Third-Party litigation funding in the european union: Regulatory challenges

A The Study of the European Parliament (2021)

The European Parliament (EP) previously concluded a study and commissioned a research paper covering the legal issues concerning TPLF in 2021.^[13] It then formulated a proposal for a directive.

According to the EP, there is a risk that “unregulated and uncontrolled third-party financing under EU law” may proliferate without legal constraints in the internal market.^[14] Thus, on 13 September 2022, it commissioned an interdisciplinary study of TPLF, which analyzed economic and legal issues and specifically focused on the risks posed by unregulated TPLF.^[15] The study investigated the origin of the TPLF industry in Europe, which can be traced back to 1967 in the UK, where it is now a well-established practice.^[16] The TPLF market in Europe has been developing steadily since the 2008 financial crisis.^[17] At present, the European market consists of several European (mainly British and German) and non-European (namely, Australian) firms.^[18] The study also attempted to define TPLF in both litigation and arbitration, where the funder agrees to fund litigation by bearing the costs of the civil proceedings and to contractually assume the risk of adverse cost awards^[19] in return for reimbursement of the litigation costs and remuneration. The funder’s investment is not necessarily recouped or repaid, and the funder’s remuneration depends on whether (and when) the funded party wins the litigation.

According to D’Alessandro & Poncibò,^[20] funders are generally more interested in funding high-value claims, given that remuneration clearly depends on the claimant’s recovery by winning the litigation. Scholars have noted that funders usually seek a ratio of between 1 and 10 in terms of the amount of money needed to finance the dispute and the value of the financed claim.^[21] A funder is more likely to agree to fund condemnation claims rather than claims for the mere ascertainment of a legal right, which will ultimately end with the enactment of a purely declaratory judgment. In fact, if the funded party obtains a condemnatory judgment, the counterparty will pay the sum ordered by the court and the funder will be able to retain the agreed percentage. A funder is more likely to agree to fund a claim against a solvent defendant that offers good prospects of recovering any sum awarded in the final judgment. For the funded party—usually a claimant who does not meet the criteria for being granted legal aid^[22]—TPLF is an opportunity to improve its access to justice in high-value disputes and to challenge defendants greatly superior to it in terms of economic power.^[23] For the funded party, TPLF is also useful for transferring the risk of any unfavorable outcome of the judgment, which is covered in full by the funder.^[24]

It also need be clarified that TPLF also differs from contingency fee agreements because it is the funder—and not the claimant’s lawyer—who is entitled to obtain reimbursement and a remuneration fee.^[25] Moreover, contingency fee agreements and TPLF agreements seem to share a common structure whereby the ‘investor’ providing funds—be it a lawyer or a litigation funder—agrees with a party to the case (generally the claimant) to be paid a fixed percentage of the recovery if that party is successful. The study noted that, at the national level, only Greece^[26] and Ireland^[27] expressly prohibit TPLF.

Following publication of the study, the EU Parliament passed a resolution requesting the EU Commission to promulgate a new directive regulating third-party funding. In particular, the EU Parliament has added a draft directive to its resolution (the “Directive”) which indicates the type of regulations that can be anticipated in EU member states in the medium term. As drafted, the Directive would apply a one-size-fits-all approach, applicable to the TPLF of all litigation and arbitration proceedings in the EU.^[28] However, this proposal has been either abandoned or put on hold for the time being, leading to considerable debate and discussion within the EU institutions and among the stakeholders.

B The European Law Institute

In the realm of TPLF, where external financiers support litigation in exchange for a share of the proceeds, transparency and accountability are paramount. The European Law Institute (ELI) recognizes this imperative and has embarked on a comprehensive project aimed at elucidating the key considerations surrounding TPLF arrangements.^[29]

The multifaceted aspects of ELI’s endeavor include spanning disclosure requirements, capital adequacy assessment, case control and conflict of interest, and fee regulation, with a focus on their implications for promoting fairness and bolstering confidence in the European legal landscape.^[30]

Central to ELI’s initiative has been the exploration of disclosure requirements concerning TPLF agreements. The institute is grappling with the delicate balance between safeguarding the confidentiality of funding arrangements and the imperative of transparency, particularly for courts and administrative bodies. By delving into when and to whom information regarding TPLF should be disclosed, ELI has tried to foster an environment where stakeholders are adequately informed, while respecting the commercial sensitivities inherent in such agreements.

