arbitration & litigation too expensive? construction
TRANSCRIPT
February 27 - March 1, 2020 | Renaissance Indian Wells Resort & Spa
Arbitration & Litigation Too Expensive?Construction Contract Dispute Funding
May Be The Answer
James G. Zack, Jr. Principal, James Zack Consulting, LLC
Senior Advisor, Ankura Construction Forum™
“The construction industry’s premier resource for thought leadership & best practices on avoidance & resolution of construction project disputes globally”
48 years experience in construction management, construction claims analysis & dispute resolution
Involved in more than 5,000 claims
Prepared & submitted claims for contractors or analyzed & resolved or defended claims for project owners in 32 States in U.S. & 32 countries abroad
Fellow of AACE International, Royal Institution of Chartered Surveyors & Guild of Project Controls
Former President, AACE International; author of RP 25R-03 (Lost Productivity); contributor to RP 29R-03 (Forensic Schedule Analysis)
CCM, CFCC & PMP
Introduction
• “Construction claim” = request for additional money &/or time
• Claims common on projects
• Most resolved on project sites
• Some become disputes in mediation, arbitration or litigation
• Tend to be larger, more complex claims
• Survey – 35% of corporate counsel expect claims to rise – only 9% think will decline
• Survey – Average claim in US = $22.2 million & takes 16 months to resolve afternegotiations fail
Introduction• Many in-house counsel “always contest
disputes”
• Survey – 63% of finance professionals abandoned claims rather than pay legal costs
• Whether claims would have prevailed – who knows?
Anticipated Value of Claim % of Claims Abandoned
$100M or More 6.8%
$50M to $99.9M 17.3%
$20M to $49.9M 23.5%
$10M to $19.9M 30.1%
$5M to $9.9M 14.3%
Less that $5M 7.3%
Don’t Know / Not Sure 0.9%
Cost of Arbitration & Litigation• Estimated cost of large claims going through
arbitration or litigation
• 10% - 15% of claimed damages
• Example - $50M claim = expenses of $5M - $7.5M
• Where is money spent?*
* Estimated legal costs from University of Texas doctoral thesis
Cost Category % of Total Transactional Costs
Outside counsel fees 61%
In-house counsel fees 5%
Consultant & expert witness fees 11%
Management & staff costs 16%
Court/arbitration/mediation fees 3%
Other costs 4%
Cost of Arbitration & Litigation
UK Chartered Institute of Arbitrators (CIArb) survey of 254 arbitrations between 1991 – 2010 before 5 arbitral associations
Cost Category % of Total Transactional Costs
External legal fees 63%
Barrister fees 11%
External expenses 8%
Witness costs 5%
Expert fees 10%
Management cost 3%
Cost of Arbitration & Litigation
• Breakdown of external legal & barrister costs
* U.S. discovery costs much higher than UK costs
Cost Category % of Transactional Costs
Pre-commencement 9%
Discovery* 5%
Hearing Preparation 12%
Commencement 10%
Fact witnesses 7%
Hearings 16%
Exchange of pleadings 25%
Expert witnesses 7%
Post hearing briefs 9%
Cost of Arbitration & Litigation• Shared costs in arbitration
• Breakdown of costs
• Average arbitrations incur 1,500 – 4,500 hours of legal work – 1,500 hours @ $300/hour = $450,000
• U.S. uses “American Rule of Law” – each party pays own expense – not loser pays!
Shared Cost % of Total Transaction Costs
Transcripts 4%
Arbitral fees 60%
Arbitral expenses 10%
Hearing venue 7%
Other 19%
Dispute Financing –A Viable Alternative?
• Dispute financing = third party funding of arbitration or litigation costs
“Getting someone else to finance cost of bringing claim in return for share of damages recovered”
• Originated in Australia & UK in 1990s
Initially used in class action or bankruptcy suits
• Entered US in early 2000s focusing on class action suits
• Some dispute financing firms now financing construction claims
• January 2020 study – 41 dispute financing firms in U.S. ready to deploy $9.5 billion
Is There A Role for Dispute Financing in Mediation?
• Study indicates following –
• Review of potential claims by financiers brings fresh perspective & weeds out weak cases
• Fact that claimant has secured dispute financing may lead to mediation & settlement
• Financiers focus on numbers, not personalities pushing mediation toward business to business process
Is There A Role for Dispute Financing in Mediation?
