A question few funders dare ask openly, given the obvious risk of excommunication, but one which is impossible to ignore, given the deafening whispers reverberating in the industry’s corridors since 10 February 2020.
On that day, Nugee J handed down judgment in respect of the application for security for costs in the Ingenious Litigation (Rowe and others v Ingenious Media Holdings plc and others) against the claimant’s litigation funder, Therium. It wasn’t just unfortunate for Therium, who were ordered to post security of just under £4 million. The comment by Nugee J, that Therium’s Association of Litigation Funders (ALF) membership was not “sufficient to give one enough confidence” to guarantee that it would pay any costs in an unsuccessful outcome, sent a subtle but deep shockwave through the industry.
For the first time since its formation nine years ago, there is a real existential question mark over ALF. Its five page Code of Conduct may have helped establish the credibility of the market initially, but it remains a largely unchanged self-regulating body whose threat to impose a £500 fine feels out of kilter with the market today. No wonder that some critics say that ALF looks like an exclusive members’ club, fading into irrelevance, than an actual regulatory body.
The real issue, however, is not an existential debate about ALF, but about the need for a consensus on best industry practices that is fit for today’s litigation funding market. Perhaps it is ALF that can bind that consensus together. But whether ALF or no ALF, the industry could do with a best industry practices code which is more current, more detailed and for the benefit of all.
Looking back on ALF
Back in January 2010, when the Jackson Review was published, the litigation funding market was embryonic. Very few funders actually existed and those that were active had limited investment capital to deploy. Of the current ALF members, Burford was less than a year old; Harbour, Calunius and Therium would close their “first” funds later that year; Vannin and Woodsford were about to be founded; and Balance Legal wasn’t even conceived.
The soon to be burgeoning industry also noted the review’s recommendation that it should self-regulate by way of a voluntary code of conduct, which ultimately manifested itself in the Code of Conduct for Litigation Funders by the Civil Justice Council. This led to the creation of ALF in November 2011, with the Code of Conduct approved by the board of the Civil Justice Council, the Master of the Rolls Lord Neuberger, and Jackson LJ himself.
At the time, this was proportionate. To recommend a detailed, regulatory framework for a market that was by every measure nascent and miniscule would have been disproportionate and unfit for purpose, if not impossible.
ALF’s Code of Conduct set out best industry practices, covering the principles of capital adequacy, general conduct, litigation funding agreements (LFAs) and control. Sanctions for breach ranged from warnings, public humiliation, excommunication or that famous £500 fine. Funders and brokers then recommended to prospective claimants and their solicitors that only an ALF-regulated funder should be used. Back in 2011, they were perhaps right.
Today, however, the marketplace looks very different. There is a vast amount of investment capital already in play and waiting to be deployed. Litigation funding opportunities are far more global geographically. They vary in size from the small to the very big, and pricing (such as Sparkle Capital’s fixed interest funding product) is no longer based on just a share of the award, as the Code of Conduct assumes every deal will be. More importantly, the market today has participation from many other types of institutions, including global law firms, substantial hedge funds and commercial banks, to whom ALF membership holds no value.
ALF now only covers a small percentage of UK litigation funders for England and Wales matters, so its recommendation to use only ALF members inadvertently devalues itself into a self-serving business development tool. In short, ALF is in need of an evolutionary overhaul.
What should best industry practices cover?
ALF’s Code of Conduct had many of the right ingredients, but its principles on capital adequacy, general conduct, LFAs and control now need further development and evolution. While this blog is not the right forum to go into the details of each one, we address at a high level how they might evolve to form the backbone of a new consensus on best industry practices.
The idea that litigation funders should not take control of any litigation is today a firmly established principle. In practice, solicitors’ primary obligations to serve their clients’ best interests has firmly enforced this anyway, making this somewhat of a moot point, especially with single case litigation funding.
At the same time, the market has evolved such that commercially-minded claimants increasingly see litigation funders as a party to sell their risk exposure to and relinquish control. In reality, this is no different from debt purchasing (where corporates sell off debts to someone who will take it off their hands) or, even closer to home, a Manolete-style assignment of a claim.
ALF’s Code of Conduct avoids getting involved by saying that its members can still engage in any “financial or investment transaction that is permitted under the relevant law”. But that is as big a loophole as any.
