THE AUTHOR:
Alain Grec, Director & Co-Founder at Profile Investment
Third-Party Funding in Arbitration: A Series on Key Aspects and Best Practices
– Part 2 –
Discover our in-depth series examining third-party funding (TPF) in arbitration. Each installment sheds light on essential aspects of TPF—from foundational principles to funders’ decision-making and collaboration with legal counsel. Through this series, gain insights into how TPF facilitates access to justice, ensures disciplined budget management, and helps claimants pursue cases with confidence.
Definition of TPF for the Sake of the Present Contribution
Although we focus on TPF as applied to arbitration proceedings, providing funding for disputes is, in essence, an ancient practice which finds its origin in the insurance industry and with close ties to the maritime sector. Other mechanisms allowing to externalise some of the financial risks of legal proceedings include After The Event (“ATE”) Insurance and Export Credit Insurance. For example, after it has paid out to an insured party the monies due pursuant to an indemnity policy, French credit insurer Compagnie Française d’Assurance pour le Commerce Extérieur (“COFACE”) will step into the insured’s shoes and pursue any rights and remedies available to it, including legal claims. By reason of this subrogation mechanism, and for the whole turnover policies, COFACE will run the proceedings and bear all related costs to the compensated part of the debt and will act with a power of attorney from the insured party for the uninsured portion of the debt not indemnified by the credit insurer. Moreover, in some jurisdictions (e.g. some States of the USA), lawyers are allowed to work on a partial or full contingency fee basis. This achieves a similar outcome since it externalises legal fees. Other examples may include dedicated side pockets of bar associations or a specific justice administration scheme (“aide judiciaire”), or a non-profit organization contributing legal fees for non-economic, and mostly ideological, environmental or political reasons. TPF in a broad meaning has thus taken a number of opportunistic forms.
However, the term “TPF” was never used to describe these practices and was coined in relation to the emergence of specialised third-party businesses whose occupation consists solely in selecting dispute matters seeking external funding for the related costs, in providing the corresponding financing considered as an investment, with an expectation of an economic return consistent with a middle to long term typical Over the Counter (“OTC”) alternative class investment (such as private equity corporate investment, project and infrastructure financing, high yield bonds, etc…). Such entities are mixing experienced legal professionals, mainly former lawyers, and finance professionals who have a structured decision-making process to determine whether to dedicate resources to a case. While funders will conduct their activities differently the various operational approaches, making the practice rather heterogeneous, historical players can range from pure TPF entities to those combining other types of assets. These may include unregulated hedge funds-like structures that provide funding on a risk-based pricing basis, regulated or even listed entities complying with supervisory rules, or entities with temporary holding and then secondary market sale strategies.
TPF is contractual. In most countries where the practice exists, it is not currently subject to statutory regulation (for example, under French law, a funding contract qualifies as a sui generis agreement as discussed infra).
To capture the broad range of potential funding arrangements, the ICCA-Queen Mary College task force on TPF defines the activity as follows (ICCA Reports No. 4, April 2018):
“In its simplest form, third-party funding involves an entity, with no prior interest in the legal dispute, providing financing to one of the parties (usually the claimant). Typically, this financing is offered on a ‘non-recourse’ basis, meaning that the funder has no recourse against the funded party if the case is unsuccessful. Under this model, the funder’s recourse for repayment of the capital advanced and return on the capital invested is limited only to the claim proceeds recovered, if any.”
In an overly simplified example of a claimant with a USD 10M claim requiring an investment of USD 1M to see the case to its end, a funder would bear the total estimated costs of the procedure, or a contractually defined portion of it, in exchange for a share of the proceeds. The funder would seek to recover an amount calculated on a multiple of the invested capital and/or a percentage of the proceeds. It is often said that funders target a remuneration of 3 to 4 times the invested amounts, while taking care ab initio (funding agreement preparation) that the client should keep the lion’s share of the amounts recovered under a conservative claim value assessment made and shared between the parties of the future funding agreement.
