This article is written by Reshma, pursuing an Executive Course in Advanced Civil Litigation: Practice Procedure and Drafting from LawSikho.

Introduction

Global market faces an economic slowdown and a future of recession, due to pandemic. In this scenario companies or entities are under financial distress which might lead to insolvency where they might not be able to take further step to wind up, restructure themselves or not even put forth their claims to bring back the asset actually not in their hand, this is where third party comes into picture. An outside entity stretches its hands to assist a person or an enterprise going through such a situation.

They help them in realizing any leftover belongings or in getting a legal sanction of their insolvency as well as settle their creditors. Involvement of third party funding in the context of bankruptcy is the most efficient application of this concept. The entities which are unable to initiate litigation, pay debts, or obtain loans by banks are funded by the third parties to carry on their process of litigation and obtain legal sanctions. This article aims to provide an overall view of third party funding and bankruptcy litigation, how it actually works in combination, its extent and scope.    

What is third party funding?

1. Third party funding or litigation financing is a growing phenomenon in which a party to a dispute is provided financial aid by a person or an entity who is a complete stranger to the dispute in sake of future benefit arise out of the litigation.

• Initially funder takes care of all expense to pursue a valuable claim in spur of fixed share from expected relief, money, property or any other monetary gain.
•  To understand it simply, let us consider an example: if overall funding related to litigation is five lakhs and winning the case would fetch 50 lakhs. Then, on an agreement between fund seeker and funder– 20% of winning amount goes to the third party.   
• This concept was not illustrious in the past, it is important to know the origin of third party funding to understand actual purpose behind it.
• Historical Background: Most of the common law countries followed the doctrine of maintenance and champerty which used to inhibit third party funding based on public policy of protecting the chastity of justice. Maintenance meant that an unconnected party to dispute would support litigation of the other party by providing fund. In return of such maintenance, the third party would be provided a share of proceedings after the litigation got over. The concept of maintenance and champerty evolved in England with an intention to facilitate access to justice for poor Section of the society. However, inverse of what was intended happened in practice. Rich and powerful strata of the society started the trend of gambling litigation, exercised absolute control over others dispute and outcome in litigation, suppressed evidences and incited witnesses to act in their favour. Due to this abuse, maintenance and champerty started being considered as a crime and a tort in various parts of the world. 

Now, we shall discuss in detail about third party funding.

• Champerty and Maintenance were later abolished as crimes under the under the Criminal Law (Amendment) Act, 1967. Other parts of the world also followed the trend. This has to an extent given rise to the concept of Third Party Funding. The admissibility of third party funding is based on public policy of   ‘access to justice’. No person shall be denied justice because of his financial crisis is the new perspective. 

2. International Bar Association in its guidelines on conflicts involving interests in International Arbitration defined “ Third party funder” as any person or entity having a direct economic interest in the award so that it contributes funds or other material support to the prosecution or defence. 

• Mainly litigation financiers can be hedge funds, insurance company, an individual, a bank, private firms and pension funds. 

3. Third party funder enters into an agreement with plaintiff for a proportion of benefit upon favourable decree. And in scenario of adverse result, it would not make plaintiff to repay the amount of the litigation to the funder. This eases the burden of the stressed litigants.

4. If funding is done to the defendant, then the defendant has to deposit an amount to funder in advance as an insurance amount. The agreement may also include a clause of making additional payment if the defendant won the case. Also, the defendant cannot enjoy non recourse funding as plaintiff. 

5. At the same time one who seek the help of litigation financer should be vigilant to choose funder with great reputation, experience and capital to support the purpose.   

6. Funder makes their interest in commercial arbitration, infrastructure, tort claims, insolvency proceeding, medical sector, anti-trust proceeding, mainly claims have a chance of monetary win.       

7. TPF covers expense of counsel fee, court / tribunal fee, cost of expert witness, adverse cost orders and other dispute related expense that take place in court, tribunal or alternate dispute resolution mechanism.

8. Quantum of benefit acquired by funder out of TPF: the proportion of benefit that can be incurred through litigation financing varies from case to case. There are certain factors take into account while determining the funder’s return such as risk involved, damage expected and other expenses. Funder can acquire their share by taking equity share in company, or a fixed percentage of share from outcome etc.

An important precedent related to funder’s benefit from third party funding by Andhra Pradesh High court in Nuthaki Vekataswami  V. Katta Nagi Reddy. In this case, the agreement between claimant and funder was ¾  share of the property on winning the case. While adjudicating this case court considered the issue whether the share of the proceeds ultimately vest in third party funder and such agreement is enforceable? Court declined to recognize such agreement and held it as unreasonable and ex facie extortionary. There is no absolute quantum and proper mode of acquiring benefit out of third party funding, however it should be proportionate, fair and reasonable.