In a world where litigation funding arrangements are becoming more bespoke to each situation, perhaps the focus of conduct should really lie less in the matter of control and more in promoting the very raison d’etre of litigation funding: access to justice.
One large section of ALF’s Code of Conduct is dedicated to articulating what the LFA should or shouldn’t say. This may have been fit for purpose in 2011, when single case funding was the only type of funding the market expected and each funding deal was a milestone.
Today, litigation funding is not just about single case funding. Portfolio funding, or funding to law firms on commercial matters (as Sparkle Capital does), case assignments or acquisitions, and so on, make any guidelines on LFAs moot. This is because it is standard practice that the funded party seeks independent legal on its terms prior to execution.
Most funders have their own standard LFAs, like banks do in corporate lending. But if standardisation is what we’re after, the industry should seek inspiration and guidance from the International Swaps and Derivatives Association (ISDA®). ISDA® is a long-standing, widely respected and very powerful body of derivative market participants, that created the ISDA® Master Agreement to govern standardised contracts for derivative transactions. In the process, it brought huge benefits, including transparency and operational efficiencies, to market participants.
ALF’s Code of Conduct remains surprisingly light on the points of general conduct when compared to the FCA’s Treating Customers Fairly Framework.
While Sparkle Capital Ltd is not an ALF member, Acasta Europe Ltd (the provider of after the event (ATE) insurance products that administers Sparkle) is an FCA regulated body. In being so, it adheres to the principles of Treating Customers Fairly. This is not just a light-touch framework, but a key priority for the FCA that must lie at the heart of regulated firms’ business models.
At the same time, many professional third party funders are staffed with solicitors regulated by the Solicitor’s Regulation Authority, which means that day to day, practitioners are often required to (or do so by habit) follow the SRA principles and the SRA Code of Conduct.
General conduct by litigation funders is an integral component of best industry practice. Perhaps the industry should be looking to take advantage of (and perhaps include) the general conduct principles of both the FCA and the SRA into its consensus.
ALF’s idea to include a capital adequacy framework (albeit a rather simplistic one compared to its banking and insurance cousins) should be commended. But Nugee J’s dismissal of ALF’s authority on capital adequacy should also be welcomed because he was not willing to accept that a corporate rubber stamp should cover for the fact that “no actual financial information about Therium had been adduced”.
As a principle, this author agrees with Nugee J’s principle because a reliance on corporate rubber stamps, at the expense of actual facts, is simply bad practice. One such parallel exists in “ATE land”, where insurance brokers, the legal industry and the judiciary have a tendency to rely on paid-for corporate ratings from for-profit companies, instead of considerably more extensive, publicly available facts that are disclosed as part of a regulatory obligation.
More importantly, if there is one lesson that could be learnt from the credit crisis of 2008, it is that paid-for corporate ratings should not be relied upon to make investment decisions, but simply to guide and better inform them, given that 13,000 AAA-rated bonds, which were obviously not so AAA, were downgraded, and approximately US $90 billion of fines in the US alone (including over US $2 billion for the rating agencies) got dished out.
With insurance, however, there is extensive publicly available information, as required by Solvency II, meaning that there is no excuse for insurance brokers or the legal industries to not do the work in “ATE land”. But the world of litigation funders differs in that its information is not so publicly available.
In practical terms, it is commercially challenging for many funders active in litigation funding to disclose actual financial information. Notwithstanding confidentiality restrictions of investor agreements, there is a reasonable objection to funders giving away market sensitive information that they perceive to be their own competitive advantage.
In other words, it’s unrealistic to expect an effective capital adequacy framework in what is essentially a private market. However, the unregulated but deep and long established (but equally private) commercial real estate lending market (£60 billion plus in the UK in 2018 alone) shows that the objectives of a capital adequacy framework can still be achieved.
How? By promoting best industry practices when entering LFAs and leveraging the fact that this market is now sufficiently established for funders, who do not have the capital adequacy to back cases they fund, to lose not only their invested capital but its market reputation, the commercial death knell of any funder.
The future is not just about ALF
Nugee J’s ruling raised a real existential question about ALF. However, to simplify it into the pros and cons of ALF would be to overlook the deeper issue at play here: the need for an evolved, modern consensus on best industry practice, in which ALF may or may not play a central role.