersen held 25% of Class D shares. According to Petersen, Argentina and YPF did not comply with the obligation to make a tender offer to purchase all shares as a condition for acquiring control of the company.

Their claim is based on the fact that the alleged contractual breach would have caused Petersen to fail to meet the payments of the credits taken to acquire YPF’s shares, leading to bankruptcy.

The claim against the Argentine Republic and YPF was filed on April 8th, 2015 in the United States District Court for the Southern District of New York. As to the date, only matters relating to jurisdiction and forum non conveniens were discussed.

While under liquidation, how was it possible for Petersen to gather the resources to promote and sustain a billionaire lawsuit against Argentina in the Courts of New York?

Simple: the funds were provided by Burford.

In 2014, Petersen's bankruptcy administrator executed a funding agreement with Prospect Investments LLC ("Prospect"), a company incorporated in Delaware, United States, and controlled by Burford. The agreement established that Prospect would fund Petersen’s claim against Argentina and, in the event of a favorable judgment, it would be entitled to receive 70% of the total amount of the ruling.

Burford's involvement made it possible to file a claim of great magnitude and uncertain outcome that poses serious procedural threats, due in particular to the lack of regulation of the TPLF.

The adverse consequences of unregulated TPLF from a legal perspective

TPLF introduces a stranger into the procedure whose sole interest is of a financial nature. The stranger wants to protect its investments rather than vindicate a claimant’s right, resulting in a number of negative consequences from the standpoint of the two basic principles of any legal proceeding: bona fide and due process.

Who is (truly) the counterparty?

Funders do not only finance: they usually have active participation on the strategy and the decision-making process, as provided in most of the funding agreements. It is common that funding agreements include clauses with a direct impact on the development of a case: the actor may assign all or part of the claim or agree to collect a portion of a favorable judgment; their lawyers can be replaced or controlled by the funder's lawyers; third-party funders may or may not be authorized to interfere with the negotiation of settlement.

When this happens, a defendant is litigating against an unknown adversary: a non-identified funder or group of funders. Defendants need to know who their counterpart is. This is of the essence to exercise a proper defense and to guarantee due process.

Consequences are material. The whole process is affected: (i) legal counsel selection; (ii) possible exceptions to raise as a defense, especially those of lack of standing or jurisdiction; (iii) the arbitrators’ appointment (key to the process); (iv) procedural strategies to be adopted; (v) likelihood of a transactional agreement; and (vi) award execution.

Further, if the defendant loses the case, it may face a group of funders instead of a single plaintiff willing to execute the award; also, it may have difficulties identifying the real beneficiary of the successful claim.

The issue is even more intricate when the third-party funder is listed on some stock exchange market or sells interests in a specific case. The challenge gets bigger: now the defendant is litigating against a whole universe of anonymous investors.

As Burford itself admitted in its last annual report to shareholders, there are approximately 40 unknown institutional investors that have purchased interest in the Petersen Case; one of them alone would have purchased a 10% share.

In other words, today, Argentina is directly confronted by Burford and indirectly by 40 unknown investors who may or may not have an influence on the parties and the development of the process, all under the formal guise of Petersen (who retains only a right to obtain 30% of a possible judgment).

Standing and jurisdiction

A funding agreement may entail an assignment of rights. When this happens, a party is totally replaced by selling its position to a funder. Upon such event, judges or tribunals ought to verify that the content of the agreement does not affect its jurisdiction or the standing to bring a claim.

This problem is deeper in international investment arbitration because jurisdiction and admissibility are premised on the fact that the claimant qualifies as an investor covered by a Bilateral Investment Treaty. The participation of a third-party funder may change the status of a claimant to qualify as an investor.

If the information on who is the actual claimant is not disclosed, a suit with no standing or jurisdictional grounds could unduly prosper by abusing the investment protection system and harming the defendant State and its citizenry.

Burford again serves as an example: in the "Teinver vs. The Republic of Argentina" case, related to the nationalization of Aerolíneas Argentinas, the agreement conferred a percentage of any successful judgment to the funder in exchange for arbitration costs.

