Funding Litigation - A Practical Approach to the Alternatives Available to a Liquidator in the Context of an Offshore Insolvency

By Tim Le Cornu
INSOL World, Quarter 1 2012

Characteristics of offshore insolvency

The demise of an Offshore Fund and appointment of a liquidator, it seems is all too often precipitated by a fraud that renders the Fund incapable of meeting its obligations. Offshore Fund insolvencies are unique in that the company’s assets, investment manager and other service providers are usually domiciled in jurisdictions other than that of incorporation. In cases where a fraud diverts the majority of the assets, the liquidator will look for potential recovery actions to recoup losses or damages suffered as a result of the fraud. Where there are insufficient assets from which the liquidator can finance recovery actions, the liquidator will need to investigate alternative means of funding. The ultimate objective, of course, is to maximize the pool of funds available to be distributed to creditors and investors.

Common litigation funding options available to liquidators

Offshore liquidators in jurisdictions such as the Cayman Islands or British Virgin Islands (“BVI”) have several alternative litigation funding options to select from prior to initiating a recovery action where they find themselves with an estate with few or no assets. The funding option selected is, inter alia, usually determined by the jurisdiction where the recovery action will be instigated, the commerciality of the funding agreement and the control the party funding the action wishes to exert over the litigation.

Litigation funding options available to the liquidator include self funding, contingency or conditional fee arrangements, creditor or investor funding or third party funding.

Self funding

Clearly, the first option the liquidator will consider is the ability to use estate assets or the proceeds of asset realisations to fund the litigation, where these are sufficient to meet the costs of the proposed litigation, subject to the liquidator obtaining the sanction of the Court.

A more unique self funding option may be available as a result of relatively recent common law precedent in re: McGrath & Anor re HIH Insurance Ltd & Ors [2010] NSWSC 404.  In a corporate  group  insolvency, one company in liquidation, without funds, may have a recovery action, but no assets to pursue it, whilst a related company, also subject to the control of a common liquidator (and which may or may not have the same or related claim), has adequate assets to fund litigation. In this case, the Court allowed the company with assets to fund the litigation of the related company without funds even though the funding company did not have the same or related claim, so long as it was a creditor of the company pursuing the recovery action such that a successful recovery would benefit creditors in the winding up of the funding company.

Common law precedents in this form of  funding indicate that the funding company is entitled to receive a return on the funds advanced at commercial interest rates.

Contingency and conditional fee arrangements

Both contingency and conditional fee arrangements are suitable alternatives for an offshore liquidator as such arrangements align the interests of legal representatives with the estate, its creditors and investors and may be considered where the estate has limited assets.

Contingency fee arrangements are characterised by legal counsel agreeing to represent an applicant with fees being paid only if the recovery action is successful and usually expressed as a percentage of actual recoveries achieved.

Conditional funding arrangements incorporate either a lower than normal hourly rate being charged by legal counsel with a “success rate”, in the form of a premium hourly rate if the action is successful. Likewise, arrangements are possible such that legal counsel will not charge any fee unless the action is successful and in the event that it is successful, they will charge at a higher than normal hourly rate.

The estate is sometimes required to meet out of pocket costs in contingency and conditional fee arrangements as disbursements and security for costs are often excluded from such agreements.

Creditor or investor funding

A creditor or investor may elect to indemnify the liquidator for the costs incurred in conducting a recovery action, or advance a non–recourse loan to the estate to fund litigation or set aside voidable transactions. This method of funding is dynamic and can include funding for adverse costs, disbursements and the liquidator’s costs of administering the estate whilst the litigation is being conducted.

Any funding to pursue claims will constitute costs of  the liquidation and will be afforded a priority of repayment from any recoveries.

Third party litigation funding

This is an arrangement whereby a “professional” funder will fund the estate a portion or all of the costs to be incurred in pursuing litigation. The agreement may include disbursements and any costs (including security for costs) awarded by the Court.

