I MARKET OVERVIEW
In Germany, the market for third party funding of litigation and arbitration cases is relatively mature and well developed, even compared to that of other major economies. The first professional third party funding services were introduced around 1998.2 The German legal framework for funding agreements is relatively non-restrictive, which makes it easier for smaller funders to enter the market.
Looking at funders in a broader sense by applying the technical definition of third party funding, which is simply that a company finances the costs of legal proceedings as a service (originally not having a direct interest in the outcome of the dispute), there are very different kinds of funders on the German market today.
The German third party funder in a traditional sense is a company that specialises in funding large cases; these companies mostly stipulate a minimum claim value of between €25,000 and €100,000 as a requirement to even review a case for potential funding. These traditional funders typically fund a large variety of cases and do not restrict their offer to specific areas of law. One reason for this may be that there are only a limited number of cases on the German market that have a sufficiently high claim value to be of economic interest to funders3 and for which funding is sought. That being said, it is often stated that these third party funders reject about 90 per cent of the cases presented to them for review, usually (but not always) based on their assessment that the prospects of success are insufficient for the purposes of the funder.
One of the major funders is Foris AG, which originally pioneered the introduction of professional third party funding services on the German market in 1998. Moreover, several German insurance companies that initially only offered legal costs insurance4 as a product have in recent years extended their product portfolio to also cover the funding of cases in which a dispute has already arisen. These include Legial AG and Roland Prozessfinanz AG (which was acquired by the Dutch founder Omni Bridgeway in 2017). The Swiss funder Nivalion AG, founded in 2017, is present in the German market with an office in Munich; Nivalion AG also funds litigation cases but emphasises that its special focus lies on the funding of arbitration cases.
Last but not least, several Anglo-American and Australian companies have recently become increasingly present on the German market, including Burford Capital and the European branch of the Australian IMF Bentham Limited.
Apart from the aforementioned traditional third party funders, Germany has seen an increase of market participants that are technically litigation funders, but are better described as legal tech companies. These companies operate with a business model vastly different from that of the traditional funders described above. They do not specialise in funding complicated, high-risk cases involving a high claim value where the law firm involved is selected by the party that receives funding. Instead, these companies specialise in funding proceedings5 in relation to specific claims that have a relatively low claim value, and they are most often the first and primary point of contact for the client. Most often, a highly specialised partner law firm selected by the funder acts as the legal counsel to the party receiving the funding, but in many cases the law firm has little actual contact with the funded party (which, formally, is the firm's own client). A prominent example of such a legal tech company (technically a case funder) is the company Flightright, which enables travellers to pursue claims against an airline based on a flight delay without an associated cost risk.6
It may also be relevant for the purpose of an assessment of the German market for litigation funding that German law, in Section 114 et seq. of the German Code of Civil Procedure, provides for a request for legal aid in cases where a party lacks the funds required to participate in court proceedings (regardless of whether it is as claimant or respondent). This request can sometimes be a viable alternative to third party funding, and it is not restricted to natural persons; a legal entity can also file a request for legal aid. An important difference from real third party funding, however, is that the party receiving legal aid may, under specific circumstances, have to pay back the amounts received from the state. In contrast, in the vast majority of German third party funding agreements, the funder also assumes the duty to reimburse the opposing party for its legal costs in the proceedings if the funded party is ultimately unsuccessful with its claim. Normally, amounts paid by the funder during the proceedings will not have to be reimbursed if the claim is ultimately unsuccessful. In other words, most German third party funding agreements, in principle, provide for a 'no-risk' scenario for the funded party.7
II LEGAL AND REGULATORY FRAMEWORK
When discussing the legal and regulatory framework for agreements in the area of third party funding, in German law it is particularly important to keep in mind that the funding agreement (the contract between the funded party and the funder) on the one hand, and the contract between the funded party and its legal counsel (engagement letter or fee agreement) on the other hand, are contracts of a different nature. Thus, they are subject to different regulatory frameworks.
i The funding agreement
Today, the majority of German legal literature takes the view that funding agreements are to be classified as German partnerships under civil law. This qualification of the funding agreement has a number of practical consequences for the content of the funding agreements.
However, it is important to note that, so far, the highest German courts have not clearly confirmed this qualification.8 On the contrary, in 2006, at a time when the clear majority of German legal literature already favoured the qualification as a partnership under civil law, the District Court Bonn in one of its decisions9 addressed the question of the legal qualification of third party funding agreements in great detail and made explicit reference to the fact that the leading view in legal literature classified the funding agreement as a partnership under civil law, but then came to the conclusion that it did not share this view.10 In the decision in the appeal proceedings regarding the appeal filed against the cited decision of District Court Bonn, the court of next instance, the Higher Regional Court Cologne,11 left the question unanswered, but stated in an obiter dictum that it was inclined to agree with the 'convincingly argued view of the District Court Bonn'.
In contrast, the Higher Regional Court Munich, in a decision in 2015, stated that a third party funding agreement was to be classified as an agreement of its own kind, but further stated that it was similar to the German partnership under civil law.12
In more recent decisions, some courts have addressed the question, but ultimately left it open for debate, including, for example, the Higher Regional Court Frankfurt in a decision of August 2017, in which it merely stated that the question was still unresolved and that it was debated whether a third party funding agreement could be classified as a loan agreement with the interest linked to the borrower's profit, an insurance contract, a purchase of receivables or a partnership.13
Regarding a potential qualification as an insurance contract,14 the former German Federal Insurance Supervisory Office (BAV), which is now part of the German Federal Financial Supervisory Authority, decided in 199915 that the only third party funder existent in Germany at that time was not regulated by the BAV, since it was found not to operate a business that could be qualified as an insurance business.16
A qualification of the funding agreement as a purchase of receivables only seems justified in the case of full and final cession of claims, while most third party funding agreements used on the market to date only contain an assignment of claims as security.
While the legal nature of the third party funding agreement under German law has not yet been fully established, the potential forms include a partnership under civil law, as the majority of German legal literature suggests, a loan agreement with the interest linked to the borrower's profit, or an agreement of its own kind, to which provisions regarding the partnership under civil law or loan agreements could be applicable.
ii Implications of the qualification of the funding agreement for the regulatory framework
As German law does not know a legal doctrine similar to the common law doctrines of champerty and maintenance, there are no special regulations or prohibitions applicable specifically to third party funding agreements.
