3rd Party Litigation Funding Agreements, Damages‎ Misallocation Risk, and Class Action Transparency.

Abstract

3rd party litigation funding agreements are an innovative new way of using private sector funding to enable legal cases, particularly in the commercial litigation, international arbitration, competition and class action spaces. The agreements themselves typically provide state-contingent cash inflows from the funding group to the recipient team during the course of the case, and state-contingent cash outlows from the opposing team to the funders typically at the end of the case and as a variable sized and proportion slice of any overall damages obtained.

3rd party litigation funding agreements are thus a special new class of financial derivatives, arguably related to credit derivatives. Typically though, they are provided by niche non-banking institutions, often to recipients who may be unsophisticated, without prior derivatives exposure or experience, and are standalone and not incorporated within a master agreement type structure, say under an ISDA Master Agreement, between the contractual parties.

This background can create a number of risks, including regulatory risks, flowing from the mismatch in financial markets expertise on potentially enormous value derivatives contracts, between both buyers and sellers and lawyers stuck in the middle.

Damages awards may allow some uplift for 3rd party funding costs, but typically the total damages award will be reduced significantly by the return to the funders. When individual claimants or companies are funded by 3rd party funding, then normal considerations of good, bad, fair and unfair contracts apply and arguably it is up to the individual claimants or companies to strike an appropriate and good deal with their funders.

By contrast in class action cases, the individual class action claimant (possibly with the exception of the class representative) has zero bargaining power relative to 3rd party funders, and so such a claimant needs more protection to be built in by the system, against sub-optimal 3rd party litigation funding agreements being imposed.

For class actions, where a claimant group is seeking compensatory damages for an alleged wrong, 3rd party funding can significantly affect and reduce any net compensation below what the court or tribunal intended to award the claimant group to receive. In this situation the 3rd party litigation funding agreement can itself cause a misallocation of damages awarded from the class action group to the 3rd party funder as a de facto, hidden, super additional member, implicitly attached to the class action claimant group.

This feature can lead to inappropriate and unfair damages awards to claimants in class action cases, that diverge from what the court or tribunal intended.

If we think of typical legal costs in large scale litigation, these can be estimated quite accurately by costs lawyers and approved by the courts according to certain fixed scales and norms. They will also typically be a very small proportion of overall net case value.

By contrast 3rd party litigation funding agreements used in class action litigation, can be hugely variable and have a priori hugely unpredictable effects on final outcomes from the court and tribunal perspective. Because of this inherent variability feature, it is arguably vital for the full details of all 3rd party funding agreements being used to be disclosed up front to all parties and the court or tribunal in class action claims, so that these 3rd party funding agreements can be analysed and understood and representations made by both sides and any initial directions and changes required to these agreements by the court or tribunal so ordered.

Keywords: Derivatives, Isda Master Agreement, Class Action, Litigation, 3rd Party Litigation Funding Agreement

JEL Classification: G13, G12