Funding options for legal services - Third-party funding

Learning Outcomes

This article explains third-party funding in legal services, including:

• The concept of third-party funding and its distinction from CFAs, DBAs and legal expenses insurance
• Legal principles and public policy controls, including maintenance and champerty
• Regulatory frameworks and professional standards (ALF Code; SRA requirements)
• Funder liability for adverse costs and the court’s non-party costs jurisdiction
• The scope and limits of the Arkin cap
• Confidentiality, privilege, and conflicts of interest considerations
• Benefits, risks, and practical considerations for clients and solicitors

SQE1 Syllabus

For SQE1, you are required to understand the funding options available for legal services, including third-party funding, and the legal and practical implications of third-party funding which may be tested in client-based scenarios, with a focus on the following syllabus points:

• the main types of funding for legal services, including third-party funding
• the legal principles governing third-party funding, including champerty and maintenance
• funder liability for adverse costs
• regulatory and ethical risks for solicitors and clients
• how to advise clients on the suitability and consequences of third-party funding
• how third-party funding interacts with CFAs, DBAs and legal expenses insurance (ATE/BTE)
• the court’s power to make non-party costs orders (including the scope and limits of the Arkin cap)

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is third-party funding and how does it differ from legal expenses insurance?
2. Which historical doctrines are relevant to the regulation of third-party funding?
3. In what circumstances can a third-party funder be liable for the opponent’s costs?
4. What are two key risks solicitors must consider when advising on third-party funding?

Introduction

Third-party funding (TPF) is an arrangement where a person or company with no prior connection to a legal dispute agrees to pay some or all of a party’s legal costs in return for a share of any money recovered. TPF is increasingly used in commercial litigation and arbitration, especially where claimants lack the resources to fund proceedings themselves. For SQE1, you must understand the legal basis, regulatory issues, and practical risks of third-party funding. TPF is distinct from legal expenses insurance: funders are investors who expect a return from the proceeds of the claim, whereas insurers cover risk under an insurance contract and are remunerated by premiums. TPF may be combined with CFAs, DBAs or after-the-event (ATE) insurance to manage both budget and adverse costs exposure.

The Legal Basis of Third-Party Funding

Third-party funding is permitted in England and Wales, but is subject to legal and regulatory controls. The law has developed from the historical doctrines of maintenance and champerty, which originally prohibited outsiders from supporting litigation. Although the crimes and torts of maintenance and champerty were abolished, courts retain a public policy jurisdiction to refuse to enforce agreements that tend to corrupt the administration of justice, for example where a funder seeks excessive control over the litigation or where funding improperly incentivises speculative claims.

Key Term: maintenance
Maintenance is the improper support of litigation by a third party who has no legitimate interest in the case.

Key Term: champerty
Champerty is a form of maintenance where the third party supports the litigation in exchange for a share of any proceeds.

Modern courts recognise that third-party funding can improve access to justice, provided it does not encourage frivolous claims or undermine the integrity of the legal process. The doctrines of maintenance and champerty still exist as matters of public policy, but are now applied to prevent only abusive or improper funding arrangements. To avoid champerty, the funded party must retain control over the litigation and settlement decisions; funder rights must be carefully drafted so they do not amount to commanding strategy or compelling settlement against the client’s wishes.

A further enforceability consideration is the structure of the funder’s return. If the funder’s remuneration is calculated by reference to the damages recovered, the agreement may be treated as a damages-based agreement (DBA) and must comply with statutory requirements under the Courts and Legal Services Act 1990 and the Damages-Based Agreements Regulations 2013. Where the funder’s return is structured as a multiple of the investment or a fixed fee, the arrangement is less likely to be characterised as a DBA, but the parties must still ensure the agreement does not permit improper control of the case. Funding agreements should also consider the indemnity principle and ensure any recovery of costs from the opponent is properly accounted for.

Key Term: third-party funding
Third-party funding is a contract where an external funder pays legal costs in return for a share of any money recovered in the case.

Regulation and Professional Standards

There is no statutory regulation of third-party funders, but most reputable funders in England and Wales are members of the Association of Litigation Funders (ALF), which has a voluntary Code of Conduct. The Code sets minimum standards for capital adequacy, transparency, and funder behaviour. It requires members to maintain adequate financial resources to meet their obligations; to state clearly any rights to terminate funding; to agree that they will not seek to influence the solicitor’s professional duties; and to provide a complaints mechanism. The ALF Code also expects that a funder will not attempt to control the litigation and will only receive case information subject to confidentiality obligations. While membership is voluntary, solicitors should consider ALF membership as a due diligence marker when advising clients on funder selection.