Furthermore, ELI’s project scrutinized the critical issue of capital adequacy assessment. By examining the responsibility and practice for evaluating the financial robustness of third-party funders and the disclosure of this information to prospective litigants, ELI aims to ensure the stability of the litigation landscape. This diligence in assessing funders’ financial standing serves to safeguard the interests of all parties involved, mitigating risks and bolstering confidence in the integrity of TPLF arrangements.

Addressing concerns surrounding case control and conflict of interest has been another pivotal aspect of ELI’s project: by elucidating who wields control over the litigation process in TPLF arrangements and how conflicts of interest are managed, ELI aims to fortify the integrity of the legal proceedings. Clarity on these matters is indispensable for upholding the rights of litigants and maintaining trust in the judicial system.^[31]

Moreover, ELI’s project analyzes the issue of fee regulation within the TPLF framework. By considering mechanisms such as caps or other regulatory measures, ELI is attempting to curb excessive fees that could compromise the fairness of the litigation process. Such oversight is instrumental in fostering equitable outcomes and bolstering confidence in the efficacy of TPLF as a financing tool.

Ultimately, the principles derived from ELI’s comprehensive analysis are poised to serve as a guiding beacon for courts and legislators alike. By promoting best practices and instilling confidence in TPLF arrangements, these principles contribute to a legal landscape characterized by transparency, fairness, and accountability. ELI’s unwavering commitment to advancing the rule of law and enhancing access to justice underscores its pivotal role in shaping the future of litigation funding in Europe.^[32]

C The Study of the European Commission (2024-2025)

Meanwhile, the European Commission (EC) recently published a new study to analyze the landscape of TPLF across the member states of the European Union. This comprehensive study is slated for completion in 2025.^[33] The preliminary results indicate where TPLF is mostly practiced in the EU member states, such as Austria, Belgium, France, Germany, Italy, Spain and the Netherlands. Finally, in Slovenia, pursuant to the legislation on collective redress,^[34] the “Law of Collective Actions,”^[35] TPLF is permitted and regulated by Article 59, in accordance with the principles set out in the Commission Recommendation of 11 June 2013.

A Regulatory Supervision & Capital Adequacy

The study by the European Commission has shown that many funders are corporations subject to different EU company laws for the locations in which they have their registered offices, as regards setting corporate standards and the capital requirements and fiduciary duties of corporate officers and directors. Additionally, other funders, such as investment funds across Europe (only a few are listed), may be subject to EU rules that apply to capital markets. In this respect, a policy option may consist of regulatory indications regarding the insurance coverage and/or capital adequacy of funders established in the EU. However, it should be noted that many funders active in the EU have their registered offices in third countries. Consequently, they are subject to the company laws of those countries. Requiring funders to obtain insurance policies or imposing capital requirements that cover the amount of their promised contributions to litigation costs would help to limit these risks.^[66]

From a comparative perspective, note that fixed capital requirements for funders have already been established by way of statute in Singapore.^[67] In the UK, fixed capital requirements have been established by way of self-regulation by the Association of Litigation Funders of England and Wales (ALF).

In particular, the proposal for a Directive proposes that funders wishing to fund any claim seated in the EU would be required to obtain an authorization and conduct their business through a registered office located in the EU (see Arts. 4 and 5 of the proposal). These restrictions may have the effect of limiting parties with EU-seated arbitration claims to third-party funders willing to operate in the EU market, thereby excluding third-party funders in other established and competitive markets (such as the UK, North America and Australia). Where TPLF agreements are permitted in accordance with Article 4, member states shall provide that an independent public supervisory authority is responsible for overseeing the authorization of litigation funders established within its jurisdiction and offering third-party funding agreements to claimants and intended beneficiaries within its jurisdiction, or in relation to proceedings within its jurisdiction (Art. 8).

Interestingly, the Proposal would also impose strict capital adequacy requirements on third-party funders. It would require them to maintain sufficient capital to fund not only the claim itself, but “any subsequent appeal” (Art. 6). Such a rule could impose compliance limitations on funders, which typically only commit to funding an arbitration claim and not subsequent challenges to the eventual arbitral award. Although the regulations on funders themselves would not impact arbitration users directly, they could increase the costs of TPLF for EU-seated claims. These costs could be passed on to users of third-party funding or make funders less willing to fund EU-seated claims.

A code of conduct, like the one in place in the United Kingdom,^[68] could be implemented on the initiative of responsible litigation funders operating in the EU market to clarify issues such as the capital adequacy and corporate standards for funders. However, we admit that there is a risk that this policy, which is dependent upon the self-initiative of responsible litigation funders, may only have a limited impact, unless funders who choose not to participate in the adoption of such a code become marginalized in the EU litigation funding market.^[69]

B TPF Agreements

Party autonomy is one of the main general principles on which the contract law of all EU member states is based, so TPLF agreements can be structured in different ways, according to individual circumstances. The parties are free to choose the content of the agreement and to follow one or other of the existing contract types, or even to create a mixture of them, provided that there is no (direct or indirect) infringement of mandatory provisions or public policy. In fact, our analysis reveals many different models.

