Legal finance as a tool to unlock value in construction disputes
The construction industry has seen recent growth in the size and number of high-stakes disputes, particularly in the Middle East and North Africa (MENA) and Latin America (LATAM) regions.
São Paulo was the fourth most popular seat for construction disputes globally, according to Jus Mundi’s most recent Construction Industry Insights report, indicating arbitration’s rise in the region. Miami—a hub for international companies that have a presence in Latin America—also gained in popularity in response to increasing numbers of cross-border construction disputes.
Meanwhile construction in MENA countries has suffered extreme turmoil due to major multibillion-dollar projects in the region and global supply chain disruptions in the past year, which have led to shortages in construction materials. The pandemic’s effect on workforce restrictions, force majeure claims and project suspensions further strained an industry prone to uncertain cash flows. As a recent example of the size and scale of construction disputes in the region, Maydan Group reached a settlement agreement with WCT Bhd under which Maydan paid AED 726.5 million ($197.7 million) to resolve the contract dispute between both parties.
An arbitral tribunal of the London Court of International Arbitration recently awarded over $200 million in interim damages to DP World and joint venture company Doraleh Container Terminal, covering the period from 18 February 2018 to 31 December 2020.
Although there is potential to receive high value construction arbitration awards, the cost of pursuing these claims can quickly run into the millions for legal fees and expenses, as well as for technical experts and consultants. While the litigation or arbitration claims proceed, the cost of pursuing a resolution can negatively impact the parties’ financial profiles. This is because pending legal claims may represent hundreds of millions (if not billions) of dollars in captive value that traditionally haven’t been counted as assets.
Legal finance, which seeks to unlock the asset value of pending legal claims, can change this dynamic. Construction disputes are ideal candidates for this specialised and fast-growing area of finance.
How legal finance works
With legal finance, a third-party financer provides capital that is collateralised by a pending legal claim. In the most straightforward arrangements, they provide non-recourse capital that can be used to pay for legal fees and expenses so that a single matter may proceed. In exchange, the financier is entitled to recoup its investment and gain a return from the settlement or damages, should the claim be successful. If the claim loses, the funder is owed nothing. Control of the litigation remains with the client.
Legal finance partners may also provide immediate liquidity to companies by accelerating or “monetising” a portion of the expected entitlement of a pending claim, judgment or award. In this type of investment, the legal financier providers non-recourse capital to the client in exchange for some portion of the final recovery. Monetisations solve the “timing problem” of long, drawn-out litigations or arbitrations by providing immediate liquidity to companies, and the working capital provided may be used for any business need.
Legal finance in the construction context
Legal finance can be helpful to parties engaged in construction disputes for a variety of reasons.
In some instances, a construction claimant may lack the financial resources to pursue a single, high stakes claim. Legal finance can provide construction companies facing disputes with access to capital, without which they might not have the resources to pursue a fair recovery through the courts or arbitral processes. It also levels the playing field in scenarios where smaller claimants face much better capitalised defendants. Lacking the resources to engage the very best counsel for the full duration of a dispute can put the claimant at a significant disadvantage. Legal finance removes that obstacle.
Legal finance is equally suitable in situations where parties are facing insolvency and where they have ample resources to pay their legal bills out of pocket. In many industries, companies are increasingly using legal finance by choice, not just out of necessity. It may simply be a more efficient way to pay for legal costs, whether for respondents or claimants.
Arbitration finance is particularly important to construction contractors facing disputes. In most cases, any construction company facing a dispute will not only have to absorb legal expenses within existing legal budgets but must also deal with significant resources being tied up for an indeterminate time. The level of risk within a construction dispute is very high, with significant dependencies on complex technical knowledge as well as significant expense needed to bring the matter to fruition. Here, arbitration finance can support in reducing or eliminating the immediate legal costs of a claim, as well as bearing some or all the risk associated with bringing the claim in the first place. It can be used to:
- Manage corporate resources by moving legal costs off balance sheets to a third party and therefore reserving cash for other corporate purposes
- Manage and mitigate the risk because a third party assumes that risk on the claimant’s behalf
Appropriate disputes for legal finance
The most obvious factor in determining the suitability of a dispute for outside finance is the likelihood of success. Because legal finance is typically provided on a non-recourse basis, and the financier will lose its investment if the underlying matter proves unsuccessful, third-party financers will look hard at the merits of the claim first and foremost. This means that parties seeking financing should be realistic about the prospect of success and prepared to explain the strength of their factual and legal position.
Beyond this basic criterion, matters suited for financing are high-stakes commercial cases with significant value to the business, in which damages or returns are sufficient to appropriately balance the interests of the client, lawyers and an outside financier. Pricing varies with risk and investment amounts; the amount provided by the financier, not the size of the claim, may range from as little as $1 million for a single case to as much as $100 million for a portfolio of cases.
Another important consideration for the legal finance provider is enforceability. A legal financier must be confident that if the case is successful, the losing party is creditworthy, or else has sufficient assets located in a favourable jurisdiction for enforcement.
Article by Joe Durkin is a Senior Vice President in Burford Capital’s asset recovery business and is based in Dubai.
