What is the current market environment?
Litigation funding is not an exclusively Anglo-Saxon phenomenon. It has been practiced in continental Europe for decades, where it originated in the field of large collective actions. It has also been used for one-to-one commercial claims in Germany since 1998. Since the early 2000s, litigation funding in the UK has emerged as - by far - the single biggest market for litigation funding in Europe.
The European litigation funding market remains relatively small. Based on Deminor’s own research, the investment potential in Europe (including the UK) can be estimated at USD 1.5 bn (EUR 1.3 bn) yearly, in comparison with USD 10.1 bn (EUR 8.6 bn) in North America. However, the actual amount invested is probably substantially lower. The invested amount is unknown since most European practitioners do not publish their yearly commitments or deployments of cash in litigation funding. The investment potential only provides an idea of the potential total amount that can be invested in litigation funding based on the current expected size of the legal market and the acceptance of litigation funding by market players (the so-called ‘penetration rate’).
The potential is likely to grow in the future as a result of an increasing penetration rate, which is currently estimated at 5% in Europe and which we expect to double to 10% in the next five years. Deminor believes that the main factors contributing to an increase in the penetration rate are (i) the promotion of litigation funding by litigation funding companies, (ii) companies’ increasing focus on working capital and growing acceptance of litigation as a way to de-risk their balance sheets, and (iii) the discovery of litigation funding as an interesting, uncorrelated asset class by investors.
Litigation funding is used for a variety of claims in Europe. The most commonly funded claims in Europe are arbitration claims, claims pursued by insolvency practitioners, IP claims, investment recovery and anti-trust claims (mostly through collective actions), and collective consumer claims. Funding is also commonly used to enforce judgments, especially in the context of cross-border litigation.
A seemingly liberal environment but there are important pitfalls
Most European countries are civil law jurisdictions where litigation funding contracts are considered as contracts ‘sui generis’ (of their own kind) governed on the basis of freedom of contract. The general rule for these kinds of contracts, is that what is not prohibited is allowed. Litigation funding is also unregulated; therefore, litigation funding companies are not subject to any specific rules of professional conduct.
The common law doctrines of champerty and maintenance, which prohibit third parties from encouraging lawsuits or exercising control over them, are not known as such in continental Europe. Consequently, funders in Europe can have more consent rights than in common law countries like the UK, the US and Australia. This should help the acceptance of litigation funding by the market in the future, as funders and clients have more freedom to tailor the funding agreement to their specific needs.
In all European jurisdictions, claimants must appoint their attorneys and maintain a direct contractual relationship with them. This also implies that attorneys must always act in the sole interest of their clients, including when a third-party funder or an insurer is involved. However, such a direct relationship does not preclude that the consent of a third party, like an insurer or a litigation funder, is required for certain decisions, e.g. for accepting a settlement or appealing against a decision. Furthermore, plaintiffs can delegate certain supporting tasks to non-lawyer third parties (including funders). In certain jurisdictions these tasks can even comprise giving instructions to the lawyer, provided that the client and lawyer maintain a direct client-attorney relationship and the lawyer always keeps a fiduciary duty towards the client only.
There are however important pitfalls. Litigation funding contracts may become invalid if they are in conflict with mandatory rules in highly regulated areas such as consumer protection or financial and legal services. For example, in certain jurisdictions like Germany and France, legal advice can only be provided by practicing lawyers. The consequences of this rule were demonstrated in a recent decision on the trucks cartel case, where the lower court of Munich decided that a transfer of claims was done in breach of the German Legal Services Act and therefore the court considered the assignment of claims to be null and void. The court also found that the assignment of claims can under certain circumstances bear conflicts of interest to the detriment of the original claimant (the assignor).
While we believe that reviewing and assessing a claim, recommending a case for funding or discussing legal strategy with the client or lawyer does not qualify as legal advice, funders should pay close attention to the scope of activities that they can perform in every jurisdiction.
Increasing scrutiny of collective actions
Europe has witnessed a strong increase in collective actions over the last few years. While funding has been explicitly recognized by courts in some high-profile cases including the Dutch Fortis settlement, they have also scrutinized the relationship between claimants and funders in cases of collective redress, especially when consumers are involved. There have been excesses on the side of claimants and their funders, promoting poor quality actions, as well as funders setting up Dutch foundations without ultimately issuing proceedings, in the hope of benefiting from part of the settlement fees. While we are still very far from a US style class action environment, it cannot be excluded that such actions will provoke a reaction from courts or legislators in the future. In the European draft regulation on collective redress for consumers, the role of funders has been limited. In class action legislation of various European member states, it is explicitly provided that bodies representing plaintiffs cannot seek profits, which creates a problem for third parties willing to fund such bodies. As a conclusion, funders of collective action groups should expect a more challenging environment in the future.
Cost shifting and security
We do not expect that funders will be held liable by courts for paying costs to adverse parties, unless they act on the basis of an assignment of claim. In case of assignment, funders should ensure that they are sufficiently capitalized at the time when the assignment is made, so they are able to honour any costs award against them. This is an especially important point to bear in mind when an assignment is made to a special purpose vehicle.
In most European jurisdictions cost orders are based on a tariff system or a percentage of the claim value, which makes it easier for funders to integrate adverse party cost in their economic models and pricing proposals. However, defendants are increasingly asking plaintiffs to deposit a financial security, especially in collective cases, which adds uncertainty to the pricing model. The risk of having to deposit a security will impact a funder’s pricing, but in jurisdictions where security can take the form of a bank guarantee (possibly on the back of an ATE insurance) the impact should be moderate.
The Covid pandemic is likely to spur demand for litigation funding as companies are paying more attention to working capital and preserving cash for their core business needs. More bankruptcies are expected to occur once Covid-related public aid schemes are lifted, which is likely to drive demand for litigation funding by insolvency practitioners. Banks and other financial institutions may want to resort to litigation funding to recover non-performing loans. So far Covid-19 related litigation has remained limited, but attempts by business owners to claim compensation from insurers of business interruption risks have led to first successes in France and Germany. It is yet to be seen whether these first decisions will be confirmed on appeal.
Written on November 12, 2020 by
Executive Board member & Managing Partner of Deminor Recovery Services. Responsible as managing partner for day-to-day management of Deminor Recovery Services.
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