However, to claim that the TPLF agreement is a new kind of contract, or a sui generis contract,^[70] does not solve the problem of its qualification, and sometimes even looking at the terms and conditions agreed by the parties is not sufficient to identify the legal regime applicable to the contract. The problem of qualification recurs, for example, when the regulation applied by the parties is found to be incomplete and a dispute arises between them regarding the gaps in it. The Proposal for a Directive has attempted to regulate the terms of third-party funding agreements, though this approach has been criticized as scarcely feasible given the autonomy of the parties and the confidentiality of their transactions.^[71]

In addition, the Proposal for a Directive would have imposed a notable commercial limitation on the terms that funders are able to offer claimants. It is important to emphasize that it states that the amount a third-party funder would be entitled to recover would be limited to 40% of the claimant’s recovery. Additionally, funders would not be permitted to withdraw funding mid-claim, in the absence of exceptional circumstances. They would be prohibited from terminating funding agreements unilaterally without a court’s permission. Finally, the funding agreement would be required to grant the claimant priority of recovery over the funder in terms of order of payment.^[72]

Clearly, the proposal was aimed at protecting claimants. However, in practice, it may have the opposite effect, particularly for sophisticated commercial parties able to negotiate with third-party funders. The regulations may increase the commercial risk of a transaction from the funder’s perspective and are likely to restrict the terms it is able to offer. Some funding arrangements may have to be structured differently, or some claims may even become commercially ‘unfundable.’

C Conflict of Interest

TPLF agreements inevitably give rise to the possibility of conflicting interests among the funder, the claimant, and the lawyer. In principle, the claimant, as the holder of the right to be protected in court, remains free to choose its preferred procedural strategy, in agreement with the lawyer.^[73]

First, the court settlement is one of the most sensitive issues in the relationship among the claimant, its lawyer, and the funder, in respect of which there is a high risk that this last may attempt to restrict the claimant’s freedom to determine the procedural strategy. In fact, many TPLF agreements require the funded party to obtain prior consent from the funder for any act of disposal of the claimed right, such as the power to enter into a settlement. A conflict of interest may also arise when the funder has an economic interest in accepting the settlement offer in order to bring the proceedings to a swift conclusion (so as to recover its own investment), while the claimant has an interest in rejecting the offer because the sum proposed by the opponent is—in the claimant’s opinion—not ‘satisfactory’. In this respect, it should be noted that many TPLF agreements provide that the funder’s remuneration and reimbursement of its procedural costs must be the first to be paid, pursuant to so-called ‘waterfall’ provisions. The remainder is then paid to the funded party. The existence of a conflict of interest between the claimant and the funder places the lawyer in a very delicate position: s/ he is contractually obliged to the claimant, but his/ her fees are paid by funder. However, according to Paragraph 2.7 of the Code of Conduct for European Lawyers, in the event of a conflict between the claimant and the funder with regard to the procedural strategy to be followed, the lawyer must focus on the best interests of his/her client, namely the claimant. In this respect, it should also be noted that Article 10 of Directive (EU) 2020/1828 of the European Parliament and of the Council on representative actions for the protection of the collective interests of consumers, repealing Directive 2009/22/EC, addresses the problem of conflict of interest between the claimant and the funder in the field of consumer collective redress.

Second, according to what is agreed in the TPLF contract, a frequent request by funders to claimants’ lawyers is to receive regular information on the progress of the dispute, as well as to view the case file. According to Paragraph 3.1.2 of the Code of Conduct for European Lawyers, an obligation to provide information on the stage of proceedings only exists towards the claimant. Nevertheless, the lawyer-client agreement in force between the claimant and the lawyer, at the initiative of the funded party (as instructed by the funder), usually includes a contractual obligation for the lawyer to report to the funder on a regular basis with regard to the stage of proceedings and allow the latter to view, upon request, the case file.

Third, a potential conflict also arises when, during pre-agreement negotiations, the better-informed funder with a stronger bargaining position attempts to obtain excessive shares of the damages in case of success at the expense of claimants, thus undermining the effectiveness of access to justice.

