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9 December 2020

Investment into chasing debtors: Ukrainian realities

Source: UJBL

Chasing debtors can be a tricky task, which sometimes requires a lot of resources to cover asset tracing, litigation, enforcement, and other costs. It can be especially burdensome if the debtor’s assets are scattered across the world or a contract at stake provides for expensive dispute resolution forums. That is why the idea of getting investments to finance dispute resolution has been on the table for a while in Ukraine.

The essence of such financing is that a special investment fund invests in the process of resolving a particular litigation or arbitration case and/or in an enforcement action. In return, the fund receives a certain percentage of the “win” – the collected amount of money. It is a beneficial risk-sharing mechanism for those who receive such investments because, in the event of loss of the case, investment funds cannot demand reimbursement of the invested money. Given that investment funds do not have any link to the disputes themselves, they are called third parties, and such type of investment is generally called “third-party funding”.

A number of state authorities have a particular interest in obtaining third-party funding as they deal with many “problematic” debts (or so-called NPLs – non-performing loans) that are challenging to collect without mobilizing enough financial resources. Private companies have also been curious about such funding opportunities, particularly during the global COVID pandemic, which caused a cash-flow deficit to a number of companies. Nevertheless, even though there is some demand for third-party funding in both the public and private sectors to enhance efficient debt recovery, it does not yet function in Ukraine. This article aims to analyze why this is so.

Who are most in need?

As we mention above, there are state authorities and public institutions that due to the particularities of their work deal with a lot of problematic debts. To collect such debts, they might need to retain highly professional foreign lawyers or asset tracing specialists, pay court or arbitration fees as well as enforcement fees. Obviously, it is not easy to do that when relying on money from the state or a local budget. Hence, to increase the chances of a successful collection of debts such state authorities and public institutions would have to look for other sources of money. Third-party funding could be a good option for them. At the same time, unlike private companies, they require detailed legal procedures specifying the grounds, conditions, and ways of obtaining third-party funding. Moreover, given their public nature, they are also more constrained with regard to the conditions of funding they can agree on.

Let us look at some authorities and institutions to understand why they have not succeeded in obtaining third-party funding so far.

One of the most interested in third-party funding institutions is the state-run Deposit Guarantee Fund (DGF). The DGF had everything to become a success story of both (i) cross-border debt recovery, and (ii) engaging third party funding for such purpose. As of 2015 around 100 banks were put into administration of the DGF (which were then usually moved into liquidation). Many such banks in liquidation held and continue to hold USD multimillion claims against the debtors under loan agreements, as well as claims for damages against former management, shareholders, and other related, often offshore, entities. Many such claims were of interest for third party funders, since they were significant, had good prospects of success, and were targeting foreign-based enforceable assets. It is also true that the DGF has been constantly performing recovery actions, including by way of tendering for advisors on condition a success fee, assuming the involvement of a third party funder. However, no single success case of cross-border debt recovery performed by the Fund, either by its own resources or with the engagement of a funder is, unfortunately, publicly reported. One of the reasons for this might actually be the inability of the DGF, being an authority with state-related roots, to provide for viable conditions for funders in a timely and efficient manner.

Another and more recent example is the Asset Recovery and Management Agency (ARMA). Here, the situation is different. Unlike the DGF, ARMA has proceeded further in an attempt to create a legislative basis for third-party funding. In particular, in May 2020 the Parliament of Ukraine voted to support Draft No. 3304, which contains mechanisms for the attraction of funding from private investment funds to assist the state in the return of illegally withdrawn assets. The Parliament of Ukraine is yet to vote for the bill again to adopt it as a law. However, it is questionable as to what kind of cases ARMA is going to attract funding. We understand that the claims ARMA holds, unlike the DGF, are closely linked to the state, rather than a commercial or private interest. In particular, ARMA’s claims are usually related to Ukrainian criminal proceedings and their prospects. It would be a challenging task to attract the attention of international funders with such types of claims.

Turning to the private sector, it should be noted that third-party funding is attractive primarily for small companies suing powerful corporations or the state, which have obvious financial advantages and, consequently, better opportunities to protect their interests. For such companies or companies facing financial difficulties, third-party funding may sometimes equal an opportunity to fully exercise their “right to a judicial remedy”.

Besides, third-party funding can also be favoring for “wealthy” companies, which can afford all the necessary costs related to litigation or arbitration as well as an enforcement action. For such companies, obtaining external financing for dispute settlement is a cost-effective tool for minimizing current costs to spend available resources for business development.

For private companies, there is not much bureaucracy as for state authorities and public institutions to obtain third-party funding as they are quite flexible in terms of choosing a funder. They can contact as many funders as they want at any time they consider appropriate. Nevertheless, Ukrainian companies do not currently enjoy the benefits of third-party funding. That is why, to get an idea of why that is the case, we should look into what funders look for and how they choose disputes to invest in.

What do funders look for?

