The following is an extract under the title “Litigation fund in a nutshell”. For the sake of good order, it should also be pointed out that the short article revised and translated below is intended solely to present the factual and legal situation in 2015 at that time. For an in-depth overview, reference is made to the Master’s thesis: “Prozesskostenfonds; Die gewerbliche Prozessfinanzierung als alternatives Investmentvehikel aus ökonomischer und rechtlicher Sicht”, published by Tectum Verlag 2015.
Summary and conclusion
In the first chapter of the publication, the starting position, the problem and the objectives are explained. The structure of the publication is presented and the methodological basis is clarified. The research approach is deliberately interdisciplinary. Only a holistic approach, taking into account both economic and legal aspects, can cover the topic in its complexity. Commercial litigation financing is a legal financial service with the character of an investment vehicle. For this reason, the research question focused on the question of when an operative investment stock corporation in the financial sector can fall under the material investment fund concept of the AIFM-Directive. This is an assumption that allows an acquisition company, correctly set up under company law, to mutate ex lege into a self-managed alternative investment fund. A mutation which, of course, still has to be carried out under supervisory law, since the current structure no longer complies with the regulatory requirements.
An independent definition is developed in the second chapter of the publication. Litigation financing is a business model in which a litigation financing company guarantees the entitled party the assumption of all litigation costs, to a large extent of certain economically exploitable active processes, in return for a profit-sharing and security assignment, and covers the necessary capital requirements either through its own resources or on the capital market. Commercial litigation financing is distinguished from other forms of litigation financing such as legal expenses insurance and legal aid or free administration of justice. Subsequently, the contract system for process financing is classified in the system of contract types. The litigation financing company is a sui generis financing model. On the basis of the economic analysis of the law, the economic consequences are presented. The asymmetrical distribution of information and the resulting contractual problems lead to a market failure. The information advantage of the litigation financing company enables it to better assess the opportunities. The party entitled to claim, on the other hand, can only assess the specific actions and also the litigation risks to a limited extent. There is a risk that the litigation financing company, as a benefit maximiser (homo oeconomicus), will use the information asymmetry for its own benefit and not act in the exclusive interest of the entitled party. Regulation as state intervention intervenes in the private market economy and attempts to alleviate the market failure. Information and clarification obligations are thus intended to reduce the information gap and harmonise interests through a material incentive system. Based on the probability of success of the process and the risk behaviour of the entitled parties, the different decision models are discussed. By means of a microeconomic analysis, it will be shown why a commercial process financing company decides in a specific case to invest in process risk, although the process risk may be too high for the eligible private party. Depending on the different risk behaviour, it is shown that the possible range of investment opportunities is wider for the risk-averse private individual entitled to claim than for the risk-neutral company entitled to claim. The entitled private individual is therefore an attractive target group for the commercial litigation financing company. Similar litigation risks can be bundled in a special purpose entity.
Commercial process financing as an alternative form of investment and as a sui generis financing model is examined in the third chapter with regard to its possible subordination under the AIFM Directive. The design possibilities of collective investment schemes are shown. Risk management and compliance are pronounced in commercial litigation financing and thus form the basis of business success. Asset management can i. c. be understood as active contract management. Specialist expertise, in the sense of a team of experts and specialist lawyers called in, serves the commercial litigation financing company to determine the most realistic possible probabilities of success in litigation. The close proximity of the self-managed collective investment schemes to the investment stock corporation active in the financial sector makes it difficult to distinguish between them. In addition, the AIFM Directive recognises the material concept of investment funds, which covers all companies that manage alternative investments as a regular business activity based on an investment policy and raise capital from a certain number of investors. The narrow definition of the corporate purpose and the legal obligation not only to strive for but also to pursue this purpose creates a regulatory dilemma for investment stock corporations refinancing themselves on the financial market. The more concretely defined and closer to an investment strategy the formulation of the corporate purpose is, the greater the risk that a component for classification as an AIF (defined investment strategy) is given. An investment vehicle should be considered as an AIF if all the elements contained in the AIF definition are actually present, i.e. it must be a UCI which collects capital from a number of investors in order to invest it in accordance with a defined investment strategy for the benefit of these investors, but may not be a UCITS. Thus, for operating companies operating in the financial sector, such as i. c. the commercial litigation financing company, it must be carefully examined whether the activity does not necessarily fall within the scope of the demanding manager regulation of the AIFM Directive. For this purpose, not only the AIFM Directive as a framework regulation but also the corresponding ESMA regulation are considered. The verification scheme developed in this way can be used in practice to provide operating companies in the financial sector with a quick overview of the legal and regulatory framework.
The fourth chapter describes commercial litigation financing in the form of a legal expenses fund within the scope of the AIFM Directive. As a de facto self-administered investment vehicle, the commercial litigation financing company is subject to approval and supervision. A business management, portfolio theory, process economics and welfare theory impact analysis illuminates the classification of the investment vehicle as an alternative investment fund.
In summary, it can be said that process financing as an alternative collective investment scheme in the form discussed represents an interesting investment vehicle and a special investment opportunity. Its financial market law architecture can also be applied to similarly structured investment stock corporations. The economically oriented operational management of companies often sees regulatory challenges as a risk for the existing business model, at best only as a cost factor in the area of legal and compliance. However, AIFM regulation in particular can also be seen as an opportunity to make the national investment stock corporation compliant with the Directive, in order to create new business models for the future of the European financial market.