Fundamentals & Perspective of Third-Party Funding in India & Abroad;

Introduction:
India is a perfect example of an ever growing economy with a herculean market size and potential. It no secret that due to this, India is fast becoming one of the fastest growing economies in the world and is also becoming more and more popular as a destination for investment. Typically, in such scenarios people bear the sole concept of Foreign Direct Investment ("FDI") in mind leaving out a very vital part of funding viz. "Third Party Funding". Third Party Funding ("TPF") or also otherwise known as 'Litigation Financing'. In this article, we dive into the basics of the concept of Third Party Funding with an aim to view it from an Indian as well as international perspective.

What is Third Party Funding?
TPF is basically the term coined for an arrangement in which the litigation costs of a party to a dispute is borne by a funder (typically a third party who is neither related to either of the parties to a dispute nor shares any kind of interest in the dispute proposed to be funded) in exchange of a share in the monetary benefit/value of the award of the litigation, if the party so funded succeeds in its claim. Funding in such a process can be done by carefully examination of the claim on its merits and the chance of the same emerging successful in the adjudication of the dispute. Such funding can also be done on an ad-hoc basis depending upon the circumstances of each case and keeping in mind the special requirements/needs, if any. TPF can cover the costs of any kind of dispute resolution mechanisms ranging from old school litigation in courts to arbitration/mediation etc. and need not be limited to any specific type.

Who can be a funder?
A funder can be anyone whether it be a specialized third party funder, investment banks, hedge funds, high net worth third party individuals and in some cases even lawyers/law firms. Eyeing the high returns that it can offer on winning the claims, off-lately even insurance companies and pensions funds have started entering the field of Third Party Funding.

Who can receive funding?
In most of the scenarios, it is the Claimant (the party initiates or brings the claim) who is funded by TPF. This also includes Counter-Claimants in case there is a counter-claim involved from the end of one of Defendants in the dispute. This doesn't come as a surprise since they are the parties who receive a good size of monetary award in case of a successful outcome of their claims in the dispute and the process of TPF by the funders and their share of monetary benefit is contingent upon the success of the claims of the Claimants or the Counter-Claimants as the case may be. Even the defendants receive TPF for a probable defence to the claim they are faced with, however, it is a rare case scenarios and the chances of a defendant (without a counter claim) of receiving TPF are none to slim.

What kind of Costs are covered by TPF?
TPF can cover a wide variety of costs including but not limited to lawyers' fees, fees of the court/tribunal, fees charged by expert witnesses, if any, costs imposed in case of adverse orders, out of pocket expenses and other dispute related expense etc. This however, does not mean that in every case of TPF, all of these costs and expenses are necessarily covered. It is open to the funder and the party receiving the funding to tweak the funding agreement/arrangement in such a manner so as to cover only the expenses and costs which are amenable to the assent of both the parties to the funding arrangement.

What kinds of Dispute can be funded?
Strictly speaking, there is no bar coded under the Indian law against any particular kinds of disputes being funded by TPF. However, in India, the concept TPF is relatively not well established in comparison with other foreign nations where the concept of TPF is comparatively quite old and is attracted across a multitude of disputes including but not limited to commercial contracts, international commercial arbitration, class action suits, tortious claims like medical malpractice and personal injury claims, anti-trust proceedings, insolvency proceedings and any other case where the likelihood of the Claimant/Counter-Claimant succeeding in their claim is quite high.

Legal Realm of TPF in India:
The development of third-party funding in India has been almost negligible and it has been only recently that this concept has attracted attention from the Indian courts. Albeit the concept of TPF as mentioned above is not very well rooted in India, it is not no stranger to the Indian market. The concept of third party funding is statutorily recognized in civil suits under the Civil Code of Procedure in states such as Maharashtra, Gujarat, Madhya Pradesh and Uttar Pradesh. This consent to third-party funding can be adduced from the Civil Procedure Code 1908, which governs civil court procedure in India. Order XXV Rule 1 of the code (as amended by Maharashtra, Gujarat, Madhya Pradesh and Uttar Pradesh) provides that the courts have the power to secure costs for litigation by asking the financier to become a party and depositing the costs in court.