Solicitors must ensure that any funding arrangement complies with the law and the SRA Principles, Codes and Transparency Rules. They must:

• explain funding options and the distinction between solicitor-and-client costs and costs between the parties
• avoid allowing funders to restrict the solicitor’s independence (SRA Principles on independence and acting in clients’ best interests)
• disclose any referral payments or financial benefits received from funders
• protect privilege and confidentiality, using appropriately drafted non-disclosure agreements and limited disclosure protocols
• keep clients informed about costs and likely liabilities throughout the matter.

Key Term: Association of Litigation Funders (ALF)
The ALF is a self-regulatory body whose Code of Conduct sets standards for third-party funders in England and Wales.

Funder Liability for Adverse Costs

A key legal issue is whether a third-party funder can be liable for the opponent’s costs if the funded party loses. The leading case is Arkin v Borchard Lines Ltd [2005] EWCA Civ 655, which established that a commercial funder may be ordered to pay the successful opponent’s costs, but only up to the amount the funder contributed to the case (the “Arkin cap”). This was guidance designed to encourage responsible funding without exposing funders to open-ended liabilities.

Key Term: Arkin cap
The Arkin cap is the principle that a third-party funder’s liability for adverse costs is limited to the amount they funded in the litigation.

However, recent cases have shown that courts have discretion to depart from the Arkin cap in exceptional circumstances, and may order a funder to pay a greater share of costs if justice requires. The court’s jurisdiction to make costs orders against non-parties derives from section 51 of the Senior Courts Act 1981 and is exercised on a case-by-case basis. Where funders have effectively controlled or driven a claim, or funded a hopeless case, the court has ordered costs on an indemnity basis against funders and has declined to apply the Arkin cap. Funders can also be liable from the point they commenced funding, and connected companies may be liable where funding was channelled through subsidiaries. The message for exam scenarios is that the Arkin cap is guidance, not a rule; the court’s overriding aim is fairness.

Worked Example 1.1

A funder pays £100,000 towards a claimant’s legal fees in a commercial dispute. The claimant loses and is ordered to pay the defendant’s costs of £300,000. Can the funder be liable for the defendant’s costs?

Answer:
Under the Arkin cap, the funder can be ordered to pay up to £100,000 (the amount funded). The claimant remains liable for the balance. However, the court may order a higher contribution from the funder if the facts justify it.

Worked Example 1.2

A funder finances a claim from the outset, dictates which experts are instructed and insists on rejecting reasonable settlement offers. The case fails and the defendant’s costs are £1.5 million. The funder’s outlay was £400,000. Is the funder likely to be protected by the Arkin cap?

Answer:
No. Where a funder exercises control over the litigation or funds a claim that the court considers hopeless, the court may depart from the Arkin cap and order the funder to pay a larger share of the opponent’s costs, potentially on an indemnity basis.

Benefits and Risks of Third-Party Funding

Benefits

• Enables claimants to pursue meritorious claims they could not otherwise afford.
• Transfers the financial risk of losing to the funder.
• Allows businesses to manage cash flow and litigation risk.
• May enable aggregation of multiple claimants’ claims (e.g. group or collective proceedings), improving bargaining power against a well-resourced defendant.
• Can be combined with CFAs/DBAs and ATE insurance to create a comprehensive risk management package, including cover for adverse costs.

Risks

• Funder may seek to influence litigation strategy or settlement decisions.
• Disclosure of confidential information to the funder may risk waiving legal professional privilege.
• Conflicts of interest may arise if the funder’s commercial interests diverge from the client’s objectives.
• If the claim fails, the client may still be liable for the opponent’s costs not covered by the funder.
• Funding is usually expensive: the funder’s return may be a high multiple of the investment or a significant share of damages, reducing the client’s net recovery.
• Termination rights may allow funders to withdraw if prospects deteriorate, leaving the claimant exposed mid-proceedings unless alternative funding or insurance is in place.
• Security for costs applications may be made against a funded claimant; funders sometimes provide security, but terms and timing must be negotiated.

Key Term: legal professional privilege
Legal professional privilege protects confidential communications between a client and their lawyer from disclosure to third parties.

Key Term: conflict of interest
A conflict of interest arises when a solicitor’s duty to act in the client’s best interests conflicts with another interest, such as a funder’s commercial aims.

Worked Example 1.3

A small business has a strong claim against a larger competitor but cannot afford the legal fees. It enters a third-party funding agreement. The funder agrees to pay all legal costs in return for 30% of any damages recovered. The case settles for £1 million. How is the settlement divided?

Answer:
The funder receives £300,000 (30% of £1 million). The business receives the remaining £700,000, less any costs not covered by the funder.

Worked Example 1.4

A claimant’s funding agreement entitles the funder to 25% of damages recovered. The claimant asks whether the agreement must meet statutory DBA requirements.