Can advocates advice their clients third party funding in litigation? 

There is no specific statutory provision inhibiting lawyers from advising third party funding. 

Under  Section 49(1)(c) of Advocates Act, an advocate is directed to maintain standard of professional conduct and etiquette. 

In compliance with Advocates Act, 1961 Bar Council of India has laid down Rules regarding standards of profession: Rule 18 prohibits advocates from fomenting litigation, Rule 20 prohibits Advocates from accepting contingent fee out of litigation, Rule 21 forbids advocates from receiving share or interest in actionable claims and Rule 22 bars advocates from participating in bid execution. As a conclusive observation, the advocate shall not involve in illicit relationship with funder or in common, to achieve improper objective or gambling litigation . Major concern of an Advocate should be to avail justice and help the cause of their clients through third party funding. 

Termination of funding: there can be instances where termination of third party agreement particularly takes place. The agreement might itself provide for a termination clause. Other circumstance open to termination of funding are as follows:

• Breach of rights and obligation of either parties to the agreement shall be the reason for termination of funding.
• Rearrangement or default in funding leads to termination of funding agreement.
• If funder feels that the litigation taking place is for frivolous and vexatious matter, then such funding can be terminated.
• Funding agreement must include a clause for automatic termination, if there is any contrary persisting legislation, new legislation or  amendment  during the period when the agreement is in force.   

Next, we shall see the use of TPF in insolvency cases.

Upsurge of third party funding in insolvency

 In the context of insolvency, even the creditor may be interested in financing a legal claim, but they are in fear of long process of litigation and adverse cost risk. Litigation financers who go for such funding usually have huge capital resource, expertise in litigation risk and bringing claims. They also do financial backing for claimant in every step and remain keen in monitoring litigation.

It is quite interesting that once a TPF gets involved, the insolvency practitioner only needs to handle the litigation financer rather than multiple creditors. Litigation financers prefer connection with leading law firms so that they can get the basic analysis about the future of claims and make arrangements to pursue such claims by best lawyers. As uninterrupted flow of money by TPF can result in him earning better outcome than an unfunded claimant.

How and why third party funding rising in bankruptcy litigation?

When a company goes into insolvency or formal process of liquidation, company might have no readily available asset to sell or money in bank to initiate or continue proceedings. It would have claim of assets to put forth. First resort is for the stakeholders to put some more money or stakeholders to approach advisors, management, equity holders and other money creditors to compensate creditors in the situation of insolvency. Stakeholders and other funders would probably provide finance to the company with asset than debts, if that doesn’t work, TPF comes to rescue. 

1. 1. Restricting company: If the asset held by the company is unable to compensate the debtor, then company goes for a loan called debtor- in –possession (DIP) in order to keep company alive during insolvency. However, during insolvency, they may not obtain DIP funding for litigation owing to adverse cost and non-recourse funding. Hence, they opt for litigation finance or TPF.
   2. Financing for litigation trust: a litigation trust is a trust created as part of bankruptcy plan  for the benefit of creditors of debtor to prosecute and conduct proceedings. TPF funding can be done by litigation finance.
   3. Financing inter-creditor dispute: If a company undergoing liquidations acquires fund to compensate the creditors in dispute on priority basis; there is high chance of dispute in concern with senior and subordinate creditors in bankruptcy estate then TPF can resolve such issue.
   4. Funding law firm: litigation financer provides funding to law firm to pursue bankruptcy case involving risk of contingency fee, otherwise law firms might not take interest in such case.          

How is the Third Party Funding operating in different parts of the world?

The aim is to provide the parallax practice followed by world around to know how and why third party funding functions in insolvency arena.

England

Litigation financing was permissible in England from 1960 subsequently abolished as crime and tort under Section 13 and 14 of Criminal Law Act, 1967. Later on in view of increasing practice of third party funding in litigation around world, proper guidelines were framed for its cautious practice. The courts look into certain factors while deciding the validity of the funding agreement such as extent and involvement of funder in litigation. If excessive control and benefit out of litigation is seen, such agreements would be struck down by courts. 

The association of litigation funder launched a code of conduct for litigation funders. Code of conduct prescribes that the funders should abstain from taking control over litigation or negotiation settlement and in client-lawyer relation. In insolvency cases, usual prohibition on vending claim is permitted under The Small Business, Enterprise and Employment Act 2015. Litigation  funder can purchase claim from insolvency practitioner , earn fund out of litigation and even funder can exercise control over litigation.