A qualification of the funding agreement as a German partnership under civil law would, for practical purposes, mean that the regime applicable to the agreement would not be as strict as in cases of qualification as an insurance contract or a loan.
However, two potential restrictions in particular should be kept in mind. First, if the share of the proceeds that the funder receives in the event of success is particularly high, the funding agreement could be found to violate public policy, because a court could assume that the party seeking funding had no other option than to agree to unfair terms because of undue duress exerted by the funder (Section 138 of the German Civil Code). Few court decisions exist that could help to clarify which success fees can, in practice, be agreed. However, the Higher Regional Court of Munich, in a case in 201517 where the funder had started to fund the case only after the claimant had already lost at first instance, decided that a success fee of 50 per cent did not violate public policy. In its decision, the Court, inter alia, pointed to the fact that the first instance proceedings that had already taken place might have led to lower projected costs to be borne by the funder, since the funder did not have to fund the case at first instance; but the Court also pointed out that, on the other hand, the fact that the proceedings had already been lost at first instance meant that the projected overall chance of success might have been reduced. In another case, the Higher Regional Court of Munich in 2004 indicated that a share of the proceeds of more than 66 per cent attributed to the funder could possibly violate public policy.18
Second, it is still subject to debate whether standard contracts introduced by funders can be subject to judicial review regarding the provisions of German law applicable to standard terms (Section 305 et seq. of the German Civil Code). As regards cases in which the funding agreement is classified as an agreement providing for a partnership under civil law, Section 310, Paragraph 4 of the German Civil Code states that the judicial review of standard terms does not extend to agreements in the area of company law. Therefore, some scholars have argued that through this exception to the applicability of Section 305 et seq. of the German Civil Code – commonly referred to as a 'block exemption' – no judicial review based on the provisions of German law applicable to standard terms would take place. However, other scholars state that through a silent exception to the scope of Section 310, Paragraph 4 of the German Civil Code, such a judicial review would take place despite the provision's wording, based on the notion that the funding agreement, while in principle providing for a German partnership under civil law, also showed traits similar to those of contracts for the exchange of performances. A judicial review based on the provisions regarding standard terms will also take place if the funding agreement is classified as not providing for a German partnership under civil law, but as a different type of contract, regarding which there is no exemption from the judicial review stipulated in Section 310, Paragraph 4 of the German Civil Code.
iii Regulatory framework for the agreement between the funded party and its legal counsel, and implications for the funding agreement
As regards the agreement between the funded party and its legal counsel (engagement letter and fee agreement), the most important restriction imposed by the regime applicable to German lawyers is that German lawyers are, in principle,19 not allowed to agree a success fee (Section 49b of the German Federal Lawyer's Act). A success fee can only be agreed if, in the individual case, the client would otherwise not be able to enforce or defend his or her rights in a proper manner for personal financial reasons (Section 4a of the German Law on the Remuneration of Lawyers). As is often highlighted in German legal literature, this provision in essence means that a German lawyer, in principle, is not allowed to fund a client's case,20 no matter whether directly (through a payment) or indirectly (through waiving the legal counsel's fees in the event of losing).
As the services provided by the funder under the funding agreement are not classified as a contract for legal advice, there is no similar restriction for the funder. The fact that German lawyers are, in principle, not allowed to agree a success fee should be kept in mind when drafting or negotiating the funding agreement. This means that the funding agreement should not stipulate that the funded party's counsel will share a portion of the risk in relation to the outcome of the case by way of a reduced fee in the event of a loss or an increased fee in the event of success in the proceedings. Such a stipulation (barring cases of exceptional circumstances pursuant to Section 4a, Paragraph 1 of the Law on the Remuneration of Lawyers) could not be complied with when involving a German lawyer as counsel.
iv Relationship between the funder and the funded party's legal counsel
Even though the legal counsel of the funded party is, in practice, an integral part of performances under the funding agreement, because of which the relationship between the funder, the funded party and the legal counsel of the funded party is often stated to be a triangular relationship,21 since the funded party's legal counsel is legally only allowed to assume duties towards one client in the same matter, there will, in principle, not be a direct contractual link between the funded party's lawyer and the funder.22 Instead, performances of the funder towards the funded party's legal counsel (typically in the form of payment of legal fees) and performances of the funded party's legal counsel towards the funder (typically in the form of the legal counsel informing the funder of relevant developments and coordinating strategy with the funder) will each be based on the funding agreement. For example, while the funder will of course pay the legal fees of the funded party's legal counsel, with the ultimate goal of complying with its own duties towards the funded party, legally the funder is at the same time settling a debt of the funded party with regard to the funded party's legal counsel.
III STRUCTURING THE AGREEMENT
In this section, an overview on the contractual provisions typically found in funding agreements will be given. For a more comprehensive picture, it is helpful to take a look at the standard contracts of the largest German funders.23 Agreements are typically structured as a financing of the claim (as opposed to a purchase of the claim); the agreements typically include additional clauses providing for an assignment of claims to the funder, but only in the form of a cession for security, not in the sense of an immediate monetisation of claims.
In the preamble of the funding agreement, the facts underlying the claim are introduced. The funding agreement then typically contains the following provisions.
i Representations by the claim holder (claimant)
Full rights to claims, power to transfer
In this section, the funded party states that it holds the full rights to the claims and that the claims can legally be transferred to the funder without consent of a third party.
In the case of a claim subject to German law, it should be noted that German law, in principle, provides for the option of a cession without the consent of the debtor (Section 398 of the German Civil Code), but that, as an exception, consent of the debtor is required if an agreement between the creditor and the debtor so stipulates (Section 399 of the German Civil Code). A restriction of this kind can also be agreed in German standard terms. If consent is required because of such a contractual restriction, and the creditor still tries to assign the claim to a third party without the consent of the debtor, the assignment is void and has no effect.
