The recent establishment of third party financing, and the resulting media coverage of this circumstance, has generated considerable interest in the market, both from customers and professionals.
While some consider that TPF encourages unfounded claims, others argue that it allows access to justice for claims with a high chance of success that would otherwise be denied legal recourse due to the financial inability of the parties to take legitimate legal action.
It also represents a means of converting what would otherwise be an accounting expense that would reduce operating profit into available cash and therefore a real claim on the assets side of the balance sheet. The third party financier takes over the costs of the litigation or arbitration, increasing the profitability of the company, which can then allocate cash to other projects.
In addition, a favorable evaluation by an independent outside investor can provide a company’s senior management with greater peace of mind and confidence in deciding whether to file a lawsuit.
In this article, the authors seek to demystify this complex issue with a 14-point guide to TPF:
What are TPF agreements?
Initially considered a phenomenon that originated in common law systems, TPF agreements are now increasingly used around the world. They are nothing new, in fact, they have existed since the early 1990s. While they were originally used more in the area of litigation, they are increasingly common in commercial and investment arbitration.
TPF agreements basically involve an outside investor, unconnected to the dispute, who pays all or part of the amount of legal and other costs of the litigation or arbitration, such as expert fees.
The decision to bear such costs will be preceded by a careful assessment of the merits of the case. In return, if the outcome of the procedure is satisfactory, the third-party financier shall obtain a percentage of the final amount awarded to the financed party and/or a multiple of the amount invested by the third-party financier.
What kind of lawsuits do the TPF Settlements cover?
TPF agreements can cover many different types of claims. The disputes in which TPF agreements have been entered into are very varied, including claims for breach of contract, trust claims, insolvency and fraud claims, professional liability claims, patent and intellectual property infringement, trade libel, shareholder and company disputes, tax disputes, antitrust claims, class actions and commercial and investor-state arbitrations.
When is it convenient to use a TPF agreement?
TPFs are most commonly used in the following situations:
- The defendant has inflicted such damages on the plaintiff that the plaintiff cannot afford arbitration/litigation.
- The Claimant is solvent and could potentially afford the costs of litigation, but wishes to focus on managing its business, and save itself time and resources in the arbitration/litigation process.
- The Claimant would like to generate cash quickly and is willing to sell the rights to the claim for a lump sum.
- The claimant is insolvent, and may not have the money or capacity to file a claim.
Who can benefit from TPF agreements?
The claimant can be an individual or a company. Although the TPF is primarily directed at plaintiffs, it may also be used by defendants to fund a counterclaim and/or a defense.
Are TPF agreements legal?
It depends on the legislation and professional regulations of each jurisdiction. In many of them, until relatively recently, a third party with no interest in the procedure could not finance or invest in it.
In order to promote greater access to justice, many jurisdictions have amended their laws and professional rules to make them admissible. It is important to have a clear view of what is permitted. In Spain, third-party financing is considered legal and more and more clients are becoming aware of its benefits.
Can only those parties benefit who do not have funds or whose financial situation is delicate?
No. An increasing number of solvent or financially sound parties are considering the use of the TPF as a way of sharing or “covering” the costs and risks involved in litigation or arbitration.
What does it cost?
There is no cost for third party financing. In fact, even the cost of negotiating the terms of the relevant agreement is recoverable. It is therefore common to refer to this type of agreement with the expression “if we don’t win, we don’t get paid”.
What do the funders get?
It will depend largely on the complexity and degree of risk involved in the dispute. The greater the uncertainty, the greater the risk. The greater the risk, the greater the amount that could potentially be recovered by the third-party funder.
In general, if the third-party financier were operating on the basis of an agreement under which its profits depend on the outcome of the procedure, it could expect to recover between 25 and 50% of the final amount granted.
In cases where the third-party financier operates on the basis of applying a multiple, if the procedure is won, the amount recovered could be a multiple of 5-10 times the level of the investment plus the return on the initial investment.