Litigation and arbitration funding in Latin America
It is inevitable in these times of pandemic that we analyse the effects the crisis is having on the economy and, very specifically, how it will affect the legal and business world in the coming years.
Financial experts warn that the fall in world GDP will be the highest since the last World War. As a result, all companies and individuals are prioritising their cash flow, which is having consequences for the legal and financial world that have already been seen since the beginning of the pandemic.
It is challenging for the legal world to continue its activities in an environment where clients are having to adjust the costs of all their services, and this cutting back is already visible at many firms that are taking additional financing and personnel measures. But these firms are also searching for alternatives, so that their clients can afford the best legal services.
In this situation, the economic crisis in Latin America (as in other regions) has increased the interest of the legal and business world in third party funding (TPF), because there is a need to look for alternatives in order to be able to finance legal and arbitration procedures when companies are not able to meet their obligations, or have to prioritise resources for their core business.
But this general financing demand is not finding a financing supply corresponding to those needs, mainly due to the level of perceived risk and the claim amounts. TPF, as an international market, requires minimum amounts for claims and a level of risk that does not fit well with the majority of cases, nor with their recovery periods.
International arbitration, with reference to Latin America, is a wide market in which international funds often participate, and where they have a lot of experience. At the same time, large firms that are developing this practice usually work with litigation funds or with clients that have received litigation funds.
In this way, the range of financing services offered starts from the beginning of the claim through to the monetisation of the awards. This last market is very interesting for funds and clients, since it clears up uncertainties about the case, which remain only in enforcement with the risks of time and solvency.
Domestic arbitration also has an appetite for litigation funds. There is no doubt that the culture of arbitration in Latin America is more developed than those of other regions, probably due to the inefficiency of the judicature in the resolution of commercial conflicts.
This is why the TPF industry also participates in the financing of domestic arbitrations in many countries. Brazil, Peru and Chile are good examples of countries where domestic arbitration represents an important way of resolving disputes and where the TPF industry has placed its focus. In this area it is also possible to find funders willing to share the risks, with the full range of services provided by TPF.
A separate issue is the world of litigation. The perception of most jurisdictions through the lens of financiers is of a world of risk that is difficult or impossible to assess. This results in a lack of interest in funding such matters in most cases because the perceived risk is too high to generate an investment. However, once final judgments are handed down, the risks associated with enforcement and the debtor's solvency are risks that can be more easily assessed and allow for the "monetisation" of judgments. This is an emerging market, but one that may take off in the coming years.
The big change that is taking place as a result of the pandemic, as in other sectors of the economy that were taking off, is the acceleration in the use of TPF. What used to be an option for individuals and companies, in order not to incur costs, is now a need, or even a business obligation, in order to safeguard finances and business.
In the case of law firms, many of them, prior to the pandemic, faced the use of TPF as an innovation; some, as an option to succeed in capturing a client that wished to file a claim but did not have the necessary funds to face its cost.
Hiring the firm under a success fee agreement is an option that works in certain litigation, but not in those that require an active contribution of capital, such as the payment of experts who cannot be hired on a contingency basis. In the case of arbitrations, a fee in case of success does not reimburse the necessary expenses of the arbitration institutions and arbitrators.
In this situation, law firms are already seeing that they must be prepared to meet and discuss with clients the opportunity to opt for TPF as a formula to help the client defend its claim, and for the law firm itself to collect its fees. In fact, it could be a competitive advantage for some law firms from now on, if other firms are unfamiliar with this tool and do not offer and use it.
Accordingly, General Counsels and private clients who are in need of alternative financing solutions are already asking firms for knowledge and advice on this matter. Therefore, General Counsels and law firms must be prepared to present these solutions.
It is important for both law firms and General Counsels to understand that the capital investment that their clients have to make has, in very general terms, a maturity of three to five years. Seen from this perspective, it becomes very complicated or even crazy to make an investment when you have to prioritise the maintenance of the fundamentals of business, such as payroll, essential suppliers, leases, and so on.
But we must also take into account that there are issues that cannot be abandoned or postponed, and actions that must be taken because there are time limits or prescriptions associated with them.
For all these reasons, it seems that the impetus of the post-pandemic economic crisis will accelerate the use of TPF in Latin America and, consequently, law firms must be aware of and prepared to recommend this tool which is very useful both for clients and for law firms themselves.
In this sense, it is also perceived that the quantitative rule of a minimum claim amount of USD10 million is changing, and that there are already financing possibilities in the international market of funds for matters exceeding USD5 million in claim value.
It seems that in the near future this offer will be opened up even more to financiers that wish to cover a neglected market in this range of claims, or even with the incorporation of new players.
Latin America is a region inclined to seek conflict resolution through arbitration and a natural breeding ground for TPF, given the need for investment (arbitration courts, arbitrators and lawyers’ fees) and the potential for profits, which, ultimately, is what attracts investors - in this case, funders.
However, as in other regions, the minimum investment threshold in these matters means that only those with a really high investment floor are of interest to funders in an international market. But we will have to take into consideration the possibility of creating a market for financing litigation and arbitration in Latin America with business rules adapted to its reality, in procedures and amounts of claims, in the coming years, which may serve as a boost to the regional legal industry.
It is clear that where arbitration is most widespread will be where TPF will be best received, and this is already happening in certain countries. This has to do with the need to finance the costs of arbitration courts and arbitrators that cannot be covered by lawyers' success fees.
Large firms are already familiar with analysing matters that are financed by third parties, either because clients have requested and obtained such financing or because they have been hired by the funders to carry out the due diligence process of a case.
But TPF is getting stronger on other issues, and smaller firms are attracting clients with the advantage of financing. Therefore, this is a distinctive element that must be taken into account in a market as competitive as the legal one.
Latin America is not a stranger to all the processes that are taking place in the arbitration courts and jurisdictions regarding transparency, which is undoubtedly a very important element when assessing conflicts of interest of arbitrators.
There seems to be a consensus on the need to disclose the existence of a financing agreement and the identity of the funder, and in this regard reforms have been made in Singapore (Singapore International Arbitration Centre) and in Hong Kong (Hong Kong International Arbitration Centre). With the reform of the ICSID Rules, the Madrid International Court of Arbitration has also regulated the need to disclose the existence of a financing agreement and the identity of the funder. The recent Code of Best Practice of the Spanish Arbitration Club also proposes this. It is likely that Latin American arbitration courts will be able to follow this practice, which is spreading worldwide, in the near future.
Latin America is a great market for TPF and has prestigious arbitration institutions. Large cases are being financed and it is a very attractive market. However, as in other regions where TPF is not widespread, most law firms still do not know its significance. There are many cases with what we could call intermediate amounts, between USD10 million and USD50 million in claim value, which are not being financed due to the lack of connection between the parties and the funders.
Trustworthiness in jurisdictions is the great challenge faced by the countries of this region so that the TPF industry can get involved in sharing the risks of the jurisdiction. However, the monetisation of rules is an activity that exceeds jurisdictional risk and is appreciated by investors.
As in other regions, there is still no mass market for small claims under USD10 million. This market could certainly be very attractive in the future, and could help to make claims happen and to have an agile environment in both the financing and the monetisation of awards.
by César Cervera Cantón, attorney and co-founder of Rockmond Litigation Funding Advisors