No undisclosed facts
The funded party states that it has disclosed all relevant facts in relation to the claims that are known to the funded party, in particular, that the funded party is not aware of counterclaims, regarding which a set-off could potentially be declared by the debtor. From a practitioner's point of view, the funded party and its legal counsel should make any reasonable effort to make sure that there are no undisclosed material facts, because if previously undisclosed important facts surface later in the proceedings, this could give rise to termination rights and even damage claims of the funder against the funded party.
The funded party also states that no enforceable judgments against the funded party have been rendered that might give rise to insolvency proceedings against the funded party. The purpose of this provision is to reduce the risk of future clawback actions by an insolvency administrator.
ii Duties of the funded party to further the proceedings in which the claims are pursued
This provision clarifies that it is the duty of the funded party to lead and support the proceedings against the debtor in a way that does not conflict with the interests of the funder. Apart from the general statements that the funded party shall always act with the required caution and that the most cost-efficient path has to be chosen if there are two options with an equal prospect of success, this section normally enumerates the following main duties:
- The funded party releases its legal counsel from its duties of confidentiality regarding all facts relating to the pursued claims, and undertakes to inform the funder (via the funded party's legal counsel) of any new development, providing full copies of all relevant documents.
- The funded party has to obtain the consent of the funder before incurring any costs.
- The funded party may not conclude a final and binding settlement agreement with the debtor without the funder's consent, and may not discontinue the proceedings without the consent of the funder. Most funding agreements, however, provide for an option for the funded party to conclude a revocable settlement without the prior consent of the funder; if such a revocable settlement is concluded, it is the duty of the funded party to inform the funder of the settlement in time before the revocation period expires.
- If the claims are pursued in arbitration proceedings, the funded party will use all tools available to ensure (if possible) that representatives of the funder can attend the oral hearing.24
iii Costs to be borne initially by the funder
Most importantly, it will be clarified whether the funder only bears the fees of the funded party's legal counsel to the extent stipulated in the Law on the Remuneration of Lawyers.
However, even if the funder, in principle, only bears the fees of the funded party's legal counsel to the extent stipulated in the Law on the Remuneration of Lawyers, the funding agreement will typically stipulate25 that the funded party's legal counsel will receive an additional remuneration (included as compensation for the time-consuming and complicated task of communicating with the funder), in the form of an additional 1.0 fee in accordance with provision No. VV 2300 of the Law on the Remuneration of Lawyers.26 In this regard, this section of the funding agreement does not in itself lead to a direct claim of the funded party's legal counsel with regard to the funder, as the funded party's legal counsel is not a party to the funding agreement. Therefore, the fee agreement between the funded party and its legal counsel has to reflect this provision by stipulating this additional fee. Furthermore, an interesting aspect of this provision is the question of who will ultimately bear the costs of this additional fee if the proceedings against the (alleged) debtor are successful; in this regard, see Section V.
If the funder is to bear fees of the funded party's legal counsel that exceed the fees stipulated in the Law on the Remuneration of Lawyers (e.g., fees calculated on the basis of hourly rates), or if the claims are to be pursued in proceedings abroad, the fees to be borne by the funder are often specified in detail, sometimes in an annex to the funding agreement.
This section will typically also clarify that costs in relation to any counterclaim or set-off declared by the debtor and the travel costs of the funded party will not be borne by the funder. It will also typically clarify that all payments by the funder will be made to the legal counsel of the funded party and not to the funded party itself, except in cases in which the funder reimburses the funded party for payments that have already been made by the funded party itself.
In the event that the funded party is unsuccessful with the claim, the funder will also reimburse the adverse party (the alleged debtor) for the costs that the court has set to be recoverable from the funded party. In German state court proceedings, the successful party can only claim legal fees from the other side to the extent that such legal fees are stipulated in the Law on the Remuneration of Lawyers. Therefore, the other side's potential reimbursement claim can be calculated with some accuracy even before the proceedings are initiated.27
The agreements typically stipulate that value added tax shall only be paid by the funder insofar as the funded party cannot offset payments against its own tax liability.
iv Review of the claim by the funder
If the funder has not yet reviewed and accepted the claim for funding prior to the conclusion of the agreement, this section will set out the related duties of the funder. Typically, it will be stated that the funder will review the claims without any initial costs for the party that seeks to receive funding. It will be clarified that the review of claims is only conducted to enable the funder to assess whether or not it wants to fund the case, and in particular that the review of claims is not to be understood in any way as the funder acting as legal counsel with regard to the party that seeks funding. Finally, it will be stated that the funder has no duty to accept the case for funding, has no duty to provide any reasons for a rejection of funding and will not be liable towards the party that seeks funding based on such a rejection.
v Distribution of costs and proceeds in cases in which the claim is successful
The funding agreement will typically stipulate that, first, both parties will be reimbursed for their recoverable costs28 from the proceeds. Regarding the question of who will ultimately bear the costs of legal fees to the extent to which they exceed the statutory fees following the Law on the Remuneration of Lawyers in the event that the proceedings are successful, see Section V.
The remaining proceeds will be distributed following a specified percentage ratio. While the agreed percentage ratio in third party funding agreements varies, often the funder is assigned between 20 per cent and 30 per cent of the proceeds in cases in which a final award is rendered. While at the time the funding agreement is concluded the claim value will already be known, funding agreements often stipulate a staggered ratio (e.g., 30 per cent of proceeds assigned to the funder for proceeds below €500,000 and 20 per cent of proceeds exceeding €500,000), because at the time of signing the funding agreement, it is not yet known to what extent the claim will be successful. Some funding agreements stipulate a reduction of the funder's fee in the case that the dispute with the debtor is resolved through a settlement before a final decision of the court is rendered.
vi Assignment of all claims to the funder as security
The standard contracts of most third party funders also stipulate that the claims are assigned to the funder, but only in the form of an assignment of claims as security. It is stipulated that the funded party may not notify the debtor of the assignment and that the funded party continues to hold claims, but only on the basis of trust in the funder, and that the funded party shall make sure that proceeds are not paid to the funded party, but only to its legal counsel. The detailed provisions addressing the assignment of claims will typically be found in an annex to the funding agreement.
vii Termination rights of the funder
Clearly one of the most important provisions of the funding agreement is the provision stipulating under what circumstances the agreement may be terminated by the funder. From the perspective of the funded party, a termination by the funder may lead to catastrophic economic results if the funded party is not able to obtain other funding. The mere right of a funder to terminate the funding agreement, even if not exercised, might also lead to substantial economic pressure on the funded party to, for example, agree to a settlement with the debtor of the claims that it would not have otherwise agreed to.
