In March 2021, the European Parliamentary Research Service published a study in English language entitled “Responsible private funding of litigation“1. Among other matters, the study considers that the return rates on litigation funders can sometimes be excessive and deprive the litigant of a substantial portion of the outcome of the litigation, and suggests fixing a cap on funders’ return rates at 30% of the amounts actually recovered.
In my opinion, this study is based on erroneous and biased premises, which show a lack of knowledge of the practice of litigation and arbitration funding, or at least only a partial knowledge that does not adequately assess the issue from the perspective of the third-party funders.
Grounds for the proposal
First of all, the lack of detail on the real reasons behind this proposal is striking. Mention is made of the alleged need to achieving a balance between party autonomy and the existence of a public interest of protecting the effectiveness of access to justice. However, beyond these abstract generalities, no justifications or specific data are provided to support the need for this measure.
If in any activity the parties are free to agree on the price of their products or services, why should the return of litigation funders be capped? Why the return of private equity investors is not capped, and yet the return of investors in litigious assets should be capped? Why can lawyers charge whatever fixed or success fees they see fit, but funders cannot do the same?
In the case of contracts between professionals, I cannot think of any minimally sound and convincing answer to these questions. The parties must be sovereign in deciding, within the scope of their activities, the prices they want to pay for the products and services they buy. Any kind of limitation in this respect would be of more than dubious legality.
The same applies to consumer contracts. A different matter is whether the agreements are transparent and whether the parties have real knowledge of the scope and effects of the clauses establishing the return of the funders. But the price or return rate of the funder should never be controlled or limited, in line with the provisions of Art. 4.2 of Directive 93/13/EEC.
The return rates of litigation funders is not excessive
In any event, to conclude as the study does that a return rate ranging between 20% and 50% of the amounts recovered is a ‘high’ return is a simplistic and erroneous premise, essentially because it does not take into account any of the following factors:
- Claim amounts: 30% of a claim of €500,000 is not the same as 30% of a claim of €50,000,000. In the first case, the success fee would not even cover the investment made by the funder.
- Amount of the funder’s investment: it is not the same to recover 30% of the amount claimed when the funder has invested €10,000,000 as when it has invested €300,000. Again, in the first case, as the amount invested is so high, it is necessary that the percentage of return rate is sufficient to cover the funder’s return of the investment and the profit expected by the investors.
- Risk assumed by the funder and probability of success of the claim: the risk assumed by the funder in this type of investment is very high, which means that the return sought is high as well. Not only is there a non-negligible probability that the litigation will be lost – in which case the funder would make a loss and would not recover anything – but it is also very likely that, if it the litigation is successful, the amounts claimed be substantially reduced in the judgment or award. And it is also very likely that the claimant ends up receiving an even lower amount when the time to pay or initiate enforcement proceedings comes. In short, the risk-return binomial.
- Time factor: this is another essential factor that affects the profitability of investments: it is not equivalent to collect €1,000,000 in July 2021 than to collect it when litigation is finally resolved and the amounts claimed are recovered, probably over a timeline of at least 6-7 years.
- Closing costs and funder structure costs: these are high costs which are not considered when considering the return of the funders either.
Fixing a cap on funders’ return rates would be ill-advised and counterproductive.
The proposal of fixing a cap on the litigation funders’ return rates at 30% is not in the least justified . There is not even an explanation why that percentage and not another, and again the proposal suffers from the same flaws as those discussed above. Not all cases are the same, nor can a homogeneous “solution” be proposed.
In any case, far from solving a non-existent problem, what such a measure would cause is that the funders would only invest in very high value claims, thus preventing access to justice for litigants – especially small and medium-sized enterprises – that will not be able to pursue smaller claims with strong chances of success.
It would also prevent professionals and companies from being able to properly manage and allocate the costs and risks of complex litigation and arbitration, putting them at a competitive disadvantage vis-à-vis their American, British or Australian counterparts.
Conclusion
In short, the suggestion to fix a cap on the litigation funders’ return rates at 30% of the amounts actually recovered is based on wrong premises and ignores the fact that when a funder receives a “high” return rate it is justified on the basis of a range of factors, including the type of asset invested in, the size of the investment, the risk assumed and the time that would have to elapse before a return on the investment is obtained, if it is obtained any.
Any kind of limitation, apart from its questionable legality, would only limit access to justice and put our companies at a clear competitive disadvantage.
