This article is written by Ramanuj Mukherjee, CEO, and Kashish Khattar, Team LawSikho.
India is actually combating two problems at the same time. Even before COVID19, the economy was doing badly. After the lockdowns and the various measures taken by the government, it is a well-known fact that a lot of businesses are under the water. Road to recovery looks grim.
As COVID-19 keeps spreading fast, with no signs of slowing down, we are probably looking at the economy going from bad to worse. All banks and institutions like the International Monetary Fund have predicted that we are already in a severe recession. India’s economy is expected to contract in this financial year.
The priority of businesses is right now to conserve working capital and if possible, to get money out from any possible source which will help them to get a longer runway as the economy and business cycles recover.
Government policies have made it harder to take businesses to bankruptcy, and courts are largely shut down except for emergency matters. This means it is very hard for businesses to get settlements or recover their unpaid dues through legal means.
This also makes them reluctant to initiate litigation at the moment. This is putting serious downward pressure on the topline of law firms.
It is a catch 22 situation. There have been an unprecedented number of contractual breaches before, during and even after lockdown. There can be a lot of legal actions in the months ahead. However, clients, very unsure of the outcome, potential delays and not wanting to spend on legal processes, are kicking the can down the road.
This is where the possibility of Third-Party Funding (“TPF”) seems very sweet.
What if we can help you to fund your litigation, especially when your case seems to be very clear on your side?
The funder gets paid only when you get paid. He takes a part of the receivables for his funding.
The immediate burden of spending, as well as some of the risk, is transferred to the thor party funder. The business could get much-needed cash if the matter is won, without having to part ways with working capital. This is a sweet deal for many in India Inc.
It could be a lifesaver for NBFCs. It could be a lifeline for importers and exporters whose contracts have been dishonoured without any remedy so far.
It would be very attractive to many in the infrastructure and real estate space – large suppliers and contractors who have been waiting to get paid without any idea about when their contracts will be honoured.
The Engineering, Procurement, Construction (EPC) industry could be a pioneer for TPF funded arbitration claims which are typically against the government or other large clients. These claims and awards often run into thousands of crores, making them very attractive investment options.
There would be many others in India Inc who can really benefit from TPF right now.
Third-party funding has known to be an upcoming trend in all commonwealth countries. It might be the case that COVID 19 has just catalysed the entry and expansion of third party funding in India. It would have helped if the government stepped in and made some laws on how it should function, though there have been no legislative initiatives so far.
However, there appears to be no legal bar against it at the moment either, except for a couple of cases being heard in different courts where TPF has been called into question.
Perhaps, funders and fund seekers are waiting for these cases to get decided, although it really looks like the stage is set for the rise of TPF in India. Large law firms have been laying the groundwork to claim their market share when that happens, while large international TPF companies are eyeing the Indian market and cautiously weighing their options.
For law firms, TPF could be a big driver for growth because if they are able to advise and assist big clients to get TPF while the others are still on backfoot, it will be a major USP to attract large clients. The TPF companies do not need to look far for deal sourcing, the lawyers and law firms will be queuing up with matters they feel would be eminently fundable.
For the uninitiated, let us start with what exactly TPF is and how it is viewed in the Indian legal system.
What is third party funding and how does it work?
Third-Party Funding means a party unrelated to a given dispute, having no stake or say in the same, would fund the litigation costs of one or more of the parties in exchange for a percentage of the proceeds of the suit, arbitration or legal action.
Basically, if the party that has been funded receives any money, relief or recourse having some monetary value due to the legal matter being pursued with the funding, the funder will be entitled to receive a predetermined share of the same.
This share is normally contingent on the condition that the litigant has to win the claim, wholly or partially.
TPF can cover costs of litigation or alternative types of dispute resolution including mediation and arbitration. It is not common for parties to take funding for mediation though, given the comparatively low cost of the same.
TPF is based on the ‘access to justice’ argument where a litigant will be provided justice with the help of a financier managing his litigation costs.
Funders are usually big hedge funds, family offices, investment banks, High Networth Individuals, pension funds and private equity firms who look at TPF like a distinct asset class.
One brilliant thing about TPF is that it is not connected to the stock market, and therefore quality TPF investments are seen as important diversification of risks for such funds and wealth managers. Also, the RoI on TPF can be very big, especially in markets like the current one, when large companies and litigators are short of capital to pursue their legal rights even when such claims can be easily established.
Tracing the history of TPF in India
The primary argument in India against TPF has been based on this: the common law system prohibits champerty and maintenance.
Maintenance, in this case, means, providing a person with financial assistance to carry on or defend any kind civil proceedings without any legitimate interest in the matter. This principle came into being because in medieval England feudal lords would often cause trouble to their enemies by financing various subjects under their control to file frivolous cases against their enemies. The principle of maintenance was evolved to block such malicious actions.
Champerty is an aggravated form of maintenance which means that the maintainer is entitled to receive a share of proceeds which will arise out of the case.
These principles were developed to protect the integrity of the justice system in a time and era that could not imagine the complexity of modern commerce. Notably, the country which evolved these principles in the Victorian age now permits TPF as a common practice.
