Authored by Pip Murphy Director Of Investments, Vannin Capital and Tom McDonaldCounsel, Vannin Capital

Professional third-party funding is a high-risk investment activity. Unlike other investments where a bad investment results only in a loss of principal, unsuccessful third-party funders suffer a heightened blow in that they will lose the principal amount invested and they will usually have to pay the successful defendant's costs up to an agreed amount. The impact of this is felt by the funder but, in some situations, it is also felt by the plaintiff who may be left to "carry the can" if the funder cannot meet its financial obligations.

In this article we discuss the importance of a plaintiff selecting a professional and reputable third-party funder, with an unblemished track record of meeting all its financial obligations in respect to adverse costs. We examine a recent case in Australia and one in the United Kingdom where Courts have considered applications by successful defendants to make costs orders against funders, their shareholders and their directors.

What is abundantly clear from these cases is that it is critically important that plaintiffs only access funding from professional funders, with sufficient capital, who can "stand by their man" and meet their contractual obligations in respect to security for costs and adverse costs orders.

AREN'T THERE REGULATIONS ABOUT THIS?

Third-party funding is subject to various "light touch" regulatory frameworks in Australia and the United Kingdom.

In Australia, the only formal requirement of third-party funders is that they have a policy for managing conflicts of interest if they do not hold an Australian Financial Services Licence.

In the United Kingdom, third-party funding is self-regulated by the Association of Litigation Funders (ALF). Vannin is a member of the association, which currently has eight members, and is an independent body charged by the Ministry of Justice (through the Civil Justice Council) with delivering self-regulation of third-party funding in England and Wales.

The ALF's Code of Conduct sets out the standards by which members have agreed to abide. Amongst other things, it sets the standards for the capital adequacy of funders, which are designed to ensure that those entities which provide the funding can meet their commitments. In particular, the Code of Conduct provides that the third-party funder will:

  • Maintain access to adequate financial resources to meet their obligations to fund all the disputes that they have agreed to fund;
  • Cover aggregate funding liabilities under all their funding agreements for a minimum period of 36 months; and
  • Maintain access to a minimum of £5m of capital or such other amount as stipulated by the ALF.

In addition, there are strict continuous disclosure and annual audit obligations that members must agree to abide by as part of their voluntary membership of the ALF.

All these provisions are designed to protect the client, an approach to the business of third-party funding which Vannin fully supports. In fact, Vannin conducts itself as if the Code of Conduct capital adequacy requirements apply not only to its UK business, but to its operations globally.

SO WHY SHOULD I BE CONCERNED?

Unfortunately, in Australia and globally, this self-regulated approach to capital adequacy hasn't always provided funded plaintiffs with absolute security. There have been circumstances in Australia and in the UK where inexperienced third-party funders have failed to make good on their obligations, resulting in the funded plaintiff being left exposed. In addition, in Australia, Vannin is aware of notionally experienced funders that lack the financial resources to meet all their commitments.

Two recent cases deal with the consequences of third-party funders failing to honour basic capital adequacy requirements. They are:

  • Ryan Carter and Esplanade Holdings Pty Ltd v Caason Investments Pty Ltd & Ors [2016] VSCA 236; and
  • Excalibur Ventures LLC v Texas Keystone Inc & Ors [2016] EWCA Viv 1144

In reviewing these cases, we have spoken with Lucas Wilk, Partner at Jones Day in Perth; Zane Kennedy, Partner at Minter Ellison Rudd Watts in New Zealand, and Harry Matovu QC at Brick Court Chambers in London who will shed some light on what these developments mean for parties interested in funding their disputes.

RYAN CARTER AND ESPLANADE HOLDINGS PTY LTD V CAASON INVESTMENTS PTY LTD & ORS

This case arose out of an earlier claim by Bakers Investment Group (Australia) Pty Ltd (Bakers) (with the support of a litigation funder) against Caason Investments Pty Ltd (Caason), concerning allegations of breach of contract regarding the exploration and development of a coal mine in Tasmania.

