Arbitration Funding | Key Structures and Market Developments

Arbitration Funding

Potential litigants often face challenges regarding legal costs and disbursements, particularly in international arbitration.

To address this issue, the market has developed several financing options, including Third-Party Funding (TPF), Damages-Based Agreements (DBAs), Conditional Fee Agreements (CFAs), and Alternative Fee Arrangements (AFAs).

These financing structures initially emerged to facilitate access to justice by offering solutions to parties with meritorious claims but lacking the necessary funds.

Over time, these structures have increased in popularity to include parties who may have access to funds but prefer to invest capital in their business rather than in litigation. As a consequence, litigation and arbitration cases can now be considered as assets that can be monetised and not simply liabilities.

As a result, a litigation financing market has developed with an increase in competition and new players continuously looking to offer new financing alternatives.

Main Types of Legal Financing Structures

Damages Based Agreements (DBAs) & Conditional Fee Agreements (CFAs)

DBAs and CFAs are special fee arrangements where a legal team’s compensation is dependent on case success. Under a DBA, the attorney will receive a fixed percentage of recoveries if the claim succeeds. Under a CFA, the lawyer is paid at a discounted rate during the case and, if successful, recover the difference plus a success fee.

Alternative Fee Arrangements

AFAs cover all fee structures between a lawyer and client that differ from the traditional hourly billing model. Examples include flat fees, capped fees, and blended hourly rates.

Third Party Funding (TPF)

Third-party funding, or litigation funding, is a financing model where an external funder provides resources for a client to pursue claims. The funder covers all or part of the litigation or arbitration costs (including lawyers’ fees, expert fees, and arbitration costs, etc.) in exchange for a success fee if the client achieves a recovery. Litigation funding originally emerged in common law countries but has recently gained significant traction in continental Europe, especially for commercial and investment treaty arbitrations.

Growing interest in third-party funding has led market players to adapt and evolve their offerings to make them attractive and appropriate for different stakeholders. Beyond the “classic” model, Litigation funding now includes diverse structures such as portfolio funding, co-funding, sub-funding, and law firm funding.

The Classic Litigation Funding Structure

A Classic Funding Agreement (LFA) is a contract between a funder and the funded party in which the funder agrees to cover all or part of the costs of a single litigation case.

 After conducting due diligence, the funder commits to pay costs and fees related to the case up to a certain amount (the funded amount).  

Key provisions of an LFA usually include:

Funding amount:

The LFA will generally define the maximum commitment of the funder, the specific items included in the budget (such as legal fees for first instance and appeal, expert fees, adverse party costs, etc.) and conditions for drawing down funds. To prevent budget overruns, funders may cap amounts per item or stage of proceedings.

Exposure to counterclaims:

The LFA will specify whether the funding covers the costs of defending a counterclaim and whether the funder will cover any financial exposure to a counterclaim.

Exchange of information:

Correspondence between the client and his or her lawyer, and any drafted, written materials drafted are protected by attorney–client privileges. The lawyer, therefore, cannot disclose any of this to the funder without the client’s express consent. The LFA regulates the exchange of information between the client, the lawyer, and the funder. This enables the latter to be kept abreast of the progress of the case and to monitor its investment.

Control or consent rights:

To protect its investment, the funder will generally seek to have some degree of control over important decisions in a case, such as filing appeals, terminating proceedings, or accepting settlements.

Termination rights:

In addition to termination for material breach, the funder and the client may also agree on a right for the funder to terminate the LFA if an event occurs that negatively impacts the prospects of the case or makes the case commercially unviable. The LFA may even allow for termination for convenience.

Funders’ Remuneration

Funders' remuneration will depend on:

• The type of claim
• Chances of success
• Enforcement issues
• Duration

The longer it takes, the more expensive the funding will likely be.

Partial funding is possible if the client seeks to limit the funder's involvement.

This may cover individual items such as security costs or lawyers' fees.

The funder’s remuneration can be either a percentage of the recovered amounts, a multiple on the funded amount, or a combination of both.

Usually, the multiple and the percentage will evolve over time on a periodic basis.

Portfolio Funding

Portfolio funding consists of funding a number of claims at the same time. This may involve several claims for the same client, or several claims for different clients, instructing the same law firm.

