Litigation To Arbitration: Why Is India An Unattractive Market For Third-Party Funding?

A court in London recently delivered a landmark ruling, empowering the prevailing party in arbitration to not only recover legal costs but also the 1.94 million euros it had paid to its third-party funder.

This groundbreaking decision was taken in light of the deliberate manoeuvres of the losing party, which strategically pushed its opponent into a position where self-funding the arbitration was unfeasible.

Across the Atlantic, a Canadian court delivered a judgement through which it opened the doors for third-party litigation funding in the context of a single-party commercial litigation. Prior to this, third-party funding was permitted only with respect to class action suits in the country.

Third-party funding has been growing at a significant pace in foreign jurisdictions, which makes it crucial to understand the implications of third-party funding on access to justice, the balance between profitability and fairness, and the overall effectiveness of this legal system in the Indian context.

Third-party financing is not a new phenomenon and experts say that it is a vital tool for ensuring access to justice and helps level the playing field.

Third-party funding is when an unconnected party takes care of the costs of defending a party in a proceeding, in return of a contingent share in the win.

In the Indian context, a recent Delhi High Court ruling had clarified that a third-party funder who is not a party to the arbitration proceedings cannot be held liable for discharging the awarded amount, merely because it has funded a party in the proceedings.

This issue of third-party funding has now reached the doors of the top court by virtue of an appeal filed against the Delhi High Court ruling and will be addressed in February next year.

In its ruling, the high court had stated the importance of third-party funding in securing access to justice and said that in absence of third-party funding, a person having a valid claim would be unable to pursue the same for recovery of amounts that may be legitimately due.

Expressing concern for imposing a liability on third-party funders, the court went on to say that it is essential for the funders to be fully aware of their exposure and that any uncertainty in this regard would dissuade third-party funders to fund litigation.

The Delhi High Court judgement is an important decision because it recognises third-party funding as a legitimate concept for arbitration claims. Secondly, the court has gone a step further than its international counterparts to clarify that a third-party funder cannot be made liable for something that is above and beyond what was agreed to in the agreement, Kartikey Mahajan, partner at Khaitan & Co., told BQ Prime.

The biggest chunk of cases that will benefit from this development would be commercial disputes. A lot of the insolvency claims will end up using third-party funding in the future as this is the trend which exists in other jurisdictions, said Mahajan.

The next step forward should be to introduce some form of regulation around this concept so as to further validate it in Indian markets. This would also clear the air around what kind of structure a global funder would need to follow, what framework he would need to operate under etc., Pranav Mago, director at Cyril Amarchand Mangaldas, told BQ Prime.

In India, the concept of third-party funding has been alive for many years. However, there is no clarity regarding rules around this concept. The earliest mention of this concept can be found in a 1876 privy council decision which says that it is not against the law or public policy for someone to agree to pay for a lawsuit in exchange for a share of the property if it is won. However, a warning was issued that such a transaction should be bona fide in nature.

As far back as in 1955, the Supreme Court had iterated that there is nothing prohibiting a third-party funder to fund a proceeding in India unless the third party is an advocate.

This view was reiterated by the top court in 2018, saying that there is no restriction on third parties (non-lawyers) funding the litigation.

The concept also finds statutory recognition in the Civil Procedure Code as states like Maharashtra, Madhya Pradesh, and Gujarat have recognised litigation financing through their respective state amendments.

The concept has not picked up in India at the pace at which it has in other jurisdictions because litigation risk in India is much higher—as compared to other jurisdictions—given the unpredictability, especially in terms of enforcement of a claim, Ila Kapoor, partner at Shardul Amarchand Mangaldas, told BQ Prime.

There is nothing prohibiting third-party funders from funding Indian litigation, but because there are no rules and guidelines around the concept, third-party funders have been reluctant to enter this area in India, Kapoor explained.

Third-party funding is a multi-billion dollar industry in jurisdictions such as Australia, the U.S., U.K. and Singapore. Experts said that it is a must have tool in foreign jurisdictions. However, the industry is still in its nascent stage in India.

From a funder’s perspective, a market would become lucrative when its commercial viability is high. A funder is also more likely to invest in those cases where the return on investment is high.

The biggest challenge is the lack of awareness regarding the roots of litigation finance in India. For the longest time, people have been in doubt as to whether it’s legal or not. However, third-party funding has found a mention in various rulings of Indian courts and in the Civil Procedure Code as well, said Mago.

Indians are very price sensitive and the margins for profit in India are less as compared with those in foreign jurisdictions like the U.S. Over there, a funder’s share in the win could go as high as 55-60% in some rare cases, said Kundan Shahi, founder at LegalPay.

Players in India generally work around a margin of 20-30%, he said.

Mago explained that the profit margin could also be a multiple of the investment in cases or a percentage of the monies received. The multiples charged could be 3-4 times of the investment as these are considered to be high risk/high reward investment since these are all non-recourse.

Since a funder assesses the merits of the claims and the potential for success before deciding to provide financial backing, another consideration that needs to be looked at is regarding the stage at which a funder would want to enter a dispute.

It could be at a stage when the dispute has not even arisen yet and is still being contemplated or it could be at a later stage as well.

Funders don’t usually have a preference. It totally depends on the stage at which the funder is approached. That said, certain funders don’t like to step in at a very nascent stage when the dispute is still being contemplated because commercial sense becomes clearer when the dispute is at a later stage, said Mago.

However, Shahi was of the view that it took time to understand that the later we enter into a dispute, the lesser profit margins are there for us. Therefore, now we want to get involved as early as possible, he said.