Third-party Funding in International Arbitration

• Publication year: 2019
• Author: Sean P. Galliher*

THIRD-PARTY FUNDING IN INTERNATIONAL ARBITRATION

Sean P. Galliher*

I. INTRODUCTION

Third-party funding of legal actions has been around, in one form or another, for years. Such funding has been particularly effective in financing litigation in the United States. Third-party funding is also increasingly popular in international arbitration, largely as a result of the broadening scope and therefore cost of arbitration. Arbitral institutions are now grappling with the financial complexities inherent in third-party funding and the impact of such funding on international arbitration. Legislation, rules, case law, and regulations are being revisited in light of the issues presented by third-party funding. After discussing the nature and types of funding currently being used in international arbitration, this article will evaluate the current state of international litigation funding mechanisms, assess the impact these funding mechanisms have on international arbitration, and discuss the financial future of international arbitration.

II. THIRD-PARTY FUNDING IN ARBITRATION: THE VARIOUS AGREEMENTS INVOLVED

Third-party funding is a mechanism whereby a non-party to a legal action—whether traditional litigation or alternative dispute resolution—funds a party involved in the legal action, with the expectation of receiving a return on this investment. The funding typically covers the funded party's legal fees and expenses incurred during the legal action. The funder may also agree to pay the other side's costs if the funded party is so ordered and to provide security for these costs.

Third-party funding in U.S. litigation has been part of the legal landscape for years. Contingent fee agreements, for example, are one longstanding form of third-party funding in domestic litigation. The recent and significant rise in third-party funding of international arbitration has led to concerns about the impact and consequences this type of funding will have in international dispute resolution.

A. The Agreements

Many different types of agreements can be involved in third-party funding of international arbitrations. Both claimants and respondents can be funded by third parties, and the agreements can be used interchangeably depending on the circumstances and the type of funding involved in a particular situation. These agreements dictate the financial terms of the relationships and often define those relationships and the responsibilities of the parties. Among other issues, some agreements dictate litigation terms that can lead to problems with the integrity of the arbitral system and create conflicts of interest. It is worth noting that many agreements between funders and arbitration parties include budgets, maximum investment limits, and repayment terms that dictate what the claimant can and cannot do during the pendency of the arbitration. This section summarizes, though not exhaustively, the types of agreements that are often used in third-party funding of international arbitrations.

1. Lawyer Retainer/Contingency Fee Agreements

These types of arrangements have been around for a long time in the United States. Certain areas of the law, particularly personal injury and tort matters, have used this type of funding to move forward with legitimate cases that may be difficult for a less prosperous plaintiff to pursue if paying on an hourly basis. These agreements are based on a successful recovery and the award of damages. The plaintiff typically gets two-thirds of the recovery after expenses are paid. Obviously, there are variations to this formula depending on particular state laws or the amount of work involved (for example, if a case goes to trial the attorney may receive 40% rather than 33.3%).

This type of fee agreement also involves the shifting of risk. The attorney must evaluate the case and decide whether it merits his or her involvement. If the case is unsuccessful, the attorney is left with no fee for the time and effort expended. A version of this attorney review takes place internationally. In international matters, bigger law firms have used a variation of this agreement in arbitration to include their active involvement in the handling of the case where this is permitted.¹ This "active involvement" gives the law firm more say in the resolution of the matter and decisions about the case that would normally be in the exclusive control of the client.

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2. Escrow Agreement

Whenever large sums of money are involved (which is common in large, third-party funded international arbitrations), the lender often requires an escrow agreement. The proceeds of the litigation are paid directly to the escrow agent. The escrow agent then deposits the proceeds into an escrow account and holds them in trust until the proceeds are distributed to the parties. Typically, the escrow agent is a financial services provider, or an attorney in smaller cases.²

3. Security Agreement

The main concern of any third-party investor is to be paid first once funds are available. One method of achieving this is to obtain an assignment of the proceeds to ensure the right to recover absent any jurisdictional issues. This method helps protect the investment against the rights of any creditors of the claimant. The funder thus ensures that the litigation proceeds pay no other stakeholder or creditor in priority.³

Another method is an assignment of the claim itself. This can be done by mortgages, pledges, and other assignment mechanisms. The effectiveness and enforceability of these assignments and security agreements is dependent upon several factors. A study carried out by the European Commission found that 47% of stakeholders in assignment of claims transactions involving a cross-border element encounter practical problems in effectively securing against third parties.⁴ Lenders will often look to the laws of the domicile to determine the effectiveness of enforcing the security agreement.

4. Standstill Agreements

Standstill agreements arise when the funder has reservations about the claimant's ability to conduct the arbitration to conclusion because of financial difficulties. The funder and creditors enter into an agreement to stop creditors from moving forward on a financially troubled claimant. These agreements ensure that the claimant manages the claim to conclusion before creditors take any action against the claimant. This type of agreement can also allocate the proceeds once the arbitration is concluded, depending on the claimant's situation. If the claimant is in bankruptcy, many bankruptcy laws will protect the claimant from the judiciary in their domicile to continue the litigation free of interference from creditors.⁵

5. Priorities Agreement

Priorities agreements are entered into to delineate the distribution of proceeds between the parties. Often an escrow agent is a party to these agreements to direct the distribution of funds. Such priority distribution arrangements could have the following characteristics:

• repayment to the third-party funder of its investment to date;
• payment to the third-party funder of its return;
• payment to lawyers of deferred, contingent, or conditional success fees; and
• payment of the balance to the claimant.⁶

In a typical restructuring, new money gets paid back first along with the return on investment. Some of the priorities included in the list above could be shifted to historic payments depending upon what transpired between the claimant and the attorney or other investors.⁷

6. Conditional Fee Agreement

A conditional fee agreement is structured so that a law firm provides for the payment of legal fees and expenses upon the successful prosecution of the claim on behalf of their client. The law firm also receives its regular charge out rate along with an uplift (success fee).

7. Insurance Agreement

An insurance agreement involves a policy taken out after a dispute has arisen, to protect the insured from paying costs and expenses if the insured loses. Some of these policies also cover other fees (including the arbitrators' fees) and expenses, depending upon the needs of the insured at the time of contracting.⁸ These agreements are sometimes referred to as "after event insurance."

B. Notice

Historically, there was no requirement that arbitration parties disclose the financial arrangements between themselves and third-party funders. That is beginning to change, as these funding arrangements can give rise to issues that could possibly affect the outcome of arbitration decisions. For instance, an ongoing financial relationship between a third-party funder and the arbitrator or the arbitrator's firm could influence the arbitrator's decision. The need for disclosure in these instances is obvious. Others argue that a funding relationship and the parties to it could not possibly influence the arbitration if the arbitrator is unaware of that relationship.⁹

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The disclosure of the relationship between funder and client has primarily been a matter of agreement between the parties. Most of the leading arbitral institutions have no rules concerning disclosure of these types of agreements. There are certain guidelines, however, that discuss conflicts of interest that force these relationships into the open. For instance, parties have a duty to disclose any relationships between the arbitrator and the party wherein the party has a relationship with a person or where entities have a direct economic interest in the arbitration.¹⁰

Notice requirements for third-party funding arrangements are in the process of changing. Mandatory disclosure of the funding arrangement is becoming compulsory in many jurisdictions. Hong Kong and Singapore, for example, have passed domestic legislation requiring disclosure of these funding relationships in the context of arbitration seated in those jurisdictions.¹¹ There are also at least three cases that discuss disclosure and third-party funding.¹²

Non third-party funded cases have never had a notice requirement, nor is...