The CAT’s welcome boost for the funding industry

Posted by Eliza Finch, head of risk management at Legal Futures Associate Litica

Finch: Ruling will mitigate potential fallout from PACCAR

There was welcome guidance from the Competition Appeal Tribunal (CAT) this week for funded cases looking for certainty following PACCAR.

The renegotiated Sony litigation funding agreement (LFA) was upheld as lawful, despite including a provision for the funder’s return to be calculated by reference to a percentage of damages.

The performance-based return was caveated by the wording “only to the extent enforceable and permitted by the applicable law”. This language was held to mean that unless and until there has been a reversal of the impact of PACCAR via the legislature, the performance-based return would not be engaged.

By way of further context, following the Supreme Court’s ruling in PACCAR, any LFA defining its return by reference to a percentage of recovered damages, is considered to constitute a damages-based agreement (DBA). As such, to be enforceable, it would need to comply with the DBA Regulations 2013. Being completely different in nature, litigation funding agreements will not be compliant.

It follows that they may be challenged as unlawful and therefore unenforceable. In reaching this conclusion, the Supreme Court in PACCAR was undertaking an exercise of statutory interpretation.

There has been extensive commentary since, highlighting what were said to be unintended consequences of the judgment. Indeed, an amendment to the Digital Markets, Competition and Consumer Bill which addresses this (albeit it only in the context of opt-out class actions before the CAT) has been put before Parliament.

In the meantime, however, the potential ramifications for those highly invested under such agreements is clear. Since the court’s summer ruling, funders have been reviewing the terms of their LFAs to identify any vulnerabilities and re-negotiating terms to shore them up.

We have observed different approaches being taken by different funders. There have been debates as to the severability of these performance-based provisions, which is, in principle, a simple and in many cases robust answer but intrinsically uncomfortable for those at the sharp end of the risk/investment.

Re-negotiation for clarity and certainty has generally been the preferred course of action. Of course, negotiating leverage will vary depending on the stage of the litigation, the situation of the claimant and the merits of the dispute.

Yet, by and large, what we have seen has proven straightforward and without conflict. It has not always been a question of simply foregoing the performance-based returns and we have seen multiples rise, but not in all cases.

As with every change of law, there is scope for gamesmanship. With the funding arrangements of proposed class representatives (PCR) under scrutiny by the tribunal, the CAT is a natural forum for these arguments to play out and defendants have not missed a beat in raising challenges.

The arguments contrived out of the renegotiated funding agreement in the Sony claim are illustrative. The funder in Sony did not propose to give up its performance-based return, lest the legislature steps in to reverse the position. Instead, as explained above, a re-negotiated LFA was presented to the CAT which included provision for the funder’s return to be determined by reference to damages, “only to the extent enforceable and permitted by the applicable law”.

The PCR argued that the plain meaning of the clause was that there would be no payment that is determined by reference to a percentage of the damages, unless and until there is a change in the law permitting such agreements.

Sony argued that the introduction of this language was insufficient to convert the LFA from a DBA into a lawful funding arrangement. A carefully drafted severance clause was also included in the LFA, which explicitly provided for that provision to be severed if necessary to ensure the legality of the agreement.

Sony argued too that the alternative mechanism for calculating the funder’s return also fell foul of PACCAR. Even replacing a performance-based return with an investment-based return was said to be unacceptable, given that the return is to be paid out of undistributed damages.

The CAT unanimously rejected all of these arguments. The clause operates with a contingency and will have no legal effect unless and until that contingency eventuates via the legislature making a change.

Helpfully the CAT also commented, obiter, on the position vis-à-vis severance. Sony had argued that the common law test for severance could not have been met in this context on the basis that severance of the relevant provision would change the character of the LFA, such that it would cease to be a DBA.

This was not accepted by the CAT, which relied on the fact that the severance clause itself expressly contemplated the offending provision being removed “without changing the nature of the contract, such that it is not the sort of contract that the parties entered into at all”. The CAT saw no reason to go behind this express agreement between the parties.

This judgment will be welcomed by the funding industry. It will help mitigate any potential fallout from the Supreme Court ruling.

Sony marks the 12th case to be certified in the CAT since the inception of the regime.


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