If you don’t have the cash flow to manage litigation costs, or prefer to share the risk of a litigation investment, litigation funding provides opportunities to realise the value of your claim using alternative financing.
Litigation funding, also known as legal financing, can provide some or all the legal costs when a party lacks cash flow or wishes to share the risk of the investment.
How does litigation funding work?
There are many ways to source litigation funding.
The most common is through litigation funding businesses, who specialise in identifying and providing capital for legal claims. If the funder chooses to invest in your claim, they can cover the legal costs involved in litigation, such as legal representation fees and court fees, and accept the risk of paying the other party’s legal costs if your claim is unsuccessful.
In exchange, the funder receives a pre-determined percentage of the damages awarded to you as a reward for taking on the risk. This percentage will depend on several factors, such as the amount of capital invested, the timing of any resolution, and the nature of your dispute.
You can obtain litigation funding at the beginning of, or part way through, the litigation process.
It is possible to source litigation funding by going directly to a funding business to make an application. Your lawyer can also prepare an application for litigation funding on your behalf.
This is just one avenue for sourcing litigation funding. A broader range of options will be explored in this article that cater to different types of disputes and preferences for sharing risk.
What are the benefits of litigation funding?
1. Realising the value of your claim
Too many businesses don’t pursue legal claims with good merit because of resource concerns, where funding solutions can provide opportunities to litigate with financial strength.
When weighing up litigation, concerns regarding legal fees, cash flow and losing the claim and having to pay the other party’s legal costs can have a dispiriting effect on the decision to pursue a claim. Overwhelmed by the problems and sense of risk, opportunities are too often prematurely abandoned.
Whereas if a claim is approached as though it were an asset – an investment in a financial and/or legal outcome – then thinking about the most effective commercial way of everaging this asset opens the door to financing and risk sharing solutions to realise the potential of those outcomes.
2. Reducing financial risk
By sourcing litigation funding in the traditional sense – where a third party provides capital to finance the litigation – the effect is to transfer risk to this third-party. If the claim fails, the funder will not look to recover the funds from you. They write off their investment and move on.
Though when it comes to sharing risk, litigation funding isn’t all or nothing. Having all the legal costs covered by a third-party funder is not the only option. There are several opportunities to have only a portion of the funds covered, lowering the percentage of potential damages allocated to the funder.
Disbursement-only funding covers only the costs incurred by lawyers in preparing a case, such as fees for court filings or barristers’ fees.
Traditional funding arrangements can go hand-in-hand with risk sharing arrangements with solicitors, blending different methods to achieve your preferred risk structure.
There are also insurance products available to limit the risks of litigation. Adverse costs insurance protects against the possibility of your claim being unsuccessful and having to pay the other party’s legal costs.
3. Balancing the scales between parties
Funding can also be used to balance the scales of investment capital where you are in dispute with a larger party with a deeper pool of resources.
Litigation funders can provide funds for costs that can be difficult for smaller parties to cover. For instance, funders can cover your security for costs – a security (usually money) fronted to the court before the case begins for the payment of the other party’s costs if your claim is unsuccessful.
4. Obtaining funding acts as a mechanism to test the strength of your claim
Some litigation funders will also provide additional legal and strategic input during this due diligence process (and throughout the case if they choose to invest), bolstering the expertise provided by lawyers.
In effect, assessing a case for funding acts as a quality filter. When you initiate a legal dispute, a high degree of trust is placed with lawyers as to whether they believe a claim is winnable. Preparing a case for funding acts as another level of assurance that litigation will provide a worthwhile return on investment and prevents charging forward without strategy or sufficient evidence.
What are the drawbacks of litigation funding?
1. Loss of a portion of the return
When you receive funds to carry out litigation, you agree to either:
forgo a percentage of the potential return on investment (i.e. the damages awarded to you if the claim is successful), or
pay an amount in interest if the funds are borrowed.
In either circumstance, you are reducing the overall benefit you will receive.
