Arbitration has always been promoted as one of the alternative mechanisms of dispute resolution providing parties with many advantages over litigation.At the same time, it is now commonly accepted that lower costs are no longer one of such advantages as arbitration has become increasingly expensive. Moreover, there are numerous examples when a prospective claimant, having previously agreed to arbitration, does not have adequate funds to cover all costs and expenses of the arbitration proceedings.
In such cases, it is possible to seek a third party to cover participation in the costly arbitration proceedings. In some cases, engaging such a third-party funder becomes the only possible way for the prospective claimant to get access to justice.
What is Third Party Funding in Arbitration?
In general, third party funding (TPF) is an instrument for the prospective claimant to obtain funds to cover the costs of arbitration in exchange for the share in the ultimately recovered sum. Initially, this tool was primarily used in litigation and was then expanded to arbitration.
Third party funding is mostly used in rather complex cases with large amounts at stake in order to justify efforts in engagement of the funder, as well as risks assumed by the funder.
Typically, third party funding in arbitration entails a complex relationship between the prospective claimant, its legal counsel and a funder based on the following contractual arrangements:
- Funding Agreement, which is entered by a prospective claimant as Funded Party and a commercial entity which funds participation of the claimant in the proceedings as Funder;
- Engagement Letter, which is entered by a prospective claimant and its legal counsel containing inter alia, a provision which allows payment of legal fees by a third party. This is crucial for further recovery of costs in the arbitration).
While third party funding raises issues concerning confidentiality, legal privilege, disclosure, conflicts of interests, cost issues and the attorney-client relationship, third party funding plays an important role in many arbitrations today.
Third party funding arguably permits greater access to justice for claimants, permitting meritorious claims to proceed that would not have been pursued otherwise. It also is said to level the playing field so that cases will not be resolved on the basis of unequal economic resources or risk preference. Even for claimants with sufficient funds, third party funding is increasingly used to take the costs of litigation or arbitration off of the company’s balance sheet, or to outsource these costs and financial risks. The terms of litigation funding agreements between funders and clients typically set out the agreed conduct of each party, the payoffs to the funder, the circumstances and conditions in which the funder can exit the case, and the reporting and updating requirements of the funder, lawyers and client.
Third party funding is not a cure-all for litigants and can be very difficult to obtain. The French third party funder Alter Litigation estimates that only one out of every twenty-five cases where funding is requested actually receives it. Third party funders will rarely fund cases where the amount in dispute is less than USD 20 million, they will only fund cases against Respondents with assets that an arbitration award can be enforced against, and it can take a year or more to set up a final and binding funding agreement following a rigorous due diligence procedure by third party funders and their insurers.
Advantages and disadvantages
A potential claimant may approach a funder for various reasons:
- Necessity: Arbitration can be expensive. If a claimant does not have the means to pursue a meritorious claim, funding may well be its only option.
- Risk management: Claimants with the funds to arbitrate may want to lay off some of the risk associated with costly arbitration, and be prepared to give up a proportion of any recoveries to do so. It also enables a company to invest that money elsewhere. In addition, the funded party is relieved of costs pressures and cash-flow issues associated with the legal costs of the arbitration.
- Validation: Funders are only interested in good claims. Therefore, they will conduct extensive due diligence and carry out their own analysis of the merits before agreeing to provide funding. This objective analysis may assist the claimant to shape its case strategy, and may also encourage early settlement once the other party is made aware that the claim has the backing of a funder.
However, there are also disadvantages to using third party funding:
- A successful claimant will generally have to pay a significant proportion of his or her recoveries to the funder.
- Although funders are generally prohibited from taking undue control or influence in an arbitration, there may be some loss of autonomy on the part of the funded party (when considering settlement) as funders may reserve the right of approval of the settlement.
- Substantial costs can be incurred when packaging the case for presentation to a funder. These will have been wasted if the application for funding is unsuccessful. Even if successful, funders are not usually liable for any costs incurred before the funding arrangement is put into place, including the costs of packaging and the negotiation of the funding arrangements.
Is Third-Party Arbitration Funding Common In Your Jurisdiction?
In India, third-party funding is expressly recognized in the context of civil suits in states such as Maharashtra, Gujarat, Madhya Pradesh and Uttar Pradesh. This consent to third-party funding can be adduced from the Civil Procedure Code 1908, which governs civil court procedure in India. Order XXV Rule 1 of the code (as amended by Maharashtra, Gujarat, Madhya Pradesh and Uttar Pradesh) provides that the courts have the power to secure costs for litigation by asking the financier to become a party and depositing the costs in court.
No law expressly bars or allows third-party funding agreements in arbitration. The Arbitration and Conciliation Act 1996 governs arbitration in India. The legality of third-party funding in arbitrations cannot be adduced from the select group of Indian states which allow third-party funding in civil suits. However, a constitutional bench of the Supreme Court has noted that a champerty contract in which returns are contingent on the success of the case is not per se illegal, except in cases where an advocate might be a party. If a third-party funding agreement contains an extortionate or unconscionable objective or consideration (e.g. recovery of a gambling debt), the agreement would be rendered unenforceable under the Contracts Act 1872.
As the 1996 act is silent on this issue, third-party arbitration agreements have been rendered virtually non-existent in India. Till date, no precedent on third-party arbitration funding exists and thus these agreements are uncommon.
What terms and conditions are generally associated with third-party arbitration funding in your jurisdiction? Does this type of funding usually include punitive measures in the event of an adverse outcome for the claimant company?
As stated above, third-party funding agreements are virtually non-existent in arbitration. Further, there are no known precedents and the 1996 act offers no guidance in this regard. Thus, the above two questions cannot be conclusively addressed.
One revolutionary mechanism that could have been used is a provision for Third
Party Funding. The role of TPF in international arbitration is continuously gaining
TPF is neither expressly recognized nor prohibited in India. But the prohibition against lawyers charging contingency fees and India’s tryst with public policy can indicate that it might not have encouraged it at least in litigation. But it doesn’t necessarily follow that the same yardstick would be applied to commercial arbitrations.
This is especially considering how so many issues relating to rights in rem (e.g. fraud and corruption) that were non-arbitrable in the past have been brought under the jurisdiction of the arbitrator. Moreover, with new strides being taken in arbitration in India and in TPF provisions around the world, one wonders if a carve out might have been made for arbitration as has been done in popular arbitration centers.