Why do third party litigation funders fear regulation? 

28th Jan 2015

Mary Terzino – In a blogpost on Global Legal Post late last year,  Chris Smith of Vannin Capital, a third party litigation financing (TPLF) company, took up the cudgel once again in an attempt to beat down the sensible reasons favouring Government oversight of his industry.  It is worth examining his arguments, if only to consider why Vannin objects to an oversight regime that could strengthen the legitimacy and ethics of funders that play by the rules.

First, Vannin asserts that England & Wales already has a “robust self-regulatory body,” the Association of Litigation Funders (ALF), displacing the need for regulation. There is no doubt that ALF’s Code of Conduct contains necessary – though not sufficient – guidance for funders. But one could hardly call the  Code “robust.”

The Code applies only to member companies of ALF, a voluntary organisation.  Vannin’s website notes – at least three times – that Vannin is “one of only seven members of the ALF.”  As Lord Beecham said last year, there are at least 25 TPLF companies operating in England & Wales. And that may be merely the tip of the funding iceberg. Some hedge funds – and even individual investors – are now dabbling in litigation investments. The real number isn’t known, because these arrangements operate in secrecy:  there is no requirement that they be disclosed to the courts or to opposing parties.

In 2013 the ALF made its membership rules more restrictive by requiring that members have at least 2 million GBP of capital. Capital adequacy is important in separating legitimate players from masqueraders.  But increased capital adequacy requirements for a voluntary association will merely continue to keep the club exclusive, while the business in which it engages is not.  ALF’s higher standards   provide an argument in favour of mandatory regulation, as the market continues to expand and attract new entrants who do not meet the ALF’s capital standards nor adhere to its Code of Conduct.

Even the Code’s helpful provisions are ultimately toothless.  The only penalty for breach of the Code is being booted from the ALF, leaving the ex-ALF member free to pursue funding opportunities without paying membership dues. One wonders why legitimate players would not welcome oversight that would expose and cull the wheat from the chaff.

Vannin  notes that funders make money only when their clients are “successful” in litigation. But it does not therefore follow that funders finance only those claims with substantial legal merit. Success is the recovery of compensation, whether that recovery occurs because a case has merit, or because a beleaguered defendant feels compelled to pay a shakedown settlement in order to avoid the negative publicity and staggering costs that litigation can produce. Funders, tempted by high stakes, may encourage litigation that would otherwise not be brought. One need only look as far as the recent Excalibur case, an egregious lawsuit in which the funders were ordered to pay not only standard costs, but full indemnity as a consequence of having funded a meritless case. It is worth noting that the funders included not only TPLF companies, but a Greek shipping executive and a U.S. hedge fund.

In that instance, the funding agreements were exposed. However, in most litigation and arbitration, the funders operate in secret, leaving defendants and the courts in the dark as to who are the real parties in interest. It is thus nearly impossible to gage the extent of abusive litigation that is backed by unregulated investors. Courts should be made aware of these arrangements. Legitimate funders should have nothing to fear from such disclosure.

While many funders have stopped pretending that TPLF increases access to justice for the little guy, Vannin continues to claim that TPLF “level[s] the playing field so that anybody with a meritorious claim can bring proceedings.”  But funders do not finance cases for “anybody;” Vannin’s model, as their website notes, is “high-value commercial litigation and arbitration matters,” not supermarket slip-and-falls and divorces.  Access to justice is a false rationalization for a lucrative commercial investment practice.  It is not an argument against regulation.

Finally, Vannin notes that funders under the ALF code are prevented from controlling litigation. The seven member companies, however, are not prevented from “providing input” into settlement decisions, a term that is left undefined; additionally, there are no constraints on non-ALF members. With the introduction in England & Wales of Alternative Business Structures, law firms now can be invested in by non-lawyers.  As such, it is possible that TPLF companies can invest – and perhaps are investing — in law firms. When the law firm and the funder have that kind of relationship, there is an inherent conflict of interest with the claimant.

Even if there is no direct investment relationship, law firms and barristers may look to funders for repeat referrals and business. Indeed, Vannin’s website touts its relationship with three barrister chambers.  This at the least raises concerns about whether the one who pays the bills will be calling the shots.

If ALF members mean what they say about not controlling litigation, they should have no concerns about that ethical position being embodied in a Government oversight scheme that applies to all third party funders. If the rules are made to apply across the board, the dabblers and fly-by-nights will be held to the same standards as the honest brokers. If a funding firm can’t or won’t meet those standards, they won’t be permitted to invest. That is good for the TPLF industry, good for both sides in litigation, and good for the legal system.