Maturing Nicely

Posted on May 1st, 2012

CDR Magazine

This article first appeared in Commercial Dispute Resolution in May 2012

by Selvyn Seidel

Until 2011, third party funding was generally considered to be an emerging industry, gaining traction and credibility but not yet with a mainstream presence in the collective consciousness of the global legal community.

Last year, however, brought a sea change on many fronts, the effect of which was to transform what was until then commonly referred to as an “emerging” industry into what can now be called a “maturing” one.

What have been the drivers here? These are identified and discussed below, along with what they mean for the future.

At the outset, it is useful to note that at least 10 new institutional funders have this past year entered the market. In contrast, only two or three dropped out during the same period (for reasons they say are unrelated to the merits of the industry, such as conflicts with their clients).

In addition to the new players, a greater variety of new products became more commonly available or pursued, including funding for claimants who do not need the cash but like the economic option, and funding for defendants, both those who are in financial distress and those who are not. Meanwhile, derivatives became a new subject for discussion.

New services as well as products are also becoming available. Advisory and consulting services offered after a claim has been funded can now support the enhancement of a good claim. These types of facilities are also available without being linked with capital advances.

This past year also saw a completely new territory open up – the funding of international commercial arbitration claims. It takes the same kind of special experience and talent to adequately fund and support such claims as it does to be an international arbitrator or advocate, perhaps an important reason why such funding has been neglected in the past (with the exception of ICSID claims). However, interest is now resolutely growing. It is now purely a matter of time before the funding of arbitration becomes an important sector within the industry.

At the same time, disclosure by funders has become a hot – and legitimate – topic with widespread importance and relevance. While there are widely divergent views on the ideal balance between the need for disclosure and the need for confidentiality, privilege and non-disclosure, these questions are now being addressed, and, where necessary, compromises made. Within this tension, there is an overriding appetite by the market and others for transparency on the part of the industry. That movement is being addressed.

Established funders are gaining experience and publishing performance and other information on their activities. This phenomenon in itself has been a driver of positive change. The Australian funder IMF, which has been public for more than a decade, recently published performance data on its years in business, disclosing a level of detail never before available. Other funders are now following suit, while analysts are conducting and publishing their own research.

Not only are the funders moving forward. The legal world is learning more about the industry. More attorneys are learning about funding and feeling a need to inform their clients. This realization should gain firm traction when the notion spreads, as it should, that the attorneys have a strict legal and ethical obligation to learn about funding, and to inform their clients – what can be described as a “duty to know” and a “duty to tell”.

In fact, in the UK there are already in place ethical rules that have been interpreted to require the solicitor to inform the client of the client’s fee options. There is also the legal notion that a lawyer can be liable for harm caused by failure to inform of such an option. A recent case in the insurance world illustrates the requirements imposed and liability coupled with a failure to meet the requirements.

One would think that within the extensive legal and ethical rules and requirements attorneys must obey in the UK and the US and other jurisdictions, a fire will be lit to review ethical and legal requirements of attorneys to know about and inform their clients about funding options.

Of course, as the attorneys learn and inform their clients, the business and financial community learn themselves. In turn, they can themselves explore funding, or insist their lawyers do so. This community is visibly growing.

Court decisions have also been reached, especially in the US and the UK, which either support funding or simply assume its validity. Scholars are noting this phenomenon, and reading it as a sign of the industry’s expansion.

More jurisdictions are beginning to accept, if not welcome, funders. The Channel Islands is a recent example, where the doors are now open and the first funder has gone public with a small listing. Others are already following suit, or are likely to in the near future.

There has also been what seems like an exponential increase in the number and frequency of both practical and scholarly articles on third party funding being published. Many come from strong academic institutions and the most prominent Bar groups and associations. Notable studies in 2011 included the Jackson Report published in the UK, the American Bar Association’s white paper on various aspects of the industry, and the ethics opinion of the distinguished New York City Bar Association Committee on Ethics.

Last year, the US Chamber of Commerce published a good many articles, letters and other writings actively presenting views that challenge funding. This effort has in many ways been a follow-up to a critical report prepared in 2010 by its counsel Skadden Arps, which became a rallying point in 2011 for those criticising the industry. Others have also raised and debated various questions, and the dialogue has in the end, despite some pitched animosity, been important to the development of the industry and market.

The mainstream media has also begun to actively cover the industry and market. Beyond this, numerous respected legal publications have noticeably lifted their level of attention – this magazine being a prime example. Major investor publications, such as InterContinental Finance and Hedge Funds Review, are also covering the topic, presenting analysis from the investor’s perspective.

In 2011, the funding industry and market have captured higher ground on the conference circuit. Many organisers (again, including this publication) have either hosted, or are preparing to host, major conferences on various aspects of the industry.

Major law firms and lawyers have been affirmatively acting in funded cases, or have made known their openness to do so. Known names include Simpson Thacher, Fulbright & Jaworski, Cleary Gottlieb, Patton Boggs, White & Case, Freshfields, Herbert Smith, Mishcon, Cadwalder and Addleshaw Goddard.

Last, but far from least, the UK Code on Third Party Funding must be mentioned. It was launched after about three years of work, on November 23, 2011. While sparking both enthusiastic praise and heated criticism, it must be considered a serious step forward in the funding industry and market.

While the above factors have contributed heavily to the remarkable industry transformation that 2011 witnessed, a parallel force has been afoot acting as a partner to these factors. That was the economic and commercial catastrophe the globe has experienced. The tidal wave of financial setbacks faced by so many claimants has led to more seeking funding, doing so with greater frequency, and for higher amounts.

A less direct but no less important impact stems from the transformation in the legal profession caused by the economic turmoil. Law firms have lost business, while clients are on the warpath to reduce and manage fees and other costs. Lawyers are for the most part on the lookout for alternative ways to finance their practice and to be more efficient, and alternative fee structures, including funding, are hot topics.

Similarly, businesses and financial institutions are searching for ways to ease the stress. Funders can and do help here – they not only support good claims, but can also advance capital for business needs, based on the collateral of the claim.

Beyond these developments in discrete disciplines, there is an integrated impact unfolding because the disciplines themselves are becoming intertwined and interdependent. Law firms and businesses and finance entities are forming alliances to provide more cost effective and efficient services, but also more integrated services. This breaking down of walls is an important and productive development. A trend exists that sees no turning back. This trend supports another trend of turning to funding to assist in making costs lower and more efficient, and enhancing value.

In a related development, and under legislation just coming into effect in the UK, Alternative Business Structures are being created where businesses can invest in law firms, and law firms can combine with non-law firms (under defined conditions). This process of integration and the development of new synergies is part and parcel of the overall process of change in the way the world operates. Although this phenomenon is too new to measure in the UK, and is being resisted on various grounds in the US and other places, it still reflects the importance of combining practices, ideas and economies. It is evidence that the operations of some funders, who also combine various disciplines, are moving in such a direction that not only make a contribution today, but also define a path to the future.

The funding market and industry have, therefore, a good deal to be optimistic about. There however remains much to be done and demonstrated to achieve the desired results. Now is not the time to celebrate, but rather for proponents to roll up their sleeves and work even harder.