The Hon'ble Supreme Court of India in its judgment of Bar Council of India vs. A.K. Balaji and Ors.1 has clearly held that there exists no bar on TPF in India in the following words:

"35. In India, funding of litigation by advocates is not explicitly prohibited, but a conjoint reading of Rule 18 (fomenting litigation), Rule 20 (contingency fees), Rule 21 (share or interest in an actionable claim) and Rule 22 (participating in bids in execution, etc.) would strongly suggest that advocates in India cannot fund litigation on behalf of their clients. There appears to be no restriction on third parties (non-lawyers) funding the litigation and getting repaid after the outcome of the litigation."

From the above extract, it can be safely said that except lawyers, any other third parties in India can fund any of the disputes without facing any legal bar on the same. However, due to bar on lawyers charging their fees on a contingent basis, they are expressly barred from being involved in a TPF transaction in the clothes of a funder.

It is also pertinent to note that there is no legislation in our country as of today, to regulate such scenarios of TPF. However, the (Indian) Code of Civil Procedure, 1908 as amended by a few Indian states including Maharashtra, Karnataka, Gujarat and MP, expressly acknowledges the role of the financier of litigation costs of a plaintiff and sets out the situations when such financier may be made a party to the proceedings. TPF has also received favourable reference in the report of the High Level Committee to review the Institutionalisation of Arbitration Mechanism in India (2017)2.

Limitation of the existing legal landscape:
It is well established that lawyers in India are expressly barred from funding litigation when representing the disputing party or accepting a success based fee. However, what the Indian parliament fails to take into account is that this could bear an inherent structural limitation for funders that typically seek contingency fees of legal counsel as a core factor to an investment decision to ensure alignment of interests. Additionally, whether a TPF arrangement falls foul of public policy would depend on the terms of the arrangement including the funder's stake in the award, if determined to be extortionate. Another limitation that is yet to evolve is the permissibility of foreign investment in third party funding of disputes in India.

Indian litigation is an ever expanding market with increased commercial activity. While there is a demonstrable demand for structured and professional TPF to facilitate the pursuit of viable claims, a few sticky areas of concern are:

  • Class actions suits or representative claims which provide high likelihood of exemplary damages that attract funders have not gained traction in India. Further, there is hardly any precedent in India for grant of exemplary or 'blockbuster' damages for commercial disputes, for reasons best known to courts. This can be seen
  • Funders often use historical data to carry out a risk-assessment analysis before taking up a case. Such relevant data is a work in progress in India and will take a few years to consolidate.
  • Factors like roster changes during the progress of the case lead to an inherent unpredictability in the system that is not conducive to risk assessment.
  • Funders often prefer sharing the risk of their investment with lawyers appearing for the funded party, by requiring the lawyers to work on a contingency fee basis. This aligns the incentives of the lawyers and funders. This practice is impermissible in India.

The need of the hour is to remove the above mentioned limitations & balance public policy considerations against each other and bridge the gap between legitimate claims and lack of resources to support the same.

Indian Perspective of TPF for Arbitration Disputes:
With increasing cross-border transactions international commercial and investment arbitrations have also increased concurrently. Though, arbitration is the more efficient and time saving procedure (as compared to litigation in domestic jurisdictions) the exorbitant costs attached with it cannot be ignored.

An argument which can be put forth for introducing formal Third Party Funding in Indian arbitration is that litigation and arbitration differ in material aspects. Firstly, arbitration is based upon the concept of party autonomy where all catalysts of the proceeding are directly or indirectly decided by the parties. Thus, keeping in line with the same, parties should be free to take the services of a third-party funder wherever necessary. In support of this, it is opined that a party is a best judge of its interest and the court should ordinarily uphold such consent if it is satisfied that the benefits arising from such funding outweigh the risks associated with such funding.

