This article was first published in the Global Arbitration Review online news, 15 April 2014
Far from encouraging unmeritorious claims, arbitration funders turn down the majority of cases they’re asked to finance. James Delaney, director of London-based funding broker The Judge, explains the mistakes to avoid when applying for funding.
The market for arbitration funding is big business. It has probably grown by well over 500 per cent since 2012, in terms of both the number of completed deals and the volume of active funders looking for viable opportunities.
There has been condemnation from some quarters as to the efficacy of the market, with fears that such funders will agree to finance spurious arbitration cases that lack legal merit. In reality, these concerns are unfounded. Notwithstanding the exponential growth in the market in recent years, arbitration funders are extremely cautious: most will reject over 80 per cent of all applications they consider. Undeniably, without recourse to arbitration funding, many bona fide claimants would be prohibited from obtaining any redress against deep-pocketed opponents.
The growth of the funding market for arbitrations has happened in parallel to an increase in lawyers’ awareness and understanding of the funding options available to their clients. However, the knowledge gap among lawyers still varies greatly, which adds to the lottery for clients.
Here we explore some of the most common errors when approaching the market and how they can be avoided.
Greed is not necessarily good
It is not uncommon, particularly in investment treaty cases, for a large claim value to be pleaded, with claims often exceeding US$100 million. The median pleaded claim value in international arbitration funding applications made to The Judge is US$250 million. Ostensibly this may appear to be to the funder’s advantage, as it leaves more headroom for their success fee, but most funders are wise to the fact that tribunal awards of this size are not common. Instead, most funders focus on the sunk investment made by the claimant.
Funders often consider the sunk investment has a greater chance of being recovered than, for example, a claim for lost profits that is potentially harder to justify. If the funder can make the numbers work on the basis of a recovery of the sunk investment, then the case will have a much greater chance of receiving multiple offers of funding. It is much harder to secure funding for pure economic loss claims. This dispels another myth of funders being unduly tempted by cases with enormous upsides, to the extent they will fund any big claim notwithstanding the merits. If anything, cases with a multibillion-dollar claim value can find it harder to secure investment compared to a $100m case.
NEWS Funders will also be mindful that the greater the claim value, the less likely the case will settle. In such situations, establishing an acceptable commercial settlement figure early on will provide some comfort that the client will be pragmatic when the time comes.
Lawyers should assume that funders will apply a greater weight to the sunk costs and the minimum settlement figure, rather than the potential loss of profits valuation.
Don’t make enforcement an afterthought
A client can have a strong case on liability but if the award is unlikely to be capable of being enforced in a reasonable timeframe, securing funding will be problematic. In some ways, a funder’s priorities in analysing the case can be in reverse order to those of the lawyer: Do the economics work? Can the case be readily enforced? What are the prospects of succeeding on liability?
Most lawyers will usually start with liability and quantum and either omit completely or only undertake a minor analysis on enforcement risks. At worst, this can prejudice the application; at best, it will slow down the process by increasing the burden on the funder to do its own due diligence on enforcement. There are few, if any, funders that would finance a case where they might have to wait eight years to see a return on their investment. Accordingly, lawyers need to demonstrate that if an award is made in their client’s favour, there is a clear strategy and budget to enforce that award as swiftly as possible.
Approaching multiple funders
Three years ago, lawyers could be forgiven for approaching just one or two funders as the available pool was much smaller. Today, with well over 15 funders capable of financing an arbitration case, it is important to undertake a broader (but still targeted) market search. Not only is this in the client’s interest, to ensure they get the best deal but an ill-advised approach to the market could prejudice an application. If you approach just one or two funders and they reject the case, not only will this waste potentially six to eight weeks, it also statistically reduces the chances of securing funding elsewhere by over 50 per cent. Funders will often want to know if anyone has seen the case ahead of them and, if so, what the outcome was.
Approaching multiple funders simultaneously, whether directly or by engaging a funding broker, is the safest way to protect the client’s position.
Insurance versus funding: understand the options
It is a mistake to assume that the only option to a client, other than self-financing, is third party funding. A concept less familiar to some US firms compared to UK law firms is arbitration cost insurance. Like funding, arbitration cost insurance removes the legal cost risk for a client. An insurer can provide an indemnity for the client’s lawyers’ fees, expenses, arbitrators’ fees and any adverse costs if the case is unsuccessful. Crucially, however, insurance tends to cost less than one-third of the cost of funding. This means cases that wouldn’t be economically viable for funding could still be workable with an insurance option.