Third-party arbitration funding continues to be a hot topic in Germany, as evidenced by the fact that it was the focus of the German Arbitration Institute's (DIS's) 2019 Autumn Conference (Third-Party Funding – Short-Term Hype or More?). However, despite the current hype surrounding third-party funding, it has been practised in Germany for more than 20 years.
Generally speaking, such funding was initially used during enforcement. For example, funding was used and funders helped to enforce judgments and arbitral awards against reluctant debtors or in difficult jurisdictions. Later, third-party funding became increasingly popular in investor-state arbitration.
In recent years, third-party funders have been at the forefront of developments shaping the German legal market. For example, they have funded technology-driven providers that, on a contingency basis, enforce passenger claims against airlines or bundle consumer and shareholder claims against car manufacturers.
With much less controversy than in many other jurisdictions – Germany does not follow the common law principles of maintenance and champerty(1) – third-party funding has thus been used in multiple ways for over 20 years and the German courts have repeatedly validated its use.
A growing number of companies are considering using third-party funding and more international funders than ever are joining established German funders in the German market. This is partly due to Brexit (ie, many financial institutions have set up a presence in continental Europe to ensure their ability to do business in continental Europe irrespective of a negotiated or a 'hard' Brexit), but it also stems from the opportunities that Germany presents.
'Third-party funding' means that an investor undertakes to pay a party's legal costs – in particular, the lawyers' fees and expenses. It may also include an obligation by the funder to:
- pay the opposing party's legal costs (if the funded party is so ordered);
- pay any other costs, such as the arbitral institution's administration fee, arbitrators' fees and expenses; and
- provide security for the opponent's costs (if the funded party is ordered to provide such security).
In contrast to factoring (a form of monetisation of a claim), the funded party will formally retain and enforce its claim.
What terms and conditions are generally associated with third-party funding?
Only a few companies publish their standard financing agreements,(2) which makes it difficult for parties seeking third-party funding to gain a market overview without legal advice from experienced counsel. In addition, the terms and conditions of third-party funding differ. Nonetheless, third-party funding agreements share some common features.
A funding agreement is entered into between a funder and the funded party, not the funded party's lawyers. The funder undertakes to finance the costs of pursuing the claim in exchange for a predetermined success fee, usually a certain percentage of any proceeds realised or a multiple of the money invested. In practice, it is often a combination thereof, with the funded party agreeing to pay the greater of the two.
Typically, the funded party must:
- assign the claims to the funder as security;
- disclose all circumstances relevant for the funder's assessment of the claim, including any legal analysis;
- release its counsel from confidentiality obligations towards the funder;
- report, or have its counsel report, any new developments to the funder;
- ensure that the funder has the right to participate in hearings;
- enter into any settlements only with the consent of the funder; and
- pay the success fee (in case of success).
The funder, in turn, must:
- provide the agreed funding (usually lawyers' fees and an advance on the arbitral tribunal's fees); and
- reimburse the adverse party's legal costs in case of an unfavourable outcome (some funders always include reimbursement of the other party; for others this is part of the commercial deal to be struck).
Not only an option for potential claimants
Although third-party funding is usually sought by potential claimants, it also is available to defendants. Such funding has remained scarce, as it is difficult to strike a deal that appeals to both the funder and the party seeking funding. If a defendant has a considerable counterclaim such that it may be considered the true claimant, a solution can be found rather easily. Otherwise, the funder's potential gain is usually a portion of the amount 'saved' by the funded party, meaning that a funded defendant that prevails will, following the payment of the success fee to its funder, still have incurred a loss. While such prospects may appear unappealing, there may nonetheless be situations in which a defendant will be interested in avoiding having to pay its lawyers' fees in return for a potential payment to the funder if the defence is successful.
Lawyers cannot offer third-party funding
In Germany, success fees for lawyers are permitted only in exceptional circumstances.(3) As a result, lawyers generally cannot:
- act as funders for their clients;
- obtain funding on behalf of their clients; or
- become party to the funding agreement.
Lawyers can assist their clients only in identifying suitable funders and agreeing on the terms of the funding agreement. Further, they will often contact the funders to inform them of how the proceedings develop and respond to their questions. However, due to a potential conflict of interest, the funded party's lawyer would never simultaneously act as lawyer of the funder. Instead, in more complex cases, funders often retain lawyers to assist them, initially in assessing the case and subsequently in monitoring the proceedings.
Settlement of funded arbitration
Third-party funding can have a significant impact on proceedings if a settlement is discussed. Difficulties arise if a funded party and its funder cannot agree on whether a settlement offer should be accepted.
In arbitrations with a German connection, the question of a potential settlement may arise more often than in other jurisdictions. German arbitrators frequently offer to assist parties to settle disputes at an early stage in the arbitration (arguably more so than arbitrators from other jurisdictions where such assistance is often considered to raise concerns in relation to impartiality). The 2018 DIS Arbitration Rules stipulate that "[u]nless any party objects thereto, the arbitral tribunal shall, at every stage of the arbitration, seek to encourage an amicable settlement of the dispute or of individual disputed issues".
