The European Parliament's proposed regulation of litigation funders: what you need to know

The European Parliament has published a proposed Directive to regulate commercial third party funding within the EU. The draft proposal can be found here and we have set out an overview of the proposal below.

Who will it apply to?

The proposed Directive appears intended to apply to litigation funders and their funding agreements no matter where the litigation funder is based, provided the proceedings are in the EU.

Key recommendations

The proposed Directive obliges Member States where third party funding activities are permitted to create a system for monitoring and authorising the activities of funders, led by an independent supervisory authority. A key requirement for authorisation will be a capital adequacy requirement to ensure that the funders have adequate financial resources to meet their potential funding liabilities.

Amongst others, the key recommendations in respect of third-party funding agreements are as follows:

• That Member States should empower their courts to make adverse costs orders against litigation funders, whether jointly or severally, following an unsuccessful outcome.
• There must be a clause in funding agreements specifying that any awards from which the fees of the funder are deductible will be paid in full to the claimants first, who may then pay the agreed sums to the funder.
• There must be defined circumstances in which the funder can terminate the agreement rather than allowing the funder to terminate at will.
• The agreement must contain a declaration that the funder has no conflict of interest.

The proposed Directive also provides that funding agreements will be invalid if:

• They grant explicit power to a funder to influence decisions or take control of the proceedings (including settlement and the management of expenses).
• They entitle the funder to more than 40% of the total award "absent exceptional circumstances" (which are not defined). In other words, a cap on funders' recovery of 40%.

Comment

The proposed Directive is intended to establish a legislative framework for third-party litigation funding in the EU, and is clearly focused on access to justice and appropriate safeguards for claimants seeking funding. Whilst this is obviously an important goal, the proposals such as the 40% cap on recovery may be somewhat controversial in the funding community within international commercial arbitration where the users of third party funding are becoming increasingly sophisticated.

The proposals appear intended to apply to arbitrations where the proceedings are seated in the EU, regardless of where the litigation funder is based. However, the proposed Directive does not explicitly address how funders will be made liable for adverse costs awards in an arbitration context where funders are not party to the arbitration and not subject to the tribunal's jurisdiction. Absent further clarification, this could lead to satellite litigation in the courts following a costs award in an arbitration.

The European Commission will decide whether to submit a proposal for the directive, which would then need to be adopted by the parliament and EU Council. HSF is monitoring the position closely.

For further information please contact: Mathias Wittinghofer, Partner, John O'Donoghue, Head of Legal Operations, Vanessa Naish, Professional Support Consultant, Liz Kantor, Professional Support Lawyer, or your usual Herbert Smith Freehills contact.