Talking about the Indian subcontinent, TPF was first talked about in the age-old Privy Council case of Ram Coomar Coondoo v. Chunder Canto Mookerjee where it was held by the court that the common law principles discussed above were mainly made for England.
It was further held that these laws were of a special character and were not applicable to India. Moreover, an agreement to give funds to carry on the action as consideration for a share of proceeds arising out of such action is not opposed to the public policy. This position was then reaffirmed again in another Privy Council case of Kunwar Ram Lal v. Nil Kanth and Ors. In Re: Mr. ‘G’, A Senior Advocate, the Supreme Court held that TPF was not against the public policy and there was no restriction under the Indian law which bars the parties from entering into such arrangements.
In India, as recently as 2018 been held by the Supreme Court that there is no restriction on the TPF arrangement in the country. Moreover, the (Bombay) High Court in 2019 has held in a case that having a contingent agreement over the fee in arbitration can not be seen as an illegal arrangement. The court relied on the Supreme Court’s decision which legitimised third-party funding back in 1954. This only goes on to show that Indian courts see these kinds of arrangements in a favourable light.
There are just restrictions on lawyers under the Advocates Act, 1961 and the Bar Council of India rules, especially given under Part VI, Chapter II, Section II, Rule 20 of the Bar Council of India Rules (Standard of Professional Conduct and Etiquette) which make sure that lawyers in India will not fund the disputes of their clients or accept any type of contingency-fee based briefs. However, this imposes no restrictions on independent third party funders from investing in litigation finance.
Few states like Maharashtra, Madhya Pradesh, Gujarat and Karnataka have made changes in their civil procedure law to acknowledge the existence of TPF arrangements in their respective jurisdictions. This is done by allowing for impleadment of a third party financier where it will be bearing the costs of the claimants only after the permission of the court.
Change is inevitable
Hongkong, Singapore and France have in the recent past all shown support to TPF. When it comes to England and Wales, the Criminal Law (Amendment), 1967 declassified champerty and maintenance as crimes under their law. The conduct for litigation funders by their civil justice council sets out the practice and behaviours to be observed by funders. France did this through a resolution by the Paris bar council. Hong Kong has done it through an ordinance and Singapore has brought an amendment in its civil laws and has brought out a regulation to govern TPF.
As recently as last month (June 2020), the Minnesota Supreme Court has abolished the principles of champerty and has held that the development of common law should change with the development of society.
What is stopping TPF from becoming mainstream in India?
The biggest problem that prevents funders from investing in India is a lack of legislative clarity on the legality of TPF. There are some cases pending before various high courts where decrees obtained with aid of TPF have been challenged as illegal in India, and a decision is awaited. It may take some time as we cannot make up our minds until the Supreme Court finally gives its verdict on the same, which could very well take a few years.
The government could, however, throw a surprise by introducing legislation given that TPF can unleash a transparent, efficient system for litigation financing, bring in much needed foreign capital and free up working capital of many cash strapped Indian businesses. It could go a long way in reviving banks and NBFCs, which are critical sectors as well.
It definitely looks like the recession and the pandemic has stirred the appetite of the government for important reforms, and therefore we can hold out some hope for a TPF legislation being in the works.
However, TPF investors are likely to start testing the waters slowly by funding some selective matters, especially where Indian companies have claims abroad. Indian law firms will surely be heavily lobbying the government too because TPF could surely grow their topline during these times of hardship.
Apart from lack of legal assurance, the other likely impediment keeping funders away is the extremely slow and unpredictable justice system in India. Without serious reforms of our court and justice system, we cannot expect TPF to reach every corner of the country. At best, it will remain limited to some very large claims of very large litigants.
There are some moral hazards related to TPF too, but these are nothing that good old contracts cannot sort out.
An investor wants to get good returns on his investment. The interest of the litigant and the funder can vary at times. For instance, if there is an opportunity to settle, and they don’t agree on whether to settle, in what direction should things move?
The funder can create strategic problems within the team as he shares a monetary relationship with the lawyer who in turn drives the litigation strategy. Should the lawyer listen to the funder or should she go by instructions of the claimant?
Usually, these things are ironed out at the time of funding contracts being signed. Experience shows that often claimants hand over much of their rights in favour of funders in exchange for the funding.
Mr Rajat Jeriwal and Ms Shruti Khanijow from Khaitan & Co. wrote on these issues here, and they agree that as TPF finds its feet in India, clarity on the issues such as corporate regulation of TPF, ethical issues regarding disclosure, confidentiality, privilege and privacy, and ethical regulation of the funder and the legal professionals involved will have to be sought.
Definitely some legislative clarity on issues like these could change the fortune of TPF as well as corporate litigation practitioners in India.
Conclusion
TPF is a growth story and could be a big source of relief for Indian businesses in the coming years, with a little push from the government.
Also, India will never achieve it’s dream of creating global arbitration hotspots like Dubai, London, Geneva, Hong Kong, Shanghai or Singapore until we allow TPF with robust legal backing.
Let’s hope the government ushers in TPF and makes it a policy priority, while courts cooperate and allow this reform to reshape the corporate litigation landscape in India in the post-COVID world.
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