Funding agreements usually provide that any settlement will require the consent of the funder. This can lead to a situation in which the funded party would prefer to accept a settlement offer but is prevented from doing so by a funder that hopes to gain more from the continuation of the proceedings. Conversely, if the funder prefers to agree to the settlement offer because (for example) a higher amount could only be realised by investing a disproportionately high amount into the continuation of the proceedings, it usually cannot force the funded party to do so.
Some funding agreements solve such situations by referring the dispute to a sole arbitrator, which must decide whether the settlement will be accepted. Problematically, under other funding agreements, if a funded party wishes to pursue the claim while its funder wishes to settle, a termination right for the funder is triggered. Funding agreements may provide that in case of such a termination, the funded party would have to put its funder into the position as if the settlement agreement had been concluded. This obligation would most likely entail a repayment of the funded costs and a success fee. A party that entered into the funding agreement because it had insufficient funds to finance its claim may thereby in practice be forced to accept a settlement agreement because it cannot afford the termination by the funder. Parties entering into third-party funding agreements should watch out for such provisions.
Because most arbitrations are confidential, there is little public information about the use of third-party funding in arbitrations with a German seat or another German connection. However, many recent high-profile litigations have been at least partly funded by international funders, such as Bentham IMF and Burford, which funded (for example) shareholders claims against Volkswagen in relation to its alleged failure to timely inform shareholders about the ongoing investigations into its diesel emissions and antitrust follow-on cases against truck makers.
In one high-profile case, the concept of third-party funding has become particularly controversial. Financialright GmbH bundled the claims of approximately 15,000 car owners against Volkswagen in relation to diesel emissions. The car owners assigned their claims to Financialright to enable it to bring the claims in its own name, joining all of the claims in a single proceeding. However, as regards the car owners, Financialright must pay the proceeds of a successful claim after deducting a certain percentage of the claim as a success fee. If the claim is unsuccessful, Financialright bears the costs.(4)
In this litigation, which is pending before the Braunschweig Regional Court, Volkswagen has argued that Financialright's approach constitutes a combination of claim collection and third-party funding, which violates the German law on legal services. After all, as the car owners do not have to pay the lawyers, Financialright essentially funds the claim in return for a portion of the proceeds; however, it also seeks to collect the claim. Volkswagen holds the view that as a result, the claims must be dismissed because the violation of the German law on legal services renders the respective agreement for the assignment of the claims null and void. Allegedly, Volkswagen and Financialright have each retained four experts on this question, many of whom have published articles on the matter in recent months.(5)
While the third-party funding element may lead to the dismissal of the claim (if the Braunschweig Regional Court agrees with Volkswagen), the discussion should not cloud the view on third-party funding as such. In this case it is not third-party funding per se that is considered inadmissible, but rather the combination of claim collection and third-party funding. Unlike the business model used by Financialright, traditional third-party funding does not involve the element of claim collection; instead, the funded party pursues the claim.
In Germany, traditional third-party funding is an established and safe instrument (with due care regarding the content of the funding arrangement). In general, a party seeking third-party funding will have to consider legal norms applicable to:
- the seat of the arbitration; and
- the expected place of enforcement.
Absent legal arguments against third-party funding, the question of funding is largely a commercial one. Naturally, a party that has a good claim but no funds to enforce it may choose to obtain third-party funding to stand a chance of having its claim realised. However, third-party funding is not only for the needy. For example, if a party has an interest in keeping its balance sheet unaffected by a costly arbitration (eg, it is preparing a takeover or is in the process of being acquired), third-party funding can be a useful tool.
Third-party funding often sounds appealing, but in reality it is not that easy for a funder and funded party to come together. A party that believes it has a strong claim will be reluctant to promise 20% to 30% or more of the proceeds to a third-party funder. Further, a third-party funder will be reluctant to fund a claim if it believes the claim to be weak and funders will be particularly mindful of the funded party's potential counterparty. Investing in a claim makes sense only if an award can be enforced. If the defendant has assets only in a jurisdiction with a weak track record of enforcing arbitral awards or if a defendant is close to insolvency, third-party funding is unlikely to be available.
Endnotes
(1) See Sessler and Saettler, Handbook on Third-Party Funding in International Arbitration, pp 229 et seq.
(2) See Roland Prozessfinanz and Legial (available in German).
(3) See Sessler and Saettler, Handbook on Third-Party Funding in International Arbitration, p 230.
(4) See Hartung (Anwaltsblatt, 2019, p 353). Reportedly, Financialright has passed on that risk to the third-party funder Burford, which advanced the legal costs. However, this is not the aspect of the concept that is the subject of Volkswagen's attack.
(5) See Hartung (Anwaltsblatt, 2019, pp 353 et seq).
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