Third-Party Funding (TPF) refers to a financial arrangement where an independent entity covers the legal costs of a dispute, with the expectation of receiving a portion of the monetary award if the case client was able to recover damages from the claim. In Mainland China, this financing model is gaining traction in recent years. Amidst economic challenges, Chinese enterprises often lack the resources for expensive legal battles, making TPF an increasingly important solution for enabling the pursuit of legal claims.
Overview of TPF in China: Litigation and Arbitration's Different Approaches to the TPF
TPF in Mainland China is still in its nascent stages, but it is showing signs of significant potential. The concept of TPF first entered the Chinese legal landscape in relation to international arbitration and has since begun to attract attention of corporates and law firms. The application of third-party financing is expressly provided for in the arbitration rules issued by a number of Mainland China’s major arbitration institutions. However, specific laws or regulations governing TPF in Mainland China are yet to be enacted, which means that while TPF is not expressly prohibited by law, there is a lack of guidance as to what can or cannot be done in practice. It is worthy to note some scarce yet valuable legal precedents, since they show the considerations of judges with the legality of TPF: what is good practice and what can be seen as red flags.
In June 2020, the Beijing courts in Dongrun Jintai (Shenzhen) Investment Management Center (Limited Partnership) v. Wanying Network Technology (Beijing) Co., Ltd. (2020) Jing 02 Min Zhong 807, examined the legality of a litigation funding agreement. The dispute was initiated by the funder, Bangying, who sought to claim the remaining payment from the party that was funded. The court ruled that the litigation funding agreement was valid, and the funded party is liable to pay the funder’s investment return.
In October 2021, in Winfirefly Information Technology (Shanghai) Co, Ltd v Changzhou Aino Textile Co, Ltd. (2021) Hu 0117 Min Chu No. 12,067, the Shanghai Songjiang District People's Court issued an order compelling the funded party to fulfil its obligation of paying service fees to the funding party as per the service contract regarding litigation investment. The court in the People's Republic of China (PRC) again affirmed the legality and validity of the agreement.
In Company A v Company B (2021) Hu 02 Min Zhong No. 10224, the Shanghai Second Intermediate People’s Court declared that the TPF agreement for a court litigation invalid as a result of the terms of the agreement:
1. The funder in the case was closely linked to the law firm acting for the funded party. Such connection caused conflict of interest concerns and doubt as to whether the law firm could remain independent, especially where there were conflicts between the funded party and the funder;
2. The relationship between the funder and law firm also gave rise to suspicion that the TPF agreement was an attempt to circumvent PRC restrictions on the level of contingency fees that PRC lawyers are allowed to charged. The TPF agreement in essence enabled the law firm to recover more than the maximum percentage of the proceeds of the case allowed under the application regulations;
3. The TPF agreement in question contained a confidentiality provision restricting the disclosure of particulars relating to third-party litigation financing to the court. The court was concerned about such prohibition to keep the court informed was against public interest as such non-disclosure also precluded detecting potential improper influence over the conduct of proceedings by the funder or the risk of a single funder financing both sides contemporaneously; and
4. The court emphasized that parties should be allowed to freely exercise procedural rights like settling, withdrawing claims or changing counsel unimpeded. However, the TPF agreement of this case gave the funder impermissible control of the proceedings, infringing on the funded party's autonomy. It improperly constrained representation selection by requiring funder’s approval for changing counsel or subjecting it to a firm's consent. Additionally, allowing funder participation in strategic discussions while restricting settlement autonomy or other action discretion compromised the funded party's independent litigation control.
In the case of Sunan Ruili Airlines Limited et al v Silver Aircraft Leasing (Tianjin) Co, Ltd, Chinese courts demonstrated a progressive approach towards Third-Party Funding (TPF) in arbitration. The Fourth Intermediate People's Court of Beijing and Jiangsu Province Wuxi Intermediate People’s Court (Wuxi Court) both addressed proceedings related to the same or related arbitral awards, affirming the legitimacy of TPF in arbitration settings. They emphasized the autonomy of parties in choosing their funding mechanisms, ruling that TPF does not violate arbitration confidentiality and is not explicitly restricted by existing laws. Key factors contributing to the courts' decisions included voluntary disclosure of TPF, an open exchange regarding its legality, and thorough documentation by the arbitration tribunal. These practices were seen as upholding the fairness and integrity of the arbitration process, thereby not affecting the validity of the arbitral award.
It should be noted that Mainland Chinese court decisions have no precedential value. These decisions nevertheless still provides helpful guidance. It should also be highlighted that the cases discussed above are fact specific. For example, in the Shanghai court case, the court was asked to determine whether the TPF agreement was valid and the agreement itself contained problematic terms that caused concerns. For the other cases, the courts were asked to determine whether validity of an arbitral award is affected by existence of a funding arrangement. In those cases, there was also voluntary disclosure of the funding arrangement in the arbitration. It was also be argued that while TPF is generally considered to be legal and valid in arbitration in Mainland China, there remains some ambiguity when it comes to court litigation. Courts in Mainland China have generally exhibited a more cautious approach when examining cases where funders have a stake in the litigation outcome. Notwithstanding the above, it is observed that there has been an increase in the number of funders who are active in Mainland China financing court litigation. It's essential for parties to carefully structure their funding agreements and arrangements, taking into account the issues identified by the Shanghai court, and to fully consider relevant disclosure obligations when engaging with a funder.