Most standard funding agreements of German funders contain a large array of termination rights. However, the provisions vary substantially.
Usually, new developments or facts may under certain circumstances lead to a termination right of the funder. The standard contract of one German funder stipulates termination rights in the case of any new circumstances as a result of which the prospects of success are lower than at the time of entering into the funding agreement; in contrast, in the contract of another funder the requirement is that new circumstances lead to a situation where the chances of success regarding the claim become lower than 50 per cent.
The funding agreements typically also contain a paragraph listing examples of developments that lead to a termination right of the funder, often including loss of evidence, an indication provided by the court that suggests that the chances for success are lower than previously estimated, insolvency proceedings or impecuniosity of the debtor, and new jurisprudence of higher courts that leads to lower chances of success.
In addition, some funding agreements include a termination right, which is not subject to any other requirement, at the end of a court instance.
The funding agreements also stipulate the consequences of a termination by the funder. Typically, the funder bears all costs only up to the point of the termination taking effect, and as if the claim had been discontinued in the most cost-efficient manner (e.g., by withdrawing the claim). Typically, it is further stipulated that the funded party may continue the proceedings at its own cost and risk, and only if it succeeds does it have to reimburse the funder for its incurred costs. The funder, however, will not receive a percentage of the proceeds.
viii Termination rights of the funded party
The funding agreements normally stipulate that the funded party may terminate the agreement only for good cause; to this extent, the provision is purely declaratory, since in German law, the right to terminate an agreement for good cause cannot be excluded.
Some funding agreements define the term 'good cause' further, which in principle is possible in German law, stating, for example, that an improved financial situation of the funded party and new developments giving rise to improved chances of success regarding the claim do not constitute a good cause for termination and thus do not lead to a right of the funded party to terminate the agreement.
ix Settlement proposal
In the event of a settlement proposal by the opposing party or the court, the agreements stipulate that the funded party and the funder should first try to reach an agreement on whether to accept or reject the offer. In the event that only one party wishes to conclude the settlement, but the other party refuses to agree, the party that sought to accept the settlement is entitled to terminate the agreement, in which case the party that refused to accept the settlement has to pay the accepting party the amount it would have received if the settlement had been concluded. The party refusing the settlement can then continue the proceedings at its own cost and risk and fully for its own benefits; since it is in some cases not feasible for the funder to lead proceedings itself in its own name (particularly considering that the cession for purposes of security will not have been disclosed to the debtor), the funder can demand that the funded party will resume the proceedings formally (but at the sole risk and costs of the funder), whereby the funder has to provide full indemnification regarding any and all future costs in relation to the continued proceedings.
The aforementioned provisions regarding settlements have drawn some criticism in German legal literature, because even though the provisions in principle provide for equal rights for both parties and thus in a sense can be called balanced, a practical difference in the position of the funder and the party seeking the funding may lie in the fact that the typically cash-strapped funded party will in many cases not have the funds to buy out the funder and then resume the proceedings at its own cost and risk, which may lead to economic pressure on the funded party to accept a settlement with terms that it would not normally have voluntarily agreed.
German third party funding agreements normally contain a clause that even the mere fact that third party financing has been employed has to be kept confidential. As an exception to this rule, the funder is allowed to share information with lawyers or other experts that the funder utilises to review claims or events in the course of the proceedings against the debtor. Some third party funding agreements also contain exceptions allowing the funder to share information with other parties for the purpose of risk-sharing agreements with such third parties.
xi Applicable law and jurisdiction clause
The funding agreements typically provide for the applicability of German law. Regarding the dispute resolution clause, agreements often vary. Not all funding agreements even contain a full dispute resolution clause. For example, the standard agreement of one funder contains a discussion clause and then a detailed mediation process but not a jurisdiction clause, and states that if mediation fails, the parties shall be entitled to commence legal proceedings. Some funders stipulate that the place of jurisdiction shall be a city in Germany. Some funding agreements even contain an arbitration clause.
Currently, there is neither a general obligation to disclose the existence of a third party funding agreement in German state court litigation cases, nor is there such a general obligation in arbitration cases derived from German procedural law or practice. However, in principle, it is conceivable that the existence of a third party funding agreement might in certain cases be relevant to the assessment of a request for security for costs, or that it might give rise to a conflict of interests,29 in which case a party could be at least indirectly forced to disclose the funding, if only to contest a statement by the other side.
i Recovery of costs for securing third party funding
With respect to German state court proceedings, in line with the majority view in legal literature, recent court decisions have held that costs for securing third party funding cannot be recovered through the system of recovery of costs in relation to the costs award (Section 91 et seq. of the German Code of Civil Procedure).30 The reason for this is that the German state court in its initial award only decides the ratio of each party's obligation as to costs, while the specific amounts are only determined in a subsequent, separate procedure for the setting of costs reimbursement claims, in which there is no substantial new taking of evidence.31 If, however, the winning party could successfully claim in this subsequent procedure to have incurred costs in relation to the financing of its claim, this would in practice lead to the requirement that new evidence is assessed, which is not compatible with the nature of the procedure for the setting of costs reimbursement claims.32 Therefore, costs for securing third party funding will in any case not be recoverable as costs in the procedural sense (referring to provisions Section 91 et seq. of the German Code of Civil Procedure).
