The Price of Victory

The litigation funding process is becoming more flexible and client-friendly, writes James Blick Director at litigation funding specialist TheJudge

The price of victory: Accessing alternative litigation funding for a claimant since 1 April is, in many ways, a much more straightforward commercial exercise. Under the outgoing regime, before implementation of the Legal Aid Sentencing and Punishment of Offenders Act, in a large commercial dispute the range of funding options available had the potential to work in very different ways when it came to calculating the price of victory.

The conditional fee agreement (CFA) or partial CFA would provide for a success fee which, while payable by the client, would potentially be recoverable from the opponent under a costs award. The after-theevent (ATE) insurance premium would typically operate in a similar way (albeit calculated differently), while a third-party funding arrangement would provide for a success fee payable out of the damages or settlement received.

A case involving all three options had the potential to produce a number of ‘success’ scenarios. If costs were awarded in the claimant’s favour the CFA success fee and ATE premium would be claimed from the losing party, with any shortfall payable from damages or possibly written off, while the funder’s return would come entirely from damages. However, in a global settlement scenario the settlement pot would be divvied up between all stakeholders.

While the implementation of the current regime has brought numerous challenges, in this respect at least the world has become a simpler place. An alternative fee arrangement (AFA) with a law firm (whether CFA or damages-based agreement (DBA)) provides for a success fee payable from damages. A deferred ATE insurance premium (as the vast majority continue to be) is payable from damages. A third-party funding success fee is payable from damages. As a result, the complex analysis of which of these options may be more or less favourable in different potential ‘success’ outcomes falls away. It becomes a pure commercial and economic analysis of which options are available and what they cost. Today, a claimant with a good claim of significant value can trade risk and cashflow for shares of its potential damages. The equity in the claim is effectively being sold to different parties at different prices according to the claimant’s funding needs and appetite for risk.

A funding package where the claimant contributes no funding and takes no realistic downside risk is achievable, but comes at a heavy price in terms of the share of damages. A funding package where the claimant commits to fund some or all the legal costs day to day, but seeks to lay off some of the risk of losing, will cost less and enable the claimant to maximise its net recovery (or enable the economics to work on a case where the likely level of damages is too low compared with the costs to enable the ‘no risk’ funding option to work). This new-found simplicity enables a claimant to
make a much more straightforward comparison of the cost of risk and the price of money. A lawyer on a CFA might charge a 100% uplift (1 x return). An insurer might charge a 60% premium (0.6 x return) for taking risk, but the insurers will not put cash out. A funder might charge 2.5 x return for financing legal costs (putting cash out) and risking that capital on the outcome of the case. Thus a claimant can pick and choose from the a la carte litigation funding menu according to availability, economics and price, as well as comparing the cost of risking its own capital to the cost of the various funding options.

Insurance

There was much debate about how insurers would change their pricing once premiums ceased to be recoverable. Would premiums go down on the  basis that they had always been too high, but claimants tolerated this because they could pass the cost on to the defendant? Or would they go up  because insurers would have fewer cases to choose from and therefore lack risk spread? The short answer is neither. Or both. Seven months into the  new regime and it remains impossible to identify a market-wide trend. We see many examples of insurers charging less – and many of insurers  charging more. What we can say is that there is much greater flexibility and creativity. Paying an element of premium upfront, including a voluntary  excess, or offering limited cover are examples of the ways insurers can manipulate premium pricing to make things work for a given scenario.

We have also started to see situations whereby insurers are offering a ‘damages-based premium’ , meaning that the insurer charges a fixed  percentage of the damages recovered by way of premium (in a similar way to a third-party funding agreement or DBA), instead of rating the premium against the limit of indemnity. It is early days for this model – by far the most common approach remains a more traditional rated premium model –  however, the fact we have seen it at all is indicative of a new world where the lines between the different forms of funding are increasingly blurred.

