Litigation Financing: An Imperative Need for The Industry

Litigation financing ensures that disputes are adjudicated upon on the basis of merits, and not extraneous factors

Litigation Financing: An Imperative Need for The Industry
Kundan Shahi 21 July 2021

The Covid-19 pandemic is causing an unprecedented negative impact on the economies of the world. Businesses around the world are cash-crunched and are taking hard decisions to survive this economic downturn exacerbated by the Covid-19 pandemic. Despite their best efforts, many companies have not been able to successfully get through this economic downturn, and have either already become insolvent or are staring at the brink of insolvency. The legal sector has not been any exception to the brunt of such economic hardships. The segment-wise cost-reducing efforts have indicated the wary outlook of the law firms, and the cash-crunch they potentially might be facing. Even the law firms with ample cash reserves are burning their reserves with no end date in sight. In such a scenario, the requirement and demand of litigation financing (also known as ‘lawsuit funding’) has exponentially risen in India, to off load the risks associated with dispute resolution processes for the various stakeholders.

Traditionally, financial resources of the parties often play a deciding practical role in the outcome of legal proceedings. Legal proceedings are often long-drawn, and we all might have heard of cases where the party in the right had to give up on the fight, owing to the deeper pockets of the opposing party or stronger appetite for stretched litigation/ arbitration. Litigation financing facilitates in alleviation of such financial differential in the standing of the parties, and in providing a level-playing field to all parties involved in a dispute. This, in turn, ensures that the disputes are adjudicated upon purely on the basis of their merits, rather than any extraneous factors.

How Litigation Financing Works

Let us imagine a breach of contract case, wherein an MSME provides services to another bigger corporation, which is in a relatively stronger financial position as compared to the MSME. After having availed the services of the MSME, the other corporation does not clear the invoices of the MSME, or attempts to settle the dispute at an amount significantly lesser than what is originally due to the MSME. In such a situation, litigation financing can come to the rescue of the MSME, whereby the MSME can transfer the risk and cost of litigation to its respective funder.

The knowledge that the plaintiff (the MSME) shall not be forced into accepting a low-ball offer because they now possess the financial resources to effectively contest the dispute in court, shall compel the defendants (the bigger corporation) to offer significantly higher sums for settlement of the disputes, thereby assisting the plaintiff in recovering their legitimate dues.

Litigation financing arrangements cover the entire gamut of the costs associated with instituting and contesting a dispute, including the court fees, making the process effective and efficient. Litigation financing is carried out on a non-recourse basis, implying the plaintiffs are only obligated to pay the funders a certain pre-agreed fixed sum out of the legal relief that they receive upon winning or settling the matter with the defendants. The plaintiffs do not owe any amount to the funders in case they do not derive any financial relief from the dispute resolution mechanisms.

Prior to funding any dispute, the funders carry out an extensive legal, financial and operational diligence of the dispute in question and the parties involved in the dispute. The funders, generally, assess the merits, complications, risks, defendant’s financial capabilities, and the litigation counsels’ experience in handling the particular kind of disputes, while carrying out the said diligence. This entire process is carried strictly in compliance with the Non-Disclosure Agreements that the funders would sign with the concerned parties, and the funders do not influence or control the choice of counsels or the legal strategies that the counsels of the parties may adopt.

Litigation Financing in India

Most of the countries across the world lack a regulatory regime for third-party funding/ litigation financing, and India is no exception to this. However, the Supreme Court has given an in-principle approval to the concept of third-party funding/ litigation financing in the case of Bar Council of India v. A.K. Balaji (2018), while reiterating the prohibition on contingency fees arrangements for lawyers. Additionally, certain Indian states, including Maharashtra, Karnataka, Gujrat and M.P., have amended the Civil Procedure Code, 1908, to give recognition to the role of litigation financers and the circumstances under which funders can be made party to the suit. The High-Level Committee on Institutionalisation of Arbitration Mechanisms in India Report (2017) has also looked favourably upon litigation financing.

There are a very few international funders that are active in the Indian market, and their ticket size is above one million dollars. Such international funders, generally, prefer cases outside Indian jurisdictions. Therefore, the litigation financing needs of the domestic mid-market segment in India has largely gone unserved. While there have always existed informal lenders, who provide financial resources to contest disputes, a formal market structure for litigation finance is largely missing in the Indian context, except for a single funding company that has recently become actively operational in the market.

Relevance of Litigation Financing for Businesses

While the central ethos of litigation financing remains to promote access to justice and level-playing field for small businesses to compete against deep-pocketed organisations, the last few years have witnessed large businesses also employing litigation financing as a financial engineering tool to boost their respective valuations. Legal expenses are, generally, viewed as a charge on the P&L of an organization, and even if an organisation succeeds in a suit contested with its own money, it does not have any positive impact on its valuation because such receipt is treated as a one-off/below the line item in Profit and Loss. Furthermore, the legal budgets of organisations are essentially dedicated to defending suits, rather than pursuing new legal disputes.

Therefore, businesses find it lucrative to offload the cost of pursuing their litigation or arbitration on the third-party financers, and channelise the capital, which would have been otherwise put into dispute resolutions, into other operating activities and human capital. Hence, litigation financing is well-suited for businesses as they can pursue their genuine legal claims without spending money out of its own pockets. The businesses generate a substantial cash-flow and transfer the non-operating expenses to a third-party by such an arrangement.

Relevance of Litigation Financing for Lawyers & Law Firms

Litigation financing ensures the timely realisation of the fees of the lawyers and the law firms, as the plaintiff shall transfer the obligation to pay the fees upon the funders. Therefore, the lawyers and the law firms do not have to follow-up or worry about their clients becoming insolvent during the course of the proceedings, and can rather concentrate fully on contesting the claims to the best of their abilities.

Litigation financing also helps the lawyers and law firms to convert prospective clients, who might not have the adequate financial means to pursue their claims, and thereby, help in increasing the revenues of the lawyers and the law firms. This facilitates a strategic partnership-like relationship between the lawyers and their clients, rather than the former being a mere cost centre for the latter.

Mass Impact Opportunities created by Litigation Financing

Litigation financing is not limited merely to funding the commercial disputes. The expanse and scope of litigation financing opportunities are vast enough to create a mass impact upon the society as a whole. Therefore, litigation funders are also actively exploring funding opportunities in the cases involving whistle blowers, sexual harassment, class action law suits and data privacy breaches.

The funding of such non-commercial disputes shall directly come into the aid of the human rights activists, legal aid lawyers and their likes, who require adequate financial resources to pursue legitimate public interest claims before the adjudicatory forums. Apart from improving the access to justice aspect and establishing the rule of law, litigation financing also helps in development of law as a whole, by facilitating such claims to be taken to courts which would not have otherwise seen their “day in court”, such as class action law suits.

Concluding Remarks

Litigation financing, ensures a ‘win-win’ situation for all the parties involved. It ensures access to justice for plaintiffs, increases cash-flow for businesses, and support the lawyers and law firms in strengthening their respective practices without being concerned about the financial uncertainty. Along with core litigation financing, there also exist other financing opportunities available in the legal market for the funders to actively explore, including ‘interim financing’ opportunities under the Insolvency and Bankruptcy Code, 2016, which can prove to be a game-changer to ensure that the distressed companies remain going concern till the approval of resolution plan. These financing opportunities in the long run shall prove to an extremely beneficial symbiotic relationships for the society and businesses as a whole.

The author is Founder, LegalPay

DISCLAIMER: Views expressed are the author's own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.