• Study indicates following –
• Financers at mediation table good due to dispassionate view of claim but not participate n presentations
• Financiers not decision makers in mediations
• Financiers may drive early settlement & participants better prepared & more knowledgeable of facts
Awareness & Perception of Dispute Financing
• 2018 survey on awareness & perceptions of dispute financing
• 922 questionnaires & 142 follow up interviews
Familiarity of 3rd Party Financing
Aware of but have not used in practice 56%
Have seen it used in practice 26%
Have used it in practice 16%
Not aware of it 3%
Awareness & Perception of Dispute Financing
Perception of Non-Recourse 3rd Party Financing
1 Negative 4%
2 9%
3 Neutral 35%
4 36%
5 Positive 18%
89%
Awareness & Perception of Dispute Financing
Perception of Non-Recourse 3rd Party Financing By Parties That Have Used It
1 Negative 0%
2 8%
3 Neutral 17%
4 39%
5 Positive 36%
92%
Forms of Dispute Financing
• Single Case Financing
• Finance single claim being pursued in legal forum
• Portfolio of Claims Financing
• Finance package of claims in legal disputes
• Claims Factoring
• Purchase claim settlements for reduced price
• Keep full settlement value when paid
• Post Judgement Financing
• Contractor wins claim, owner appeals decision
• Appellate decisions = 1 to 2.5 years
• Finance appellate expenses
Forms of Dispute Financing
2019 study showed % of $2.3 billion of financing deals to different types of claims
• 47% to portfolio of claims
• 38% to individual claims
• 15% to corporate portfolios
“…many funders look for cases with potential damages 10 time greater than their
investment…”
Types of Dispute Financing Firms
2020 study showed following types of dispute financing firms
• Traditional Dispute Funders
• Firms dedicated to financing disputed matters
• Hedge Funds
• Do not specialize in dispute financing but have access to funds that do
• Other Sources of Dispute Financing
• Wealthy individuals, family firms, other hedge funds without dedicated dispute financing groups
• & some dispute funders have sold interest in funded matters to other investors
Dispute Funders Considerations
• Potential claimant’s status
• Claimant or respondent
• Amount, type of work needed differs as does cost
• Claimant have objective other than damages?
• Want to maintain business relationship or reputation?
• Amount in dispute
• Damages in dispute?
• Must be large enough to recover funder’s cost + profit
Dispute Funders Considerations
• Anticipated legal & expert costs
• To maximize return funder may negotiate reduced fees or alterative fee arrangements
• Claim in mediation, arbitration or litigation
• Mediation – claims compromised to get fast closure
• Arbitration – experienced panel & appeals rare
• Litigation – inexperienced judges or juries & decisions frequently appealed
• Claimant subject to other legal actions?
• Claims from subs, False Claims allegations
When Considering Dispute Funding
• Consider alternatives
• Dispute funders do business differently
• Need funder with best fit & best deal for situation
• Prepare
• Help funders with their due diligence
• Help them understand claim
• Advise on adjudication process
• Provide information on owner’s ability to pay any award
• Collect
• All documents & make available to funders
When Considering Dispute Funding
• Speak
• Funders need interview contractor staff (percipient witnesses) & experts
• Need to assess “winnability” of claim
• Ask
• Ask questions about process & details of funding deal
• Avoid adverse “surprises” at end of dispute
• Should not ask attorney to arrange financing
• May violate legal ethics or lead to negligence suit later
• Remember – funders are investors, notclaimants
Pros of Dispute Funding
• Non-recourse funding provides
• Assurance claim legitimate & winnable
• Reliable estimate of cost of pursuing claim
• Budget certainty
• Assessment of strength & weakness of claim
• Degree of assurance needed to move forward
• Likely range of settlement or decisions
• Non-recourse funding serves as risk management tool
• Balance downside liquidity risk vs. upside recovery
Pros of Dispute Funding
• Purpose of legal system – resolve disputes on merit, not financial resource of parties
• Dispute funding levels playing field
• Non-recourse funding not loan, an asset purchase
• Funder pays cost of pursuing claim
• If wins – gets back cost of pursuit + % of awardor multiple of costs funded
• If loses – gets $0 back
• Dispute funding frees up contractor’s capital
• Use capital to advance business, not pay legal fees
Pros of Dispute Funding
• Dispute funding enhances contractor’s ability to retain top notch legal counsel as fees assured
• Many law firms not take complex construction cases on contingency
• Funders apply forensic level of due diligence to cases
• Vet validity, chances of success & weed out weak cases
• Legal system more efficient
• Dispute funding empowers contractors to negotiate fees with legal counsel
Cons of Dispute Funding• 3rd party funding
• Encourages frivolous & abusive litigation
• “More litigation financing means more litigation!”
• Prolongs litigation as clients encouraged to reject early settlement offers
• Poses serious ethical dilemmas & weakens attorney client relationships by interposing 3rd
party
• 3rd party may try to control case – direct legal strategy, pressure attorneys over settlements
• Makes providing candid legal advice less likely
• Attorneys provide less candid advice to protect privilege
Cons of Dispute Funding
• If funders focus solely on profits vs. helping clients solve legal problems, dispute funding may be detriment to clients & industry
• Increasing number of funders in industry, but many not trial lawyers
• Never helped clients solve challenging legal issues
• Not understand ethical obligations owed to clients
• Dispute funding may give claimant attorneys unfair advantage in settlement talks
Issue: Champerty Doctrine –Is Dispute Funding Legal?
• Champerty Doctrine defined –
“A bargain by a stranger with party to a suit, bywhich such third person undertakes to carry onlitigation at own cost & risk, in consideration ofreceiving … part of the proceeds … recovered”
• Old concept in law, not favored by U.S. courtstraditionally
• Funding not classified as champerty unless claimpurchased solely to commence litigation
So far no state court barred 3rd party funding
Issue: Dispute Funding Discoverable?
• Should dispute financing be disclosed?
