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Arbitration experts agree: Litigation Funding does not generate frivolous lawsuits

Third party funding, IPA Peru

The second International Congress on Litigation Funding (LF), organized by Stonward and the Peruvian Institute of Arbitration, highlighted some ideas: litigation funding does not generate frivolous claims, and the legislation being proposed by bodies such as the EU is prone to “over-regulation”.

The experts who participated in the talk –specialists in third-party funding and/or specialized in the world of arbitration who have worked directly with funding– were: Antonio Bravo, partner in charge of the Litigation and Arbitration practice at Eversheds Sutherland in Spain; Daniel Rodríguez, partner and co-head of the arbitration and litigation practice at CMS Rodríguez-Azuero in Colombia; Guido Demarco, Director at Stonward; Heitor Castro, Portfolio manager at LexFinance in Brazil; and Luis Dates, Partner in the dispute resolution practice at Baker McKenzie’s Argentina office.

For them, the reasons for this severe regulation are a mix of: a lack of real knowledge of how this legal tool works, a misconception and sometimes negative idea about the investment funds behind it, and some lack of transparency.

With the background framework of the ICSID rules and the draft European Directive that intends to regulate LF, the debate unfolded during two hours around whether legal finance increases frivolous claims, the transparency and confidentiality of the LF Agreements, how the security for costs clause should work, the legal fees, and to what extent LF can legally influence the proceedings, as well as the terms that could allow to terminate an Agreement. All topics were discussed from both general and regional perspectives (Argentina, Brazil, Colombia and Spain).

There is no doubt that Litigation Finance is a useful tool and that it plays an important role in facilitating access to justice, something that has become an increasingly expensive commodity,” opened the talk Guido Demarco, co-host and moderator of the event, “but it seems that, in the 21st century, if there is a motivation to make money, a negative connotation arises; and that is why I think that there are many prejudices around this industry. Because of that, and because of the lack of knowledge of how an Agreement is written, what the process is like, etc.”.

In this sense, the meeting sought to explain and dismantle some of the current misconceptions about the Litigation Funding industry.

For example, the study on Responsible Private Funding of Litigation carried out by the European Parliamentary Research Service in March 2021 explicitly mentions the potential that Litigation Finance, if not regulated, could lead to an increase in frivolous claims.

Heitor Castro, a lawyer specialized in finance, believes that it is just the opposite: “Whoever invests money does not want to lose it. This is a basic argument to dismantle the idea. We must understand that funds are always interested in generating value to their investors, and financing frivolous lawsuits does not generate that value“; furthermore, he added that there is no causality or correlation between this legal tool and the existence or increase of frivolous lawsuits. “The European Parliament does not show statistics to prove this assumption, there is no data to support it, and the data that I’ve been able to find suggests precisely the opposite,” he said, referring to an ILFA report that analyzes commercial arbitration cases that have had funding and whose data is public, and which indicates that cases that are funded have a better chance of winning. 

Antonio Bravo agreed: “Before signing a funding agreement, there is a thorough review of all the merits and, in fact, one of the downsides of going to litigation funding is that it can delay the case. Precisely because the funder has everything at stake, he must be 200% sure that the case will perform well. Although one never knows what can happen, of course,” he explained, adding that, at the same time, signing an Agreement conveys an image of solvency and seriousness. “You know someone is taking a big gamble on that case and, thanks to it, in many cases the counterparty wants to settle at the beginning of the claim. I don’t know where the data or ideas have come from either,” he said.

Luis Dates also confirmed the ideas of his fellow speakers, and reassured that every time he has come across a case with a Funding Agreement, the case has ended with a settlement between the parties and not with an award. “The principle we should follow is the reverse: one must start from the fact that when there is funding, that claim, far from being frivolous, is strong. That is my experience also from the point of view of my jurisdiction,” he said.

New regulations to control the increase of frivolous lawsuits would be acceptable if we could observe a correlation here, but there is no data,” Castro said, and explained that there are already regulations to prevent frivolous lawsuits: “In Peru and Brazil, for example, in international arbitration, there is already the possibility for a judge to apply bad faith litigation, which means that if a lawsuit is frivolous, there are already procedural measures to stop it. There is also the summary judgment, which is a preliminary trial in which a judge could withdraw a claim due to frivolous merits. And there is also the issue of admissibility. In this sense, no further regulation is necessary.”

Regarding the transparency and confidentiality of the Agreements, as Bravo explained, one must distinguish three phases: a first one, where there was no obligation to inform about anything; a second one, which started three or four years ago and in which we are, where it is recommended to inform about the existence of a Financing Agreement with the exclusive purpose of avoiding conflicts of interest; and a third one, which is the one sought by the EU Directive, which forces to disclose the existence of the Agreement, its terms, and that even talks about the creation of a control body that could authorize or not such Agreements. Moreover, it mentions the possibility for the counterparty to challenge the Agreement. In the case of ICSID, the Rules are in line with what is done today and only if deemed appropriate should further information be requested.

For Bravo, “if the important thing is to avoid conflicts of interest, it is not necessary to disclose the details of the Agreement. I am in favor of transparency, but I don’t think very private aspects should be made public”. In addition, in his opinion, by granting the other party the power to challenge the Agreement, the Directive “will generate controversies and incidents within the procedure itself, and it could lead to suspensions, delays, etc. “.

