Understanding the ins and outs of this Alternative Asset Class
Litigation funding, also known as ‘third party funding’ is a mechanism by which a third party unrelated to the lawsuit finances the costs of the legal proceedings of a plaintiff, especially those under financial stress, in exchange for a share of any recovery made through the proceedings. These types of funding are on a non-recourse basis, meaning the plaintiff is not required to pay back legal costs if the case claim is not recovered. Hence most of the financial risk is born by the litigation funder.
According to the World Bank’s Ease of Doing Report, commercial contracts are resolved in around 1445 days in India, while in OECD (Organisation for Economic Co-operation and Development) countries it takes around 590 days. The report shows that the cost of litigation in India is approximately 31% of the claim value which is about 10% higher than in OECD countries. The higher legal costs associated with the cases have always been a roadblock, for many people and companies from pursuing litigation, which might have a potential for recovering claims.
In anticipation of contentious legal proceedings, dedicated financiers view legal funding as a prospective business opportunity. In simple terms, Litigation financiers fund legal costs and profit from the proceedings by charging a commission on the successful recovery of the claim. The funder typically considers six critical aspects when assessing a claimant’s request for litigation funding, including the claim’s merits, the claimant’s background, the litigation budget, the claimant’s legal counsel or law firm, anticipated damages, and the form of recovery. Funders prefer situations that can be rectified promptly. They are averse to taking part in situations that could lead to extended legal disputes because of the element of uncertainty and the associated risks to a successful outcome.
The further scope of scrutiny will be decided by the nature of the case, the significance of the proceeding, the complexity of the issues at stake, the drafting of the diligence papers, and the litigation counsel’s capacity to communicate its viewpoint. Usually, the funding of the litigation will be on a predetermined basis, however, if the budget is exceeded the funder may charge a higher cut which is mutually pre-decided in the funding agreement to compensate for the additional risk borne by the funder.
Perceived Benefits of Litigation Funding–
- Risk Management: The litigation funding cases are operated on a non-recourse basis, meaning that the plaintiff does not have to return the legal costs incurred by the funder, in the case of non-recovery of the claim. The entire financial risk of losing a case, and bearing subsequent damages will be undertaken by the funder, leaving the claimant with zero risk.
- High potential for settlements: Sometimes the presence of an established funder alerts the tribunal of the fact that a third party with deep expertise in the field of assessing the risks associated with the case is taking interest signifying the merits of the underlying claims. This often forces the defendants to come to an early settlement and gives the claimant comfort of not accepting a low settlement offer.
- Freeing up working capital: The fact that a claimant can pursue litigation without actually committing any of their current or fixed assets, is one of the biggest advantages of litigation financing. This provides the ability to pursue claims that clients might otherwise not have pursued.
Apart from being a saviour for claimants to finance their lawsuits, litigation financing has also been a tremendous alternative asset class for institutional and retail investors. The third-party litigation funder instead of sourcing money from his pockets, pools a fund from a set of investors and charges a commission on the successful realisation of the claim. Thereby further diluting the financial risk associated with each investor. Litigation finance has expanded from a few standalone cases in Australia over the past two decades to a £30 billion industry across the UK, Europe, the US, and Asia. Litigation finance has been providing outstanding returns, as per the data sourced by Morning Investments Data, Investors have witnessed an overall IRR of 39.2% in commercial claims during 2019, which is much higher compared to the traditional counterparts like equities and mutual funds. Such returns are, however, not without risk; in the event of a case loss, the investment losses are 100% since these cases are undertaken on a non-recourse basis. Therefore, the funders, in order to mitigate the above risk, create a portfolio of multiple cases with varied risk dynamics and try to deliver portfolio level returns that are well above the returns offered by other traditional asset classes. In India, this lucrative investment opportunity which was earlier only available for HNIs (High Networth Individuals), Family offices, has lately been democratised for retail investors as well who can now invest in these assets at a minimum investment of just ₹25,000.
The COVID-19 pandemic’s resource shortage has already made it difficult for businesses in some sectors to operate as they struggle with contracting balance sheets and a decline in credit availability. Due to these considerations, there are prospects for litigation funding and for funders in India to support businesses in pursuing their legal claims via “third-party finance.” In India, certain states (such as Madhya Pradesh, Maharashtra, Gujarat, and Uttar Pradesh) have amended Order XXV Rules 1 and 3 of the Civil Code of Procedure (CPC), 1908, to allow third-party litigation funding . As a result, we can observe that the CPC in India has granted permission for third-party financing. Furthermore, the same is not expressly prohibited by any laws.
Major Indian infrastructure companies are dealing with stretched receivables and huge pending claims, the scope of litigation finance can surely help companies in resolving their claims without losing the comfort of their working capital.
The incorporation of the Indian Association for Litigation Financing (IALF) on February 11, 2021, by practitioners, law firms, and third-party funders offers some optimism for this funding source. The organization seeks to self-regulate litigation funding in India and to educate the public about the field so they may understand how it operates. This establishment marks the beginning of the legal funding regulatory framework in India.
India needs a solid regulatory framework regarding judicial scrutiny. With growing popularity, companies have managed to ensure that there is an equal and fair settlement process for parties receiving litigation funds. It is worth noting that many parties are striding forward in order to fund the costs of litigation required to recover a claim. Also, investors are searching for alternative investment opportunities like these to diversify their portfolios. Western economies have adapted these asset classes long before, and now these are the mainstream investment opportunities for retail and institutional investors. With growing financial literacy amongst Indian investors, these modern asset classes are well poised to be utilised to their fullest potential.
 World Bank’s Ease of Doing Business Report, 2020.
 Litigation Finance Investing: Alternative Investment Returns in the Presence of
 Litigation Funding: A breakthrough for Avoidance Proceedings under IBC, by Debajyoti Ray Chaudhuri and Radhika Agarwal