What is litigation funding?

In Italy, a new form of litigation financing is timidly emerging, the so-called litigation funding or third-party litigation funding (TPLF). TPLF is an investment transaction: a lender invests in a legal dispute (whether judicial or not) or an arbitration, in which he has no interest, taking on himself, in full or in part, the costs and the risk, in whole or in part, in the event of losing (including the payment of judicial expenses to the other party).

In case of success, the lender will receive the fee, calculated in percentage; in the event of a loss, given that transaction involves a transfer of the risk of the dispute’s failure to the lender, the funder must not be repaid. This factor constitutes a strong incentive to the request of funding.

The legal financing activity is relatively new for our country. Still, it is already widespread in Common Law countries such as Great Britain, the US, Australia and Canada, but recently also Germany, Switzerland, up to reaching Asia.

Big international funds supported several famous international disputes, among all, the class action against Volkswagen for the dieselgate, the lawsuits brought by the shareholders against Lloyds TSB for the rescue of HBOS and against the Royal Bank of Scotland, and finally the one for the execution of the divorce of the Russian oligarch Farkhad Akhmedov from his former wife Tatjana of 453 million pounds value.

There are many British and American funds. Still, some realities in Italy (even rather small, but enticed by the opportunities that this business can offer) are gearing up to open international funds, sometimes attracting some big investors available to finance these possibilities.

The litigation funding underlies the so-called agreement de quota litis, forbidden in Italy and which prevents lawyers from receiving, as a compensation, the asset object of the service or a share thereof. The ban, however, does not operate against third parties, allowing intermediation of a third party, as happens with the instrument of litigation financing.

The related litigation funding contract may apply in our country in compliance with the general principle of contractual autonomy under art. 1322 c.c., and, in particular, the principle of contractual atypicality according to art. 1322, paragraph 2, of the Italian Civil Code.

The goal is, therefore, also in the Belpaese, particularly in cities like Rome and Milan, the assumption of legal costs of disputes by specialized funds, in exchange for the return of the invested capital, of private subjects, companies, companies and also Public Administrations.

The advantages of the operation and the selection criteria of Funders

The institute is born, as main goal, as financial and legal support for those who do not have financial resources required to take the high costs of jurisdictional and arbitration disputes. Still, TPLF is useful for companies who intend to allocate their budget differently and target their core business (such as multinational companies, who are facing a growing number of disputes).

The costs of justice represent a strong disincentive, as well as the risk of the outcome of the litigation. Therefore, the financing of litigation by third parties represents:

           • An incentive for access to justice for private citizens and businesses;

           • A risk-transfer mechanism for the uncertain outcome of the dispute to the lender;

       • It requires a thorough due diligence analysis to assess the risks of the investment. DD is also useful to evaluate the chances of success of the dispute, which will avoid the opening of a lawsuit with a low probability of a favourable outcome, from subjects of weak solvency and in which the trade-off between high judicial costs/times and benefits it is not beneficial.

In particular, due diligence analysis is based on the following parameters: the value of the case; solidity and solvency of the parties involved; the progress status of the dispute; likely duration and the total cost of the investment.

And it is precisely on the risk factor that the game of international funds is played: legal financing takes into account the risk of a negative outcome of the dispute, holding back a percentage, only in the case of victory. Risk-transfer can give a decisive contribution to the choice to access to jurisdictional and arbitration protection for private citizens and businesses.

To draw the attention of Litigation Funders, therefore, the lawsuit must reach a specific value, assure good chances of a positive outcome (the ROI analysis serves this purpose). Also, the counterpart must guarantee individual solvency and the timing of the dispute, although not necessarily fast, should be predictable with a relative margin of safety.

Usually, there is a limit on the value of the litigation as the minimum threshold for accessing the operation.

The agreement, the so-called litigation funding agreement, it can be rather elaborate and intricate. It must include a special section that regulates the relationship in the event of an unsuccessful settlement, an area still not covered by Italian insurance companies.