In fact, this is obviously relative to other forms of funding of litigation, including hourly fees and insurance. With hourly fees there is a two-player relationship instead of a three-player one, which reduces transaction costs. If the claimants win, they receive the full damages. However, if they lose, they may have to pay the litigation costs—so claimants may be willing to bear the TPLF risk premium. With insurance, from an ex-post perspective, the insured may be paying the premiums for nothing if they never get into a legal dispute. This may result in a situation where, in the aggregate, plaintiffs may be left better off with TPLF than with the two other forms of private funding.

In practice, litigation funders in Europe typically take twenty to fifty percent of the amount awarded in the case. In England and Wales, the landmark Arkin case provided strong judicial approval for TPLF and established the well-known ‘Arkin Cap.’^[74] It was deemed that by virtue of the fact that a professional funder could be liable for the costs of the opposing party “to the extent of the funding provided” if the claim fails, “the funding is provided on a contingency basis of recovery.” The funder would therefore be entitled, as “the price of the funding,” to a portion of the proceeds if the claim succeeds. The damages recovered by the successful claimant would be decreased. While the court called this “unfortunate,” it saw it as a “cost that the impecunious claimant can reasonably be expected to bear.” This was considered more just than a situation where successful defendants cannot recover their litigation costs from funders, whose intervention is the reason why claims, which eventually prove to be without merit, are maintained to an advanced stage. Despite the cap being subsequently criticized by many, the court here provided justification for the acquisition of shares of the damages by the funder when the funded case wins. This, however, does not satisfactorily attenuate the concern that the shares recovered by the funder could be excessive or unfair. In the Fortis collective redress case in the Netherlands, it was decided that, given the considerable procedural risks and funding costs that the claimant organizations and their litigation funders undertook for lengthy periods of time, the compensation to be paid by Ageas was not unreasonable and had not been provided at the expense of the damages paid to the shareholders.^[75] This suggests that in the case of commercial parties, the chance of excessive return rates for funders would be reduced by market forces, which would lead to the normalization of rates.

In any case, our analysis has revealed the tension between public policy and freedom to contract in the case of TPLF agreements. The freedom of the parties is generally limited by public policy and by mandatory provisions of the applicable law. For example, EU consumer law includes a set of mandatory provisions to protect consumer rights in consumer contracts (eg unfair terms), and Slovenian law on collective actions sets a cap on the funders’ return rate. Interestingly, in this respect, it should be noted that the EU Parliament^[76] has stressed that the private autonomy of the parties in determining the remuneration may prejudice the effectiveness of the result obtained by the claimant through successful access to justice. Ultimately, the claimant has to pay a substantial part of what is recovered to the funder. In light of the foregoing, Art. 17.1 (d) of the Directive (Review of third-party funding agreements by courts and administrative authorities) attempts to limit private autonomy with respect to the public interest in protecting the effectiveness of access to justice, in particular by granting the courts the power to assess that the share of any award to the litigation funder is not unfair, disproportionate and unreasonable. However, EU courts will be unwilling to review TPLF agreements for lack of competences and adequate resources.

D Courts’ Control over TPF Agreements

A very controversial issue concerns the existence of an obligation for the funded party to disclose the existence of the funding in court to make the judge aware of potential conflicts of interest, at the same time enabling the defendant to gain a better understanding of the claimant’s means. At the national level, in those member states in which TPLF is more widespread (such as Austria, France, Germany, Italy, Poland, and Spain, which have been considered for the purposes of this study), where no English- or American-style ‘disclosure’ takes place, there is no duty for the party who receives funding to disclose this fact in court, and there is no basis for a court to order the disclosure of any potential third-party funding agreement.^[77] In such member states, the decision on whether or not to disclose in court the fact that TPLF is being used lies with the claimant, as part of its procedural strategy, for instance, to avoid the risk of incurring a security-for-cost order, where permitted by national law. However, the litigation funding agreement may contain a contractual obligation for the claimant not to disclose the funder’s involvement in the litigation without the funder’s express written consent.

Bearing in mind the need to make the court aware of a potential conflict of interest, Rule 245 (1) of the ELI-Unidroit “Model European Rules of Civil Procedure”^[78] encourages the introduction into domestic civil procedural rules of a general duty to disclose the fact that TPLF is being used and the name of the funder to the court and the other party upon commencement of the proceedings. In the case of breach of the duty to disclose, the sanction may not result in any claim dismissal in the form of an adjudication on the merits. The aim of this provision (Rule 245 (4) of the ELI-Unidroit “Model European Rules of Civil Procedure”) is to clarify that TPLF cannot affect the right of the funded party to have the case decided on its merits.

