Written by Lincoln CaylorOriginally published in FraudTalk, ICC FraudNet.
Your drinking water has been poisoned, your car is defective, or you have lost your life savings in an investment fraud. Neither you, nor the other victims have the money to pay for a lawsuit, but an investment company backs the suit, allowing you to mount a vigorous case. A win would not only net damages for you, but a return on investment for the company that banked the lawsuit. This is the brave new world of third-party litigation funding, or litigation finance, in which institutional investors offer financing in return for a contingency in the recovery. One of the most critical developments in civil and potentially commercial litigation, the practice has the potential to impact many types of cases, including international fraud, environmental and corporate cases worldwide.
Originating in Australia and the UK more than a decade ago, third party litigation funding agreements (LFAs) are becoming commonplace in class actions in Canada, and have spread to the United States and Asia. However, while LFAs have yet to become as common in commercial litigation, a court ruling in Ontario earlier this year (Schenk v. Valeant Pharmaceuticals International Inc.,2015 ONSC 3215), could signal further expansion of the practice. Although the motion for approval of the LFA was ultimately denied, the court permitted the LFA to be amended in accordance with its decision. In the wake of the decision from Schenk, Canadian courts are bound to see more LFAs in commercial litigation. In a global world, other jurisdictions may not be far behind.
The deck is often stacked against plaintiffs who dare to take on companies with deep pockets. LFAs level the playing field, by providing access to the courts for parties who would not otherwise be able to litigate a case. Funders can also balance lopsided financial resources between parties and assist parties who would otherwise accept lower settlements, because they lack the financial resources to continue with the litigation.
Third-party funders do not fund meritless cases, or at least those that do will not be in business for long. Accordingly, access to funding will not clog the courts with meritless cases.
Meanwhile, as the debate continues, what are the big issues, responses by the courts and the future of LFAs?
Are LFAs a hindrance or do they actually facilitate the administration of justice?
Courts have aimed to strike a balance in governing the use of LFAs, between their potential to interfere with the administration of justice and their potential to unlock greater access to justice. On one hand, concerns arise when third-party funders are permitted to interfere with lawsuits in which they have no legitimate interest. Intermeddling in a dispute in which a third-party has no interest without justification or excuse is known in common law as maintenance. Profiting off such a dispute is known as champerty. The common law prohibitions against maintenance and champerty have historically deterred LFAs.
On the other hand, there is the notion that LFAs facilitate access to justice, a concern that has grown increasingly prevalent in recent years. In the commercial litigation context, contingency retainers are less common than in class actions or personal injury litigation. As such, the risks and expenses associated with litigation fall primarily on the client. The often complex and document heavy nature of commercial litigation typically makes it very expensive and therefore a lack of access to adequate funding may create a barrier to justice.
Given that investments are designed to make a profit, when is that profit mercenary?
In Schenk, the primary basis on which the court refused to approve the LFA was that the third-party funder could potentially receive over 50% of the proceeds of the litigation. That threshold was adopted from Ontario's statutory cap on contingency fee agreements, which is set at 50%.In the court's view, an LFA in which the third-party could receive the majority of the proceeds did not provide access to justice. Rather, the LFA provided an attractive business opportunity to the third-party, who suffered no wrong. However, obviously funders find investing in litigation is good business when the payments are less than 50% or they would not invest.
Limiting the third-party funder's decision making power
Third-party funders may exercise influence over the litigation where the funder is permitted to terminate the LFA. Courts have refused to approve LFAs where the funder possessed the power to terminate the LFA without cause (see e.g. Metzler Investment GMBH v. GildanActivewear Inc.,  O.J. No. 3315 (Sup. Ct.)). However, where reasonable limits are placed on the funder's ability to influence the litigation through termination of the LFA, courts will not interfere. In Schenk, the funder possessed the ability to terminate the LFA in the event that it reasonably ceased to be satisfied with the merits of the claim. This was viewed as a reasonable limit on the power to terminate the LFA.
Courts may require the disclosure of an LFA
An LFA itself is not confidential, and its terms may be required to be disclosed. In the recent International Centre for Settlement of Investment Disputes tribunal decision from Muhammet Cap & Sehil Insaat Endustri ve Ticaret Ltd. Sti. v. Turkmenistan, the claimants were ordered to disclose the identity of the third-party funder and the terms of the LFA. Grounds cited by the tribunal for requiring the disclosure included the potential that a conflict of interest existed between the arbitrators and the funder as well as the opposing party's intention to apply for security for costs. Similarly, Canadian courts have required LFAs to be disclosed to opposing parties (see e.g. Fehr v. Sun Life Assurance Co. of Canada, 2012 ONSC 2715).
LFAs in the United Kingdom
With its lengthier history of permitting LFAs, the United Kingdom has a more progressive approach in place. In particular, the U.K. has developed the Association of Litigation Funders of England and Wales, which is an independent body whose purpose is to regulate litigation funding. A Code of Conduct for Litigation Funders was also put into place, which mirrors some of the concerns discussed above that were addressed by Canadian courts. For example, litigation funders may not try to take control of the litigation, may not terminate funding absent a material adverse development, and must have the financial resources to pay for the litigation.
In Schenk, the court noted that the third-party funder was a member of the Association of Litigation Funders of England and Wales and that it was therefore expected to adhere to the Code of Conduct.
The future of LFAs in Canada and beyond
In the absence of legislation or a Code of Conduct, LFAs are still governed by the courts in Canada. As such, there are no clear guidelines and no guarantees that any particular LFA will hold up in court. However, even where LFAs are not approved, Canadian courts have provided guidance on how to amend the LFAs and permitted the parties to renegotiate the LFAs accordingly.
Although the court in Schenk opened the door for LFAs in the commercial litigation context, it may be some time to feel the impact of the decision. This is because parties to commercial litigation often have their own financial resources with which to finance the litigation. However, where individuals are involved in commercial disputes, where sophisticated parties lack adequate financial resources, or where sophisticated parties wish to hedge the economic risks associated with litigation, LFAs will continue to be a valuable tool.