Pandemic to drive Asia’s adoption of Third Party Funding

Updated: Jan 27

The global economic downturn has changed the conversation in Asia around third-party funding (TPF), with corporations and law firms increasingly open to alternative financing options

Asia’s leading dispute resolution centres have been slow to open the door to third-party funding (TPF), with Singapore and Hong Kong only changing their rules in 2017 and 2019 respectively. As such, these markets remain relatively under-developed, with TPF still not as widely embraced there as in more mature markets such as the US, UK and Australia.

The global economic downturn appears set to change that situation, however, with corporations now scrambling to protect their balance sheets. Companies that may have been reluctant to consider new approaches to litigation and arbitration funding have begun to re-evaluate their budgets, with costly legal bills increasingly under the microscope.

The International Monetary Fund (IMF) forecast in October that the coronavirus (COVID-19) pandemic would see a 2.2% contraction in the Asia-Pacific region’s economic activity this year, before it rebounds to 6.9% in 2021.

But the pandemic’s long-term financial ramifications are still unknown, with governments across Europe having just launched a new round of lockdowns. As such, a more conservative corporate approach to expenditure should be expected in the short to medium term.

As companies throughout Asia seek to free up balance sheets from costly legal bills there will be an increasing opportunity for TPF providers to gain ground.

Opening the door

Singapore and Hong Kong’s common law doctrines of maintenance and champerty prohibited the use of TPF, leaving companies with a serious interest in alternative funding options to carefully weigh up their choice of dispute resolution centre when drafting contracts.

This began to change in January 2017, however, when Singapore amended its laws and removed the threat of tortious or criminal liability from external funding of international arbitration and related court proceedings. The city state then announced in October 2019 that TPF would be extended to include domestic arbitration, certain proceedings in the Singapore International Commercial Court (ICC) as well as connected mediations.

Although case law dating back to 2015 had validated the use of TPF in insolvency cases, with the city’s courts confirming this position in 2018, Singapore introduced this year some highly anticipated reforms that consolidated the insolvency and bankruptcy sectors and established a new licensing and regulatory regime for insolvency practitioners. The Insolvency, Restructuring and Dissolution Act 2018 (IRDA) came into effect on July 30, providing some welcomed clarity for liquidators, judicial managers and bankruptcy trustees on the use of TPF.

Singaporean law, however, continues to prohibit funding for an unconnected party’s litigation.

In February 2019, Hong Kong followed Singapore’s example by legalising TPF in arbitration and mediation. When it comes to commercial litigation, Hong Kong has also remained circumspect about opening the door to litigation funding. With the exception of three scenarios – either where a funder has a common interest in a case, there are access-to-justice considerations or the case involves insolvency proceedings – there is no room for TPF in Hong Kong commercial litigation for the time being.

By expanding the funding options available to those engaged in arbitration, both cities have brought themselves in line with rival arbitration centres around the world. Singapore and Hong Kong have consistently ranked among the world’s most preferred arbitration destinations in recent years, as demonstrated by the Queen Mary University of London’s (QMUL) International Arbitration Survey, and the two cities’ decision to approve TPF helps to cement that positioning.

The changes have been seen as a watershed moment for Asia’s arbitration scene, prompting one TPF to set up shop in the region.

Olivia de Patoul, senior legal counsel for the Asia-Pacific at third-party funder Deminor, said: “We opened our Hong Kong office in 2018 as we saw the opportunities that Asia, and more specifically Hong Kong and Singapore, had to offer for third party funding. Even though the market still needs to get familiar with this new way of pursuing claims, we expect TPF to be more commonly used very soon.”

More than simply bringing Asia’s leading arbitration hubs in line with their rivals, though, the reforms have also afforded parties with limited financial resources the chance to consider pursuing claims against much larger opponents. This could have far-reaching consequences now that the global economy finds itself in its worst recession since the Great Depression.

Belt tightening

COVID-19 has led to a rise in the number of funding requests. Companies are allocating their funds differently and are not keen to block a budget for litigation so they prefer to transfer the risks and costs to a funder.

Olivia de Patoul, senior legal counsel, Asia-Pacific, Deminor

Companies have become increasingly wary about taking on unnecessary risk, given the current climate. Paul Starr, co-head of arbitration at King Wood & Mallesons (KWM), noted that some clients were “pulling in their belts” in response to the downturn and that the costs of lengthy legal battles were becoming too great a burden.

He said: “It’s at the point where clients have even requested a review of already agreed legal fees for ongoing cases. While discussing such things at the start of a case is not an issue, it becomes exponentially more difficult once a case is underway.”