Scholars discuss whether disclosure before the court should cover the mere existence of the TPLF agreement or all (or part) of its contents. In this regard, the ELI-Unidroit “Model European Rules of Civil Procedure” opt for the disclosure of the mere existence of the TPLF agreement. The details of the litigation funding agreement should not be subject to disclosure: (i) to protect the details about the chances of success, and (ii) not to force the funded party to breach the confidentiality clause included by many funders.

However, Rule 245 (4) of the ELI-Unidroit “Model European Rules of Civil Procedure” proposes providing the domestic courts with the discretionary power to ask “for details of fee arrangements with a third party.” After having exercised this discretionary power, upon consulting with the parties, the court may consider the lack of fairness of such an arrangement when it makes its final decision on costs and determines the part of the claimant’s costs to be reimbursed. Rule 245 (4) seems to be an attempt to protect a defendant who loses the case. Thus, particularly in the member states where the lawyers’ remuneration fees to be reimbursed are not calculated according to a fixed tariff system, a defendant who loses the case may be exposed to the risk of reimbursing major legal costs because of the existing TPLF agreement. For example, because of the existing TPLF, the claimant may have made indiscriminate allegations that increased the claimant and defendant’s lawyers’ hourly fees and, consequently, the defendant and claimant’s legal costs to be reimbursed. However, Rule 245 (4) seems unable to simultaneously protect the claimant in the event that the funder’s success fee is unfair. Since the TPLF agreement appears to remain valid and effective regardless of the content of the judicial decision on the allocation of costs,^[79] it is the claimant—and not the funder—who will suffer the consequences of the court cutting the claimant’s costs to be reimbursed.

In this respect, Article 16 of the Proposal of a Directive has stated that the claimants or their representatives are required to inform the relevant court or administrative authority of the existence of a third-party funding agreement and the identity of the litigation funder; and to provide, at the request of the court or administrative authority or of the defendant, a complete and unredacted copy of any such third-party funding agreements relating to the proceedings before the relevant court or administrative authority at the earliest stage of those proceedings. Member states shall also ensure that defendants are made aware by the court or administrative authority of the existence of a third-party funding agreement and the identity of the litigation funder.

E European Lawyers’ Ethics

There is no doubt that the presence of a conflict of interest between the claimant and the funder puts the lawyer in a delicate position, because s/he is engaged by the claimant but paid by the funder.^[80] Professional rules of ethics require lawyers to act in their client’s best interests, and these rules are deemed to be relevant also with respect to TPLF. Therefore, the lawyer should only allow the level of control by the funder which is most beneficial to the claimant in the funding. Ethical standards and rules of professional responsibility must always be kept in mind during litigation, but particular attention must be paid to this aspect when a litigation funder is involved. In this regard, Paragraph 1 of the Code of Conduct for European Lawyers clarifies the commitment that a lawyer must devote to the claimant. When a litigation funder finances a dispute, the ethical principles that permeate the legal profession—such as loyalty to the client, confidentiality, independence, the claimant’s freedom and claimant’s interest—all come into play. First, the fact that the lawyer must always act in the best interest of the client (Paragraph 2.7 of the Code of Conduct for European Lawyers) seems to suggest that the lawyer should inform a client who does not meet the criteria for being granted legal aid about the possibility of using TPLF. At the same time, the lawyer should make sure that the client has clearly understood what TPLF is, and what its pros and cons are.^[81]

The same Paragraph 2.7 of the Code of Conduct for European Lawyers seems to imply that if the client asks the lawyer to represent him/her in the due diligence phase with the funder, the lawyer should consider whether s/he has the experience required to negotiate with a funder. If so, the lawyer must describe to the client the relevant circumstances and related material risks. For example, if the funder seeks confidential information regarding the client, the lawyer must advise the client of the risks of disclosure. According to the same Paragraph 2.3 of the Code of Conduct for European Lawyers (confidentiality), the lawyer shall obtain the client’s informed consent to disclose confidential information to the funder in the due diligence as well as in any other further stage. If a TPLF agreement is signed, the ethical principle of loyalty to the client (Principle e of the Code of Conduct for European Lawyers) implies that henceforth the lawyer must avoid any meeting with the funder in the absence of his/her client. In principle, notwithstanding the TPLF agreement, the claimant remains free to choose his/her own trusted lawyer for conducting the litigation. However, our analysis reveals that the funder sometimes acts as an intermediary between the potential claimant and the lawyer. Nevertheless, when appointed, the lawyer must act independently of the funder according to Paragraph 2.1 of the Code of Conduct for European Lawyers.^[82]