When applying for funding, it is important to understand whether the portion of the damages you expect to receive, or the amount remaining after borrowing costs, will be proportionate to the time and cost you personally will invest. This is also an important consideration in the first meeting with your lawyer.
2. Potential loss of a degree of control
Different funders will have varied levels of involvement in the strategic management of your litigation. In the process of agreeing on funding terms, it is important to also understand the degree to which you will need to consult with the funder or require their consent or agreement before making decisions.
Most third-party funders will require you to seek their permission before accepting a settlement offer. If you do not wish to accept the offer, but the funder does, it is common for a dispute resolution clause in the funding agreement to require the engagement of senior counsel to provide independent advice on the offer. Their decision becomes binding, and if you don’t accept the decision, you will default on the contract and likely be required to repay the funder for their investment.
3. Funding options may be limited for smaller claims
Not surprisingly, funding for smaller claims can be limited because the potential size of the pool from any payment of a claim is not enough to ensure that you will also receive an appropriate outcome. No reasonable litigation funder or lawyer would assist in a claim that is unlikely to result in the person claiming receiving some appropriate benefit from the claim.
Litigation Funding Options
What is Third-Party Funding?
The most common type of litigation funding is third-party funding, where a funding business contributes funds in exchange for a portion of the settlement sum.
When is Third-Party Funding best suited?
When you have a sizeable claim (at least $5-10M) against a party who either has assets in Australia or is insured. Funders are looking to make a return on their investment in your dispute and will assess this in part through the size of your claim and the ability of the other side to honour a future payout of damages.
If your claim has a low risk profile. There are not many litigation funders in the market relative to the number of claims seeking financing, so, not surprisingly, funders tend to invest in matters with lower risk profiles and higher returns.
When you are looking to avoid all financial risk as a plaintiff, either because you don’t have the available cash flow, or you do not prefer to invest your available cash flow in litigation.
How to obtain Third-Party Funding
Before you apply for third-party funding, your lawyer will typically conduct an investigation into your matter to present to funders.
This can include:
a summary of the matter
the causes of action
information on the parties
preliminary quantum calculation
estimates of costs
the likelihood of recovering damages from the other party
This process may involve some back and forth with the funders. Note also that you can approach multiple funders at once.
There is generally a cost associated with this legal work, however it is possible to negotiate a funding agreement with your lawyer for this work is done on a conditional fee basis, where you won’t have to pay the fees unless/until you obtain funding or achieve a successful outcome.
Note that the process of applying for funding is complex and may take several months. Engaging a lawyer who has expertise and experience with the process can help minimise the time and cost.
Other considerations for Third-Party Funding
Whilst in some circumstances funders will agree to cover all your costs, some funders may request a blend of conditional and unconditional funding. This means that a percentage of the funds will be covered as they are incurred each month, whilst the remaining portion is withheld until the outcome is determined. If a successful result is achieved, then the funds are released by the funder. If the litigation is unsuccessful, the law firm bears the cost.
Throughout the litigation, this requires the law firm to cover the portion of the costs that are ‘conditional’ on the outcome. The reason for this is for funders to have law firms bear some of the risk and have ‘some skin in the game’ where a dispute appears to carry some risk.
The effect of this for clients is that law firms can charge an uplift fee on the conditional component of the fees, up to a statutory maximum of 25%, in exchange for bearing this risk. For example, if the conditional component of the legal fees across the lifetime of the litigation equates to $100,000, then the actual cost to the client will be $125,000.
There is no limitation on the percentage of damages that a funder can be allocated in a funding agreement. A typical funder’s commission is between 15-30% of the settlement sum, which is a sliding scale depending on the point at which the proceeding is resolved (e.g., pre mediation, at mediation, by judgement). This commission can also be calculated as a multiple of the total costs (e.g., 5x), depending on what is specified in the agreement. Because there is no limit on the funder’s commission, it is important to understand the terms of the funding agreement before signing. However, in class action disputes, the Courts will need to approve any funding agreement.
A funder can cover your security for costs. As a plaintiff, you may receive a court order at the beginning of litigation to front some capital to the Court to protect the defendant against the situation in which you lose the litigation but are unable to pay their legal costs. This is called a security for costs order.