All types of litigation can be included in a portfolio. Depending on the size of the portfolio, in-depth due diligence may not be required for each individual case.

The main advantage of Portfolio funding is that it allows for the cross-collateralisation of the litigation assets upon which a return is obtained.

If the portfolio contains several claims held by the same client, it allows for the inclusion of less promising or less certain cases because they are balanced with more meritorious cases.

Taken alone, a less promising case would not have made it to funding.

A portfolio structure allows the risk to the funder to be spread over many claims, allowing for more flexible terms.

The funded amount will be determined for each case in the portfolio, and the funder’s return might either be calculated on the entire portfolio or per case, depending on how different the cases are.

Another type of portfolio is where the same law firm seeks funding for several clients with similar claims but with each claim being an individual case (i.e., not a class/group action).

For example, funding was provided in France to several business owners in their pursuit of indemnification from insurance companies for losses suffered due to the closure of their restaurants during the COVID 19 pandemic.

The exact number of cases that would be included in the portfolio was not known at the outset.

The structure was built on an estimate of the number of claims to be funded for clients working with the same law firm.

A fixed amount of fees were agreed in advance with the lawyer to be paid per case by the funder. The lawyer would also be entitled to any applicable success fees.

In this type of portfolio funding, it is almost impossible to know the exact number of cases to be funded in advance (although there should be an estimate).

It is also not possible to conduct due diligence on each individual claim.

Typically, a few cases amongst the existing portfolio will be chosen randomly for due diligence, and the results of that can be duplicated on the others.

This is only possible if all the cases are very similar in terms of who the defendant is, the facts, and the applicable law.

A budget will be created on an individual case basis (generally including a success fee for the lawyer if permitted) and the same level of funder’s remuneration will apply to all cases.

The main advantage of this structure is that the funder’s due diligence is very efficient, as it will focus on a limited number of cases.

The success rate can be very good because the same arguments will be raised across the board. This means that if there is already a track record when the portfolio is presented to the funder, it is likely that the same outcome will apply for most of the cases.

If the portfolio involves only one law firm, the relationship between the lawyer(s), the clients, and the funder is very important.

This type of portfolio usually takes time to reach a conclusion. Depending on the size of the portfolio, the funding is likely to last longer than a classic funding as the cases will be spread over time. This means that the duration of the funding is more difficult to discern at the outset.

If the funding is disclosed where the portfolio concerns the same defendant, the chances of settlement may increase. This is a result of the mass effect perception that a funded portfolio may trigger on the defendant.

Co-funding and Sub-funding

A co-funding structure allows for liabilities and potential risks to be shared amongst two or more funders.

Co-funding might be an option, for example, if the funder who initially reviewed a case has reached its capacity in a specific claim type, or is simply willing to share the risks on a case.

All co-funders will be parties to the funding agreement with the client and entitled to be paid a portion of the proceeds.

The LFA will need to determine the extent of each funder’s participation in the payment of the costs and the allocation of any proceeds. It will also define the role of each funder and its role in monitoring and case management.

Considering a Claim

When co-funding is considered for a claim, it is important to discuss this at an early stage of the due diligence process. Consent must be obtained from the client to work with several funders and stakeholders need to work efficiently during the due diligence process to ensure all funders are proceeding at the same pace and to the same timetable.

Potential Delays

As the co-funding process involves more than one funder, there can be concerns over potential delays in the due diligence process.

To address this concern, one alternative is sub-funding. This structure allows only one funder to sign the LFA, complete due diligence and act as the liaison for the client and the law firm.

The funder can also limit its exposure by sharing risks with another funder via a participation agreement where the sub-funder undertakes to fund part of the costs in exchange for part of the proceeds.

In this structure the sub-funder will not have direct contact with the case and will only be paid by the main funder once the latter has received its remuneration.

This arrangement requires a high degree of trust between the relevant funders. While the main funder remains the debtor of the full funding amount towards the client, it is also the direct beneficiary of the entire remuneration.

With this structure, the client is satisfied that it has only one interlocutor during the due diligence process and one partner during the litigation. However, the funder has made it possible to onboard the case by sharing risks internally with another funder.

