Third Party Funding of Disputes: Easing the Burden on Stressed Litigants

[Soham Banerjee is an Associate in the Dispute Resolution team of a law firm in Mumbai]

With the outbreak of the of the Covid–19 virus, litigants are under immense stress owing to the non-functioning of the courts, except only for urgent matters. The judiciary, which is, in any event, overburdened with backlog and pendency of cases has been functioning in an extremely restricted manner, potentially encumbering assets and cash flow of litigants and businesses whose disputes now remain dormant. The instability of the financial markets has furthermore rendered ‘business continuity’ obsolete, making it extremely difficult for businesses and corporates to remain operational. In the circumstances as above, the author will explore the advent of third party funding (TPF) of disputes in India and argue that encouraging such a system to flourish will create a new asset class for investors to explore and gain outsized returns, with sufficient possibility of generating additional liquidity.

What is TPF?

Third party funding of disputes or ‘litigation financing’ involves an independent entity infusing funds and financing the claim of any party to a dispute (generally the claimant or a counter-claimant), in return for a portion of the money recovered by the party should it succeed in the dispute. Structuring such an investment is advantageous, since it frees the value of a legal claim much prior to its recovery from the courts. Owing to the wide disparity between the class of litigants in India, meritorious claims often do not reach the courts due to the high cost of pursuing litigation. Litigation financing, therefore, helps parties realize the full value of their claims and avoid being dragged into a protracted court battle. It also allows parties to solicit the best attorneys and solicitor firms to strategize their dispute and build a case for realization of the full value of their claims.

Is TPF legally permissible in India?

At the outset, it is crucial to note that the Code of Civil Procedure, 1908 (CPC) does not expressly prohibit TPF of disputes in India. Order XXV, rule 3 of the CPC (as enacted in Maharashtra, Gujarat, Karnataka and Madhya Pradesh) allows for the impleadment of a third party financier to the dispute where it is bearing the claimant’s costs, subject to a direction from the court. Order XXV, rule 3 should, however, be read with a caveat since the CPC effectively allows a backdoor entry to TPF in India by allowing the impleadment of such parties to the dispute and does not provide any clarity on the establishment of any supervisory body to oversee such investments or the structures by which such investments can be made. Pertinently, it is crucial to note that advocates and solicitors are precluded from financing the litigation costs of a party that they are representing. As a matter of fact, advocates and solicitors are prohibited from entering into a transaction or agreement of such a nature, in toto [See Part VI, Chapter II, Section II, Rule 20 of the Bar Council of India Rules (Standard of Professional Conduct and Etiquette)].

Understanding TPF through judicial precedents

The reservation against TPF is predicated on ancient common law doctrines of ‘maintenance’ and ‘champerty’, and the implications such an arrangement could have on the public policy considerations under law. In brief, maintenance refers to the funding of disputes by an unconnected third party, while champerty (which is a sub-set of maintenance) refers to financing of disputes by third parties in exchange for a share in the profits (if any) thereof.

The Privy Council as early as 1876 in Ram Coomar Coondoo v. Chaunder Canto Mukherjee watered down the principle of champertous agreements being hit by the public policy principle in common law and held that such agreements would only contravene the public policy of India if they were inherently inequitable, unconscionable and not made with malafide objects of supporting a claim. Accordingly, Ram Coomar set the stage for the interpretation of transactions including TPF and restricted it to transactions which had the possibility of injuring or oppressing others by aiding and abetting unrighteous suits.

In Kunwar Ram Lal v. Nil Kanth (1893), the Privy Council categorically held that the common law approach to champertous agreements cannot ipso facto be imported into Indian jurisprudence and reaffirmed the Ram Coomar test, i.e., of the agreement being extortionate and unconscionable for it to fall foul of the public policy doctrine and hence becoming unenforceable in law.

In Lala Ram Swarup v. Court of Wards (1939), the Privy Council had occasion to expand upon the scope of champertous agreements under Indian law. The Court held that an agreement to finance a dispute in consideration of receiving a share in the property (if recovered by the successful party) is not per se illegal and opposed to public policy. The Court further went on to hold that “in considering whether the bargain between the parties is a fair one it is essential to have regard, not merely to the value of the property claimed, but to the commercial value of the claim. This has to be estimated by the parties in advance of the result; and where they have weighed the probabilities in a manner which has not operated unfairly it is more reasonable to regard this as confirming their shrewd estimate of the chances, than condemn the agreement outright as unfair by reason only of the possibility that a great gain to the claimant would have had to be shared with the financier.”