Argentina argued that the claimants were no longer the real party since they had assigned their rights to a fund that did not qualify as an investor under the Argentina-Spain Bilateral Investment Treaty.

The tribunal concluded that jurisdiction is assessed on the date the case is filed and, since the funding agreement was executed afterwards, it did not affect claimant´s standing or court´s jurisdiction. The decision is pending of final revision under the annulment petition field by Argentina in December 2017.

The resolution of the Teinver case did not address standing and jurisdictional issues because its analysis is based on a time matter: it is not clear what would happen when a funding agreement is executed before case filing.

The situation is similar in the Petersen Case, where Petersen could have lost its property right in the legal claim to bring a suit when the agreement with Burford was executed. It means that Burford’s appearance may be the direct cause of Petersen’s lack of standing, as is being discussed in Spanish courts by claims raised by Argentina and YPF, which could have fatal effects on the dispute pending in the United States.

Conflicts of interest

Allowing unknown parties to take a share in the result of a case augments the risk of conflict of interests and hides it behind the shield of a funder. Worse, it creates an appearance of bias, which is a ground for disqualifying a process or an arbitral award.

Funds of third-party funders come from different sources (e.g. capital obtained by funds listed by issuing shares or bonds, private capital of large companies or institutional investors, investment funds, etc.) and involve an indeterminate amount of subjects, individuals or institutions, which may or may not be related to one of the parties, their lawyers, judges, arbitrators, or any other person with substantial influence on the outcome of a case.

Furthermore, arbitration system gives claimants a direct voice in the selection of arbitrators or adjudicators, allowing funders a degree of influence over the tribunal that is unthinkable in judicial litigation.

Disclosure of the identity of funders is necessary to address and avoid potential conflicts of interests that are otherwise inevitable.

It must be noted that in the Proposed Amendments of the ICSID Rules, it is being considered to include a rule to compel the parties to file a written notice disclosing information of any third party that provides funds for the pursuit or defense of the proceeding through a donation or grant, or in return for remuneration dependent on the outcome of the dispute.

It would be better for the integrity of the arbitration processes if the final provision includes the obligation of the funded party to disclose also the terms and conditions of the funding agreement.

In the Petersen Case, Burford is not compelled to disclose the terms of the agreement with Prospect neither the identity of institutional investors that have purchased interest in the case. It is not possible to figure out if any of them has a conflict of interest with the parties, their lawyers, experts who testify in the courts of New York or even the judges.

Who is compelled to pay the costs/award?

Lastly, the real possibility of enforcing third-party funders to pay any sums that may be awarded against the party should be assessed. A judgment should be enforceable not only against the formal counterparty, but also against those who provided funding under the promise of participating in the award in case of a favorable resolution.

If they are not compelled to pay the cost when they lose, they have a strong incentive to bring risky and treacherous claims. An alternative to reduce this type of claims is requiring a guaranty to the funders to cover the cost of an eventual loss, or to allow judges to extend the enforcement to those who provided finance or acquired rights in the claim.

This is another comment that the Argentine Republic required to be included in the Amendment of Arbitration Rules for ICSID in 2019. In particular, the following provision was proposed: "At the request of the State party to the dispute, the Tribunal shall order the party benefited by third-party funding to submit insurance to cover the costs in the event of possible defeat, under penalty of termination of the process".

It may well be the case that the claimant does not have enough resources to comply while the third-party funder is financially able to.

This is relevant when a sovereign State is the defendant, particularly so in an economic recession scenario. Cases against States may constitute a tremendous burden and public funds should not be invested in this frivolous contends with low probabilities to collect the costs. Instead, they should be applied to public services or real public interest activities.

In the “Teinver” case, for example, it is not clear who is going to pay the considerable costs if Argentina turns to win since claimants are bankrupt and Burford or Titan Consortium 1 LLC are not parties in the arbitration. Identical situation takes place in the Petersen Case where the plaintiffs' bankruptcy is in full process and Burford is not obliged to pay if it is defeated.

