Startup Survival: Can Litigation Funding Level the Playing Field?

– Ksheerja Srivastrava

Introduction

Recently, the rise of several Litigation Funding firms has been observed in India. It has indicated the development of a relatively new but an expanding market. While the increased adoption of litigation funding is being observed in India now, it has existed as a common practice globally. A recent report by Chambers discussed about the legal framework of litigation funding in several jurisdictions globally. When access to justice is discussed, there is no doubt that funding for the same is an aspect that cannot be ignored. This is where litigation funding comes in. This approach has gained traction in India due to high litigation costs and growing commercial disputes. This article will analyze the assistance that startups receive from litigation funding firms through a microeconomic lens, specifically the misalignment of interests in the principal-agent problem which may hamper the process of seeking justice.

What is Litigation Funding?

Litigation funding is essentially funding by a third party. It is an arrangement wherein a third party shall cover the cost of litigation in exchange for a share in the amount won by the claimant in case of a favorable judgement. Additionally, no recovery of the funding is required in case of an unfavorable judgement. This practice is hence, usually used for civil matters. It can broadly be divided into 2 categories: Personal Litigation Funding and Commercial Litigation Funding. The distinction between the two lies between the claimant in the case. Personal litigation funding assists individuals while commercial litigation funding may assist corporations, companies etc. The litigant acts as the principal and the litigation funder acts as the agent in such a situation. 

Due to financial limitations that restrict their capacity to seek or defend legal actions, startups frequently need litigation funding. Startups must prioritize operations and growth due to limited cash flow, which makes expensive litigation a major burden. They can challenge anti-competitive behaviours, settle contract disputes, and protect intellectual property rights without using up essential resources with the help of litigation funding. Apart from that, financial risk is reduced for startups and the playing field is levelled for such startups against well-funded opponents. Opting for funding by a third party also helps startups get access to top notch legal counsel while also avoiding detrimental early settlements. This funding allows for guarantee of equitable results alongside leaving funds to foster growth and development of the company.

The Principal-Agent Dilemma 

The Principal-Agent Dilemma is a microeconomic problem of misalignment of interest amongst the principal and agent. This problem was introduced and explained by the economists Stephen Ross (1973) and Michael Jensen & William Meckling (1976) as a fundamental idea in microeconomics. 

A conflict of interest may arise when one party, being the principal, gives decision making authority to another party, being the agent. This occurrence is broadly called the principal-agent dilemma. It may be because of the agent behaving in their own self-interest rather than the principal’s best interests. The cause of this dilemma is often information asymmetry. Issues like moral hazard and adverse selection may further follow because the principal knows more about the situation than the agent. The principal-agent dilemma can also be observed in financial markets, employer-employee interactions, and corporate governance. 

The principal-agent dilemma can be viewed in the context of litigation funding as well. The problem arises when a claimant, who in a traditional arrangement would be the principal, and the funder being the agent, have conflicting or simply different interests while pursuing legal action. On one hand, the claimant may have diverse motivations such as protecting goodwill, or maximising settlement value, etc., while on the other hand, the funder’s interests lie in the return on investment. Information asymmetry in this situation occurs as the principal is more aware about the situation and the funder may not know the details of the case after the arrangement has commenced due to the attorney-client privilege. The funded party also has more details regarding the legal tactics and settlement options making the imbalance worse. Additionally, moral hazards may occur such as the claimant taking unwarranted risks because of the funder being responsible for the majority of the costs.Litigation funding in India has several benefits, both legally and economically. It provides people and companies who lack funding with an option to pursue legitimate legal claims. Third-party funders help level the playing field, especially in arbitration and business disputes, by paying legal fees in exchange for a portion of the settlement or verdict. Legally speaking, it can result in more effective dispute settlement because well-funded cases are less likely to be dropped because of budgetary limitations.  Litigation funding promotes legitimate claims and discourages frivolous litigation. This is because litigation funders evaluate the feasibility of the cases before investing in a case. This mechanism also encourages settlements which may help lessen the burden on courts because the other parties may be willing to settle at a mutually beneficial amount if they are aware of the financial support.

