Since the Supreme Court of Appeals’ judgment in 2004 in what is colloquially known as “the potato case”, businesses have been turning to litigation funders to assist them in funding legal proceedings.
Litigation funding aligns the interests of a claimant (who wants a result as cost effectively as possible), the interests of the legal representatives (who need to be remunerated regardless of the result), and the interests of funders (who want a fair return on their investment).
Traditionally, litigation funding has been seen as a way of ensuring that a lack of money isn’t the only hurdle to a business instituting a claim against another party for a breach of contract or other commercial disputes.
This is because legal disputes tend to be complex, expensive, take several years to conclude, and are usually against well-resourced and well-represented defendants; success is not guaranteed, and many companies are unable to properly bankroll their claims.
However, companies with more than sufficient monetary reserves also have sound business reasons to make use of litigation funding.
At Taurus Capital, we are seeing a small groundswell of resourced corporates and businesses using litigation funding strategically to bankroll their claims, rather than paying legal costs out of their reserves or cash flow.
The funding is part of their overall business strategy, rather than a cry for help. They are willing to share the proceeds of litigation to help reduce their risks of tying up cash that could be used for capital or income-generating projects. These companies understand that there has to be a solid business case for the claim itself — judged on the merits of the case and balanced against the quantum of the claim that a court is likely to award as part of the funder’s due diligence.
They have also paid special attention to the other commercial considerations before entering the funding agreement. In these cases, most commercial issues revolve around how the litigant’s control is affected, and to what share of the litigation proceeds the funder is entitled if the litigation succeeds.
Two main considerations fall under the ambit of control: who instructs the legal representatives (including what happens if there is a dispute between client and funder as to the instructions to be given to the legal representatives), and who gets to decide on the settlement amount. These considerations are usually dealt with when negotiating the transaction, and as a result the litigation inevitably becomes the basis for a strong partnership between the claimant and the funder. The funder is usually comfortable with taking a backseat in instructing legal counsel because, at the outset of the transaction, the litigant and legal team lay out the prospects, applicable law and strategies, and plot forthcoming legal instructions including outlining the matter’s prospects of success. Incidentally, this also provides the litigant with additional insight into what they will face in court, as reputable funders will have deep and thorough knowledge of the latest legal developments in the field.
To protect the funder, litigants can expect a transaction to include safeguard clauses that prevent litigants from prejudicing the claim’s prospects, delaying the litigation, or giving the legal team unfettered instructions. In this regard, one commercial consideration is whether the funder has a say as to how much the case can settle for.
The solution is to set, at the outset of the transaction, a trigger amount(s) which, if offered by the defendant as a settlement, must be accepted by the parties unless otherwise agreed. A commercially sound agreement will also stipulate how to resolve conflicts of interest that may arise between funder and claimant. Usually, the solution is a dedicated dispute-resolution process adjudicated by an independent counsel.
Splitting the proceeds
Companies should also consider carefully what portion of the proceeds of a successful claim they are willing to share. This is, in our experience, the most negotiated term in the transaction. It depends on the funding amount required, potential duration of the litigation, the identity of the defendant, the nature of the claim (whether it is a determinable or an indeterminable amount), and a variety of other salient factors.
The solution is for the litigation-funding transaction to base the settlement value on equity and risk. This approach considers the funder’s investment as high value, non-recourse and illiquid, with a binary risk of a win-or-lose outcome to the funder.
In the absence of an industry standard, most reputable litigation funders are comfortable with basing their returns (remuneration) on a multiple of the amount invested. Another common way to calculate the returns for the funder is a sliding scale of between 10% and 50% of the claim.
The exact percentage is a function of the quantum of the claim – larger claims generally attract lower percentages of returns for the funder. For example, 5% of a R500 million claim and 50% of a R50 million claim both deliver returns of roughly R25 million to the funder. Interestingly, their respective legal costs may also be very similar.
Finding the balance
A careful assessment of the commercial elements of control and distribution of litigation proceeds properly balances the interests of a litigant and funder, while preserving the attorney-client relationship. It also allows a business to spend its reserves on, say, growing a new division and revenue line, rather than on funding a legal case — and who wouldn’t rather build their business than fight a legal case with their own dedicated war chest?