Litigation financing or the monetization of claims has not often been used as a method of fund raising by companies in the past. However, the liquidity constraints that they face because of the covid-19 pandemic may encourage the use of such structures more frequently. This is a particular concern due to the ongoing credit crunch in the market.
The primary reason why litigation financing has not been popular in the past is because there is a general perception that such arrangements are not permitted under the law. There are no direct judicial precedents approving a typical litigation financing structure, that is a structure in which a company assigns the risks and rewards of a claim or a pool of claims in return for an upfront consideration to a special purpose vehicle that is owned or funded by investors. However, some court rulings seem to indicate that not all forms of litigation financing arrangements would be problematic.
For instance, the Madras High Court in the case of MT Rajamanickam Chetty and Anr v TR Abdul Halim Sahib held that the restriction under section 6(e) of the Transfer of Property Act, 1882 (TOPA), which provides that a mere right to sue cannot be transferred, was limited to the right to transfer the contesting of a legal proceeding, and that the provisions of section 6(e) did not prohibit the transfer of benefits that may arise from the results of pending litigation. Not only that, but other judicial precedents, such as Nakiben W. v Maneklal Bhagwandas also suggest that the right to plead a case can also be transferred so long as the interest in the subject matter of the litigation is also transferred.
Perhaps the observation of the Supreme Court in the matter of Bar Council of India v AK Balaji and Ors is more directly on point, where in dealing with an unrelated issue, the Supreme Court observed that “there appears to be no restriction on third parties (non-lawyers) funding the litigation and getting repaid after the outcome of the litigation”.
Courts have also observed that agreements which are in the nature of maintenance or champerty are not illegal in themselves, but would not be approved if they are for improper objects, such as for the purpose of gambling in litigation, or of injuring or oppressing others by abetting and encouraging unrighteous suits (Ram Coomar Coondoo and Anr v Chunder Canto Mookerjee), or if they are extortionate and unconscionable so that it would be inequitable for the claim to succeed against a party (Suganchand and Ors v Balchand and Anr). Accordingly, so long as the claims that are proposed to be monetized are legitimate claims arising out of genuine business transactions, the transfer of such claims should not be defeated by claims that they involve maintenance or champerty. To support the argument that a transfer is neither extortionate nor unconscionable, parties to litigation financing may also consider pricing the transaction on the basis of the fair value of the claims as estimated by an independent third party valuer. However, while litigation financing structures are permissible in theory, there are a few caveats that investors should be wary of in any such transaction. For instance, when valuing a claim, investors should also assess if there are any counterclaims in the litigation that is proposed to be transferred. If counterclaims exist and are successful, then the amounts receivable or recoverable from a transferred claim will be reduced to the extent that any such counterclaim or set-off is awarded to the counterparty.
Another aspect to be aware of in litigation financing structures is that due diligence investigation should typically also cover the creditworthiness of the counterparty to the claim that is being transferred. After all, holding a favorable award or decree against a third party may not have much value unless the third party has the wherewithal to pay out on such a claim.
Lastly, in any litigation financing, parties may also consider structuring the transaction in such a way that the transferor of the claim continues to have some interest in the matter after the upfront assignment of the claim. For a successful recovery of the underlying claim, investors are likely to require considerable assistance and cooperation from the transferor, such as helping with the production of witnesses, the execution of affidavits and the adducing of evidence to support the claims. It is therefore important that the transferor continues to have an incentive to provide such cooperation until the recovery is complete.
Gunjan Shah and Karun Prakash are partners at Shardul Amarchand Mangaldas & Co.
Shardul Amarchand Mangaldas & Co
Mumbai – 400 021Executive Chairman: Shardul Shroff
Managing Partner Mumbai: Akshay Chudasama
Tel: +91 22 4933 5555
New Delhi | Mumbai | Gurugram | Chennai | Bengaluru | Ahmedabad | Kolkata