A recent U.K. appellate court sends a strong cautionary note to litigation funders about the need for vigorous and independent pre-litigation due diligence and of the risks that can follow their support of an unmeritorious claim. In a November 2016 Judgment, the U.K. Court of Appeal ruled that the litigation funders that supported a claimant’s unsuccessful claim to oil field production rights are jointly and severally liable for the successful parties’ fees and costs. The Court’s ruling acknowledges litigation funding’s role in the system of civil justice, but the Court’s decision also highlights an expectation that the funders must evaluate the claims they support – and, because they have a substantial stake in a claim’s outcome , must accept the consequences if their evaluation is deficient. The U.K. Court of Appeals’ November 18, 2016 decision in Excalibur Ventures LLC v. Texas Keystone, Inc. et al. can be found here.
In the underlying claim, Delaware-based Excalibur Ventures LLC claimed that it had a 30 percent interest in oil fields in Kurdistan with Texas Keystone, Inc. and Gulf Keystone Petroleum Limited and related entities. The oil field proved to be productive and valuable. Excalibur sued to enforce the terms of the contract it alleged entitled it to a percentage of the revenues from the field.
In the litigation, Excalibur was represented by attorneys from the Clifford Chance law firm. The Clifford Chance firm took the case on under a “conditional fee agreement” under which the firm discounted its usual fees in exchange for a fee “uplift” of 40% in the event of success. The Clifford Chance firm presented the claim to a number of litigation firms. As the Court of Appeals later noted, “the action could not have been pursued without third party litigation funding.” In the end, five different litigation funding firms – including the now-defunct U.S.-based litigation funding firm, BlackRobe Capital Partners — provided a total of £31.75 million of litigation funding, of which £14.25 represented Excalibur’s own litigation costs (essentially paid to Clifford Chance) and £17.5 million represented security for the payment of the defendants’ costs, in recognition of the U.K.’s “loser pays” litigation model.
As the appellate court later noted (in an observation that seemed highly relevant to the court’s view of the case), only one of Excalibur’s funders had any experience in litigation funding and with respect to the one this case was its first foray into litigation in the U.K. None of the funders were members of the litigation funding industry trade association that appeared as an amicus on appeal.
In a September 10, 2013 opinion, the trial judge in the underlying case comprehensively rejected Keystone’s claims. As the appellate court noted, Keystone’s claim failed on every point. The trial judge described the claim, which was “gargantuan in scope,” was based on “no sound foundation in fact or law and it has met with a resounding, indeed catastrophic defeat.” Excalibur’s principals, the Wempen brothers , whom the trial court described as “long on assertion and confidence, but short on analysis and understanding,” had pursued the claim “as if it was an act of war.” Excalibur’s claims were, the trial judge said, “an elaborate and artificial construct,” that had been “reverse engineered from the position in which the Wempens found themselves” and that was “replete with defects, illogicalities and inherent probabilities.” In short, the trial court said, Excalibur put forward “a range of bad, artificial and misconceived claims” that had required “a great deal of expense, labor and time to refute.”
In light of this evaluation, the trial court ordered not only that the £17.5 million security be paid to the defendants, but further that the Excalibur pay the defendants’ costs on an indemnity basis (representing their actual costs of defense), making Excalibur liable to the defendants for an additional £5.6 million. Excalibur’s limited assets left of shortfall of Defendants’ costs of approximately £4.8 million. The defendants sought to impose these costs in Excalibur’s third-party litigation funders.
The trial judge concluded that the funders should be jointly and severally liable to pay the defendants’ costs on an indemnity basis, reasoning that the funders’ provision of funds to Excalibur represented an investment in the case and entitled them to the benefits of success.
The funders appealed, arguing that they should not have to pay the defendants’ costs on an indemnity basis, essentially arguing that they should not have to “follow the fortunes” of Excalibur.
The November 18, 2016 Judgment
In a November 18, 2016 Judgment written by Lord Justice Stephen Tomlinson for a unanimous three-judge panel, the Court of Appeal dismissed the funders’ appeal. In reaching this conclusion, Justice Tomlinson reasoned that “the suggestion that these funders, whose stake in the litigation was very substantial, ought not to be responsible for the successful parties’ costs is simply hopeless.”
Justice Tomlinson characterized the funders’ argument as essentially contending that “it is not appropriate to direct them to pay costs on the indemnity basis if they have themselves been guilty of no discreditable conduct or conduct which can be criticized.” He rejected this argument, noting that this argument “assumes that the funder is responsible only for his own conduct.” The funder, Justice Tomlinson noted, “is seeking to derive financial benefit from pursuit of the claim just as much as is the funded claimant litigant, and there can be no principled reason to draw a distinction between them in this regard.”
