Litigation funding; needed in Cayman?

Litigation funding, a form of third party financing of litigation, has been the topic at several events in Cayman recently with several lawyers arguing that it should also be considered in the Cayman Islands, although a code of conduct might be needed.

Speaking at last month’s Higgs & Johnson client seminar Gonzalo Zeballos of Baker & Hostetler described litigation funding in the US as amorphous, explaining that it included various forms of funding for litigation, including recourse and non-recourse loans as well as contingency arrangements.

Typically litigation funding is a non-recourse loan made by an outside party to fund all or part of the cost of litigation in exchange for a 30 to 40 per cent share of the proceeds of that litigation.

The form of financing developed as an extension of contingency fees, which are well established in the US and have been around for some time in personal injury and other low stakes litigation.

What has emerged more recently, Zeballos said, is the external funding of high stakes litigation among corporations and the increasing level of comfort among large law firms, which appear to be embracing litigation funding as a positive development for their clients.

Litigation funding is offered by entities that are modelled on traditional hedge funds, which raise prodigious amounts of investment capital. The decision of which litigation to fund is based on a sophisticated and rigorous vetting process by teams of lawyers working for the funders.

“The largest of litigation funding shops out there will typically not even consider investing in cases unless the amounts at issue exceed $25 million, there appears to be a reasonable probability of a fast settlement and of course it survives the vetting process,” said Zeballos.

While litigation funders face the risk of losing everything if a case is unsuccessful, the upside is extremely high. The ability to collect 35 to 40 per cent of the recovery amount often represents multiples of several hundred per cent of the initial investment.

What’s the appeal?

For larger commercial organisations the appeal of litigation funding is that it eliminates the cost of bringing litigation. “While it caps the potential upside, it virtually eliminates the downside. So it is free litigation or at least risk-free litigation,” Zeballos said.

In addition, it gives the in-house lawyers greater confidence in bringing the case, if it has been accepted by a litigation funder, after a vetting process by outside counsel. Conversely, having a submitted case rejected by a litigation funder can help avoid bringing a loser or risky case, Zeballos argued.

“It provides access to a sophisticated economic analysis at little or no cost to the in-house lawyer, certainly at significantly less cost than you would face if you were hiring forensic accountants or another outside consultant.”

Regulation

While Maine and Ohio have enacted independent oversight of litigation funding, there is so far no federal legislation and state regulation is largely in its infancy, Zeballos said.

Maine and Ohio allow litigation funding but require disclosure of fees and interest rates to the client as well as representation that the lender will not interfere with the decision making of the lawyers during the course of the litigation.

Other jurisprudential limitations arise from the common law doctrines of maintenance and champerty. Historically these doctrines were meant to prevent use of the courts for exerting political or economic influence through spurious or vexatious litigation. In a few US states and in Cayman champerty provides the biggest obstacle to litigation funding.

At the Campbells Cayman Fund Focus in November, a panel discussed litigation funding issues for liquidators. Campbells Partner Guy Manning explained maintenance is giving assistance to a party of litigation by someone who has no interest in that litigation and champerty is a specific form of maintenance consisting of giving assistance for financial reward. There are exceptions that allow liquidators to sell a claim, which a party not involved in liquidation would not be able to sell because it would fall foul of the doctrine of champerty, he said.

Liquidators in Cayman can use third party funding but they have to retain the control, Manning said. The risk is that litigation funders, who are providing the money, would like to have a say in how the litigation is conducted.

Other important restrictions to litigation funding come in the form of ethics. The American Bar Association’s model rules prevent lawyers from accepting third party compensation without the client’s consent and without assurances that the funder will not interfere or influence the lawyer’s professional judgment and most importantly that the client’s information will remain confidential.

“You can see this will be a significant sticking point for litigation funding because of the process of making the decision whether or not to fund the case. One of the things they are going to want access to is at the very least the client’s documents,” Zeballos said.

Hence, there is a risk of unwanted disclosure.

A contentious issue

Not surprisingly litigation funding has been quite contentious, with supporters saying it increases efficiencies by promoting the prosecution of meritorious case.

At the same time frivolous cases would be limited as litigation funders reject as many as 95 per cent of cases brought before them. Practice appears to confirm this, noted Zeballos. According to a study last year 250 cases were pending last year.

Opponents describe litigation funders as “ambulance chasing hedge funds” and say litigation funding is unnecessary given that the contingency fees already exists and there is a multitude of lawyers to take on these kinds of cases. Moreover litigation funding would increase the number of law suits and distort the attorney client relationship.

“Who gets to call the shots – clients or the funder? Who gets to decide whether a case is going to be settled or will go to court?” asked Zeballos. “The right answer is always the client.”

Another question is whether the funder can withdraw the investment after initial funding and what happens when funding is withdrawn after the initial investment has run out?

And from a public policy perspective, Zeballos asked, is the commoditisation of litigation funding something that we really want? In theory at least a secondary market, trading financial products or derivatives based on litigation to spread funding and creating an increased risk appetite are not unthinkable.

Zeballos concluded that although there is a lot to be said for both sides of the argument, the regulatory framework in the US is about to change and litigation funding is here to stay.

Edward Estrada of Reed Smith noted at the Cayman Fund Focus conference that litigation funding used to have a very negative connotation, mainly on the basis of personal injury and not commercial types of cases. While he acknowledged that there are some issues around who is controlling the litigation, he said the whole concept of litigation funding in the US has evolved and is now very common and accepted.

“A few years ago if you were soliciting funding you might have been hard pressed to find one or two different offers, now it is quite easy to get five to ten different proposals for funding,” Estrada said.

Litigation funding in Cayman

Higgs & Johnson Partner Philip Boni argued litigation funding is something that should be considered in the Cayman Islands. The only case involving third party funding in Cayman has been Quayum v Hexagon Trust in which the chief justice recognised conditional fee agreements, albeit in a somewhat restricted form, he said.

“It seems to me that we need to put in place a code of conduct. That is something that the chief justice flagged up in Quayum. And we also need some form of commission to look into it,” Boni said. “Subject to some of those regulatory and other issues I think this is something that is not going to go away and I think it is something that you can expect to see more of in the Cayman Islands in the future.”

The issue is already “beginning to wash up on our shores”, Boni said, with litigation funders looking for cases in the Cayman Islands.

Deloitte’s Stu Sybersma said in the last year six or seven third-party funders were looking for deals in Cayman and noted that there have been some homeruns hit by third party funders in the US, which has galvanised the market as a whole.

Manning agreed, saying that his firm has certainly seen a steady stream of litigation funders coming to Cayman and looking for opportunities. Where deals have gone forward, he said, he had so far not encountered difficulty in persuading the court that it is the best deal in the situation and often it is the only deal out there.

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