Filtering Out Meritorious Claims to be Brought to Materialize
Third party funders typically finance claimants but also, depending on the case, respondents, with a variety of options to finance the costs of carefully selected cases in exchange for a share of the proceeds exceeding their initial investment. This shifts the risks to the funder who will only get paid if the case is successful and if the amount awarded is effectively paid or settled, while the client suffers no financial consequences if they lose their case. This non-recourse nature of finance deters the prospect of a significant proportion of cases from being funded: making a blind selection or even pushing frivolous claims would substantially impact the profitability of the business and potentially lead to its disappearance from the market due to loss of investors’ trust.
A funder has a number of direct stakeholders including its investors, the funded party, and the funded party’s counsel. It owes its fiduciary duty to its investors, for whom it shall ensure a satisfactory return on their equity investment on the one side, while putting the entrusted equity capital equity at work by funding the thoroughly selected dispute resolution cases.
This illustrates the delicate issue of keeping both wheels running in harmony: ensuring the continuity of the investors’ trust who will provide the TPF with financial means for 7 to 9 years, and getting a sufficiently large, sustainable, and diverse flow of leads to enable the adequate selection to put these monies at work safely.
This is all the more challenging as the investors will not know in detail the matters which will be invested in: by reason of the private and almost always confidential character of commercial arbitration proceedings, external capital providers do not have access to information about the cases being financed.
agreement and with the assistance of the funded party’s counsel, they typically assess cases on the merits, consider the evidence and possible counterclaims, jurisdiction and limitation periods, before conservatively evaluating the quantum, the possible returns and the realistic chances of a quick recovery against the estimated required budget. This procedure is particularly useful as it is aligned with the assessment that the funded party would need to perform prior to launching any claims in order to determine its chances of success.
Alongside, the TPF will keep a particularly close eye on the ethical acceptability of the matter at stake: not only the party seeking funding will be assessed for its respectability and standing but the whole context of the dispute, the behaviour of the parties from the outset of the story and their background will be assessed on an ethical and anti-money laundering perspective. This is to prevent any undue reputational risk (fiduciary duty to the investors), as well as the risk of the tribunal dismissing the claim for such irregularities, and for the business sustainability of the funder’s team.
Funding proceedings does not only come down to providing financial support to pursue claims against an alleged wrongdoer. A reliable and experienced funder with a strong track record and a staff consisting of experienced litigators provides potential claimants with a cold, hard and objective financial assessment of the case: this is valuable for the party seeking funding, as that angle of the assessment is well aligned with its own interests.
Finally, a fully-fledged TPF will provide a considerable debt collection expertise too. It may issue recommendations as to an eventual settlement or enforcement strategy while never providing legal advice, which generally falls within the domain of licensed attorneys.
In the case of an impecunious or weakened claimant, funders allow access to justice when cases would otherwise not materialize. This is particularly true in David versus Goliath situations, where the backing of a funder contributes to levelling the plain field. The same applies for liquidators or judicial administrators who, despite having a solid case to launch, lack the financial means to do so.
In the opposite case of a large and well performing company, resorting to TPF amounts to a business decision: shall it tie up the totality of the required funds in risky years-long proceedings and receive the totality of the proceeds, or deflect some (or all) of the financial risk to a third-party who will only get paid if the case wins, thus freeing funds for another investment?
ABOUT THE AUTHOR
Alain Grec is Director and Co-Founder of Profile Investment, a company specialized in third party litigation funding (predominantly commercial international arbitration) with more than 15 years of experience under the Luxembourg regulation of Alternative Investment Funds.
Alain is also heading a complementary business line of external assessment and valuation of litigations for companies, investment funds or auditors.
Alain has held various positions within the banking group Natixis, where he was Head of the German branch of Natixis (1994-2002), as well as Head of Development of its Corporate and Investment Financing bank between 2005 and 2009. He has also lectured in various French university courses, symposiums or seminars as they pertain to his specialisms in international arbitration, notably in Montpellier (D.U. Arbitrage).
*The views and opinions expressed by authors are theirs and do not necessarily reflect those of their organizations, employers, or Daily Jus, Jus Mundi, or Jus Connect.