Justice Tomlinson rejected the funders’ suggestion that upholding the funders’ indemnity liability would “send an unacceptable chill through the litigation funding industry.” He cited with approval that the trial judge’s statement that the message to the industry is rather that the appropriate way to “reduce the occurrence of the sort of circumstance” that might lead to an indemnity award is a “rigorous analysis of law, facts and witnesses, consideration of proportionality and review at appropriate due diligence.”
And while Justice Tomlinson emphasized that they question of whether or not a litigation funder could be held liable for an indemnity award should not depend on a factual determination of whether or not the funder had conducted sufficient due diligence (his concern being that otherwise the process could produce further satellite litigation), he had no problem saying that here “the due diligence undertaken by the funders before agreeing to support the litigation was inadequate.” With respect to the funders’ attempt to rely on the claim assessment of the Clifford Chance law firm, Justice Tomlinson noted that, owing to its contingent fee arrangement, the Clifford Chance law firm “had from the outset an acute conflict of interest, the extent to which worsened as their investment in the case increased over time.”
Justice Tomlinson summarized his observations in this regard by noting that “on-going review of the progress of litigation through the medium of lawyers independent of those conducting the litigation, a fortiori those conducting it on a conditional fee agreement, seems to me not just prudent but often essential to reduce the risk of orders for indemnity cost.”
Although the funders involved in this case took a beating, the decision is not a referendum against litigation funding as such; indeed, in the midst of its criticism of the due diligence of the funders involved here, Justice Tomlinson expressly noted that “litigation funding is an accepted and judicially sanctioned activity perceived to be in the public interest.” He emphasized that “what is to be expected of a responsible funder” is a “rigorous analysis of the law, facts, and witnesses … at appropriate intervals.” Justice Tomlinson’s gloss about a “responsible funder” includes a reference to the type of “educated assessment” that “sophisticated funders” can make.
In the end, Justice Tomlinson’s opinion is not so much a criticism of litigation funding as such as it is a rebuke to inexperienced litigation funders who fail to exercise what Justice Tomlinson’s opinion essentially frames as a supervisory and prudential role. Indeed, observers commenting about the court’s decision in a November 22, 2016 Law 360 article about the case (here) suggested that the case emphasizes both that funding is a “necessary part of the litigation world,” and that “there is a real distinction between the professional and ad hoc funders.”
While the more established members of the litigation funding industry may seek to take comfort from this interpretation of the court’s analysis, it cannot be overlooked that the opinion definitely raises expectations about the level of the litigation funders’ analysis, as well as for the need for both independent assessments and ongoing reconsiderations.
Litigation funders may well have financial incentives to assess claims in this fashion, but what the court’s opinion highlights is that there can be consequences beyond the mere loss of investment for funders whose analysis is deficient.
This opinion is of course not only a product of the specific and somewhat peculiar facts involved in the underlying case, but it is also very much a reflection of the “loser pays” model that prevails in the U.K. The U.S. does not follow the “loser pays” model; rather, the model in the U.S. – often referred to as the American Rule – is that each party bears its own costs. As a result of this important distinction between the two systems, the implications of this U.K. court ruling for litigation funders in the U.S. arguably are limited.
That said, there are aspects of this decision that are worth considering, regardless of jurisdiction. Of particular interest is the portion of the court’s decision which held that the litigation funder must “follow the fortunes” of the litigant it is supporting. The suggestion that the funder’s investment and hope to participate in the benefits of any success eliminates the distinction between the funder and the party it supports is a provocative proposition; it could have interesting implications at least in some circumstances here in the U.S. – if, for instance, the litigant were to be held liable for court-ordered sanctions. In those circumstances, could the funder be held liable for the sanctions, on the same “follow the fortunes” analysis that the court applied here?
There are other features of this case and of the fact that it went forward in the U.K. that are interesting and that raise interesting questions when considered in the light of practices in the U.S. For example, it is clear that the defendants who sought to recover their costs from the litigation funders were able to obtain complete information about the funders involved and about their funding arrangements. In the U.S., we have not yet gotten to the point where the identity of funders must be or even can be compelled to be disclosed; indeed, we haven’t get even gotten to the point that the fact of litigation funding must be disclosed. Obviously, it would be much more challenging to try to enforce an indemnity award against an unknown funder.
There is a larger point about this case that should be emphasized in closing. That is that what this case stands for is the idea that at least in certain circumstances a third-party litigation funder can be held liable for the costs created if the funder finances an unmeritorious claim. Even if you accept the analysis of the U.K. court here, it is still not a self-evident proposition that a third-party litigation funder can be or should be held liable to the parties sued in an unmeritorious case. In the end, it may be that this underlying aspect of this court’s decision is a direct reflection of the “loser pays” litigation system in which the case arose, and if that is indeed the case, then this aspect of the court’s decision is just a reflection of the system involved. On the other hand, this aspect of the court’s decision is much more interesting and has potentially much more significant implications (particularly in the U.S.) if it is not simply a reflection of the “loser pays” system in which the question arose.