This may require you to put up a bank guarantee or pay a sum of money to the court. If you cannot front the security of costs, then the proceeding is put on hold (or ‘stayed’) until the security is provided. If you can’t provide the security, then the Court can dismiss your claim.
This is common if the plaintiff is based outside Australia, or has assets based outside Australia. A benefit of obtaining commercial litigation funding is that funders can put up this security on your behalf if it is negotiated in the funding agreement.
Third-Party Funding can be a sign of strength to the other party. Obtaining third-party funding can signal to the defendant that your claim has financial depth and has passed through a process of examining its legal merit, which may influence negotiations.
What is Litigation Lending?
Similar to an unsecured loan, Litigation Lending is a funding arrangement where you are fronted legal costs by a third party and are expected to repay them regardless of the outcome.
There are lenders in the market that specialise in providing funding for business related legal fees. This works by the lender providing funds upfront to a law firm to provide a service. Clients repay these fees directly to the lender, with the firm bearing the risk of you defaulting on those payments.
The terms of these payments will depend on the lender. For example, lenders typically offer payment terms of a maximum of 12 months. If your legal fees equate to $60,000 in total, then the minimum requirement would be to repay $5,000 per month plus interest.
Most litigation lenders provide funding for legal representation fees and not disbursements or other legal costs.
When is Litigation Lending best suited?
When the quantum of your dispute is not high enough or is not the type of matter accepted by a funder. As mentioned above, some litigation funders will have minimum thresholds for the amount in dispute they will accept, to ensure they can extract a viable return. Similarly, funders also tend to specify what types of matters they will accept e.g., shareholder disputes, negligence, claims against professional advisors etc. Whereas, litigation lenders tend to accept a broader range of matters, given that their repayment is not dependant on the outcome.
Where you are a defendant. For the same reason of pursuing a financial return based on damages awarded, litigation funders typically only provide funding for plaintiffs. Whereas lenders will also provide funding for defendants.
When your barrier to engaging in litigation is cash flow or affordability. Some matters can progress quickly and require significant sums of money to be paid in short periods of time. Businesses who would otherwise run into cash flow or general resource issues can sustain their involvement in the dispute with commercial litigation lending options, which can be utilised at the beginning of, or midway through a dispute.
How to obtain Litigation Lending
The process for applying for Litigation Lending is similar to applying for an unsecured loan. As with commercial litigation funding, your lawyer will typically package up information on your dispute and the terms of your engagement to present to lenders. If successful, the lender will also conduct a credit check before you sign a loan agreement.
The interest rate of your lending will vary depending on the loan term and the amount being financed.
Other considerations for Litigation Lending
Beware of pay-day lenders. There are many pay-day lenders who can provide quick financing for your legal fees, however the interest rates on these loans are often exorbitant. It is preferrable to engage with lenders who specialise in providing legal fee finance.
Litigation lending can appear on your credit report. Credit reports record all your credit history and borrowing habits, which can therefore include any loans taken out to finance your litigation.
Conditional Fee Arrangements
What is a Conditional Fee Arrangement?
Also known as a no-win-no-fee arrangement or a speculative agreement, this type of funding is an agreement made with a law firm that they will cover your costs (excluding disbursements), and only charge the client if a successful outcome is achieved (e.g., a win at trial or a settlement). The law firm carries the risk and cannot charge if a successful outcome is not achieved (i.e., if the claim fails).
You can also arrange a part-conditional funding agreement with your lawyer.
When is a Conditional Fee Arrangement best suited?
If you are a plaintiff with a highly substantiated claim that carries low risk. Given the risk a law firm shoulders when litigation is funded this way, firms will only offer conditional fee arrangements where there is a higher likelihood of success. Conditional fee arrangements are not offered to defendants.
How to obtain a Conditional Fee Arrangement
Given there is no third-party involvement, a conditional fee arrangement is obtained by discussing your pricing and finance options with your lawyer at the beginning of the litigation.