Cayman Islands

Very recently, Cayman island came up with legal framework which codified guidelines related to litigation funding, The Private Funding of Legal Service Act, 2020. It entered into force on 1 may 2021. Before the statutory framework, TPF was determined on case to case by court in compliance with doctrine of maintenance and champerty. The newly formed Act widens access for litigation funding and brings Cayman island in agreement with onshore jurisdiction such as UK and US. The Act abolishes the offence of champerty and maintenance and welcome litigation financing.

Dubai

The Dubai International Financial Centre welcomes foreign investment and new business. DIFC court permits third party funding under practice direction No: 2 of 2017. The direction prescribes that claimants must disclose the presence of funder but not the terms of agreement between them. There is no regulation for fee and interest charged by the litigation financer. Since it is common law modelled on law of England, Rule of maintenance and champerty are practiced as a public policy. The excess control on litigation and disproportionate sum out of litigation would turn the concept contrary to public policy. Litigation financing in Dubai local court is not yet clear, there is no hindrance to such funding or no reported case that has prevented TPF.             

Australia

Prior to 2006, litigation funding was prohibited in Australia due to the doctrine of maintenance and champerty. TPF was later introduced in Australia for insolvency. It was broadly utilised in civil and commercial litigation and arbitration matters. Now it is well established in class action suits. The recent update from Australia is the Corporation’s Amendment (litigation funding) Regulation 2020. Now Insolvency funding arrangement can be done by funder hold Australian financial service licence (AFS)L or else seek declaration of Australia security and investment commission (ASIC) if funding is done by non AFSL holder.

Singapore 

The doctrine of maintenance and champerty prohibited third party funding in Singapore till 2017. An amendment in civil law act in 2017 authorised outside funder to relate with dispute resolution and gain considerable share of profit out of litigation. However judiciary recognised agreements on third party funding in insolvency proceedings even before this amendment. 

Finally, in 2018 the legal framework in the context of Insolvency, Restructuring and Dissolution Act, 2018 (IRDA) brought clarity for third party funding in insolvency cases. IRDA is unambiguous about funding in relation to claim against counterparty.

United States

US have a full fledged legal framework to implement third party funding in bankruptcy litigation. Bankruptcy Code And Federal Rule requires sanction of court for TPF in litigation. The approval of such funding is based on the facts in need of fund by stakeholder.

Guidelines for the approval of litigation finance in bankruptcy:

• Section 364 of the bankruptcy code requires approval of court for debtor in possession (DIP), trustee or creditor TPF in bankruptcy case.
• If any professional is funded in the pendency of bankruptcy case is required to disclose under Bankruptcy Rule 2014 and 2016.
• Section 363 of Bankruptcy code approval of court for litigation asset condition need to comply in TPF in Bankruptcy litigation:

1. State reason TPF is the best option for shareholder.

2. There should be a funding agreement

3. Terms of funding should be tested in market by seeking bid.

• Party seek fund from litigation financer who is well established, holding a huge capital. Party should involve specialized firm in handling case experienced in commercial case, bankruptcy and financing the same. 
• Funder should seek partners who are stable, experienced with financial stability.

US provides overall safeguard to practice TPF in bankruptcy litigation as well it hope to perform.

Indian perspective

The misconception prevailing in Indian jurisdiction is that third party is restrained from funding litigation. In India, the Rule of maintenance and champerty has not been applicable in its strict sense. It was considered in privacy council decision Ram Coomar Coondoo and Ors. V. Chunder Canto Mookerjee (1876) L.R.4I.A. 23 , wherein it was held that agreements to fund litigation in consideration of share of asset should not be entered in extortionate and unconscionable manner. Improper object is the only proviso. In this case suit was instituted by Ram Coomar Coondoo who was a successful defendant in two former suits instituted by Mc Queen and his wife, against Chunder canto Mookerjee who was neither a party nor an added party to former suits. Mc queen and his wife had approached Mookerjee to fund the litigation due to poverty. The Council went to say that an agreement does not get abrogated in relation to third party funding on mere reason of doctrine of maintenance and champerty. Only, if it is contrary to public policy enshrined under Section 23 of the Indian Contract Act, 1872, such agreement would be void.