Purchase of Future Proceeds

In this structure, the funder purchases a portion of future proceeds against payment of certain expenses and disbursements associated with the pursuit of the claim.

The purchase price will be defined as the total amount effectively funded. It will be paid in several instalments throughout the litigation, depending on when costs are incurred.

The final purchase price will be known only at the end of the litigation, once all costs are paid.

At the signature of the LFA the purchase price is an estimate with a defined maximum purchase price, equivalent to the maximum approved funding amount.

The client remains the owner of the claim during the litigation and the transfer of the proceeds only occurs if and when there is a success.

If the claim is successful, the amount of proceeds to be transferred to the funder will be calculated based on a formula similar to the one usually applied for the calculation of a funder’s return.

A multiple of the purchase price. a percentage of the total proceeds or a combination of both.

This structure is very similar to a classic funding structure and is frequently used in Italy, known as “Cessione di Credito Futuro” or “Vendita di Cose Future”.

Assignment of Claims

On the occasion of certain events such as:

• insolvency,
• restructuring,
• business reorganisation,
• sale or merger,

A company or its trustee may be interested in selling a claim.

It can also be appealing to a claimant which has already paid significant litigation costs to obtain a final decision or arbitral award.

If the judgment or award is likely to require costly enforcement proceedings, the client might be willing to remove this litigation from its balance sheet and sell it to a funder.

In such cases, the client and the funder sign a sale agreement under which the funder pays the client a purchase price for its claim. The ownership of the claim transfers from the client to the funder in exchange for the payment of a discounted price compared to the value of the underlying litigation.

Through this mechanism, the client transfers its ownership of the claim and is no longer involved in the litigation once the sale agreement is executed. At this point, the claim is solely the funder’s property, and the funder will take all decisions regarding future litigation, strategy, or settlement.

The financial risk for the funder is higher compared to other types of funding due to the additional upfront cash payment. However, if the case is successful, the return is likely to be higher as the funder will recover the entirety of any damages obtained.

The applicable law is critical when assessing this funding structure. Many jurisdictions allow a debtor in certain circumstances and defined conditions to extinguish its debt by paying the beneficiary of the assignment an amount equal to the price it paid to purchase the claim, a principle known as retrait litigieux under French law.

The application of this principle has led to many discussions under French law leading to disputed case law from the French Supreme Court.

Law Firm Funding

Law firm funding is an increasingly popular model in which the funder provides capital directly to the law firm rather than to the litigant.

Risks for Law Firms

In jurisdictions where lawyers and law firms are permitted to act under CFAs or DBAs, the law firm takes both a credit risk and a litigation risk.

During the proceedings, the firm must often fund some or all of its own costs, creating a financial burden that may last for years—something most firms are not structured to handle. This is particularly true under DBAs, where no payment is received until the case concludes. The firm also bears the risk of an unfavourable outcome, which could result in no payment or only a reduced fee.

While a case is ongoing, the law firm will have to carry some or all of its own costs in pursuing the litigation or arbitration. This creates a financial burden, often over a period of years, something most firms are not structured to handle. This is especially true in the case of DBAs where the law firm will not be receiving any payment from the client until the case is resolved.

The firm also bears the risk of an unfavourable outcome, which could result in no payment or only a reduced fee.

A funder can enter into an agreement with a law firm pursuant to which the funder will pay the law firm a proportion of its fees incurred on a regular basis.

If the claim succeeds and the law firm receives its success fee, a share of that fee is paid to the funder.

If the case is unsuccessful, the law firm will not be paid any success fee but will still have received remuneration from the funder as the case progressed.

This model can be utilised on single cases or as part of a portfolio of cases run by the same law firm.

This allows law firms to build significant books of smaller claims where the law firm’s running costs can be split across a number of cases.

Law Firm Investment

Other forms of law firm funding are emerging where funders in some jurisdictions are providing capital to law firms for expansion, acquisition of other firms or cases, or for launching new practices of claim types.

The funder can get a return from the law firm’s profits or from the future proceeds of cases which are due to the law firm.

For law firms, this type of funding offers a chance to obtain financing which is acclimatised to both litigation risk and law firm structures.