Other considerations for Conditional Fee Arrangements
Your ability to change lawyers can be limited. Typically, conditional fee arrangements will specify that early termination of the service requires you to repay the costs incurred to the law firm. Therefore, if you become dissatisfied with your lawyers during the dispute, it can be difficult to change to another firm under a conditional fee arrangement.
Conditional fee arrangements carry uplift fees. If your matter is successful, law firms can charge up to an additional 25% of the agreed legal fees in exchange for taking on the risk of a conditional fee arrangement.
Conditional fee arrangements do not typically cover disbursements, so you will likely still need to pay for costs such as expert witnesses and court fees throughout the dispute.
Conditional fee arrangements do not cover security for costs, so where, as discussed above, you are required to provide security for the other party’s costs if unsuccessful with your claim, you will still need to find funding for security (such as ATE Insurance discussed below).
There are specific legal requirements under the Legal Profession Uniform Law that set out what must be included in a conditional costs agreement. For instance, section 181 (4) sets out the requirement of a cooling-off period of not more than five business days, during which the client may terminate a conditional costs agreement.
After-The-Event (ATE) Insurance
What is ATE insurance?
If your claim is unsuccessful, the other party may be able to seek an order that you pay a portion of their legal costs (known as adverse costs). Rather than providing funds for you to pursue the claim, ATE funding is an insurance product that offers protection against the payment of these costs.
In exchange for a premium, the insurance will generally cover your liability for the other party’s legal costs and disbursements.
When is ATE insurance best suited?
ATE insurance is an effective mechanism for sharing and insuring against the downside risk of pursuing a claim.
ATE insurance is appropriate where you are likely to be unable to pay a costs order in the event that your litigation is unsuccessful.
ATE insurance can also be used as a form of security for costs.
How to obtain ATE insurance
ATE insurance is not a highly developed market in Australia.
An application can be made at any stage of the litigation process, though it can be difficult to secure ATE insurance as a matter approaches trial. Premiums tend to rise, and some insurers will not provide a quote for within 3-6 months of trial.
ATE insurance and third-party litigation funding are often sought together at the beginning of litigation.
There are several structures for ATE insurance premiums, from up front premium payments to the premium being contingent on the outcome to a mix of both options. The earlier in the litigation process that ATE insurance is taken out, and the more of the premium paid that is not dependent on the outcome, typically the lower the amount of the premium.
Other considerations for ATE insurance
Without insurance, the amount of costs which you may be required to pay will ordinarily be between 60% and 70% of the other party’s out-of-pocket costs. The standard approach for calculating this percentage involves a process of the court going through the file and determining what the reasonable costs should be (which generally sees the total amount reduced to the 60-70% bracket).
There are also situations where the court can order that no costs are to be paid by either party, such as when there is no clear ‘winner’ when the dispute is resolved.
What is Disbursement-Only Funding?
Disbursement-only funding covers only the third-party costs incurred by lawyers in preparing a case, such as court fees, expert reports and barristers’ fees.
Disbursement-only funding typically works by deferring the payment of your costs to third parties, until the time of settlement or a pre-determined time limit.
When is Disbursement-Only Funding best suited?
Clients who want to minimise initial costs in exchange for a smaller risk reduction.
When used in combination with another method of funding that doesn’t cover disbursements, such as conditional fee arrangements.
How to obtain Disbursement-Only Funding
Disbursement-only funders work in a similar way to litigation lenders. Funding is typically provided to law firms on behalf of a client, with the application process dependant on the provider.
There is a smaller market for disbursement-only funding in Australia. Most providers of disbursement only funding will only invest in personal injury claims where the claim is being backed by a lawyer under a conditional fee arrangement.
There are several opportunities to unlock funding from the ATO if you are engaged in a dispute with them.
ATO Small Business Funding
What is ATO Small Business Funding?
If you are involved in a dispute with the ATO in the Small Business Taxation Division of the Administrative Appeals Tribunal (AAT), and the ATO engages external legal representation, you may be eligible to have the ATO cover the cost of your legal representation.
