Legal Backing

Exploring the litigation financing landscape in India

Prateek Bagaria, Partner, Singularity Legal

Third-party funding or litigation financing has been a staple of the disputes landscape for many years. It has proved to be an effective and efficient risk management tool, and recent years have seen an upward su­r­ge in litigation financing, especially in the construction and infrastructure sector.

What is litigation financing

Litigation financing is an arrangement between a third party and a party to a litigation or an arbitration, where the former agrees to fund the legal expenses in relation to the dispute, in­cluding lawyers’ fees, disbursements and other costs, in exchange for a share of the claim proceeds. This type of funding occurs on a non-recourse basis, meaning that if the claim cannot be recovered, the claimant is not responsible for repaying the legal costs incurred by the litigation funder.

It provides a reliable financial tool and risk management option, especially for the cons­tru­c­tion industry, vis-à-vis mediation through arbitration or court trials – for single claims, claim portfolios and joint venture claims. The goal of litigation financing is to provide liquidity as well as budget certainty for a claimant’s finance and legal departments in order to pursue worthy claims.

Litigation financing in India

Litigation financing was traditionally a resource for funding when one could not afford to pay one’s own legal fees. This perception has now changed, and law firms and companies are inc­reasingly utilising litigation finance as a strategic risk mitigation and cash flow management tool to transform disputes from cost centres to revenue generators. However, this change in perception does not undermine or do away with the underlying principle of access to justice. This concept of open access to justice for all and the creation of a level playing field is still a fundamental purpose and characteristic of litigation finance.

India has rich jurisprudence on litigation finance unlike many other common law countries, mainly because common law torts and cri­mes of maintenance and champerty were never in force as special laws in India. Conse­qu­ently, a fair agreement to supply funds to carry on a suit in consideration for a share of the litigation proceeds has never been considered void, illegal or against public policy in In­dia. Notably, am­endments by states such as Ma­ha­rashtra, Guja­rat, Madhya Pradesh and Utt­ar Pradesh to the Civil Procedure Code, 1908, make express provisions recognising and providing rules in relation to litigation finance.

However, it is worth noting that if an Indian court finds that a funding agreement is extortionate, unconscionable or inequitable, it may refuse to give effect to it under Section 23 of the Contract Act, 1872, on the ground that it is against public policy. This raises the question of what makes a litigation finance agreement (LFA) unfair, extortionate, unconscionable or inequitable.

The answer is subjective and varies from case to case. However, some common principles that emerge from jurisprudence are that the funding agreement will be invalidated and/ or held unenforceable if an agreement is sh­own to have been entered into for an improper object or to encourage litigation which, on the face of it, is unrighteous; or where a lawyer fun­ded their client’s dispute; or where the funder had influence over the judge.

The courts have also considered other principles with respect to the LFA. For instance, a rise in the total return due to the funder, depending on the length of the litigation and the funder’s participation, has been accepted; as has been a waterfall clause under a non-recourse funding agreement as an equitable assignment of the litigation proceeds to the funder.

India has now become a hotbed for high-value international commercial disputes. The Indian market has been a busy participant in the growing international litigation finance industry. There are several examples of Indian parties being funded in arbitrations and litigations outside India. There are also reported examples of foreign parties being funded for claims against Indian parties. Further, the courts’ intervention in the enforcement of arbitral awards is also minimal, thus making a strong point to the funders in favour of the Indian market.

A good example of claimants (who have no means to recover property) are financially stre­ss­ed engineering, infrastructure, and oil and gas companies, having large claims against the sta­te and state-owned enterprises in India, but little or no capital available to pursue those clai­ms. Financing of the legal costs for such companies, including by banks and financial institutions, in exchange for a share of the recovered proceeds, is therefore permitted by law.

Litigation financing and the infrastructure sector

The pandemic brought with it disputes and lesser businesses. This led to:

(a) lesser or no capital to run meritorious dispu­tes, leading to many companies having to shut shop.

(b) lenders having to write off the loans and overdrafts as bad debts.

(c) lack of capital to seek an effective enforcement regime, despite having a favourable arbitral award or judgment.

This is the trend seen mainly across the construction and energy sectors.

The complexity, length and expense of construction disputes can often be a daunting pros­pect, especially for contractors who may already be facing cash shortfalls due to accumulated unpaid claims or cost overruns on the project itself. Third-party funding offers a viable option for these parties, who would otherwise be faced with the alternatives of either writing off their losses or negotiating unfavourable settlements.

Many struggling companies saw a way to remain afloat through these critical times in litigation financing, resorting to it to run their disputes or enforcement regimes, while using their existing capital to continue their business. An example of this is Hindustan Construction Com­pany Limited’s (HCC) litigation finance deal in the engineering, procurement and construction sector, in pursuance of which HCC would monetise a pool of arbitration awards and clai­ms in ex­change for an upfront cash payment, which would allow the company to repay debt and meet its working capital needs. Under the terms of the transaction, HCC would transfer its beneficial interest and rights in its claims to a special purpose vehicle controlled by a consortium of investors, led by BlackRock. HCC got Rs 17.5 billion for the deal.

Third-party funding therefore allows for an effective allocation of the risk involved by relieving the funded party of part, or potentially the entirety, of the risk involved. Moreover, since the intermediate and direct costs are borne by the funder, the funded party is free to allocate the resources and funds which would otherwise be tied up in pursuing the claim to other matters. Additionally, the party can propose portfolio fun­ding for all its claims. Port­folio funding is an att­ractive option for funders, as it cross-collateralises its risk across multiple potential outco­m­es. The funder is more likely to receive a return, co­ver its investment and make a profit, whilst the company reaps the benefit of an improved cash flow and reduced risk.

Many lenders also found recourse in a number of options. For instance, on the one hand, we assisted our clients’ lenders in financing me­ritorious claims to recover their dues. On the oth­er, we assisted our lender clients in selling their debt to litigation financiers, thereby assisting le­n­ders in removal of non-performing assets from their balance sheets. Litigation financiers could also assist by funding and managing the deb­tor’s dispute up to the enforcement stage.

An additional option is direct debt recovery against the companies. A good example is the cases where we assisted our lender clients in ob­taining finance to pursue aggressive debt re­covery action against their debtors. The companies/debtors regularly come up with creative wa­ys of funnelling the money to jurisdictions that are out of the reach of lenders. The lenders/ ba­n­ks benefited from the global presence, expertise and creative strategies employed by litigation funders in terms of asset tracing and investigation. The investigation teams of litigation funders pierce through the corporate veil and come up with equally creative solutions.

In sum

The infrastructure market is perfectly positio­n­ed for litigation financing for all stakeholders – funders, lenders, employers, contractors, sub-co­ntractors and vendors. A funder’s involvement also provides a helpful indication of whe­ther a claim is worth pursuing, based on the third-party funder’s assessment.

This second-level validation of the merits of claims, the rebuttal of highly unfavourable settlement offers, and allowing good lawyers to run all the cases, both to defend and also to realise monies owed, are elements particularly relevant to the construction industry, as recent times have highlighted.

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