However, a different question is whether the funded party can demand reimbursement for such costs through a request as part of the substantive claim itself, based on a material law claim for reimbursement following Section 280 et seq. or Section 823 et seq. of the German Civil Code.33 In principle, costs for financing of a case, in particular, regarding interest paid by the claimant regarding a credit facility, can be claimed as part of the material law claim.34 However, for expenses to be classified as, or as being similar to, damage in the sense of Section 280 et seq. or Section 823 et seq. of the German Civil Code, the expenses must have been necessary to pursue the claim. In that sense, regarding specifically a success fee agreed in the course of third party funding, it has to be noted that as long as the claimant does not have his or her own funds available at all to finance the claim, he or she can file a request for legal aid as stipulated in Section 114 et seq. of the German Code of Civil Procedure, as described in Section I. If, however, such a request would not be successful because the claimant still has funds at his or her disposal, it may be argued that the funds obtained through the funding agreement are then not required to pursue the claim. With a similar line of argument, the District Court Aachen held in 2009, specifically in a case where the claimant had claimed costs in relation to third party funding of its case as part of the claim (based on a material law claim relating to Sections 280 et seq. and 249 et seq. of the German Civil Code), that such costs could not be recovered from the other side.35 In a decision of the Higher Regional Court Koblenz in 2006, the Court similarly implied in an obiter dictum that a reimbursement of funding costs cannot not be sought if a request for legal aid in the sense of Section 114 et seq. of the German Code of Civil Procedure was not filed, despite its legal requirements being met.36
In German arbitration proceedings, since the arbitral tribunal, in practice, has more leeway when it comes to the basis for the costs award (compared with German state court proceedings), it is, in principle, conceivable that an arbitral tribunal might order the unsuccessful party to reimburse the adverse party for its costs in relation to the financing of the case. If a claim for reimbursement for these costs is planned, it should be considered at an early stage whether the claim shall be raised as part of the costs award or as part of the material claim itself; the difference might be even more decisive if the law of the seat of the arbitration and the law applicable to material law damage claims are different.
ii Liability of a funder for adverse costs
Funders do not have an obligation with regard to the adverse party to reimburse it for costs of the proceedings initiated by and in the name of the funded party. However, as explained in Section III, a German funding agreement typically contains a duty of the funder with regard to the funded party to hold the funded party harmless of claims for reimbursement of costs that are brought by the adverse party as a result of the funded party being unsuccessful in the proceedings.
iii Security for adverse costs
German state court decisions ordering a party to provide security for adverse costs are very rare. While Section 110 of the German Code of Civil Procedure in principle provides for an opportunity to file a request for security for adverse costs, Paragraph 1 of the provision stipulates that it only extends to requests filed by a respondent in relation to a claimant that is based in a country that is not a Member State of the European Union. Paragraph 2 of the provision limits its applicability even further, stipulating a number of exceptions where even a request for security for adverse costs in relation to a claimant based in a country outside the European Union will not be successful. In any case, the mere fact that it appears doubtful whether a party will be able to reimburse the adverse party for its costs in the event of a defeat in the proceedings is not sufficient for a successful request for security for adverse costs in German state court proceedings, as the associated risks are, in principle, deemed part of the ordinary risks of life.
In arbitration proceedings where German law is the law of the seat of the arbitration, Section 110 of the German Code of Civil Procedure will already not be applicable as long as the seat of the claimant is a country that is a Member State of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, as a costs award rendered by the arbitral tribunal could in any case be enforced against the claimant on the basis of a treaty in the sense of Section 110 Paragraph 2 No. 2 of the German Code of Civil Procedure.37 A request based on the rules of the arbitral institution (e.g., a request for interim relief pursuant to Section 20.1 of the Rules of the German Institution of Arbitration) is, in principle, conceivable in exceptional cases where a substantial risk exists that the adverse party will not be able to reimburse the other party for its costs following a costs award and if this risk has only arisen after the arbitration agreement was signed;38 however, in practice, such a request will only rarely be successful.
iv Other issues regarding costs
In German state court proceedings, the successful party, in principle, will be able to recover its costs from the adverse party.39 However, specifically regarding legal fees paid by the successful party to its legal counsel, the unsuccessful party only has to reimburse the successful party to the extent of the statutory fees stipulated in the Law on the Remuneration of Lawyers.40 As a consequence, in practice, in complex proceedings, the winning party will usually only be able to recover a part of the legal fees that it paid to its counsel.
Therefore, in the case of a claim successfully pursued in state court proceedings, for any legal fees initially borne by the funder that exceed the fees stipulated in the Law on the Remuneration of Lawyers, the funder will have to be reimbursed from the proceeds relating to the main claim, which means that the funded party will bear a substantial part of these fees indirectly (through receiving a smaller overall amount from the proceeds, since the amount that is distributed between the funder and the funded party according to the agreed percentage ratio has already been reduced through the initial reimbursement of costs).
This effect also extends to the additional 1.0 fee calculated on the basis of No. VV 2300 of Law on the Remuneration of Lawyers, as mentioned in Section III, which is typically stipulated in the funding agreement as an additional fee in the case that the funded party's legal counsel is remunerated following the provisions of the Law on the Remuneration of Lawyers. In German state court proceedings, it is likely that the additional 1.0-fee cannot be recovered from the other side. This means that since the funder will be reimbursed for its expenses before the remaining proceeds are distributed between the parties, the funded party will end up bearing a large portion of the additional fee itself, even in the case that the proceedings against the debtor are won.
In arbitration proceedings in which German procedural law is the law of the seat of the arbitration, in practice, the costs award will usually allow the successful party to recover the full legal fees paid to its counsel, even if calculated on an hourly basis; but only to the extent that the fees were reasonable, which will be reviewed on a case-by-case basis by the tribunal rendering the costs award. While it is also conceivable that an arbitral tribunal might decide that the legal fees to be reimbursed should be capped in accordance with the statutory fees stipulated in the Law on the Remuneration of Lawyers (considering German law is the law of the seat of the arbitration), in practice, this will happen only very rarely.
VI THE YEAR IN REVIEW
The past year has seen some change in the German market for third party funding. While the period 2016 to 2018 saw both new major participants entering the German market41 and funders introducing new products to the German market,42 several of the key events most talked about in the German third party funding scene in the past year were international events outside the German market,43 or concerned the procedural framework for civil litigation in Germany as a whole rather than specifically the business of funders.