Answer:
If the funder’s remuneration is calculated by reference to damages, the agreement may be treated as a DBA. Parties should ensure compliance with the Courts and Legal Services Act 1990 and the DBA Regulations 2013 to avoid unenforceability. If the funder’s return is structured as a multiple of sums advanced rather than a percentage of damages, it is less likely to be a DBA.

Solicitor’s Duties and Regulatory Issues

Solicitors advising on third-party funding must:

• Act in the client’s best interests (SRA Principle 7).
• Ensure the client understands the terms, risks, and costs of the funding agreement.
• Protect client confidentiality and privilege.
• Avoid conflicts of interest between the client and the funder.
• Not allow the funder to control the litigation or settlement decisions.
• Carry out proportionate due diligence on the funder, including capital adequacy, track record and ALF membership.
• Consider whether ATE insurance is needed to cover adverse costs and whether the funder will contribute to, or require, ATE.
• Disclose any referral fees or other financial benefits received from introducing a client to a funder, and obtain informed consent.
• Maintain independence on case strategy and settlement, documenting any discussions with the funder and any reasons for accepting or rejecting settlement proposals.
• Address money laundering and source of funds checks when receiving third-party money for legal costs, applying the firm’s anti-money laundering policies.

A clear written retainer should explain the relationship between the client, solicitor and funder, and identify who will be responsible for costs if funding terminates. The funding agreement should state that control rests with the client; that the solicitor acts for the client and owes duties only to the client; and that any funder rights (such as consultation on budgets or receiving updates) are limited and do not undermine privilege or independence.

Exam Warning

Solicitors must not allow a funder to dictate litigation strategy or settlement. The client must retain control of the case. Breach of this duty may result in disciplinary action.

Revision Tip

Always check whether the funding agreement gives the funder any right to veto settlement or instruct the solicitor directly. If so, advise the client to seek independent advice.

Practical Considerations

• Funding is usually available only for claims with good prospects of success and a realistic chance of recovery.
• Funders will conduct due diligence before agreeing to fund a case.
• The funding agreement should clearly state the funder’s rights and obligations, including liability for adverse costs and termination rights.
• Solicitors should advise clients to consider after-the-event (ATE) insurance to cover the risk of adverse costs not funded by the third party.
• Case information shared with funders should be carefully managed to protect privilege: use non-disclosure agreements and restrict documents to what is strictly necessary, noting that common interest privilege typically applies only once the funder has a legitimate interest.
• Budgeting should be realistic: funders typically require detailed cost budgets and may condition funding on adherence to agreed budgets and milestones.
• Security for costs: where ordered, assess whether the funder will provide security, or whether ATE insurance can be used to resist or satisfy security.
• Settlement mechanics: ensure the agreement addresses how settlement proceeds will be divided, the priority of payments (including costs, funder return, ATE premium and any solicitor’s success fees), and how disputes are resolved.
• Termination: identify objective triggers (e.g. prospects drop below a stated percentage or breach of budget) and the consequences for ongoing representation and liability for costs.
• Interplay with CFAs and DBAs: combinations are common (e.g. CFA for solicitors, TPF for disbursements, ATE for adverse costs). Ensure proper compliance with statutory requirements where any arrangement falls within the scope of DBA Regulations.

Worked Example 1.5

A claimant enters a third-party funding agreement. The funder pays the legal fees, but the agreement allows the funder to withdraw funding if the case’s prospects fall below 60%. What should the solicitor advise the client?

Answer:
The solicitor should warn the client of the risk that funding may be withdrawn before the case concludes, and advise on alternative funding options or insurance to cover this risk.

Worked Example 1.6

You provide the funder with counsel’s opinion and key documents during due diligence. The defendant later argues privilege was waived. How should privilege be protected?

Answer:
Use a tailored confidentiality agreement with the funder, limit disclosure to what is necessary, and note common interest privilege once the funder has a legitimate interest. Keep a record of what was shared and the basis on which it was shared.

Key Point Checklist

This article has covered the following key knowledge points:

• Third-party funding allows an external funder to pay legal costs in return for a share of any recovery.
• The law of maintenance and champerty restricts improper funding, but modern TPF is permitted if not abusive.
• Funders may be liable for adverse costs, usually limited to the amount funded (Arkin cap).
• Courts may depart from the Arkin cap and make broader non-party costs orders under section 51 of the Senior Courts Act 1981 where justice requires.
• Solicitors must protect client confidentiality, avoid conflicts of interest, and ensure the client retains control.
• Funding agreements must be carefully reviewed for risks, including funder influence and termination rights.
• Consider ATE insurance to manage adverse costs exposure and address security for costs.
• Where funder remuneration is linked to damages, assess whether the arrangement is a DBA and ensure compliance with statutory requirements.

Key Terms and Concepts

• maintenance
• champerty
• third-party funding
• Association of Litigation Funders (ALF)
• Arkin cap
• legal professional privilege
• conflict of interest