Most significant areas of interest for Litigation Funders in Italy

Arbitration, both national and international, is the area of most considerable interest for international funds in the Italian litigation market; the execution of sentences abroad; claims for compensation for non-contractual liability; the proceedings against the Italian State; class actions, insolvency procedures and debt collection for bankrupt companies.

Italy is undoubtedly fertile ground for this type of financial operation. Usually, the timing of dispute resolution is quite long (above all, in civil and commercial disputes) and the legal expenses are very high so that the parties - companies or private citizens - are induced to give up on the dispute. These unfavourable conditions can, however, represent a strong incentive for specialized funds, which can easily transform an issue into a real business opportunity.

In particular, SMEs, not being able to afford the costs of activating and managing national and, above all, international procedures, renounce all credit claims and, being unable to pay their debts, they will inevitably fall into bankruptcy.

Italy, such as the other Eurozone countries particularly hit by the sovereign debt crisis, including Spain, Greece, Portugal and Ireland, was particularly affected by austerity policies, low productivity and slow growth, and witnessed the wear out of its productive fabric, based mainly on small and medium enterprises. Therefore, in recent years, bankruptcy and insolvency proceedings have increased dramatically, as well as disputes for companies which, despite not being at risk of insolvency, are forced to invest their resources in litigation.

It is well known that in our country bankruptcy and insolvency procedures, in general, represent a large percentage of disputes: in Italy, almost 90,000 files stand before the bankruptcy sections of the Italian courts.

The arbitral procedures are the most interesting to the eyes of international funds, and also the most suitable to respond to the needs of the operation (particularly, to the expenses to incur). However, the Italian legislation does not seem to keep the pace. To this end, the Milan Chamber of Arbitration intervened to adapt Italian arbitration praxis to the activity of third-party litigation funding and, therefore, when dealing with a third party funder. In particular, the new regulation of March, 1st 2019 introduced the disclosure’s obligation, already existing for the arbitrator, and now also for the third-party investor.

The role and benefits of the institute for lawyers: what Italian law firms must do to adapt

This growing interest in the institution places law firms and arbitration chambers in front of the need to develop new strategies and new systems suitable to manage the dispute in the light of the opening of the dispute to a third funder.

The incentive to collaborate with these funds also exists for lawyers and law firms, who can obtain higher guarantees to receive their remuneration, while maintaining the freedom to exercise their activity autonomously and independently (but also with the obligation to promptly inform about their legal strategy to the investors).

To do this, they must demonstrate an openness to the new frontiers of litigation, providing themselves with appropriate desks within their law firms. The purpose is to adapt the instruments to intercept and dialogue with these international funds. Milan and Rome are the Italian cities that are proving to be more prepared to deal with these foreign funds due to their greater openness to the international market.

The specialized fund dialogues directly with the law firm, which has an intermediary role between them and the client, to whom it can recommend or not the contract. To this end, the documents necessary for the agreement are drawn up (included application for financing complete with a technical-legal report on the dispute and the related documents attached), due diligence analysis by the lender and presented to the investors, who will evaluate the convenience of the transaction. The lender, in case of acceptance of the application, will communicate the general and particular conditions of the financing operation. The lawyer’s task will be to assist the client in all phases of the transaction, up to the actual drafting of the litigation funding agreement. There is also a need for a trilateral agreement (between lawyer - fund - client) regarding the priorities of the operation.

Therefore, hopefully, there will be soon the proliferation of joint ventures between law firms for both national and international disputes also in Italy.

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BLB Law firm was founded in Milan in 2008, with offices in Rome and Shenzhen and it is active, among others, in the fields of Corporate, Administrative Law, Banking, Finance and Insurance, M&A, IT, Private Equity, Real Estate and Data Protection.

The Firm, recommended by Legal 500, has always had a strong international vocation and has collaborative relationships with the most prestigious firms in Europe, Asia and North America. Through its global desks, BLB is able to offer a wide range of services to its clients in arbitration and judicial litigation, to provide entrepreneurs and investors with the opportunity to operate at an international level and to provide high-level assistance thanks to the consolidated experience of its members and collaborators, always free of linguistic, cultural and professional barriers.