Paying for Conflict and Resolution: Europe Seeks Further Third-Party Funding Regulation
On Sept. 13, 2022, a majority of the members of the European Parliament adopted its Legal Affairs Committee’s proposal, “Resolution with recommendations to the Commission on Responsible private funding of litigation” (available at https://bit.ly/3L2TBAO). See also analysis at EU Litigation Update, Quinn Emanuel Urquhart & Sullivan (Feb. 28, 2023) (available at https://bit.ly/41RB80P).
The recommendation proposes offering to the European Union Parliament and the Council a directive on commercial third-party litigation funding. But before the European Commission proposes the directive, the proposal requires an assessment of the impact of the related Directive (EU) 2020/1828 on Collective Redress for consumers. This assessment needs to be completed by next month. Joan Salvà, “The Dawn of a New Litigation Model for Intellectual Property?” International Federation of Intellectual Property Attorneys (Feb. 22, 2023) (available at https://bit.ly/41wGa2U).
Once the assessment is completed, the European Commission will need to propose a directive. If the directive is enacted, Member States would be given a deadline to implement the directive in their domestic law. See EU Regulatory Developments, Omni Bridgeway (available at https://bit.ly/3oG6TvD).
The European Parliament proposal’s objective is to bolster the current rules on private investors’ ability to generate profits through third-party litigation funding. See EU Litigation Update, above. While the European Commission has yet to submit any legislative proposal, the European Parliament has called for a directive in order to establish common minimum standards for third-party funding in the European Union. See Robert Wheal & Oliver Dean, “The End of the Regulatory Vacuum in Europe and a New Era for International Arbitration in Ireland? Developments in Third-Party Funding Regulation,” White & Case (available at https://bit.ly/3n7BMbD).
The concept of commercial third-party litigation funding was born almost a quarter of a century ago. It is a business model in which investors cover the litigation costs of a party involved in a dispute. In return, the investors receive a portion of the award, if the case is successful. See EU Litigation Update, above. In addition to conventional litigation, third-party funding firms back arbitration parties.
According to available data, litigation funders may, in certain countries within the European Union, demand a disproportionate share of the proceeds that exceeds the typical returns of other types of investments. The amounts claimed by litigation funders normally range across the European Union from 20% to 50% of the award. Furthermore, empirical data shows that litigation funders most often select cases that represent the best potential returns and would not invest in cases they regard as too risky or not profitable enough. See EU Recommendations, above.
The third-party funding market has expanded significantly in recent years to become a global industry worth an estimated 40 to 80 billion Euros. In the European Union alone, more than 100 commercial funds are now active, with increasingly sophisticated players entering the market. See Robert Wheal & Oliver Dean, above. It is hard to determine the number of litigation funders but at least 45 such funders operate in the European Union. See EU Recommendations, above.
Although third-party funding has become common in international arbitration proceedings within Europe, it has been left largely unregulated, resulting in each Member State adopting different stances regarding the role third-party funding is permitted to play in their respective legal systems. See Robert Wheal & Oliver Dean, above. Divergences in the legal framework applicable in each Member State entail a risk of discrimination in access to justice between claimants in different states, in particular in cases with a cross-border element and a risk of forum shopping by litigation funders. See EU Recommendations, above.
In an effort to address this, the proposal seeks to introduce a third-party funding regulatory regime “focused on transparency, fairness, and proportionality.” See Robert Wheal & Oliver Dean, above.
The proposal seeks to ensure a balance between granting access to justice and providing appropriate safeguards to those engaged in proceedings, to prevent their right to access justice from being unjustly exploited. See EU Recommendations, above.
According to the proposal, “when litigation funders provide financing for legal proceedings in exchange for a share of any compensation awarded, a risk of injustice can arise. That risk includes litigation funders being able to take advantage of claimants, or those whom they represent, including, where relevant, consumers whose interests are represented by qualified entities, to serve their own purposes and to maximize their own return, thus leaving claimants or intended beneficiaries with a reduced share of the potential award.” This risk can be particularly acute when those expecting to benefit from litigation are consumers or victims of fundamental rights violations who might welcome the involvement of a litigation funder ready to pay for proceedings. See EU Recommendations, above.