There are several precedents that can be referred to as guidelines related to TPF and which show growth of this concept in India:

• In Damodar Kilikar and Ors. V. Oosman Abdul Gani 1961 KLJ 356, the suit was instituted by successors of funder for recovery of sum as promised.  The court embarked that an agreement which is not illegal for mere reason of doctrine champerty. The judgment paved the way for third party funding in India.
• Most recent case related to TPF would be Bar Council of India v. A.K Balaji and Ors. 2018 (5) SCC 379, wherein a writ petition was filed before Madras High court and eventually the matter reached Supreme Court in an appeal. The main issue in the case was whether foreign lawyers and law firms can practice in India. While deciding the writ petition supreme court nodded on the observations made by Madras high court that even though TPF is permissible in India, advocates are exempted from participating in such funding in observation with Advocate act and BCI Rules.

When we follow precedent there is no further growth other than answering the point validity of TPF agreements. Variant judgments provide clarity that lawyer should refrain from TPF agreement.

Need for a legislative framework

India still does not have any specific provision or legislation governing third party funding. Section 35 of Code of Civil Procedure,1908 mentions certain circumstances in which costs may be awarded by court to third party in compliance with general principles. States like Maharashtra, Tamil Nadu, Madhya Pradesh, U.P and Orissa amended order XXV Rule 1& 3 of CPC 1908. As per order XXV Rule 1, plaintiff financed by third party for return of benefit is empowered to demand security of cost from financer.  Under XXV Rule 3 Court may order the funder made to be a plaintiff to the suit with consent of such person, or suo moto or on an application by defendant for an assurance to the sum incurred or adverse cost in relation with litigation. If funder resists to be impleaded as plaintiff, it would mean that they have renounced their interest in the outcome of the suit.

Further, the courts are empowered to declare third party funder as defendant and provide security of cost for other defendants. On non-compliance with such order, the financer shall be debarred from claiming interest in litigation. Ultimately, the agreement between funder and claimant has to be informed to  the court to obtain protection of the law. These are the only statutory provisions to practice third party funding. However, India is loaded with insolvency cases but The Insolvency and Bankruptcy Code remain silent about TPF. Delayed justice, adverse cost and lack of funders have restrained the growth of TPF in insolvency.

Having said that, since the concept has prevailed in India and has not been slammed or even objected by the judiciary, we do need some guiding Rules or a legislative framework to safeguard the interests of parties that enter into such agreement. Until then, such agreements would only be governed by the Indian Contract Act and would only be void if they are against public policy or contravene any existing laws of the land.

As a ray of hope on 11th February, Indian Association for Litigation Financing was launched with the participation of law firms, practitioners and third party funders. They aim to self-regulate and promulgate information about litigation financing in India. The Association should carry out advocacy out reach programmes to create more knowledge and awareness in this domain and also work in close association with government machineries in order to suggest a legal framework.

Conclusion

Access to justice is the paramount of third party funding. Non availability of resources and lack of strategic approach are effectively handled with the coming in of third party funder. However, TPF in bankruptcy should be done with great caution. Litigation financers usually fund companies only with high value of claim, less chance of adverse cost and high chance of winning. It is another business venture with great future in India. Insolvency and Bankruptcy Code 2016 must be amended to include provisions related to third party funding in insolvency and bankruptcy cases. Absence of statutory frame work would give rise to illegal TPF agreements, affect confidentiality and stability of the case, suppression of litigation financer and extraction of disproportionate sum out of litigation. Indian courts are already flooded with cases and so proper statutory framework is needed to make sure that it is properly regulated. On this note, I think India is now ready for the grand launch of legal framework on TPF.

References

1. Victoria Shannon Sahani; judging Third–party-funding 63 UCLAL.Rev 388(2016)  
2. Lord Neuberger,” From barrety, maintenance and champerty to litigation funding “, Gray’s Inn speech, May 2013.- (Nurton Rose Fubbright)
3. https://www.lexology.com/library/detail.aspx?g=f13ae227-6f19-4d86-b40e-f6e520c2cb50
4. https://www.burfordcapital.com/insights/insights-container/litigation-funding-in-insolvency/
5. https://www.mondaq.com/uk/insolvencybankruptcy/980372/third-party-funding-in-the-context-of-insolvency-principles-on-when-the-court-will-sanction-third-party-funding
6. https://www.financierworldwide.com/third-party-litigation-funding-in-insolvency#.YMBGtdIzZdh
7. Third party funding in india- Cyril mangaldas Advocates and solictors
8. Expert Q&A on bankruptcy litigation financing- resource: ID-018-8859
9. https://www.barandbench.com/columns/third-party-funding-indias-time-is-now
10. https://www.legaleraonline.com/articles/third-party-litigation-funding-is-india-ready-for-it

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