News on the German market for third party funders is still predominantly centred on the effects of the introduction of the model declaratory action44 to the German Code of Civil Procedure in 2018.45 As at September 2019, about 430,000 claimants have registered their claim in the model declaratory action filed against Volkswagen AG in connection with the diesel investigations. However, the German media have also reported extensively on the weaknesses of the new instrument, most notably the fact that only certain consumer and similar organisations can file a model claim of this kind, and that only declaratory relief can be sought.46
For its business year 2018, the major German funder Foris AG reported a decrease of its effective return per share, but stated that this was due to two unscheduled depreciations, including a re-evaluation of the book value of Foris AG's subsidiary 'Go Ahead' (which offers shelf companies47 and is not active in case funding).48 Conversely, Foris AG stated that in the year 2018, the economic situation of its funding activities had actually materially improved, since the total number of funded cases had increased considerably. More specifically, Foris AG reported that its acquired option volume,49 which Foris AG defines as its theoretical total maximum (future) revenue share in all funded cases combined, was actually 10 times as high in 2018 as the amount for 2017; considering that a funded case has typically required three to four years to resolve, this means that Foris AG's revenue would increase in the future.50
In early 2019, a new litigation funder, Profin, was created. As at September 2019, Profin places special emphasis on funding claims filed against automobile manufacturers in the wake of the diesel investigations, but states that it also offers funding for other claims.
In February 2019, the funder Nivalion AG (with offices in Switzerland and Germany) reported that it focuses on, inter alia, Germany and the Nordic countries, as well as other continental European regions.
In a widely reported decision of the German Federal Court in late 2018,51 the Court decided that third party funding in actions for confiscation of profits pursuant to Section 10 of the German Act Against Unfair Competition52 was inadmissible. The Court based its decision on the notion that the legislature had intentionally limited the organisations able to file a claim of this kind to consumer and similar organisations, which was incompatible with claims filed on the basis of financial motives such as those of a litigation funder. The Court rendered this decision despite the fact that the German Federal Office of Justice53 had approved the funding agreement.
In a decision of the District Court Stuttgart in February 201954 in litigation following in the wake of the 'Trucks Cartel'55 decision of the European Commission of 19 July 2016, the Court decided on a case where the original creditors of the alleged antitrust damage claims had assigned the claims to a special purpose vehicle, which then initiated and led the proceedings against the defendant (a major international manufacturer of trucks) in its own name. The funding agreement did not provide for any purchase price for the assignment of the claims, but instead stipulated that the original creditors would receive 60 per cent of the proceeds from the litigation. However, the special purpose vehicle had not been registered as a provider of legal services within the meaning of the German Legal Services Act56 and the Court rejected the claim as inadmissible, because the articles of association of the special purpose vehicle were legally invalid pursuant to Paragraph 134 of the German Civil Code; the Court stated that this was due to the claimant offering legal services without being authorised to do so, which violated the German Legal Services Act. The Stuttgart District Court's decision follows similar earlier decisions of the German Federal Court,57 but it was still widely discussed in the litigation funding scene, because the case exemplifies once again that the assignment of claims of multiple creditors to a special purpose vehicle for a more effective legal pursuit of claims is subject to several important restrictions in the German jurisdiction, and these continue to be a challenge for funders and legal tech companies alike.
VII CONCLUSIONS AND OUTLOOK
Even though the German market for third party funding is relatively mature and developed, the legal qualification of third party funding agreements is still subject to debate. The same can be said about the question of whether a funding agreement can be subject to judicial review on the basis of the provisions of German law regarding general terms and conditions. Both points may in some cases lead to a degree of uncertainty when assessing the validity of a certain provision in a funding agreement.
However, it should be noted that the regulatory framework regarding third party funding agreements in German law is relatively non-restrictive. German law does not know special regulations specifically addressing third party funding agreements and does not know doctrines like the common law doctrines of champerty and maintenance.
German lawyers are, in principle, not allowed to agree success fees with their clients; exceptions exist, inter alia, in cases in which the client would otherwise not be able to enforce or defend his or her rights in a proper manner for personal financial reasons, but these exceptions are handled in a strict way by the courts. However, there is no limitation regarding success fees for the funder in a third party funding agreement under German law, which is why German funding agreements in almost all cases stipulate a success fee for the funder.
The standard contracts of the largest German funders mostly contain relatively similar clauses.
Typically, the funder will cover all costs of the proceedings, including the adverse party's cost, but excluding internal costs of the funded party such as travel fees for representatives of the funded party. However, in the case of German state court litigation proceedings, since the legal counsel fees recoverable from the other side are capped at the statutory fees stipulated in the Law on the Remuneration of Lawyers, the portion of the legal counsel fees of the funded party that exceeds the statutory fees stipulated in the Law on the Remuneration of Lawyers cannot be recovered from the other side, even in the case of success in the claim proceedings. Thus, the funder who initially bears these fees will first recover these amounts as recoverable costs directly from the proceeds before the remaining proceeds are, in a second step, distributed between the funder and the funded party following the agreed ratio. Thus, the funded party will end up bearing a large portion of the legal fees that exceed the statutory fees in cases in which the claim is successful. In arbitration proceedings, however, the situation is different as the fees for the funded party's legal counsel can typically already be fully recovered from the other side (provided the fees were reasonable).
Typically, German funding agreements will provide for a cession of the claim (assignment of the claim to the funder), but only in the form of a (silent) cession for purposes of security and not in the sense of a full monetisation and full and final purchase of the claim. The latter, an immediate monetisation of a claim, is a relatively new phenomenon on the German market.
From the practical standpoint of the legal counsel, the provisions in the funding agreement containing the description of the claim and the related facts and available evidence, as well as the related disclosures are very important, because if it should later surface that the funded party did not disclose important facts that it was aware of, not only may the funder terminate the agreement, the funded party will potentially even be liable for damages. Also particularly important are the provisions containing the termination rights of the funder and the provisions that stipulate the legal consequences for the situation that only one of the parties to the funding agreement votes in favour of agreeing a proposed settlement with the adverse party (the debtor).
It is likely (and desirable) that the German courts will at some point in the future provide a more detailed assessment regarding the views that have been voiced in Germany's legal literature on the legal qualification of third party funding agreements and its implication for the legal framework applicable to such agreements. Currently, there are no indications for upcoming legislation specifically addressing third party funding agreements.