In the resolution, members of the European Parliament recognized that Member States have a primary responsibility to make adequate legal aid available to those who lack sufficient resources and to ensure access to justice for all, in line with Article 47 of the Charter of Fundamental Rights of the European Union.
The proposal acknowledges that if properly regulated, third-party litigation funding can be used more often as a tool to support access to justice, especially in countries where legal costs are high, or for women and marginalized groups with additional funding barriers. Third-party litigation funding can also increasingly help to ensure that public interest cases are brought to court and to reduce significant economic imbalances that exist between corporations and citizens seeking redress, and thereby ensure appropriate corporate accountability. See EU Recommendations, above.
The September 2022 European Parliament proposed directive would regulate commercial third-party funding within the European Union. See also EU Litigation Update, Quinn Emanuel, above.
The directive proposes to:
- Create an independent public supervisory authority which would be responsible for overseeing the authorization of third-party funders and for monitoring their activities;
- Empower Member States’ courts to hold third-party funders jointly liable with claimants to pay any adverse costs that may be awarded in unsuccessful funded proceedings where the claimant party has insufficient resources to meet those costs;
- Require third-party funders to demonstrate on an annual basis that they possess adequate financial resources to pursue their activities;
- Impose a fiduciary duty of care on third-party funders toward the claimant that they are funding;
- Establish specific disclosures and transparency obligations to inform the relevant judicial or administrative body of the existence of any third-party funding agreement;
- Require that any third-party funding agreement should be written in the official language of the Member State in which the claimant and intended beneficiaries are resident;
- Require that, on the request of the relevant judicial or administrative body, a complete and unredacted copy of the agreement be provided at the earliest stage of proceedings;
- Require a clause in funding agreements specifying that any awards from which the fees of the funders are deductible will be paid in full to the claimants first, who may then pay the agreed sums to the funder;
- Require defined circumstances in which the funder can terminate the agreement rather than allowing the funder to terminate at will;
- Require that agreements must contain a declaration that the funder has no conflict of interest;
- Render funding agreements invalid if they grant explicit power to a funder to influence decisions or take control of the proceedings (including settlement and the management of expenses);
- Prohibit unilateral termination of the third-party funding agreement by third-party funders without the claimant’s informed consent; and
- Prohibit litigation funders from abandoning funded parties in litigation at any stage in the litigation process, leaving claimants solely responsible for all costs of the litigation, which may have only been pursued due to the involvement of the funder, except in exceptional and strictly regulated circumstances.
The directive also provides that funding agreements will be invalid if:
- They grant explicit power to a funder to influence decisions or take control of the proceedings (including settlement and the management of expenses), and
- They entitle the funder to more than 40% of the total award absent exceptional circumstances.
The proposals would apply to all European Union arbitrations. The proposed directive, however, does not explicitly address how funders will be made liable for adverse costs awards in an arbitration context where funders are not a party to the arbitration and not subject to the tribunal’s jurisdiction. Absent further clarification, this could lead to satellite litigation in the courts following a costs award in arbitration. “The European Parliament’s proposed regulation of litigation funders: what you need to know,” Arbitration Notes, Herbert Smith Freehills (available at https://bit.ly/3LAfIjw).
The proposal reportedly has been met with a mixed response. On the one hand, European Union lawmakers have recognized the efforts of the proposal to regulate third-party litigation funders. On the other hand, funders have called for caution, stressing that any future third-party funding regulation should avoid unnecessarily interfering with basic market principles, and that a one-size-fits-all regulatory approach would be inappropriate. They also highlight the lack of empirical data used in the report and the limited engagement with funders regarding the proposed recommendations. See Robert Wheal & Oliver Dean, above.
The recommendations differ from the Law Commission of England and Wales’ approach to third-party funding. Currently, third-party funding is permitted in England and Wales where the market remains largely unregulated. Consequently, London may become an even more popular center for international dispute resolution. See Robert Wheal & Oliver Dean, above.
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The author, a second-year Brooklyn Law School student in New York, is a CPR 2023 Spring intern.