The Rise of Third-Party Funding (TPF) in Mainland China

Third-Party Funding (TPF) is one of the popular topics in the international arbitration community in recent years. To date, TPF has been permitted in a number of jurisdictions, such as the United States, Australia, the United Kingdom, Singapore and Hong Kong. The new legal service model of TPF has also been introduced to Mainland China since 2016 and a number of professional investment institutions with financing legal cases as their core business have emerged since then. Instead of drawing any conclusion, this article aims at pointing out some observations and holding a discussion on this phenomenon.

Introduction of TPF in China

Background

The parties choose TPF for two reasons: financial difficulties and transfer of risks. For enterprises, litigation or arbitration does more than taking up company resources. The uncertainties surrounding a pending litigation or arbitration bring huge operational and financial risks to the company, thus increasing its difficulty in attracting external financing, affecting its capital flow and efficiency in resource allocation, which will ultimately hurt its enterprise value. Hence, parties with financial difficulties tend to allow funders to invest in cases in which they have funding difficulties, even though they will have to share a large proportion of the proceeds with the funders if they win the case. For many institutional and individual investors, TPF is a promising land for their capital.

The relatively lower costs in dispute resolution in Mainland China have affected the development of TPF in the country to a certain extent. As a result, for a long time, this model has remained rarely known.

As is known to all, TPF has been prohibited in traditional common law jurisdictions as it violates the laws of maintenance and champerty. Yet, this doctrine has never been introduced in Mainland China in terms of legal provisions or judicial practice, even though traditional Chinese law recognises financing in dispute resolution and its legitimacy in helping parties to access justice. For instance, China is one of the few jurisdictions that allows lawyers to charge contingency fees. Meanwhile, legal expenses insurance, transfer of debts and other financing approaches also play an important role in alleviating the burden on the parties. Hence, while TPF is a novel model for most dispute resolution parties in China, the concept of investing in litigation and arbitration cases has already been realised in practice. Although the legislature and the regulatory authorities have not made their positions clear on this issue, there is no legal obstacle to TPF in China under the current legal framework. As TPF continues to develop, corresponding law and regulations will be gradually enacted and optimised in the future.

Currently, TPF market participants in China are mainly domestic institutions, and the raising of funds required for investment have to be done domestically.

Current Definition of TPF

There is a lack of consensus on the definition of TPF, both in theoretical research and judicial practice, in Mainland China. As a matter of fact, as TPF has yet to fall into the scope of the existing legal regime (while the regime for risk agent and other financing arrangements are defined), it is understood in a narrower sense in practice, meaning an investment without recourse based on the costs of the case. Regardless of whether it is called litigation financing, advance litigation fund, champerty or debt investment, its core business adopts a non-recourse investment model under which "losing party bears the risk and winning party takes the proceeds".

Development of TPF in China

Major Funders’ Annual Market Performance

With the law amendments in Singapore and Hong Kong, TPF has a more solid legislative and policy foundation, which enables its continuous development in China. Taking large-scale funding cases as an example, according to the 2017 annual report of DS Legal Capital, there were 405 new investment cases in 2017, representing a 57-fold increase year-on-year. Investments in batches have also been launched on trial and the result has been satisfactory. Apart from the pioneers who launched the industry in Beijing, Shanghai and Shenzhen, funders have also mushroomed in many cities, such as Wuhan, Changsha, Chengdu and Guangzhou. Pioneer agencies are competing for market coverage through setting up branches or recruiting business partners.

Other Alternative Dispute Resolution Financing Products

External financing in judicial proceedings is common practice in China. Parties with financing needs have other financing options apart from TPF. Each financing option has its strengths and limitations. They include litigation loan, lawyer financing, legal expenses insurance and transfer of right of action.

Litigation (Arbitration) Loan

Litigation loan, also know as litigation (arbitration) advances, means regardless of the outcome of the case, the borrower has to reimburse the amount invested by the lender, plus a loan interest or a percentage of the proceeds of the case as a reward. The financing of traffic accident or personal injury cases usually falls under this scope as the risk of losing is relatively low, even though the parties do not need to provide guarantee in advance.

Lawyer Financing

Lawyer financing is also known as "risk representation" under Chinese law. It should be the most common financing approach in litigations and arbitration. It means that lawyers represent the parties without charging any fees or only charging the basic costs upfront, and the final costs will be decided based on a certain percentage of the proprietary interests as determined by the judgments or arbitral awards, or depending on certain conditions.

Legal Expenses Insurance

Legal expenses insurance under Chinese law is different than in other jurisdictions. Traditional ATE and BTE insurances have not received much market attention or merely remained at a pilot stage. In contrast, legal expenses insurance for specific categories, namely patent insurance and litigation property preservation liability insurance, has developed rapidly. TPF model has been gradually introduced in these two categories. At the same time, some insurance companies have started to explore the insurance on seizure discharge on the basis of litigation property preservation liability insurance.

Transfer of Debt

Transfer of Debt is also an effective way to relieve the financial difficulties encountered by dispute resolution parties. It is well adopted and supported in arbitration. Article 9 of the Interpretation of the Supreme People’s Court concerning Some Issues on Application of the Arbitration Law of the People’s Republic of China promulgated on 8 September 2006 stipulates that "Where the credits or debts are entirely or partially assigned, the agreement for arbitration shall be binding upon the assignee, unless the parties concerned have otherwise agreed, or the assignee explicitly objects to the assignment of the credits or debts or does not know there is a separate agreement for arbitration." This highlights the Supreme Court’s support for the transfer of credits in arbitration and its confirmation of the validity of the arbitration clauses after the transfer. In recent years, some small financial institutions dispose of the bad debts of the acquired small and medium-sized enterprises and financial institutions, and then obtain the corresponding benefits through litigation and arbitration. In a way, this can be seen as a form of TPF.

Development Prospects of TPF in Mainland China

It can be expected that major funders in China, while further expanding the domestic market, will consider setting up overseas branches as Chinese enterprises expand their business overseas along with the gradual implementation of the Belt and Road initiative. Their place of choice for that is likely to be Hong Kong. Domestically, funders may further focus on specific areas (Intellectual Property Rights, Construction Engineering, International Arbitration). The original funding model may also experience cross-dimensional innovation in China with the advancement of new technologies such as artificial intelligence and big data. Major arbitration institutions will also actively respond to market demands and make adjustments to arbitration rules so as to cover or regulate TPF.

Editorial note: This is a translation of the Chinese article

Jurisdictions: 

Chief of Research Department of DS Legal Capital

Medivh HU is the Chief of Research Department of DS Legal Capital, he also acts as the Regional Ambassador of HK 45. Medivh often write articles regarding the domestic and global expansion of TPF and make speech on those topics in various seminars and conferences.