Another noteworthy point in this respect is that in litigation, there are statutory provisions for providing free legal aid to the party who cannot afford the same. Thus, it is not absolutely incorrect to say that India is perhaps justified, to some extent, in not expanding the scope of third party funding in litigation. However, it is noteworthy to mention here that in contrast to the same, there is no such provision in the Arbitration Act. In such circumstances, a party is either required to put forth its claim (or defend it) on his own or surrender it due to financial restraints. In this respect, it has been observed that unlike litigation, where the litigant has a constitutional right to access to justice; a party de facto loses this right if it is unable to support the costs of arbitration.

In certain cases, the less privileged party may be able to hire the services of a lawyer but the opposite party might be in a position to hire better lawyers, thereby enabling it to put forth its claim in a much better way. Such situations may arise in case of Loan Agreement Defaults, land development/redevelopment agreements with a real estate developer on one side and an individual(s) on the other, where the individual(s) are in an inferior position as compared to the developer. In such circumstances, third-party funding can play a pivotal role while financing such less privileged parties whose claim is likely to succeed thereby, levelling the playing field.

Though TPF transactions are still taking place involving Indian parties to an arbitration dispute, the third party funders are extremely hesitant in funding Indian parties especially when the seat of the arbitration is in India. This is because of lack of judicial and legislative regulation over TPF transactions and contradicting judgments from various high courts in relation to arbitration law weakening its position as a pro-arbitration destination in the world. However, the chances of Indian parties getting third party funders increases exponentially when

International Perspective on TPF:
Over recent years, the concept has attained global impetus and jurisdictions such as Australia, Germany, United Kingdom, Singapore, and Hong Kong have taken steps to abrogate the legal barriers associated with TPF. Evidently, these jurisdictions have acknowledged the benefits associated with the concept, which include enhanced capital, effective recovery mechanism, and facilitating access to justice, to name a few. In the Asian setting, Singapore has passed amendments to its Civil Law Act legalising third party funding for arbitration and associated proceedings. Similarly, Hong Kong has also legalised third party funding for arbitrations and mediations. Other legislative efforts have focussed on creating a conducive environment for arbitration through favourable regulatory measures and tax incentives.

For instance, Singapore has passed legislation waiving the requirement for work permits for foreigners rendering arbitration services in Singapore and removing restrictions on the nationality of counsel and arbitrators involved in arbitrations in Singapore. Singapore also provides incentives in the form of tax exemptions for income derived by non-resident arbitrators for arbitration work carried out in Singapore and a tax exemption of 50 per cent for qualifying law practices on their incremental income that arises out of international arbitration cases which culminate in Singapore or in which substantive hearings have been held in Singapore.

In Hong Kong too, there are no restrictions on foreign law firms engaged in arbitration and no requirements are imposed on nationality and professional qualifications on advisers to parties.
In Sweden, any person with full legal capacity without constraints of nationality or professional qualification is permitted to act as an arbitrator.

It is more than clear that various actions around the world are making changes and adapting their legal system by introduction of legislations with an aim to regulate TPF in their nation since they recognize its importance and benefits and hence show a willingness to inculcate the same in their legal system. Similar measures, if adopted with suitable modifications for the Indian context, could give a boost to India's image as a pro arbitration jurisdiction and encourage advent of foreign companies and their business in India thereby giving an impetus to the economic growth of the country.

Need for TPF in the India Legal Scenario:
As per the Access to Justice Survey3 Report prepared By Daksh India, Civil litigants spend INR 497 per day on average for court hearings. They incur a loss of INR 844 per day due to loss of pay. Criminal litigants spend INR 542 per day for court hearings on average and incurred a cost of INR 902 per day due to loss of pay4. Litigants in family matters and service cases spend more on each hearing than other litigants.5

Further, the lowest income group (with an annual income of less than INR 1 lakh) is seen to be most optimistic about their cases being resolved within 1 year. 44% of litigants cited expense as a major deterrent for filing appeals in the High Court if their cases were not resolved in their favour. It is rather very shameful that apart from the real time loss, the loss of productivity due to attending court hearings because of wages and business lost comes to 0.48% of the Indian GDP6. An average of cost of litigation per year (as on the date of publishing this report i.e. during the F.Y. 2015-2016) came up to a staggering figure of Rupees Thirty Thousand Crores. This cost, in consonance with number of pending cases can only be said to have gone up till the current year.

