Litigation funding, sometimes called third-party funding or litigation finance, is becoming increasingly popular in Switzerland these days. One major force behind this trend is the procedural law in Switzerland. At the beginning of proceedings when the action is filed, the plaintiff may already have incurred substantial costs. Swiss civil courts may demand the plaintiff to make an advance payment up to the amount of the expected court costs. The amount of the advance payment will depend on the value in dispute and might be the full amount of the expected court costs. In addition, the plaintiff under certain circumstances has to provide security for party costs at the defendant’s request. If the advance or the security is not provided, the action will be declared inadmissible.

Swiss courts usually decide on the procedural costs in the final decision. The costs are charged to the unsuccessful party. If no party is entirely successful, the costs are allocated in accordance with the outcome of the case. The court costs are set off against the advances paid. The balance is collected from the person liable to pay. The party liable to pay has to reimburse the other party its advances and has to pay the party costs awarded. Since the actual court costs are offset against the advances made, the plaintiff, in addition to the general risk of litigation, always bears the defendant’s credit risk should the defendant be incapable of reimbursing the plaintiff for the advances paid.

As a consequence, the plaintiff in proceedings before Swiss civil courts has to spend significant financial means at an early stage, which remain committed during the entire proceedings. Additionally, the plaintiff has to carry the credit risk of the defendant party until the final decision. However, even if the plaintiff succeeds at the end, he or she might have uncovered costs.

As a result, the demand for litigation funding is rising. Since the decision of the Swiss Federal Supreme Court of 10 December 2004, DTF 131 I 223, litigation funding has been generally permitted in Switzerland. However, the general legal framework as well as the professional law applicable to the participating actors must always be respected, which will be discussed in more detail below. At present, litigation funding is mainly used as a remedy for circumventing the cost barriers in proceedings before Swiss courts.

In the case of proceedings before state courts, the funder takes over the court costs including advance payments, the costs for the legal representation of the plaintiff, the costs of the opposite party in case of failure according to the applicable tariff and the costs of enforcement of a decision. Furthermore, funders also take over the risk of proceedings in Swiss arbitrations. Such arbitrations may also entail considerable cost risks. However, they have only remained of minor significance in the practice of Swiss funders.

Ultimately, a substantial legal restriction in Switzerland is the prohibition of the pactum de quota litis, which makes the financial participation of the mandated attorneys in the success of the relevant proceedings severely restricted. In addition, the independence of such mandated attorneys must always be respected and their conflicts of interest avoided.

Lastly, a crucial question remains as to how the funder will be refinanced since the individual refinancing structures might violate Swiss financial market regulations. Despite the general permissibility of litigation funding in Switzerland, all other applicable Swiss laws have to be respected at all times, which will also be discussed in this article.

I. General Legal Framework in Switzerland

A. Legal Permissibility

The laws of Switzerland have never had a legal doctrine in force which prohibits litigation funding. Nevertheless, litigation funding is a relatively modern remedy for seeking funding for filing an action before a Swiss court. Coming from Germany, litigation funding was introduced in Switzerland in the early 2000s. In the year 2003, the Canton of Zurich intended to introduce an explicit ban on litigation funding. However, before the cantonal ban was brought into force, it was challenged in court. By the judgment of 10 December 2004, DTF 131 I 223, the Federal Supreme Court lifted the ban, because the general prohibition of litigation funding had shown an excessive restriction in the constitutional right of economic freedom under art. 27 of the Swiss Federal Constitution. Since this first ruling, litigation funding is considered as permissible and has been confirmed by the Federal Supreme Court in 2015 (decision 2C_814/2014 of 22 January 2015).

In the reasoning of the first decision, the Federal Supreme Court examined whether litigation funding was in compliance with, in particular, the attorney’s independence, the avoidance of conflicts of interest for the mandated attorney, and the protection of the attorney-client privilege. Although deciding in favour of permissibility, the Federal Supreme Court made it clear that it cannot be ruled out that, depending on the specific designs of a litigation funding system, the independence of the mandated attorney might be impaired. Consequently, in spite of the general admissibility, there is no so-called regulatory free pass about the conceivable design variants. Thus, in the following, the legal framework for litigation funding will be discussed.

B. Qualification of Funding Agreement

Up to the present day, litigation funding has not yet entered into a cantonal act or a federal act, which is currently in force. Additionally, such funding agreements are not covered by the scope of the Swiss Consumer Credit Act. Also, there are no best practice guidelines in Switzerland for such funding schemes. Accordingly, the regulatory framework has not been conclusively defined in Switzerland. Even the Federal Supreme Court did not comment on the legal qualification of the litigation funding agreement, but denied a qualification as an insurance contract. Hence, the qualification of such funding agreements in the academic literature remains controversial. The prevailing Swiss doctrine qualifies such agreements as articles of association to establish a simple partnership in the sense of art. 530 et. seq. of the Swiss Code of Obligations (CO).

