Arbitration & Litigation Too Expensive? Construction ...

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

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 ofArbitration & Litigation

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 Funding –A Viable Alternative

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 & Perceptionof Dispute Funding

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%


Perception of Non-Recourse 3rd Party Financing

1 Negative 4%

2 9%

3 Neutral 35%

4 36%

5 Positive 18%

89%


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 &

Financing Firms

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 FundersConsiderations

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 ConsideringDispute Funding

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 & Cons ofDispute Funding

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


• 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


• 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

Unresolved IssuesConcerning Dispute

Funding

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


• 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


• 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


• 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


• 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: 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…”


Trends & Prediction Concerning Litigation

Funding

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


• 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


• 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


• 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


• 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

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

[email protected]

Thank you.

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