The Supreme Court in Re: Mr. ‘G’, A Senior Advocate (1954), while deciding on the issue of whether an advocate recovering proceeds from the success of his client amounts to professional misconduct, held that while it is a settled proposition in law that third party financing of disputes is not against public policy and unconscionable, the standards applicable to advocates funding disputes of their clients or recovering proceeds therefrom ought to be different. Accordingly, while the Court ultimately held against Mr. G and ruled that his agreement with his client for recovery of proceeds would be unenforceable in light of it amounting to professional misconduct, there was no restriction under Indian law for such agreements to be executed between willing parties and third party investors.

However, the Rajasthan High Court just a year later in Suganchand v. Balchand (1956) observed that while champertous agreements are prime facie legal under Indian law, they would become unenforceable if the following conditions are satisfied:

(a) if they are extortionate and unconscionable so as to be inequitable against the party;

(b) if they are made not with the bona fide object of assisting a claim believed to be just and obtaining a reasonable recompense therefor, but for improper objects as:

(i) for the purpose of gambling in litigation; or

(ii) of injuring or oppressing others by abet-ting and encouraging unrighteous suits.

Accordingly, having regard to the specific facts and circumstances of the case, the Court ruled that the financing agreement in the present case amounted to gambling in litigation since the transaction was not executed with the bona fide intent of assisting the appellants in their claim but to make profits on the chance that the appellants succeeded in the appeal.

Yet another interesting aspect of TPF was highlighted by the Andhra Pradesh High Court in Nuthaki Venkataswami v. Katta Nagi Reddy (died) (1962), wherein the Court had the occasion to adjudicate upon whether the quantum of the proceeds that ultimately vest in a third party financier may have a bearing on the enforceability of such agreements. In the instant case, the agreement envisioned the financier to retain 3/4^th of the claimant’s property should its claim be successful before the court. Refusing to recognize such an agreement, the Court, relying upon established precedents held that such an arrangement of sharing of profits was not held to be fair or reasonable in any other case and, as such, was unconscionable and ex facie extortionary.

The judgment in Nuthaki heralded a shift in the narrative of the Indian courts towards TPF of disputes. It seemed to suggest that while the courts would look favourably upon recovery of the amount extended as funds towards the dispute (and perhaps even interest), financiers would be unable to enforce contracts and recover monies where the fund disbursed was either in consideration of recovery of a large portion of the stake or was executed with the malafide intent of merely making profits on the possibility of the claimant’s success.

More recently however, the Supreme Court in Bar Council of India v. AK Balaji (2018) reaffirmed the legal permissibility of TPF in litigation and observed that though advocates in India are prohibited from funding litigation, there appears to be no similar restriction on third parties (non-lawyers) funding litigation and recovering the amount due to them after the outcome of the dispute. TPF of disputes has also been received favourably in the Report of the High Level Committee to Review the Institutionalisation of Arbitration Mechanism in India.

TPF in foreign jurisdictions

With the progressive development of the law, the general trend around the world seems to suggest that TPF of disputes is no longer looked at as crimes involving champerty and maintenance. For instance, England and Wales abolished the classification of champerty and maintenance as crimes under the Criminal Law (Amendment) Act, 1967. Similarly, the Code of Conduct for Litigation Funders published by the Civil Justice Council – an agency of the UK’s Ministry of Justice – in November 2011, and the Association of Litigation Funders have been charged with administering self-regulation of the industry. Reference must also be drawn to the landmark decision of the English Commercial Court in Essar Oilfields Services Ltd. v. Norscot Rig Management (2016) where the Court upheld the arbitrator’s decision to allow the successful claimant to recover its third party litigation costs from the losing party as ‘other costs’ under section 59(1)(c) of the Arbitration Act 1996 (AA 1996). Similarly, in a decision on the preliminary issues in UK Trucks Claim Limited v. Fiat Chrysler Automobiles NV and Road Haulage Association Limited v. Man SE, the Competition Appeal Tribunal described third-party litigation funding as a well-recognised feature of modern litigation and facilitates access to justice for those who otherwise may be unable to afford it.