1 Daniel Sharma is partner at DLA Piper UK LLP.
2 Frische/Schmidt, 'Eine neue Form der Versicherung?' in: Neue Juristische Wochenschrift (NJW) 1999, page 2,998 et seq.
3 It has often been stated that cases have a high claim value in this sense if the claim value exceeds €1 million.
4 Typical (before-the-event) legal costs insurance is characterised by the fact that, at the time the contract is concluded, a dispute has not yet arisen.
5 Recently, a growing number of these companies have also started to purchase claims directly, and these are not mere assignments of claims as security, but true and final purchases of claims to enable the alleged creditor to immediately and fully monetise an alleged claim. However, the mere funding of proceedings in which the party seeking funding for its case will receive the lion's share of the expected returns remains the primary business model of most of these market participants for the time being.
6 For purposes of illustration, Flightright currently charges a fee of between 20 per cent and 30 per cent of the claim value (excluding VAT), which also covers the fee of the legal counsel involved, and the maximum value of the claim under the applicable EU regulation providing for the compensation claim is €600; it is therefore clear that a business model of this kind is only viable if the internal costs of the funder and the costs of the legal counsel combined will on average be far below €150 per case. Such a business model thus requires a highly automated handling of cases by both the funder and the legal counsel involved. As at September 2019, Flightright claims on its website that its service has been used 5.2 million times so far, with Flightright having successfully pursued claims exceeding €200 million.
7 The no-risk scenario for the funded party is subject to certain further requirements; for example, compensation claims may be asserted by the funder against the funded party if the funded party has violated its duties of full disclosure regarding all material facts in relation to the claim.
8 See District Court Bonn (Landgericht Bonn), Decision dated 25 August 2006, Case 15 O 198/06, para. 73 et seq. Also see Higher Regional Court Frankfurt (Oberlandesgericht Frankfurt), Decision dated 22 August 2017, Case 16 U 253/16, para. 25.
9 District Court Bonn (Landgericht Bonn), Decision dated 28 August 2006, Case 15 O 198/06, para. 73 et seq.
10 While the District Court Bonn made clear in its decision that it did not view the third party funding agreement as a partnership under civil law, it did not present a clear alternative qualification. The Court merely stated that the third party funding agreement was to be classified as a contract for the exchange of performances in the form of a legal relationship where performance of one party is tied to the profit of the other. But this form of relationship does not in itself entail a clear qualification of the funding agreement as, for example, a loan or an insurance contract.
11 Higher Regional Court Cologne (Oberlandesgericht Köln), Decision dated 29 November 2007, Case 18 U 179/06.
12 Higher Regional Court Munich (Oberlandesgericht München), Decision dated 31 March 2015, Case 15 U 2227/14, para. 46.
13 Higher Regional Court Frankfurt (Oberlandesgericht Frankfurt), Decision dated 22 August 2017, Case 16 U 253/16, para. 25.
14 Regarding potential arguments for such a qualification, see Frische and Schmidt, 'Eine neue Form der Versicherung?' in: Neue Juristische Wochenschrift (NJW) 1999, page 2998 et seq.
15 German Federal Insurance Supervisory Office, Decision dated 29 April 1999, in: Veröffentlichungen des Bundesaufsichtsamtes für das Versicherungswesen (VerBAV) 1999, page 167 et seq.
16 For arguments against a qualification as an insurance contract, see also an article published in answer to the aforementioned article of Frische and Schmidt, written by two members of the board of directors of the funder Foris AG, Müller-Güldemeister and Rollmann, 'Die Prozessfinanzierung der FORIS AG ist keine Versicherung' in: Neue Juristische Wochenschrift (NJW) 1999, page 3,540.
17 Higher Regional Court Munich (Oberlandesgericht München), Decision dated 31 March 2015, Case 15 U 2227/14.
18 Higher Regional Court Munich (Oberlandesgericht München), Decision dated 13 October 2004, Case 7 U 3722/04, para. 28.
19 Until 30 June 2008, according to Section 49b, para. 2, sentence 1 of the German Federal Lawyer's Act, German lawyers were generally not allowed to agree a success fee. However, on 12 December 2006, the German Supreme Court decided that a general prohibition of this kind, in not providing for exceptions in cases where the claimant has no access to financing for its case, was incompatible with and violated Article 12 of the German Constitution; see German Supreme Court (Bundesverfassungsgericht), Decision dated 12 December 2006, Case 1 BvR 2576/04. To comply with this Court decision, the provisions of the German Federal Lawyer's Act and the Law on the Remuneration of Lawyers were amended; see in more detail Onderka and Schneider in AnwaltKommentar Rechtsanwaltsvergütungsgesetz, Section 4a Law on the Remuneration of Lawyers, para. 1 et seq.
20 cf. Von Seltmann, in: Beck'scher Online-Kommentar zum Rechtsanwaltsvergütungsgesetz, Section 4a Law on the Remuneration of Lawyers, Introduction; Rauscher, in: Münchner Kommentar zur Zivilprozessordnung, 5th Edition 2016, Introduction, para. 77.
21 Scholl, in Beck'sches Rechtsanwalts-Handbuch, 11. Edition 2016, Section 54 para. 250.
22 Scholl, in Beck'sches Rechtsanwalts-Handbuch, 11. Edition 2016, Section 54 paras. 250, 252.
23 The German text of one of the standard contracts (standard contract of Legial AG) can be found in: Bonefeld/Kroiß/Tanck, Der Erbprozess, 5. Edition 2016, Section 15 para. 81.
24 This provision typically refers only to arbitration proceedings because German state court proceedings are public proceedings; therefore, representatives of the funder can attend proceedings before a state court without the need for related requests to the court.
25 Scholl, in: Beck'sches Rechtsanwalts-Handbuch, 11. Edition 2016, Section 54 para. 249.
26 The fees stipulated in the Law on the Remuneration of Lawyers are calculated based on claim value; e.g., in the case of a claim value of €200,000, a 1.0 fee in accordance with provision No. VV 2300 of the Law on the Remuneration of Lawyers amounts to €2,013 (excluding VAT). In the case of a claim value of €500,000, a 1.0 fee in accordance with No. VV 2300 of the Law on the Remuneration of Lawyers amounts to €3,213 (excluding VAT).
27 Some uncertainties exist, however; for example, in relation to potential reimbursement claims covering costs relating to expert opinions or witnesses.