The ATO specifies that it will cover “reasonable costs” in your litigation, which can include:
counsel’s fees, where the number and seniority of counsel engaged is equivalent to the ATO’s legal representation
Costs that are deemed unreasonable by the ATO (and therefore not covered by small business litigation funding) include:
the preparation of your engagement agreement with a law firm
administrative work such as tasks typically performed by legal secretaries
expenses related to tasks after the proceedings have concluded.
A full list of conditions and instructions for applying for ATO small business litigation funding can be seen on the ATO’s website.
When is ATO Small Business Funding best suited?
Applicants in the AAT’s Small Business Taxation Division
Suited to matters valued at less than AUD $10 million, but should be considered by any business or individual in dispute with the ATO
How to obtain ATO Small Business Funding
The ATO will inform you if they engage external counsel, and this is your cue to apply for small business funding.
A lawyer can then help you draft a submission to the ATO’s small business funding unit. On a case-by-case basis, they will determine whether to escalate your application to the assistant commissioner for review.
Both the process of applying for funding and taxation disputes in general can be complex and difficult to navigate. It is essential you choose a lawyer with the expertise and experience to guide you through this process.
Other considerations for ATO Small Business Funding
The ATO won’t cover GST if the taxpayer is registered for GST
Counsel and solicitor’s rates will be capped based on the scale for solicitor and counsel costs under the Federal Court Rules 2011 (Cth)
ATO Test Case Funding
What is ATO Test Case Funding?
ATO test case litigation funding applies to individuals who are engaged in a dispute with the ATO that has broader policy implications, which may be tax, superannuation or ATO debt-related issues.
Having ‘broader policy implications’ means that your dispute contains circumstances around which the law is ambiguous, and the decision in your dispute will likely be used to determine the outcome of other similar cases in the future.
Although, ATO test case funding is rarely provided. If you or your advisors believe that your case has genuine merits for a successful funding application, you will need to provide relevant and persuasive information to the ATO in support of your funding application.
When is ATO Test Case Funding best suited?
The ATO specifies that for a case to be approved for funding, it must either have:
Significance to a substantial section of the public
Significant commercial implications for an industry
For example, as at 1 March 2022, the ATO is hearing a matter approved for test case funding with the following details:
High Court of Australia
Whether a clause in a Convention between Australia and the UK regarding double taxation and fiscal evasion with respect to income tax and capital gains tax prevents the Applicant (a UK national) from having the working holiday maker tax rates applied in full to her working holiday maker income.
Reason for uncertainty and/or contention
“The case has the potential to establish principles of law that go beyond the working holiday maker provisions, particularly in relation to the operation of the non-discrimination clause in those of Australia’s tax treaties that include it.”
Impact on other taxpayers
Because the non-discrimination clause also exists in other jurisdictions’ tax treaties, international communities will be interested in the outcome. The decision may also create precedent for future similar cases involving working holiday makers.
How to obtain ATO Test Case Funding
To obtain ATO litigation funding, your case needs to be approved by an ATO panel, which consists of ATO decision makers and external stakeholders. For the panel to consider your case, you need to prepare a bundle of information and documents outlining how your case meets the criteria for test case funding.
This is submitted to the ATO’s strategic litigation unit, which acts as the gateway between the public and the ATO panel. The panel typically only convenes a few times a year, but can be called together if a significant case arises.
In reviewing your case, one of the things the ATO panel will consider is whether the facts of your case are clear enough for the matter to be run through the court. The ambiguity around test cases should only be in the application of the law, not in the facts surrounding the dispute itself.
Upon submission, the ATO will typically take 1-2 months to advise you of whether you are eligible for test case funding. It will then commonly require another 1-2 months to get the funding agreement in place.
Other considerations for ATO Test Case Funding
Test case funding is not particularly common. In an ATO report titled ‘Your case matters’, the ATO’s funding panel only considered 12 test case funding applications between 1 July 2011 to 31 December 2011. Of these, the panel approved 2, declined 8 and approved 2 on a conditional basis.