Litigation funding also presents challenges, especially in terms of moral and legal considerations. The possibility of third-party funders exerting too much control over litigation tactics orpushing for settlement to ensure their return remains ever-present. This would infringe on the independence of the lawyer as well as the company. There is no regulatory framework in India that would govern these problems. Furthermore, due to funder’s charges, the claimant’s ultimate payout may be reduced substantially, leaving the whole practise redundant economically. Litigation funding may promote speculative lawsuits resulting in an undue demand being placed on the legal system.

Therefore, there are both benefits and challenges to the practise of TPF. Litigation funding however can be used as a useful instrument which can improve access to justice in India. It however must be governed in a way that would maximise the benefits and minimise the dangers.

Current Legal Status in India and Other Countries

The legal framework in India for regulation of litigation funding remains a grey area presently. India has not introduced any statute, however there are precedents that recognise third party funding as a valid arrangement. The case of Bar Council of India v. A.K. Balaji (2018) is one of the leading cases which upheld the professional conduct rules for advocates while also making third party litigation funding legal in India. The only restriction is that lawyers cannot directly fund the cases of their clients. This restriction comes from the Advocates Act, 1961. This type of funding was first recognised in the case decided by the Privy Council, Ram Coomar Coondoo v. Chunder Canto Mookerjee (1876). It held that such agreements are legitimate as long as they are not against public policy. Most disputes that arise from such a situation are governed by the Indian Contract Act, 1872, due to lack of any legislation passed for this purpose. The Indian Association for Litigation Financing is an organisation which was established recently in 2021. It offers a promising step toward legitimizing the funding mechanism by seeking to self-regulate litigation funding in India. They also raise awareness regarding this industry to help people learn about this business. This would mark as a move towards developing a structure for litigation funding in the country. Even with implementation of Insolvency and Bankruptcy Code in India, elements of litigation funding have been incorporated into the legislation.

Some countries have a functioning framework for third party funding. In United Kingdom, the Association of Litigation Funders (ALF) enforces a self-regulatory Code of Conduct to guarantee moral and transparent fundraising. It forbids funders from dictating litigation strategy, settlements, or legal representation and provides for capital adequacy, transparent funding terms. Singapore Institute of Arbitrators lists out guidelines for TPF agreements related to arbitration. A legislation governing litigation funding for arbitration and mediation in Hong Kong was also passed. European Law Institute has also listed out 12 principles regarding the same while focusing on transparency, confidentiality and management of conflict of interests. However, like India, the litigation funding in United States remains unregulated and instead follows self-imposed ethical guidelines.

Need for a Regulatory Framework

In India, litigation funding is still mostly unchecked therefore an effective regulatory structure is necessary to guarantee fairness and transparency. Firstly, it is important that the rights and responsibilities of funders, plaintiffs, and attorneys must be clearly recognized by the law. This would help in demarcating accountability.

Funders should be required to register with a regulatory body and fulfil financial stability requirements to stop exploitation. Enforcement of such transparency procedures, such as notifying courts and opposing parties of funding agreements, arguably can improve the procedure. Regulations need to be brought in to minimise conflict of interest as well as protection of attorney-client privilege and legal tactics. Restrictions in regards to funders’ returns and profit-sharing agreement may be placed to prevent excessive profiteering. Court supervision is also necessary to enable review of such arrangements. Interests of litigants should be protected from unfair practices of funders by introducing a grievance redressal system. Establishing such a regulatory environment would encourage access to justice and prohibit unethical practices in litigation funding. Clear norms and regulations will draw in more ethical funders as well to the industry.

Conclusion

Litigation funding, acting as an essential instrument, assists in removing financial barriers from accessing justice. The funding by a third party, in particular, helps startups in legal disputes against well-funded opponents. The TPF agreements allow startups to fight their legal battles without compromising on their growth or development. The funds of the company remain only for the functioning of the business aspect while a third party, in exchange for a portion of the winnings, funds their legal battles.

While the arrangement in itself has been recognised, the legal framework to regulate the same is still missing. The loopholes left due to this cause ethical and economic concerns for both parties as observed when viewed in context of the principal-agent dilemma. 

The conflicting interests of the parties may be resolved by establishing registration and transparency requirements, profit limitations, agreement disclosures and judicial supervision. This would uphold legal integrity and improve access to justice. Litigation funding laws will lead to economic empowerment by balancing between ethical and financial sustainability.