For Rodriguez, if the Directive is approved in such terms, the issue “should be understood in the way that it should be provided all the information needed to prove that there is no conflict of interest. This is, which one is the Fund, the holding company, who are final beneficiaries and other interest groups”. He also explained that in Colombia there is no regulation for this issue, “but there are some general rules that apply to arbitrators as judges, and one could understand that, although the parties are not obliged to inform, if the arbitrators know that there is a financing agreement, it should be verified to avoid conflicts of interest.”

Both Luis Dates and Heitor Castro confirmed that in Argentina and Brazil the scenario is exactly the same, and the general rules or principles regarding conflict of interest should be applied to assess each specific case. “In Brazil there was a case,” explained Castro, “in which the existence of legal financing was reported spontaneously and the counterparty requested the termination of the contract and also wanted to know its terms, but the arbitration court said that the terms were irrelevant and it only requested the name of the funder to avoid a conflict of interest”.


Security for costs, legal finance expenses and legal fees

Both the Directive and the ICSID Rules address these issues. The existence of a funding agreement means that the party should provide security for costs? To what extent can a funder be obliged to provide it?

According to Rodriguez, in many jurisdictions, security for costs is associated with precautionary measures. To decide this measure, the court has to assess the legitimacy and interest of the parties, the existence of a threat, the effectiveness and proportionality of the measure. “However, even if there is room to demand this security for costs, can it be demanded from the funder? In general terms, I would say that a fund cannot be obliged to cover this, because it is not part of the process,” he explains. Luis Dates agreed with this idea, “the concept of party makes it legally impossible to extend the judgment to the funder,” he said.

For the Colombian expert, the underlying question when the arbitral tribunal is given the power to review the existence of financing, as indicated in ICSID Rule 53, is: what should the arbitrator analyze before deciding whether or not to request this measure?

RULE 53: Upon request of a party, the Tribunal may order any party asserting a claim or counterclaim to provide security for costs. (…) In determining whether to order a party to provide security for costs, the Tribunal shall consider all relevant circumstances (…) , including the existence of third-party funding.

For Luis Dates, the arbitrator should look at the motive, because the reasons for resorting to funding are varied and are not always related to insolvency or lack of liquidity. In this sense, Antonio Bravo explained that “many times it is associated that the company that looks for funding does not have liquidity, and that is why they ask you for a security for costs. But this is not true; sometimes this tool is used because the company prefers to allocate its resources differently. That is why Litigation Funding should not be identified with security for costs; that is a misconception of what litigation funding is”.

In fact, Dates recalled that, in a case in Argentina, a tribunal decided that the existence of Funding alone does not prove the impossibility of payment or an insolvency. “The fact that there is a LF Agreement is one element to take into account, but not the only one,” he added. 

When asked whether a contractual obligation to pay costs could be enforced towards a Fund, the experts agreed that it could be, but it would have to be done in a different process.

They also pointed out another trend that is emerging, which is that the funding expenses can be included among the legal fees to be paid by the losing party, as a sort of reparation. Demarco pointed out a precedent in which an arbitrator considered an additional compensation for the costs related to the funding agreement, “but it was a very specific case and due to certain behaviors”, he clarified.

As Dates explained, “from the point of view of domestic law, there is no rule in this regard and under Argentine law, the traditional concept of legal fees does not include these type of expenses. In fact, this would be a case-by-case situation, because the principle of reparation does not include self-inflicted costs, and this could be raised as such; although it could also be said that without this aid, there would have been no case. What it’s for sure is that the funding agreement could not be enforced within that same process.”


Influence during the process and Termination of Agreements

Lastly, the degree of influence during the arbitration process and the termination of Agreements was discussed. “The Directive proposes very clear-cut clauses regarding the influence that a funder can have during the process and on what circumstances an Agreement can be terminated, but the funder can contribute to the matter in a very positive way,” Demarco began the debate on this last point.

“When I read this issue, I found it frightening,” said Daniel Rodriguez. “The legislator here is meddling in the essence and autonomy of any relationship. This is a matter of my litigious right and should not be restricted. I understand that the debatable issue here is whether the funder, for example, can prevent the parties from reaching a settlement. But that’s not the case, it doesn’t happen that way.”

“It is extremely paternalistic,” added Guido, “besides, you cannot on one hand oblige funders to bear the cost of legal fees, and at the same time not even let them have a voice”. For the Director of Stonward, one of the big problems is that this Directive would not only apply to consumers involved in class actions, who in such a case may need an extra level of protection, but would apply to any individual or legal entity.

All the experts agreed that there should be interaction and influence between the party and the Fund although, as Antonio pointed out, “the client is always the owner of the case. But it is not very realistic to think that whoever puts the money in, won’t want to control and have a say in the matter. Of course, the funder cannot impose lawyers, but it can –and does- recommend them, for example. This is a sensitive issue where the terms of the Agreement will be key. I imagine that the Directive wants to make sure that the control of the case is not exclusive to the fund.” 

Regarding the feasibility of terminating an Agreement, the panel rejected the idea of funders randomly terminating Agreements. When it happens, it is because something unforeseen arises that makes the trial unfeasible, or when the client has not provided key information in advance. The circumstances for terminating a Settlement are highly scrutinized and reviewed.

Undoubtedly, the idea of those who participated in the round table is that the current regulatory proposals are going too far in some cases, and there is still a lack of knowledge about the functioning of this legal tool that, in essence, facilitates access to justice.

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