C. Key Content of Funding Agreements

Drafting a litigation funding agreement under Swiss law, the following three parts should be reviewed in detail.

In return for financial support, the funder participates in the litigation gain in case of success. In addition to the reimbursement for the invested capital, the plaintiff undertakes to pay a share of the remaining net proceeds to the funder. The funder’s share may vary greatly depending on the funder, the plaintiff and the individual disputed claim. In practice, quota participations of approx. 30% to 50% are observed. Other forms of participation are also conceivable, such as in the form of a multiple of the costs paid. Concerning the legal boundaries of the amount of profit-sharing, there has not been a judgment from the Federal Supreme Court yet. In the leading case DTF 131 I 223, the Federal Supreme Court pointed out that certain types of funding agreements or individual clauses thereof may be inadmissible. The court referred to an essay in the legal literature in Germany, where 50% profit-sharing has been considered as excessive and, thus, immoral. However, the exact upper limit of the maximum permissible profit-sharing of funders has never been directly challenged in court.

In addition to profit-sharing, litigation funding agreements usually provide for securities in favour of the funder, such as a pledge or an assignment of the disputed claim. Bank guarantees can also be observed in practice. The Federal Supreme Court has not yet ruled on the admissibility of such means of security. In the above mentioned leading ruling, the Federal Supreme Court solely pointed out that, by assigning the disputed claim to the funder, the plaintiff might risk losing its capacity to sue. Thus, it is advisable to verify that the plaintiff retains the legal property of the respective claim.

Critics sometimes point out that control over the proceedings is at the expense of the plaintiff on the side of the funder, which might impact settlement negotiations, as the funder could influence the amount of the settlement sum. Such contractual rights could potentially lead to conflicts of interest for the mandated attorney, which would jeopardize the attorney-client relationship. Litigation funding agreements in Switzerland solve such incentive issues via termination rights on the part of the funders which limit their exposure in the respective proceedings. In the event of a change of circumstances, for example when new facts become known, or when there is a change in the relevant jurisdiction or the creditworthiness of the defendant, as well as in the event of a defeat before a judicial instance or in the event of disagreements regarding the settlement offer, funders usually have the right to terminate the agreement. With respect to admissibility of such termination rights, the Federal Supreme Court briefly stated that such ancillary rights do not necessarily impair the independence of the mandated attorney and are therefore not generally prohibited.

III. Professional Law

A. Plaintiff as Beneficiary of Funding

On the part of the plaintiff, there is currently no regulatory framework in place which regulates the receipt of funds for the financing of civil proceedings. Such agreements are also not qualified as insurance agreements, and are, therefore, not covered by the scope of the Swiss Insurance Supervision Act. Besides, there are significant differences between litigation funding and the legal expense insurance products which are comprehensively used in Switzerland. In the case of a traditional legal expense insurance, an insurance company undertakes to remunerate or to provide services in connection with insured legal matters against payment of a premium. In contrast to litigation funding, there are often risk exclusions and limitations in such insurance agreements mostly addressing legal matters which insurance companies may have difficulty in comprehending, but which may be of interest to funders. If a successful judgment is awarded by the court, the insured party benefits in full, whereas the beneficiary of the litigation funding has to partially share the awarded damages with its funder.

B. Funder as Investor in the Proceedings

From the funder’s perspective, litigation funding can be fully employed in Switzerland. The individual funding entity is not regulated by any state supervision. However, the funders have to ensure that their internal funding structure is compliant with the applicable Swiss financial market laws. The internal financing scheme must adhere to the provisions of the Swiss Federal Banking Act since noncompliance would result in the violation of the banking license requirement. It should also be noted that the funder’s internal financing structure must not fall within the scope of the Federal Collective Investment Schemes Act. Finally, funders in Switzerland also have to comply with the provisions of the Federal Anti-Money Laundering Act (AMLA), should their internal financing scheme fall within the scope of the relevant provision (art. 2 AMLA).

C. Professional Conduct of Mandated Attorney

Another party involved in litigation funding is the mandated attorney. In its leading decision, the Federal Supreme Court expressed its opinion on the legal framework under which attorneys have to comply at all times with regard to litigation funding. With reference to the Federal Act on the Freedom of Movement for Lawyers, the mandated attorney must be independent and as free as possible from conflicts of interest. In case of litigation funding, the Federal Supreme Court argued that even if the plaintiff gives the funder the right to be informed about the progress of the proceedings or to be able to co-determine a settlement offer, such contractual rights do not affect the independence of the mandated attorney. However, the court also firmly held that, depending on the specific funding structure, the legal independence might be impaired. As examples of such dependencies, the court referred to cases in which the mandated attorney was the funder’s employee, a shareholder or a board member at the same time. Consequently, as long as the mandated attorney is not subject to funders’ instructions and also not subordinate to a dependence, the requirements are met. The Federal Supreme Court also clarified whether litigation funding schemes might violate the prohibition of the so-called “pactum de quota litis” in Switzerland. A violation of this prohibition would be the case if the mandated attorney receives a share of the litigation gain instead of a fee. The Federal Supreme Court ruled that the way in which the plaintiff finances his or her proceedings only affects the plaintiff-funder relationship, but not the attorney-client relationship. Thus, the court concluded that litigation funding does not in principle violate this prohibition as long as the mandated attorney does not receive any part of the litigation gain instead of a fee payment, which also excludes indirect participation by using legal entities and other conceivable circumventions. Ultimately, the Federal Supreme Court ruled that the attorney-client privilege can also be maintained as long as the attorney was authorized to disclose.