If the recovery action is successful the funder will receive an agreed upon share of the litigation proceeds. However, if unsuccessful, the funder will not have a right of recourse against the liquidator or the estate to recover the funds contributed.

Practical considerations in selecting the appropriate manner to fund litigation

Whilst considering the available funding alternatives, a liquidator in the Cayman Islands or BVI will seek to obtain support from the Liquidation Committee for the arrangement, prior to seeking the sanction of the Court. The Liquidation Committee is a committee of representatives of the liquidation charged with providing guidance to the liquidator in respect of certain aspects of the liquidation.

Prior to sanctioning the proposed funding agreement, the Court will not only want to be satisfied the proposed action has merit, but also that the funding agreement is acceptable in the jurisdiction in which the litigation is to be conducted and that the liquidator has retained sufficient control of the proceeding to discharge his duties.

Jurisdiction of recovery action – United States of America (“US”) and United Kingdom (“UK”)

US

The jurisdiction in which the recovery action is to be instigated is an important consideration. The legal doctrines of maintenance and champerty have long been adopted in certain US jurisdictions, which prevent third parties without any connection or “interest” in the litigation from funding it and sharing in the benefits. These doctrines have been stated to curb frivolous and vexatious litigation and to prevent “speculative” litigation.

Third party litigation funding is not perceived as champertous in some US jurisdictions (eg. New York) and in recent years other US states (e.g. Maine and Ohio) have revised their laws to relax the doctrines of maintenance and champerty and/or enacted statutes regulating  third  party  litigation  funders.  Prior  to  these changes, contingency and conditional fee arrangements were prevalent in the  US  and  provided  one  avenue for liquidators pursuing litigation. The changes now provide an offshore liquidator  with  another  alternative, as third party funding is becoming increasingly common in the US.

In the past, both the BVI and Cayman Islands Courts have sanctioned split fee structures contained in retainers with US lawyers whereby both elements of a fixed hourly rate and contingency fee are incorporated into the fee arrangements. The hourly rates are discounted and, in the event that certain actions are successful, uplift is awarded to align the interests of the lawyers, the liquidators and Company. There remains some doubt whether the Cayman and BVI Courts would sanction contingency fee arrangements for actions initiated within these jurisdictions as these may be seen as champertous.

 UK

The general rule in civil proceedings in several common law jurisdictions, such as the UK, is that unsuccessful plaintiffs may be ordered to pay all or some portion of the legal costs of the successful party. The possibility of an adverse cost order being granted against the liquidator is also a factor to be taken into account.

The third party litigation funding market in the UK is well developed with a number of funders operating in that market. Funding agreements usually include terms that require the funder to meet adverse cost orders or provide security for costs which are key considerations faced by an offshore liquidator. Such terms are viewed favorably as they restrict the potential costs to an estate with limited financial resources, alleviate the risk of a liquidator having to satisfy an adverse costs order and counter the tactic often used by defendants to seek security for costs to delay or circumvent litigation.

Control of litigation

In a self funding recovery action the liquidator is capable of exerting unfettered control over the litigation as there are usually no third parties with the ability or standing seeking to exert influence. An Offshore liquidator will encounter a dilemma when implementing a third party, contingency/conditional, or creditor/investors funded recovery action as the entity providing the funding will wish to exert some control over the recovery action to protect their financial interest. This requires some level of balancing of interests however, as both the BVI and Cayman Island Courts, prior to sanctioning an alternative funding agreement, have required that the liquidator retain ultimate control of the proceedings.

Key considerations a liquidator will take into account when considering an alternative funding agreement include retention of the right to accept settlement offers, withdraw from the recovery action, in part or in its entirety, and estimating whether the funding offered is sufficient to see the litigation until completion. Whilst these aspects of control sought by a liquidator are not exhaustive, they are considered essential for the liquidator to discharge its duties. The Court is unlikely to sanction any funding agreement if it stipulates that control vests in the funding party.