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The following post was contributed by Guido Demarco, Director and Head of Legal Assets at Stonward.

In March 2021, the European Parliament’s Research Service published a study on Private financing responsible for litigation. This study was then supplemented by a draft report prepared by the European Parliament’s Legal Affairs Committee in June 2021. The two documents, the study and the draft report, contain certain recommendations for regulating the financing of disputes and criticize the economic costs that these funds impose on their clients by labeling them as “excessive”, “unfair” and “offensive”.

More specifically, on the issue of fees, the study suggests setting a 30% cap on donor rates of return, while the draft report recommends that LF agreements be invalid if they provide for a benefit. for the applicant equal to or less than 60% (except in exceptional circumstances). In other words, a ceiling of 40%.

While this can be seen as a logical step to make litigation funding more affordable, what needs to be considered is that the expected return from funders is simply a consequence of the risks and costs that arise from litigation, and not the reverse.

The costs

Let us take the case of a foreign national, the “Citizen Kane”, which invests in the energy sector in Ruritania[1]. Imagine that a bilateral treaty between the country of nationality of Mr. Kane and Ruritania protects the investment of Citizen Kane. The Republic of Ruritania suddenly indirectly expropriates Mr. Kane’s business without due compensation. To claim damages, Mr. Kane will initiate arbitration through the International Center for Settlement of Investment Disputes (ICSID). The total cost of the litigation will depend on the complexity and length of the case, including the number of pleadings, experts, hearings and the time spent by lawyers. Only the first advance to ICSID can be approximately $ 150,000.

If Citizen Kane estimates the damage at $ 30 million, the costs of such a litigation could easily rise to $ 3 million or more. In investor-state arbitration, the average costs to investors are approximately $ 6.4 million and the median figure is $ 3.8 million. The average court costs in ICSID arbitrations are $ 958,000 and the median is $ 745,000.[2]

As a result, after years of being subjected to arbitrary measures and unsuccessful disputes in local courts, Citizen Kane will now have to invest an additional approximately $ 3 million to file a claim for damages, the outcome of which is totally uncertain. Even if Citizen Kane wins, Ruritania may not be willing to follow the sentence voluntarily, and he will have to incur more expense to enforce the judgment.

The risks

Aware of the prohibitive costs of litigation, Ruritania can play the long game, unnecessarily prolonging the dispute to financially exhaust the plaintiff while expecting that a future administration will be in place to foot the bill later. This can be difficult even for a financially healthy business, as litigation costs are often seen as an expense in the income statement and therefore CFOs are increasingly looking for alternatives to preserve the working capital of the company. main activity of the company.

How long will the procedure take? What will be the final amount of damages awarded? Will the other party voluntarily follow the award? What if, in the end, I lose? These questions do not have exact answers as the answers depend on third parties, including how a judge or court interprets the law and the facts of the case, as well as the performance of experts and lawyers in pursuing the case. claim.

The litigation budget and estimated damages will play a key role in the investment decision, as well as the merits of the case, the liquidity and reputation of the defendant, as well as the reputation of the law firm chosen by the client. Risk analysis is not easy, given the latest figures which show that investors succeed in only 47% of cases, and that the median amount of damages claimed over damages awarded is 36%.

However, the main factor in determining risk is the structure of non-recourse litigation finance loans. This is not just a typical loan, but a risk transfer mechanism. It is normal that the higher the risk assumed by the lender, the higher the expected return.

Conclusion

Limiting the return expected from a funder will not reduce financing costs for clients and therefore make litigation more affordable, which is the aim of the proposed EU regulation. Funders will not provide funding if they perceive that the risk / reward of a case is not worth the given circumstances. However, a performance cap could have a direct effect on the number of cases taken on by funders – which is already low – since there will be cases in which the combination of the factors described above will not make it profitable investment, taking into account the barter risk. Unfortunately, there is a cost floor shared by cases large and small, and complex claims like the Citizen Kane expropriation case would be that much more difficult to fund. A ceiling could therefore limit Mr. Kane’s litigation options.

Should funders charge a profit fee? No, but a fee cap may not be the answer. Ultimately, the direct beneficiaries of the proposed settlement could be some states like Ruritania, which act as defendants in arbitration or court cases, rather than the individuals the EU is trying to protect. Ironically, states fund their legal firepower with taxes, the same taxes Citizen Kane has paid the Republic of Ruritania for years.

[1] Ruritania is a fictitious country used as a frame for novels by Antoine Hope, such as The prisoner of Zenda (1894). Jurists specialised in international law and Private international law use Ruritania to describe a hypothetical case illustrating a legal point. [2] 2021 Empirical Study: Costs, Damages and Time in Investor-State Arbitration, British Institute of International and Comparative Law and Allen & Overy, available at: Costs, damages and duration in investor-state arbitration – Allen & Overy.

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About Guido DeMarco