Quietly changing third-party funding regulations have left a series of pitfalls for unwary solicitors. Jamie Carpenter reports

A quiet revolution has taken place in the law relating to third-party funding. Not so long ago, the idea of a party financing a claim in which it had no interest in return for a share of the proceeds would have been met with a cry of 'champerty', but under the banner of 'access to justice' parliament and the courts have, in recent years, opened the doors to forms of litigation funding which would have been unthinkable a generation ago.

With the backing of the courts, third-party funding is set to take off as a method of financing commercial litigation, from the smallest to the largest claims, and it is not just litigants that stand to benefit. At a time when stock markets are collapsing, investors are looking for other ways to increase their returns and funding commercial litigation is increasingly attractive.

Third-party funding, however, is still in its infancy. There are unanswered questions and no shortage of pitfalls for the unwary. Lawyers will increasingly be approached to advise parties contemplating the use of third-party funding, parties facing claims funded by a third party and the funders themselves. This article aims to highlight some of the issues that need to be kept in mind and the areas of future uncertainty.

Commercial third-party funders are not charities: they expect something in return for their investment, that something being a proportion of the proceeds of the litigation. There could not be a clearer example of champerty, and until recently there would have been no doubt that such an arrangement was unlawful as contrary to public policy. However, public policy moves on. In 1967, champerty ceased to be a crime (along with the equally heinous offences of scolding, eavesdropping and night walking).

The revolution really got underway in 2002 with the Court of Appeal's decision in R (Factortame) v Transport Secretary. An arrangement whereby a firm of accountants financed the impecunious claimants' litigation in return for 8% of the damages recovered was held to be not merely lawful, but commendable. Since then, the courts have continued to uphold litigation funding agreements and the impression given is that they will be slow to strike them down. That is not to say that every third-party arrangement will be lawful. If the funder has too much influence over the conduct of the litigation or claims too great a share of the proceeds, the courts will still intervene.

If the agreement is unlawful, the consequences for the funder are dire. A champertous agreement is unenforceable. In a winning case, therefore, the funder will not be entitled to its success fee and may well not be able to recover payments actually made to benefit the winning party. In a losing case, the funder is likely to be liable for the entirety of the opposing party's costs

Costs orders against funders

Both funders and litigants facing commercially-funded claims are likely to want to know whether funders will face adverse costs orders in the event of the funded claim failing. In short, they will – the quid pro quo for a funder of a success fee in the event of the litigation succeeding is a liability for the other side's costs in the event of it failing.

Distinguishing commercial funders from 'pure' funders who have no financial stake in the litigation, the Court of Appeal held in Arkin v Borchard Lines that the funder should pay the winning party's costs but its liability should be capped at the amount of funding that it had provided to the losing party.

However, the protection of that cap is likely to be conditional on the funder's good behaviour. A funder who gets too closely involved in the litigation may be exposed to an unlimited costs liability (in Arkin the funding was strictly arm's length) and a funder whose agreement is found to be champertous can expect the same result.

With stringent claims vetting, there is likely money to be made from funding litigation, but success will depend on having a large enough share of the market to swallow any losses. Anecdotal evidence suggests that some funders are finding very few claims they are willing to back. The spectacular collapse of Moore Stephens v Stone & Rolls, the largest commercially-funded case yet to reach the courts, may cause some funders to think again. Furthermore, as the market becomes more competitive, the proportion of litigants' damages that funders will be able to take is likely to be forced down.

From the litigants' point of view, commercial funding will not necessarily be the best option. Consideration will have to be given to whether after-the-event (ATE) insurance – which will leave the client with the whole of their damages – may not be a better option, and the effect of the cap on a funder's liability as a result of the Arkin decision may force even funded litigants to take out ATE insurance to cover any adverse costs liability in excess of that cap. Funded claims also offer challenges to opposing parties, who will have to plan their approach to a claim in the knowledge that they may well not recover the whole of their costs if successful.

In short, commercial funding of litigation is here to stay, but it is likely to be a while before we know exactly what limits the courts will place on it. In the meantime, anybody involved in commercial litigation needs to keep abreast of developments, and should be aware of the possibility of taking specialist advice in a difficult case.

Jamie Carpenter is a tenant at Hailsham Chambers.