Test case funding typically is only grantedin the Federal Court – it is very rare for disputes being heard in tribunals to receive test case funding.
The key to securing test case funding is in crafting a persuasive, cogent submission that will be viewed by members of the committee as having wider ramifications in society.
What is Crowd Funding in a litigation context?
Crowdfunding is a method of raising funds for litigation online by sourcing small contributions from a wide range of members of the public.
Crowdfunding is a relatively new phenomenon in the litigation funding space in Australia, and has been used sparingly but at times successfully in recent years.
Broadly, there are three approaches of crowdfunding based on the way your campaign is framed to potential donors:
Donation-based crowdfunding: where donors are asked to provide funds for litigation with no expectation or offer of reward or return.
Rewards-based crowdfunding: where donors are offered some kind of reward in exchange for their funds to support legal action, for example, a product or experience.
Equity-based crowdfunding: where donors contribute legal funds on the basis that they will receive a percentage of the damages awarded, or some other form of financial return.
When is Crowd Funding best suited?
Whilst commercial third-party funders tend to prioritise claims of higher potential value and certainty of success, crowdfunding can provide funding for disputes regardless of the quantum or legal merit.
Crowdfunding therefore has the potential to meet the gaps between more traditional funding options for both individuals and organisations. However, it should be noted that in many cases crowdfunding alone may not raise sufficient funds to fund litigation in its entirety.
Crowdfunding provides an opportunity to directly engage with the public on important legal issues, though it tends to work best with popular or controversial subjects and/or persons.
An activist sought crowdfunding to defend a defamation claim made by Peter Dutton in relation a tweet posted in February 2021 that went to the High Court, which raised over $150,000 on Chuffed. Matters with less public interest may be unlikely to generate this kind of traction.
How to obtain Crowd Funding
Each crowdfunding platform will have different guidelines for establishing your campaign, though it is a relatively straightforward process.
You will need to determine your eligibility for the platform based on the kind of campaign you are looking to establish. Kickstarter, for example, does not allow equity-based campaigns. You should also ensure you understand the fee structure of the crowdfunding platform.
Once you choose a platform, starting a crowdfunding campaign is as simple as creating the content for your page and promoting your campaign to interested stakeholders in your dispute.
Other considerations for Crowd Funding
There are important regulatory considerations for each type of crowdfunding.
Donation based crowdfunding is the least regulated, in that it is not subject to the Corporations Act 2001 (Cth) or oversight from the Australian Securities and Investments Commission (ASIC). Donations made by donors are generally considered to be gifts, which carry few consequences under contract law. For example, if you raise more funds than you end up requiring for your litigation, you will likely not be required by law to return these funds to donors. However, any improper, deceitful, or unethical conduct involving the collection or use of donation-based crowdfunding can still be enforceable by civil remedies.
Rewards-based crowdfunding carries more regulatory considerations, as the offer or promise of a reward creates the possibility for disputes with donors under contract law or under Australian Consumer Law if, for example, funds are not used in the manner specified on the crowdfunding campaign.
Equity-based crowdfunding can be classified as a ‘financialproduct’ under the Corporations Act if a direct financial reward is offered (e.g. in the form of damages) in exchange for the investment. This would require you, as the receiver of this crowdfunding, to be licensed and comply with the Corporations Act and ASIC. Failure to do so can lead to serious penalties. Equity-based crowdfunding is the most regulated and should be carefully researched beforehand.
Charities are subject to additional regulations with regards to litigation crowdfunding. If you are a charity and have deductible give recipient (DGR) status, you will have tax obligations from crowdfunding based on the type of crowdfunding used and whether the charity is carrying on an enterprise.
There are possible consequences of disclosing confidential information about the dispute in your crowdfunding campaign, such as the waiver of legal professional privilege and breaching the requirement to not disclose information provided by another party under compulsion.
Crowdfunding may not cover adverse costs. If you use crowdfunding to cover all or a portion of your legal costs, you should still account for the situation in which you may be required to pay for the other party’s legal costs if the litigation is unsuccessful.