• Today only Wisconsin mandates disclosure
• But bill introduced in Congress to do this
• Arguments for disclosure
• Potential bias & conflict of interest
• Arbitrators, judges or jurors may have financial interest in funder that may sway decision
• Control
• Funder may control strategy or pressure attorneys on settlements
Issue: Dispute Funding Discoverable?
• Proportionality
• Claimants often try to limit discovery as “overly burdensome”
• If funder paying costs, argument not supportable
• Fee shifting & security for costs
• Where cost shifted to “prevailing party” & adverse party unable to pay costs, dispute funding should be disclosed & funder should pay
• Insurance analogy
• Federal statute requires disclosure of all insurance available to parties
• Litigation funding should be disclosed likewise
Issue: Dispute Funding Discoverable?
• Arguments against disclosure
• Irrelevance
• Funding has nothing to do with merit of claim
• Definition
• Litigation funding takes many forms
• Defining such funding highly problematical
• Prejudice
• Funding not always involve “unconditional obligation” to pay all costs
• If adverse party knows claimant’s budget may employ tactics to exhaust budget & leverage unfair advantage
Issue: Dispute Funding Discoverable?
• Efficiency
• Disclosure of funding may lead to more discovery & “fishing expeditions” lengthening arbitration or trial
• Passivity
• Funding agreements typically passive in nature
• Disclosure on basis “control may exist” may lead to more discovery, more motions
• Legal process longer, decision delayed
• Lack of reciprocity
• If funding disclosure required, respondent’s assets should be disclosed to prevent cases with unrecoverable judgements
Issue unresolved at present time
Issue: Dispute Funding Discoverable?
• Should all documents provided to funder be discoverable?
• Communications between contractor & attorney “privileged”, not subject to discovery
• Documents will be provided to funders during vetting
• Documents may become discoverable
• 37 cases around country with court decisions on issue
• 30 cases (81%) – “no significant discovery or discovery on redacted basis”
• 7 cases (19%) – “discovery permitted”
Issue unresolved at present time
Issue: Litigation Financing Costs Recoverable in Arbitration?
• Claimants often attempt to recover legal fees & expenses in arbitration
• Funders fees = % of recovered amount or multiple of financing provided
• Several recent cases awarded these costs
“…third party financing of litigation generally not baraward of attorneys’ fees…”
“…position consistent with … proposition wrongdoersshould not reap windfall of victim’s industry in havingsecured alternative source of payment…”
Issue unresolved at present time
Trends & Predictions on Litigation Funding
• Increase in volume of claims requiring funding
• Industry recognizes claims funding “works”
• Higher quality claims presented
• “Reviewing & rejecting bad claims part of funder’s job”
• Rising tide of megaprojects• Growing opportunity to provide litigation
funding
• Dispute funding increasingly about morethan litigation
• Funding de-risks or monetizes litigation positions
Trends & Predictions on Litigation Funding
• Uncertainty & political flux increasingly about more than litigation
• Funding one way to manage risk for contractors & legal counsel
• Continued affirmations of dispute funding by courts will undermine critics
• Law firms will become more like funders
• May arrange funding for themselves to finance contingent fee claims
Trends & Predictions on Litigation Funding
• Funders will become more like financiers
• Will turn expertise to risk analysis & ROI
• Will accept more risk but hedge risk on secondary market
• Pricing will be more competitive
• Contractors can expect to receive multiple offers
• Funders will create new products
• Monetize work in progress, invest in start up law firms, purchase judgements & awards
Trends & Predictions on Litigation Funding
• Courts will become more sophisticated at dealing with issues created by dispute funding
• Case law likely to develop guidelines for funding
• May lead to mandatory government regulation
• Greater transparency & accountability• Claimants learn about options previously
unaware of
• May lead to association of funders to self-regulate industry
• Funders will expand geographic reach• Open new fully staffed offices around country
Trends & Predictions on Litigation Funding
• Pricing begins to segment deal size
• Claimants & legal counsel transferring risk to funders
• Size of deals likely to become larger due to portfolio deals
• Secondary market growth
• Funders now selling off portions of asset purchases
• Similar to re-insurance deals
• Courts, Congress & Department of Justice studying litigation financing
• Impact to litigation funding unknowable at present
Conclusion
• Litigation funding not new in U.S.
• What is new is funding of construction disputes
• Too many claims abandoned due to lack funds to pursue matters into legal process
• Litigation “levels the playing field”
• Quality of claims going into mediation, arbitration or litigation will improve
• Steep learning curve for first time funding users
• Procedure, forms of financing, deal terms, etc.
Conclusion
• Non-recourse dispute funding likely bestoption for contractors
• Funders pay all legal & expert fees + other costs
• If contractor prevails in mediation, arbitration or litigation funder gets back costs funded + percentage of award or multiple of costs funded
• If contractor loses claim funder recovers $0
• Given number of funders & different deals available contractors & legal counsel well advised to work with litigation funding advisor
• Help find best fit funder & funding deal
Questions or Discussion
James G. Zack, Jr.
Principal
James Zack Consulting, LLC
+1.970.775.8066 Direct
+1.949.439.9407