Benefits of TPF to Mainland Chinese clients
One of the primary benefits of third-party funding is that it allows clients who may lack funding for high legal fees to pursue valid claims, particularly in the context of cross-border disputes. Third-party funding transfers the financial risks associated with legal proceedings from the funded party to the funder. This enables the funded party to allocate its resources towards business growth and development rather than litigation expenses.
In Mainland China, clients are generally unfamiliar with the rigorous evidential burden commonly associated with common law requirements and thus adopted by third-party funders in their due diligence process. This is especially so if the arbitration or litigation in question is to take place outside of Mainland China. Such unfamiliarity stems from a legal culture that has not traditionally emphasized extensive pre-engagement due diligence for litigation cases. Unlike the comprehensive approach adopted by third-party funders—which may include background checks, case merit assessments, and financial audits of both the client and the opposing party—Chinese legal practices are often less exhaustive. The due diligence process conducted by the funder will help clients prepare for subsequent legal proceedings and be aware of weaknesses in the case at an earlier stage. To assist Mainland Chinese clients in the process, law firms and third-party funders can offer clients detailed checklists or guides that outline the due diligence requirements. Proactive communication and educational efforts can help clarify expectations, resolve misunderstandings, and foster a stronger relationship between all parties involved.
Clients may not be thinking about enforcement risks before deciding to commence a legal proceeding. It is also often difficult to identify assets located across multiple jurisdictions, which may give rise to difficulties in obtaining a favorable decree and enforce the recovery claim in multiple jurisdictions. Third-party funders may be able to assist with asset tracing, determination of an enforcement strategy and potentially work with clients to resolve any difficulties arising from the payment of security for costs and adverse party costs.
Additionally, third-party funders may also connect clients with respectable law firms and experts and allow clients to familiarize themselves with the common law requirements at an early stage.
TPF also provides additional advantages to law firms. A funder's expertise and global network can prove invaluable, especially when a law firm needs to initiate proceedings or enforce a decision abroad. Funders also facilitate access to specialized experts when required. By taking on the financial risks of the case, funders may also help to reduce financial risks borne by law firms in contingency fee arrangements.
Application of TPF in Mainland China: Challenges and Opportunities
The Wuxi and Beijing Courts’ rulings stand as a compelling illustration of the growing willingness within the legal community to embrace financial mechanisms like TPF as catalysts for equitable and effective dispute resolution. Yet, in practical application, because law firms and clients are mostly unfamiliar with how TPF operates, there are issues that parties should be aware of when considering TPF:
1. Understanding of Legal Costs: Clients in Mainland China often lack understanding of these expenses and may be taken aback when faced with unanticipated legal costs post-funding. For instance, they may be unaware of the potential obligation to cover the opposing party's legal costs should they lose the case, a relatively uncommon occurrence in domestic China legal disputes. The purchase of after-the-event insurance covering adverse party costs can help to mitigate such risks.
2. Foreign Exchange Challenges: Mainland China maintains stringent foreign exchange controls, the nuances of which can vary by region. This necessitates a thorough understanding of local foreign exchange policies specific to the client's jurisdiction. A clear route for payment of investment return to the funder should be determined at the outset.
3. However, the involvement of TPF can sometimes give rise to concerns about potential conflicts of interest. Clients may worry that the law firm's relationship with the funder could compromise their own interests or the integrity of the case. It should be made clear to the parties that the law firm continues to represent the client and is obligated to act in the best interest of the client. Funders do not sign engagement letter with the law firm. Such an arrangement would help to avoid the risk of conflict of interest as highlighted by the Shanghai court in the Company A v. Company B (2021) Hu 02 Min Zhong 10224 case.
4. Chinese State-Owned Enterprises (SOEs) often struggle to secure internal approval to spend on arbitration or litigation. While TPF can be a solution, it is observed that SOEs often also find it difficult to obtain internal approval for third-party funding. SOEs are typically subject to stringent internal controls, making it challenging to get approval for decisions that fall outside the conventional realms of operation. For instance, securing funding for legal disputes can be problematic as it requires the SOEs to expose their internal affairs to the funders, or agreeing to share part of the state-owned assets (being the claim) with an external party. However, it is observed that with the economic downturn in recent years, SOEs are more active in seeking solution to their bad debts or legal claim, and are more willing to consider TPF, although the process of negotiating the funding terms may take longer than compared to privately-owned enterprises.
Conclusion
Third-Party Funding is gaining foothold in Mainland China as an increasingly important financial tool for commercial disputes. While there has been growing interest in TPF amongst clients and law firms in Mainland China, it appears that many clients and even legal practitioners are generally still unfamiliar with the funding process. The lack of knowledge regarding the due diligence process and financial implications of funding have caused many practitioners to be slow to recommend funding to their clients. The adoption of TPF in Mainland China is further complicated by various challenges ranging from legal ambiguities and financial complexities to cultural gaps and ethical considerations. As the landscape evolves, stakeholders—including law firms, third-party funders, and clients—will need to navigate these intricacies carefully. The development and acceptance of TPF in Mainland China will likely continue to be a complex, multifaceted process that requires ongoing education, adaptation, and ethical vigilance.