28 Costs that are part of the excluded costs that are not borne by the funder initially cannot be recovered in this way; e.g., the funded party will not be reimbursed up front for its travel costs or costs in relation to a counterclaim or set-off. Therefore, in practice, this provision will normally only enable the funder to recover costs before the remaining proceeds are distributed among the two parties to the funding agreement. This section will typically also clarify that costs in relation to any counterclaim or set-off declared by the debtor and the travel costs of the funded party will not be borne by the funder.
29 For both these general notions and their background (not specifically relating to German procedural law), see, e.g., in more detail Maxi Scherer, 'Third-party funding in international arbitration: Towards mandatory disclosure of funding agreements?' in: ICC-Dossier Third-party Funding in International Arbitration, ICC Publication No. 752E, 2013, page 95 et seq.
30 Higher Regional Court Koblenz (Oberlandesgericht Koblenz), Decision dated 4 January 2006, Case 14 W 810/05, in: Neue Juristische Wochenschrift (NJW) 2006, page 2,196; Higher Regional Court Koblenz (Oberlandesgericht Koblenz), Decision dated 25 August 1987, Case 14 W 604/87, in: Zeitschrift für das Versicherungsrecht (VersR) 1988, page 972; Higher Regional Court Munich (Oberlandesgericht München), Decision dated 14 September 1999, Case 11 W 2389/99, in: Monatsschrift für Deutsches Recht (MDR)1999, 1466; Higher Regional Court Düsseldorf (Oberlandesgericht Düsseldorf), Decision dated 13 August 1980, Case 10 W 34/80, in: Zeitschrift für das Versicherungsrecht (VersR) 1981, page 437. With the same result and in more detail Jerger/Zehentbauer, 'Grundlage und Geltendmachung von Schäden im Zusammenhang mit der Finanzierung des Zivilprozesses' in: Neue Juristische Wochenschrift (NJW) 2016, page 1,353 et seq.
31 Schneider/Thiel, Das ABC der Kostenerstattung, 3. Edition 2016, Section 'Prozessfinanzierungskosten'.
32 Schneider/Thiel, Das ABC der Kostenerstattung, 3. Edition 2016, Section 'Prozessfinanzierungskosten'.
33 e.g., see Higher Regional Court Koblenz (Oberlandesgericht Koblenz), Decision dated 25 August 1987, Case 14 W 604/87, in: Zeitschrift für das Versicherungsrecht (VersR) 1988, page 972, and Higher Regional Court Munich (Oberlandesgericht München), Decision dated 14 September 1999, Case 11 W 2389/99, in: Monatsschrift für Deutsches Recht (MDR) 1999, 1466, both stating that the two questions are to be seen separately and that such costs, if at all recoverable, have to be claimed as part of the claim itself.
34 Jerger/Zehentbauer, 'Grundlage und Geltendmachung von Schäden im Zusammenhang mit der Finanzierung des Zivilprozesses' in: Neue Juristische Wochenschrift (NJW) 2016, page 1,353 et seq., in particular, page 1,357.
35 District Court Aachen (Landgericht Aachen), Decision dated 22 December 2009, Case 10 O 277/09.
36 Higher Regional Court Koblenz (Oberlandesgericht Koblenz), Decision dated 4 January 2006, Case 14 W 810/05.
37 Voit, in: Musielak/Voit, Zivilprozessordnung, Section 1042 ZPO para. 12; Pörnbacher/Thiel, 'Kostensicherheit im Schiedsverfahren' in: Zeitschrift für Schiedsverfahren (SchiedsVZ) 2010, page 17.
38 Pörnbacher/Thiel, 'Kostensicherheit im Schiedsverfahren' in: Zeitschrift für Schiedsverfahren (SchiedsVZ) 2010, page 17.
39 Section 91 para. 1 of the German Code of Civil Procedure (Zivilprozessordnung).
40 Section 91 para. 2 sentence 1 of the German Code of Civil Procedure (Zivilprozessordnung); Schulz, in: Münchener Kommentar zur Zivilprozessordnung, 5. Edition 2016, Section 91 ZPO para. 61. The mechanism just described also means that the legal fees for which the other side will potentially have to be reimbursed can be calculated up front in German statutory proceedings (based on claim value).
41 e.g., the Dutch litigation funder Omni Bridgeway acquiring Roland Prozessfinanz AG, one of the leading German litigation funders, in 2017; in June 2018, the funder Vannin Capital opened a German office in Bonn; other foreign funders (e.g., Burford Capital and IMF Bentham) also considerably increased their presence on the German market.
42 Most importantly, first Foris AG and then other funders offering not only traditional funding of cases, but also an immediate monetisation of claims.
43 e.g., an international topic of interest was that several funders increased their financing capacity to further invest in their third party funding business; for example, the funder IMF Bentham launched a new US$500 million fund with the purpose of financing non-US disputes.
45 The introduction of this new instrument was made with effect from 1 November 2018; cf. the German Federal Law Gazette (Bundesgesetzblatt) 2018, Volume 1 (No. 25), page 1,151 et seq.
46 The fact that only declaratory relief can be sought in practice entails that the consumers, even in the event of a successful model declaratory action, still have to pursue their claims in individual legal proceedings afterwards.
48 cf. the annual report of the funder Foris AG for the year 2018 (Geschäftsbericht der Foris AG zum 31. Dezember 2018) in German language, pages 10–11.
49 Akquiriertes Optionsvolumen.
50 cf. the annual report of the funder Foris AG for the year 2018 (Geschäftsbericht der Foris AG zum 31. Dezember 2018) in German language, pages 10–11.
51 German Federal Court (Bundesgerichtshof), Decision dated 13 September 2018, Case I ZR 26/17.
52 Gesetz gegen den unlauteren Wettbewerb.
53 Bundesamt für Justiz.
54 District Court Stuttgart (Landgericht Stuttgart), Decision dated 18 February 2019, Case 30 O 72/18.
57 German Federal Court (Bundesgerichtshof), Decision dated 11 June 2013, Case II ZR 246/11; German Federal Court (Bundesgerichtshof), Decision dated 15 February 2017, Case IV ZR 373/13.