Starr added: “Some are even opting to settle disputes for far less than expected rather than continue carrying the cost of the case. In some cases, settlements have been reached on the verge of a judgment being handed down.”

TPF, however, offers an attractive alternative to the risk averse. Third-party funders provide financing that can cover not just legal fees and expenses but also after-the-event (ATE) insurance and security for costs. In return, the funders receive a payout upon as successful litigation or arbitration.

Even for companies that can finance their legal battles, there is still good reason to consider engaging a funder. By being able to remove long-running legal bills from their balance sheets, companies using TPF are able not only to post higher annual operating profits but their accounts also offer a truer reflection of their performance.

“COVID-19 has led to a rise in the number of funding requests. Companies are allocating their funds differently and are not keen to block a budget for litigation so they prefer to transfer the risks and costs to a funder. Especially given the uncertain times we currently find ourselves in. TPF is a way to transfer legal claims into financial assets where litigation is not seen as a cost anymore but as a potential profit centre,” de Patoul said.

Starr echoed this sentiment, noting that the pandemic had changed current perceptions towards legal bills that had been quoted some years ago. He added: “If clients had talked to a funder at the outset then there might have been an option to negotiate access to financing further down the track. But the further you get into a case the more of an administrative headache it becomes to make back-end funding work.”

Opening a dialogue with a funder early, de Patoul, noted would help to define the long-term costs and outcomes for a case, making the benefits for all involved clear. It would also enable the funder to assist at an early stage with funding proposals and by that avoiding delay in the process.

“It’s important to have a good ratio between the legal fees and the claim amount. At the end of the day, after having paid the costs, the lawyers and the funder, the major part of the recovery must still go to the client who ultimately remains the owner of the claim,” de Patoul said.

While corporations may be cagier over potential risk, funders too have become more cautious when deciding which cases to back and have begun investigating co-funding opportunities.

Funder considerations

Interest in TPF has been growing in line with the rising number of arbitration cases in Hong Kong and Singapore, with the downturn only expected to stimulate awareness in the coming years. Another long-term driver of interest in external funding will likely be mainland China’s trade and development programmes.

Although funders use different value-based criteria to decide which cases to take on, de Patoul said the decision to back a claim hinged on risk vs reward considerations, with funders tending to gravitate towards cases where damages can be objectively calculated.

She added: “We have seen a lot of construction claims recently in arbitration, where the amounts are generally high. The major difficulty with construction claims is having a proper claim value that can be objectively assessed and not only depends on expert opinions.”

Winning a case and not being able to enforce it is also a major concern for funders and weighs heavily on their due diligence process. “Jurisdiction and place of enforcement are key. A major question is always: ‘Can we enforce the award and make sure that payment will occur?’,” de Patoul said.

She added: “The current downturn has obviously affected questions about enforcement. For example, when the defendant is specialised in an industry that has been hit particularly hard by the pandemic, such as aviation, it might affect our decision process. If you compare this to a couple of years ago, aviation wasn’t considered risky in the slightest.”

Other potential enforcement red flags typically include whether a counterparty will go the distance of the case and whether the defendant is able to pay out at the end. She said: “If the defendant is an empty shell, with no assets, this is obviously a no-go.”

Third-party funders have also begun reviewing their strategies, with a growing number of players opting to co-fund cases and share the risk.

“Many funders, including Deminor, are investing smaller amounts in more cases. While we’re not risk adverse, we are approaching our risks differently by opting for co-funding and having other funders involved in the process,” de Patoul said.

Interest in TPF has been growing in line with the rising number of arbitration cases in Hong Kong and Singapore, with the downturn only expected to stimulate awareness in the coming years. Another long-term driver of interest in external funding will likely be mainland China’s trade and development programmes.

Growth opportunities

The Belt and Road Initiative (BRI) and Greater Bay Area (GBA) project will require billions of dollars’ worth of both domestic and foreign investment in order to be realised. The Beijing government’s goal for GBA is to link Hong Kong with 11 cities across Southern China, while the BRI will serve as a global network of trade routes that connect the mainland economy with various member countries.

Clients from China Mainland are not overly familiar with TPF and can be reluctant about pursuing claims. By bringing them up to speed, funders have a real opportunity to get in at the ground floor.

Paul Starr, co-head of arbitration, King Wood & Mallesons

The level of investment needed for both projects is enormous and will inevitably lead to disputes and Beijing has already made it clear that it sees Hong Kong as the natural seat to resolve these.