IV. Funders’ Involvement in the Proceedings

A. No Disclosure Obligation in Switzerland

Similar to the parties involved in litigation funding, the funder’s conduct is also not regulated. For example, when the plaintiff receives external funding for his or her action to file in court or in arbitration, the funder’s involvement does not have to be disclosed. Nether the Swiss Civil Procedure Code nor the Swiss Rules of International Arbitration require such disclosure. There is also no best practice in Switzerland that would demand such a line of conduct. In practice, however, it is also evident that disclosure of a funder’s involvement can deliberately be used as a way to strengthen the plaintiff’s negotiating power or to eliminate part of the procedural costs.

B. Funder’s Status in the Proceedings

In addition to the disclosure, there are also questions as to how the funder can directly influence the litigation, e.g., as an accessory party, as a substitute party or as amicus curiae. In case of accessory party, the funder would be required to substantiate a legal interest, a merely economic or factual interest is not sufficient. The interests of the funder are in most cases mainly of an economic nature, which is why the material requirements of becoming an accessory party are typically not fulfilled. The situation is, however, different if the funder is in the process of becoming the holder of the title of the particular claim in dispute. If the funder acquires the litigious claim before or during the trial, a change of party could take place. Art. 83 para. 1 of the Swiss Civil Procedure Code permits the acquirer to enter into ongoing proceedings in the event of an acquisition of the object in dispute without the consent of the opposing party being required.

In the case of arbitration proceedings, art. 4 para. 2 of the Swiss Rules of International Arbitration provides that a third party who is not party to the proceedings may participate in the proceedings. According to legal scholars, the nature of this participation is deliberately left open in the Swiss Rules. It is conceivable, for example, that an accessory intervention, principal intervention and also institutes of the Anglo-American judicial area, such as amicus curiae, can be applied.

C. “Piercing the Veil” and Cost Issues

In some jurisdictions, the question might arise as to whether the plaintiff, in the event of winning the case in court, will be able to claim the paid profit-sharing as part of the party compensation. Art. 95 para. 3 lit. a of the Swiss Civil Procedure Code determines the reimbursement of necessary outlays as part of the compensation. However, based on the academic discussion of legal scholars in Switzerland regarding the criterion of necessity, it seems rather unlikely that a Swiss civil court would include the profit-sharing to the funder as part of the necessary outlays.

If, however, the defendant should win before court, the question might arise as to whether the defendant can directly claim the reimbursement of litigation costs from the funder. In the litigation funding structure applied in Switzerland, the funder does not usually become party to the proceedings and only enters into the funding agreement as pointed out previously. Therefore, if the defendant should win the case, he or she has no direct recourse to the funder. The plaintiff remains solely liable for the reimbursement of the costs awarded to the defendant.

V. In Practice – Swiss Market for Litigation Funding

The market for third-party funding began to develop following the leading decision of the Federal Supreme Court in 2004. At present, there is a functioning market in Switzerland, but its development is still significantly behind other more established foreign markets. At its current size, the Swiss market has remained a relatively small niche area and is considered as a recognized remedy for circumventing the cost barriers shown in proceedings in Switzerland.

Some litigators may criticize the fact that litigation funders only consider lawsuits with a high amount in dispute for financing and that this behavior is responsible for the rather moderate market growth in Switzerland. However, the reason can be found in the applicable Swiss procedural law. As pointed out, the funders bear the credit risk of the defendant in addition to the general litigation cost risk and the enforcement risk. Moreover, even if the plaintiff wins the lawsuit and gets the procedural costs awarded, the funder might have uncovered costs at the end since the party costs are in general determined by tariffs and not by the actual legal fees paid. Hence, funders will only accept lawsuits with a certain minimum value in dispute for risk-return considerations. Otherwise funders risk being left stranded with the costs even if the plaintiff succeeds in the end. The respective minimum litigation values can vary greatly among Swiss funders, starting at around CHF 250,000 and going up to CHF 5 million.

Currently, there are about a handful of litigation funders serving the Swiss market. Furthermore, insiders assume that foreign litigation funders are also active in the Swiss market from their foreign branches at the moment. For the past year, individual Swiss funders have also been offering co-financing as well as secondary financing to companies and their litigation funders, which can be considered as an innovative further development of traditional litigation funding in Switzerland.