Caason was ultimately successful in defending the claims made by Bakers. Security for costs orders had been made but these fell short of the total amounts claimed by Caason for their costs. Caason then applied for non-party costs to be awarded against the litigation funder, the funder's sole shareholder, Esplanade Holdings Pty Ltd (Esplanade) and Ryan Carter (Carter), the sole director of Esplanade. The court of first instance held that, as the funder had only $100 of paid up capital, the court should pierce the corporate veil to hold Esplanade and Carter liable for Caason's costs. The funder, Carter and Esplanade all sought to appeal this decision. On 7 October 2016, the Victorian Court of Appeal upheld the decision to pierce the corporate veil, and to award costs against two non-parties to a dispute.

The Court indicated that each case would depend on its own facts but, that there were several factors that should be considered when deciding whether to order costs against a non-party: "The financial position of any party against whom a costs order would be made; whether there have been orders made for security for costs; whether the nonparty has a 'real interest' in the litigation, and if so, its extent; the amount of funding contributed by the non-party; and whether the non-party has agreed to provide an indemnity if an adverse costs order is made against a funded party."

The Court agreed that it was appropriate to award costs against the funder, and go after the parties that stood behind it, and it made the following observations:

  • The funder only had $100 of paid-up capital so it was "a person of straw";
  • While the plaintiff retained ultimate control over the litigation, the funder had a significant role, involvement and financial interest in the proceedings and any settlement discussions. Importantly, it was held not to be a passive funder; and
  • The defendants' solicitors had written to the funder putting them on notice that the defendant reserved its rights to make an application for non-party costs against them, and they received no response to that letter.

Given the factors above, the Court held that costs were appropriately awarded against the funder, its shareholder, and director. It was ultimately decided in such a way that was favourable to Caason. It could recover its costs against two non-parties to the dispute, but the path to this conclusion was not an easy one. The need for Caason to pursue its application for costs all the way to the Court of Appeal added significant time and costs to its recovery efforts. All of this could have been avoided if the funder had the appropriate capital support, as Vannin does, for its investment.

Lucas Wilk, Partner at Jones Day in Perth makes the following observations arising from this case:

"This judgment is a reminder of the need for potential plaintiffs considering funding options to be very careful in their selection process. There are now many funding options in the Australian legal market at present. However, there are few funders who have the ability and expertise to guide plaintiffs in funded matters. More importantly, there are few who have the financial capacity and track record for making good on payment obligations (whether as a result of costs orders or otherwise). These considerations will be especially acute for insolvency practitioners. There are many examples of insolvency practitioners standing behind insolvent plaintiffs having to personally pay adverse costs orders. These practitioners should ensure that they are adequately protected from personal liability by having adequate security for costs in place and ensuring that their funder is not a 'person of straw'."

EXCALIBUR VENTURES LLC V TEXAS KEYSTONE INC & ORS [2016] EWCA VIV 1144

The recent decision by the Court of Appeal of England and Wales in Excalibur Ventures LLC v Texas Keystone Inc and Others [2016] EWCA CIV 1144 (Excalibur) highlights the extent of the Court's jurisdiction to make non-party costs orders against third-party funders if the interest of justice require it. With the benefit of third-party funding, Excalibur Ventures LLC had brought a large claim against various defendants, seeking an interest in oil fields located in Kurdistan. The claim failed on every point and the Court made orders that the plaintiff pay the defendants' costs on an indemnity basis. Whilst the plaintiff (with the funders' help) had provided some £17.5 million in security for the defendants' costs, there was a shortfall of about £4.8 million.

The High Court made orders that each of the funders (including parent companies of certain funders) were jointly and severally liable to pay the defendants' costs on an indemnity basis.

In doing so, the Court:

  • Confirmed its broad and plenary jurisdiction to make costs orders against non-parties if the interests of justice require it. Given that the funders' assistance was critical to bringing the claims and that they stood to benefit from any recovery, the Court did not have any difficulty in making them subject to non-party costs orders;
  • Rejected the funders' arguments that indemnity costs orders were inappropriate. Even though there was no finding that the funders' had acted inappropriately, the case had still failed spectacularly – both in terms of factual findings and the claim's basis in law. The interests of justice required the funders to wear these consequences; and
  • Applied the "Arkin Cap" (see Arkin v Borchard [2005] 1 WLR 3055), such that the funders were only liable up to the amount of funding they had provided (including amounts for security for costs) and only for costs incurred by the defendant after the date from which the funder first provided funding.