First of all, it should be mentioned that as for now, in Ukraine there are no local investors offering third-party funding even though there have been several initiatives to establish them. That is why at present the main target of Ukrainian companies willing to obtain third-party funding is international funds.

There is a number of large international funds that provide funding around the world (for example, Augusta, Burford, or Vannin). Each of them has its own guidelines for choosing disputes for investing. However, there is a certain “gold standard” for the minimum claimed amount of money in a dispute, which they are ready to consider for financing. In particular, it is unlikely that any of the international funds would be willing to invest in a case with a potential “win” of less than USD 5-10 million. However, a group of smaller disputes has chances to obtain funding if the total amount of claimed money is substantial (a kind of “portfolio” of claims). In return, funds demand a certain percentage of the “win”, which often ranges from 10 per cent to 50 per cent.

Furthermore, it goes without saying that in order to obtain funding, it is important that the chances of a successful recovery of the awarded money are significant. To ensure that, applications for third-party funding involve a detailed analysis of the circumstances of a particular case and an estimate of the chances for a successful recovery.

This analysis is usually carried out with the involvement of a team of professional lawyers and other consultants. For that most investment funds have professional in-house teams consisting of multidisciplinary specialists who assess risks, help in the search for assets or individuals, provide legal advice, and negotiate with government agencies. The extent to which they are involved in a particular case depends on the agreement with the client. Sometimes their participation is limited to assessing the dispute to decide on the investment and periodic reports on the case in question. However, some funds tend to be more involved in the cases: they choose consultants, organize the collection of evidence, influence the strategy of action. For example, with the help and funds of the well-known Omni Bridgeway fund, a German construction conglomerate managed to recover money from a Ukrainian football club.[1] In particular, the fund’s specialists organized asset tracing and enforcement actions related to the football club’s assets in Austria, Switzerland, and the Netherlands. That is, in this case, the fund not only funded the process but also joined it organizationally. Obviously, the more funds involved in the dispute resolution process, the bigger the share of the win they want to receive, which can be a deal-breaker for some companies.

Also, claimants are more likely to obtain third-party funding than respondents. However, respondents can sometimes get such funding. For example, in the well-known arbitration case between tobacco company Philip Morris v. Uruguay, the state was funded by an anti-tobacco foundation that had an interest in resolving the dispute.[2]

Finally, international investment funds tend to invest in disputes that have a cross-border element (foreign respondent or some property located in another country). They usually deal with a shareholders dispute and collective disputes (especially regarding consumer protection, bankruptcy disputes, etc.). Most of them are settled through commercial and investment arbitrations.

As the demand for financing the settlement of disputes is consistently high, and the supply is not so great, the funds are free to choose the most interesting cases for them. For example, according to some data, the percentage of refusals to provide funding is more than 90 per cent of all applications. Due to the coronavirus pandemic and related quarantine measures, which have led to a large number of outstanding contracts and bankruptcies and, as a result, disputes, the demand for dispute resolution financing has increased even more.

Why don’t funders find attractive cases in Ukraine?

As we have outlined, both public and private sectors in Ukraine are interested in getting third-party funding. While for public sector authorities and institutions there are a number of constraints even to apply for such funding and to offer acceptable conditions for potential funders, private companies are flexible in this regard but still have little luck with getting money from the funds.

One of the reasons for this is, in our opinion, the rather demanding “filters” for disputes that may receive third-party funding. Not surprisingly, the Ukrainian market does not have many disputes aimed at the recovery of more than USD 5-10 million. Also, as already mentioned, the chances of winning in a particular case should be quite high, and this is quite difficult to predict.

Additionally, foreign funds today are not ready to bear “local Ukrainian” risks, which may include the instability of the political and economic situation, legislative changes, doubts about the transparency and efficiency of the judiciary, and the enforcement system in Ukraine. Therefore, such funds are more likely to provide funding to resolve disputes related to Ukraine, if at least the enforcement of the decision will be carried out in other countries, and it would be better if the entire dispute resolution process took place in Western jurisdictions with more predictable judicial systems.

In these disturbing pandemic times, which have been causing even more disputes than usual, international third-party funders have a huge selection of potential disputes to  invest in. That is why Ukrainian disputes have fewer chances of being shortlisted for financing.

At the same time, more and more Ukrainian companies are going beyond the Ukrainian market, which means that there is a high probability of disputes with a foreign element and more need to chase debtors around the world. Moreover, some legislative changes, especially in the green energy sector, might well trigger large-scale international action. That is why the situation with third-party funding will hopefully improve for Ukraine-related business and, if political and legislative steps are taken, also for state authorities and other public law institutions.

[1] https://omnibridgeway.com/insights/case-studies/all-case-studies/case-study/case-studies/2020/05/28/multi-jurisdictional-enforcement-claims-for-german-construction-firm-against-ukrainian-football-club

[2] Report of the ICCA-Queen Mary Task Force on Third-Party Funding in International Arbitration, <https://www.arbitration-icca.org/media/10/40280243154551/icca_reports_4_tpf_final_for_print_5_april.pdf>, pp. 23-24.

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