Third-party funding

As illustrated above, the third-party funding component of a funding deal will typically be the most expensive, pound-for-pound,  and often with good reason. After all, we are talking about someone spending real money, with the possibility of waiting three years or more to see a  return. As such, a sensible approach is often to consider other elements first – the claimant’s resources, the law firm’s willingness to risk-share and  insurance – and then use funding to plug the gap.

It is interesting to consider whether the cost of third-party funding, as a market-wide average, has materially changed in the past five years. Our sense is that it has not, which is surprising. The most common (although by no means universal) model is a funding fee that is the greater of a  multiple of the funded amount and a percentage of the damages recovered. The multiple gives the funder first call on any recovery, while the  percentage enables the funder to share the upside if the claimant achieves a good result.

Competition

This approach to pricing was forged in a different era – a time when there were only a handful of funders, almost no competition and limited  awareness among lawyers and clients. Today, the third-party funding market in the UK has become a busy space. Awareness is high, many of the  less serious players have been and gone, and there are probably a dozen credible funders in the UK alone. Any case meeting the basic sniff test of  good merits and significant claim value should attract a number of potentially interested funders. This means clients accessing the funding market  today are in a better position than ever. More funders means more chance of getting a deal done and the possibility of shopping around to ensure it  is competitively priced.

However, while we are definitely in a buyer’s market when it comes to third-party funding, this has not yet translated into a market-wide reduction in  the cost of funding. Many will rightly point out cases like Moore Stephens vs Stone & Rolls Ltd (in liquidation) [2009] UKHL 39 and Excalibur Ventures  vs Texas Keystone & Ors to show that third-party funding is a risky business and argue that funders need to charge what they do to make the  numbers work. However, we are starting to see the early effects of a more competitive marketplace. For example, we have now seen a small number  of deals whereby the funder charges a percentage of damages only, with no multiple of capital underpinning the arrangement. It is early days, but  this approach is inherently attractive to many clients. It may, in some scenarios, cost more, but crucially it means that the claimant shares in the winnings pari passu, providing a much closer alignment of interest between claimant and funder when it comes to things such as settlement.

The alternative fee arrangement

There is no escape from the fact that the AFA is a fundamental part of the equation when it comes to litigation funding,  but here too there are changes, especially in attitudes to the dreaded ‘skin in the game’ issue. I recently heard one lawyer making the very sensible  point that any suggestion that putting a percentage of fees at risk somehow alters the lawyer’s approach to the case is outdated. Of course, a lawyer  willing to risk fees is comforting for any third party and the economic benefits of a CFA over third-party funding are clear. But beyond this the value of  law firm risk-taking should not be overstated.

Furthermore, placing too much pressure on conservative law firms to take risks is a sure-fire way for  funders to lose friends quickly. But assuming that risk-sharing is in the law firm’s comfort zone, what does this mean for price? As of 1 April lawyers  have the option of charging more like funders, either on the basis of a multiple of fees (1 x fees under a CFA) or on the basis of a percentage of damages under a DBA (although, of course, unlike funders they cannot do both).

The shortcomings of the DBA Regulations 2013 are  well-documented. However, once much-needed clarity is given to the regulations – especially if partial DBA arrangements are permitted – we should start to see the DBA emerge as a viable, mainstream litigation funding option. Looking to the  future, in a world where partial DBAs are permitted and funders and insurers will both price their returns on the basis of a simple percentage of  damages, one can imagine a nice simplicity for a claimant. The claimant can agree a deal whereby a total of 35% of their damages will go to third  parties, with a slice going to the funder, a slice to the insurer and a slice to the law firm, but, crucially, knowing they will always retain 65% of their  damages.

We are certainly not there yet, but in the meantime lawyers and their clients must be alive to the changing face of the litigation funding  market. It is no longer enough to ask clients if they want funding or insurance. We must now undertake a qualitative assessment of a client’s  litigation funding needs including risk appetite, cashflow and, of course, affordability, to enable us to discuss, explore and compare the right range of  funding options.