In a Resolution adopted in 2017, the Paris Bar Council indicated its support for third-party funding. The resolution confirms that third-party funding is in the interests of both clients and counsel, particularly in the context of international arbitration. It is also not prohibited by French law.

In March, 2017, Singapore promulgated the Civil Law (Amendment) Act, 2017 along with the Civil Law (Third Party Funding) Regulations, 2017 which confirmed that the use of TPF in litigation was not contrary to public policy or illegal, if used by eligible parties and in the categories so reserved for its use.

Hong Kong too passed the Arbitration and Mediation Legislation (Third Party Funding) (Amendment) Ordinance, 2017 to devise regulatory frameworks for the use of TPF in litigation and to ensure that common law doctrines of champerty and maintenance do not preclude the exercise of TPF Agreements in litigation.

More recently, the Supreme Court of Minnesota in Maslowski v. Prospect Funding Partners LLC abolished the common law prohibition against champerty and held that the development of common law should be determined by the needs and demands of the social community which it governs and refused to subscribe to the ancient common law prohibitions against champerty.

A cost-benefit analysis of TPF

A discussion on the viability or feasibility of TPF will not be complete unless a cost-benefit analysis of its potential implications in the legal market is undertaken. At the outset, it is essential to note that allowing independent agencies to undertake the job of financing claims of parties in a dispute offers a two – fold advantage:

(a) First, it takes away the risk generally associated with the success or failure of the claim in an adversarial judicial system from the claimant and places the liability of the same solely upon the financier; and

(b) Second, it makes the justice dispensation system more egalitarian by improving its access to impecunious litigants who now have the necessary wherewithal to invest in a competent legal team and gain insights on strategic measures to ensure optimum realization of their claim.

Additionally, TPF of disputes can impact EBITDA and cash flow generation in the financial books of corporates, often resulting in the depreciation of the value of the company. TPF of litigation covers such eventualities by removing such costs from contingency events in the balance sheet of a company and predicting future cash flows and revenue generation with a greater degree of precision. Since the costs of litigation are generally incorporated in a company’s operating profit or EBITDA, TPF of litigation will eliminate the costs of dispute financing from the account books and consequently bolster a company’s EBITDA projections. Resultantly, the company can generate a higher level of profitability and business value for itself in the market.

Allowing for TPF of disputes also releases a sizeable chunk of the company’s resources usually reserved for litigation expenses and allows such resources to be diverted into revenue-generating sectors of the business. More importantly, TPF of disputes enables companies and business to pursue claims and remedies it would under normal circumstances not pursue owing to budgetary restraints, at no cost and no risk and also facilitates in expediting and driving high value settlements.

Per contra, litigation financing presents unique challenges which any potential client or litigant ought to be conversant with before assenting to the same. The principal challenge posed by TPF of litigation is in the significant proportion of the recovery which the successful claimant needs to pay the financier. Loss of autonomy in decision making, particularly during settlement negotiations is another aspect that litigants need to take into account before foisting the finances of their claim upon a third party. The financier may seek to reserve its right to approve the settlement arrived at between the parties, rendering itself as the sole decision making authority in respect of settlement decisions with disputing parties.

Conclusion

While there continues to exist legislative inertia in devising a regulatory framework for governing TPF of disputes in India, the favourable treatment meted out to TPF investment structures by the judiciary is a welcome step towards incorporating the system of TPF of disputes in India, in toto. However, issues such as accounting for the variation in the success of a case induced by regular modifications in the judicial assignment of the courts and apportioning the risk in the investment by making advocates work on a contingency basis (which is prohibited under Indian law) need to be ironed out, legislatively before we can truly embrace the advent of TPF in India.

In any event, since desperate times call for desperate measures, financing litigation through third parties might potentially help revive businesses in this failing economy and push them towards gradual operationalization of their businesses. Since the courts are unlikely to take up regular matters for hearing anytime soon, assigning the litigation liabilities in the balance book to a third party could potentially be the panacea struggling businesses desperately need during the pandemic.

– Soham Banerjee