Economic issues associated with TPLF

TPLF encourages speculative claims

TPLF encourages frivolous and abusive litigation and promotes claims that otherwise would never be filed. This tendency will increase after the Covid-19 and the certain upcoming recession. The reason is obvious: commercial disputes will rise due to the difficulties to comply with several contractual obligations, and financially stressed companies will prefer to look for litigation funders rather than allocate their own resources in an expensive dispute.

It is not about facilitating access to justice; is about balance sheet management. Just negatives externalities.

Besides, if the potential claim is sufficiently large, it will be an attractive investment, even when the likelihood of recovery is small. Litigation market will be full of opportunities and it will be easy for a funder to produce an apparently good-looking portfolio.

Funders usually inflate estimated case values in an effort to attract investors. A favorable award in any one sizeable case could offset the cost of other unsuccessful cases. The development of portfolio funding, in which the range of claims varies in terms of success probability, may encourage the promotion of more speculative or risky claims.

Under these circumstances it is extremely difficult to identify the real estimated value of a case and its true chances to be awarded. Sophisticated litigation funds tend to seduce the market by selling meritless claims with unpredictable chances of recovery.

Particularly in investment arbitration, TPLF increases the overall number of claims brought against States. As damages are the primary remedy, the raise of claims would disrupt the balance between investor protection and State interest, negatively affecting the whole system.

TPLF on investment arbitration is likely to fuel the injustice for States that signed Bilateral Investments Treaties.

From a respondent State´s perspective, such type of claims, even if most of them fail, can consume significant resources and cause reputational damages (e.g. increased country risk).

TPLF discourages settlements

TPLF discourages what could otherwise be advantageous settlements for the parties. This occurs both in the private claims and in claims against States.

The reason is simple, almost arithmetic: a claimant would hardly settle for any amount offered by the defendant that is less than the aggregate of the principal amount advanced by the funder and the current interest accrued.

Burford sold a 10% share in the Petersen case for USD 100 mm, which means the case value is estimated in, at least, US 1 bn. A settlement for a lower price sounds difficult even though it purchased Petersen's rights for just EUR 15 million.

By promoting coercive settlements TPLF increases the profitability of abusive litigation.

Conclusion and proposals: stronger TPLF regulation is urgently needed

TPLF industry is growing and there will be more than ever litigation assets available due to one of the largest economic depressions in history.

It is not a question of prohibition but of regulation of the activity in order to enhance and develop all its positive externalities while avoiding abuses, which result in injustices and violations of due process rules.

The prevailing anomy has institutionalized abuses, particularly affecting the legitimacy of international arbitration systems. In short, trust in the system has been damaged.

Measures on two fronts could be implemented: codes of conduct within the industry and amendments to local procedural rules and international arbitration ones (i.e. ICSID and UNCITRAL Rules).

At least the following provisions should be considered:

Mandatory expansive disclosure of TPLF presence and identity. Also, the terms of funding agreement should be fully available for parties, arbitrators and judges.

Funders’ obligation to follow the same confidentiality rules that apply to all parties in an arbitration or judicial process.

Legal consequences in case of non-compliance with disclosure or confidentiality requirements.

Prevent third-party funders from acquiring full control of a case or the strategic decisions and agreements to resolve it.

Mandatory security for costs and expenses. Tribunals hearing claims should be empowered to impose mandatory security for costs as a matter of course.

Proper elements for courts to assess whether TPLF had an impact on the procedure that resulted in a violation of due process.

To ignore the third-party funders and to deal only with the formal parties in a claim is naïve. It amounts to missing the elephant in the room. Properly regulated, the activity can turn its actors into agents that enhance dispute resolution, especially in the field of international arbitrations.

The world confronts with one of the greatest economic reconstruction challenges. National and international institutions will have a leading role.

Many will be overcome by the context; others will require a profound transformation to live up to the new circumstances.

In some cases it is possible to foresee and prevent negative outcomes by timely making the necessary adjustments. This is the case for the TPLF industry.