Apart from the above mentioned reasons, TPF should be viewed in light of the various advantages it offers which are as follows:

  • TPF arrangement allows businesses to use their allocated/planned funds for their core business activates instead without have to do egregious spending on their litigations.
  • Gaining non-recourse finance with zero cost to its capital helps the business with extra funds in their pocket to finance their actual business.
  • TPF brings about a balance between parties by levelling the playing field and providing equal bargaining power to both the parties to the dispute.
  • TPF helps the weaker party in not getting arm twisted by the elite army of lawyers hired by the dominant party to the dispute with deep pockets.
  • TPF helps ensure greater amount of discipline from lawyers and expert witnesses who all play a vital role in the outcome of the dispute.
  • TPF provides a high return and relatively lower risk for funders encouraging them to help a party in need and gaining the subsequent economic benefits as the return for the funders is not contingent on market risks or any other vagaries.
  • TPF on a large scale will help any nation to be internationally recognized as a pro-arbitration or pro-litigation jurisdiction and will help make it a preferred seat for adjudication of disputes.

CONCLUSION:
In recent times, amidst the COVID-19 Pandemic and its deadly repercussions not only on the health of the citizens but also on the economy and the spending power of Individuals in India, there is a dire need of regularizing and encouraging TPF in India. Due to widespread economic distress, parties to such disputes may find themselves unable to bear the high costs of litigation or arbitration. India is but a cost-effective jurisdiction for litigation and dispute resolution. Not only individuals, but even business houses and companies are helpless in facing red in their balance sheets and shrinking size of business with more and more restrictions being put in place.

The corona virus pandemic has also caused more contractual disputes between the companies in India. Indian companies have only one option to fight the case and pay hefty legal fees to lawyers who are very expensive. Companies are not able to meet the working capital requirement due to payment of hefty legal fees to the lawyers. Number of cases having good merits are going uncontested in India. Last year two notable examples of third-party funding have raised awareness amongst corporate finance advisors to see litigation funding as an alternate means of financing: the monetisation of arbitration award in Hindustan Construction Company and Patel Engineering. Major infrastructure companies in India are struggling with stressed assets and huge pending claims, litigation funding would definitely help them to settle their claims.

Having said that, global Third Party Funders are planning to enter the Indian market, anticipating a rise in contractual disputes and bankruptcy related cases. With the benefits/advantages that TPF offers, India should consider introducing a potent legislation in place to regularize TPF in India and extract the maximum benefits out of this system by exploiting the humongous scope that Indian litigation market offers.

  1. Regulation 22, SEBI (Alternative Investment Funds) Regulations, 2012 read with SEBI circular no. CIR/IMD/DF/10/2013 dated July 29, 2013. Available at https://www.sebi.gov.in/legal/circulars/jul-2013/circular-for-operational-prudential-and-reporting-requirements-for-alternative-investment-funds_25105.html
  2. SEBI Circular No. SEBI/HO/IMD/IMD-I/DOF6/CIR/2021/549 dated April 7, 2021. Available at https://www.sebi.gov.in/legal/circulars/apr-2021/circular-on-regulatory-reporting-by-aifs_49788.html
  3. Available at https://www.sebi.gov.in/legal/circulars/apr-2021/circular-on-regulatory-reporting-by-aifs_49788.html.
  4. Final Report of The Alternative investment Policy Advisory Committee Report dated July 23, 2018. Available at https://ivca.in/wp-content/uploads/2018/08/AIPAC-4.pdf.
  5. SEBI circular no. CIR/IMD/DF/16/2014 dated July 18, 2014. Available at https://www.sebi.gov.in/sebi_data/attachdocs/1405675574305.pdf.
Dated: April 26, 2021
Author: Chirag M. Bhatia - Associate

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