Litigation Financing and Its Viability under Insolvency Bankruptcy Code, 2016
Rachit Gupta
(Pursing Graduate Insolvency Programme, Indian Institute of Corporate Affairs, Ministry of Corporate Affairs, India)
Introduction
Third party funding (TPF), also known as litigation funding, is a significantly growing contemporary area of practice now a days. It involves a third party acting as a litigation financer who is ready to incur the entire cost of legal battle on behalf of the claimant of a legal claim in exchange of returns by a fixed share from expected relief from the case.
To put it simply, let us consider an example: Suppose there is an overall expected cost of litigation amounted to Rs. 5 lacs and winning the case would fetch Rs. 50 lacs. According to an agreement between claimant and litigation financer, it was decided that 20% of the realisable amount will be appropriated by the litigation financer. So, in this case, financer will receive Rs. 10 lacs.
Such a type of funding is often on a non-recourse basis i.e., if the claim cannot be recovered then the claimant will not be held personally responsible for paying any of the legal amount. As a result, the litigation funding agreement specifies that the litigation funder incurs the majority of the risk, whether it is the risk of losing a claim or any damages incurred as a result of the litigation relating to the claims costs incurred by the litigation funders.[1]
If funding is provided to the defendant, then the defendant has to deposit an amount to funder in advance as an insurance amount. The agreement may also include a clause of making additional payment if the defendant won the case. One who is seeking the help of litigation financer should be vigilant to choose financer with good reputation, experience and capital to support the purpose.[2]
Generally, TPF arrangements have seen application in disputes which are likely to end in monetary gains for the claimant like, EPC (Engineering, Procurement & Construction) space, tort claims, insolvency proceeding, medical sector, anti-trust cases etc. TPF covers expenses pertaining to counsel fee, court/tribunal fee, cost of expert witness, adverse cost orders and other related expenses.
Important precedents related to funder’s benefit from third party funding was cited in the case of Nuthaki Vekataswami V. Katta Nagi Reddy[3] wherein the claimant agreed to share ¾ of the total proceeds with the financer. The court considered the issue whether the share of the proceeds ultimately vest in third party funder and whether such agreement is enforceable? The court declined to recognize such agreement and held it as unreasonable and ex facie extortionary. It was held that there is no absolute quantum and proper mode of acquiring benefit out of third-party funding, however it should be proportionate, fair and reasonable.
Relevance of Third-Party Funding under IBC
During CIRP or liquidation proceedings, one of the key responsibilities of the Resolution Professional (RP) or the liquidator, as the case may be, is to make the accurate assessment of the assets and liabilities of the Corporate Debtor (CD). This assessment is important because the recoveries to be made by creditors depend on this value.
Generally, the assets fall under two categories i.e., clear assets (assets recorded in balance sheet and having a book value) and contingent assets (such as litigation claims). The value of contingent assets can’t be taken into account because they are unrealised assets. This leads to reduction in value of assets of the CD. Contingent assets often require infusion of funds and long legal battles to make them realisable assets.[4]
Instinctively, the CD will rely upon RP and creditors of the CD for realising the contingent assets. However, creditors due to unpredictability of outcomes of legal battle and need to invest money, avoid funding to realise these unrealised assets.
This is where TPF can be game changer under IBC, as it can facilitate realisation of contingent assets and ultimately help in enhancing the value of the CD.
It is quite interesting that once a TPF gets involved, the insolvency practitioner only needs to handle the litigation financer rather than multiple creditors. Litigation financers prefer connection with leading law firms so that they can get the analysis about the future of claims and make arrangements to pursue such claims by best lawyers.
When a company goes into insolvency or formal process of liquidation, company might have no readily available asset to sell or money in bank to initiate or continue proceedings. It would have claim of assets to put forth. First resort is for the stakeholders to put some more money or stakeholders to approach advisors, management, equity holders and other money creditors to compensate creditors in the situation of insolvency. Stakeholders and other funders would probably provide finance to the company with asset other than debts, if that doesn’t work, TPF comes to rescue.
Restricting company: If the asset held by the company is unable to compensate the debtor, then company goes for a loan called debtor- in –possession (DIP) in order to keep company alive during insolvency. However, during insolvency, they may not obtain DIP funding for litigation owing to adverse cost and non-recourse funding. Hence, they opt for litigation finance or TPF.
Financing for Avoidance Transaction: TPF quite useful for litigation funding in avoidance proceedings under the IBC, because it frees IP to concentrate on maintaining the CD as a going concern and managing CIRP processes including inviting claims, conducting committee of creditors (COC) meetings, inviting expressions of interest, etc.[5]
Financing for litigation trust: A litigation trust is a trust created as part of bankruptcy plan for the benefit of creditors of debtor to prosecute and conduct proceedings. TPF funding can be done by litigation finance.[6]
Financing inter-creditor dispute: If a company undergoing liquidations acquires fund to compensate the creditors in dispute on priority basis; there is high chance of dispute in concern with senior and subordinate creditors in bankruptcy estate then TPF can resolve such issue.[7]
Funding law firm: Litigation financer provides funding to law firm to pursue bankruptcy case involving risk of contingency fee, otherwise law firms might not take interest in such case.
Validity of Third-party litigation
In Bar Council of India v. A.K Balaji and Ors. 2018 [8], a writ petition was filed before Madras High court and eventually the matter reached Supreme Court in an appeal. The main issue in this case was whether foreign lawyers and law firms can practice in India. While deciding the writ petition supreme court nodded on the observations made by Madras high court that even though TPF is permissible in India, advocates are exempted from participating in such funding in observation with Advocate act and BCI Rules.
Conclusion
Third Party Funding plays a vital role in permitting Administrator and Liquidators to pursue proceedings against the wrongdoers or take action against contingent assets claim that would otherwise be impossible due to the lack of funding opportunities. Non availability of resources and lack of strategic approach are effectively handled with the coming in of third-party funder. However, TPF in bankruptcy should be done with great caution. Litigation financers usually fund companies only with high value of claim, less chances of adverse cost and high chances of winning. It is another business venture with great future in India. Insolvency and Bankruptcy Code 2016 must be amended to include provisions related to third party funding in insolvency and bankruptcy cases. Absence of statutory framework would give rise to illegal TPF agreements, affect confidentiality and stability of the case, suppression of litigation financer and extraction of disproportionate sum out of litigation. Indian courts are already flooded with cases and so proper statutory framework is needed to make sure that it is properly regulated.
Reference
[1] https://ibbi.gov.in/uploads/resources/7e99c866b866e02fa7b8549752e55914.pdf
[2] https://blog.ipleaders.in/need-know-bankruptcy-litigation-third-party-funding/
[3] AIR 1962 Andh Pra 457
[4] https://economictimes.indiatimes.com/industry/banking/finance/bankrupt-firms-third-party-litigation-funds-eyeing-interim-finance-space/articleshow/89856594.cms?from=mdr
[5] https://www.mondaq.com/india/insolvencybankruptcy/1071166/avoidable-transactions-under-the-insolvency-bankruptcy-code-2016
[6] https://www.lexology.com/library/detail.aspx?g=55d3a6b4-f274-41f4-8187-be44f9b0f6e2
[7] https://www.lexisnexis.com/uk/lexispsl/bankingandfinance/document/391289/5CD6-XNM1-F185-X20M-00000-00/Intercreditor_issues_in_finance_transactions_overview
[8] Civil Appeal Nos.7875-7879 Of 2015
Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.