Whilst the findings of the High Court were upheld by the Court of Appeal, aspects of the Court of Appeal's judgment are worthy of note. In particular, the Court appeared to leave open the possibility that the "Arkin Cap" might be revisited later, particularly in circumstances where the funder's control of the action overstepped judicially accepted limits.

Harry Matovu QC at Brick Court Chambers makes the following observations arising from this case:

"Two important points emerge from the judgment of the Court of Appeal. First, the Court of Appeal confirmed that third-party litigation funding is an important aspect of civil justice delivery in the UK. As Tomlinson LJ put it in the leading judgment, 'Litigation funding is an accepted and judicially sanctioned activity perceived to be in the public interest.' Second, the judgment provides a crystal-clear and salutary warning to all funders investing in cases in the English courts, notwithstanding the extreme facts of this particular case (from funding of £31.75 million, some of the funders expected returns of up to £320 million out of the value of an interest in the oil exploration block if the claim succeeded). The Court confirmed that litigation funders should ordinarily be required to meet their client's obligation to pay the winning party's costs on whatever basis such costs were to be assessed, even if they themselves were not guilty of any discreditable conduct. As Tomlinson LJ observed, 'I can see no principled basis upon which the funder can dissociate himself from the conduct of those whom he has enabled to conduct the litigation and upon whom he relies to make a return on his investment.' So, if a funder decides to back a claim which is so devoid of merit or so improperly conducted as to result in an adverse costs order on an indemnity basis, it cannot expect to escape liability for those adverse costs on the basis that it did not know what was going on or that it wasn't the funder's fault. The Court emphasised the importance of an ongoing review of the progress of litigation by lawyers independent of those conducting the litigation in order to minimise the funder's liability for adverse costs. '[R]igorous analysis of law, facts and witnesses, consideration of proportionality and review at appropriate intervals is what is to be expected of a responsible funder ... and cannot of itself be champertous.'"

THE TAKE AWAY

Whilst regulation of third-party funders is appropriate and to be welcomed, it alone is not enough to ensure that plaintiffs who enter funding arrangements are adequately protected.

Zane Kennedy, Partner at Minter Ellison Rudd Watts in New Zealand, echoes these sentiments in the context of the New Zealand market:

"Recent authority has established that there are no significant common law or statutory obstacles to litigation funding in New Zealand (see Waterhouse v Contractors Bonding Ltd [2013] NZSC 89). This has been reflected in a tangible increase in both the awareness of the availability of litigation funding and the market appetite to fund qualifying claims.

Although the incentives for litigation funding are now firmly established, the costs decision of the NZ High Court in Houghton v Saunders [2015] NZHC 548 emphasised that there is an associated downside in the event the claim does not succeed. In that case, the Court awarded costs of around $5 million against the funder in favour of the successful defendants. The costs award exhausted the funder's adverse costs insurance policy which was capped at $5 million. In pursuing an appeal to the Court of Appeal, the plaintiff was forced to rely upon an indemnity provided by the funder in respect of security for costs.

This case illustrates the importance to prospective plaintiffs of due diligence in evaluating the available funding options. To protect themselves from personal exposure1, plaintiffs must ensure that their proposed funder has sufficient access to capital and/or insurance cover to satisfy any adverse cost awards as well as the resources necessary to prosecute the claim through to completion.

Recent case law in the UK, New Zealand and Australia show that superior Courts of Equity are prepared to take an expansive view of their power to make non-party costs orders, but two clear messages for plaintiffs emerge from a review of these judgements:

  • Extreme caution needs to be exercised if a proposed funder does not have staff with significant legal and third-party funding experience. Excalibur makes clear the important role that appropriate due diligence must play in any third-party funding transaction; and
  • Plaintiffs need to be satisfied that their funder has access to sufficient resources to make good on their end of the bargain to indemnify the plaintiff for adverse costs. If plaintiffs have any doubt about this, they should think carefully about whether to enter a funding arrangement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.