Third party funding in Arbitration Disputes

In less than a decade, dispute finance, also known as litigation funding or Third-Party Funding (‘TPF’), has risen to prominence in international litigation and commercial arbitration, albeit at high risk.

One of the earliest organizations to address TPF was the International Bar Association (IBA). In considering conflicts of interest, the 2014 IBA Guidelines include a reference to third-party funders in General Standard 6(b):

“If one of the parties is a legal entity, any legal or physical person having a controlling influence on the legal entity, or a direct economic interest in, or a duty to indemnify a party for, the award to be rendered in the arbitration, may be considered to bear the identity of such party.”

The explanation to General Standard 6(b) further clarifies:

“Third-party funders and insurers in relation to the dispute may have a direct economic interest in the award, and as such may be considered to be the equivalent of the party. For these purposes, the terms ‘third-party funder’ and ‘insurer’ refer to any person or entity that is contributing funds, or other material support, to the prosecution or defence of the case and that has a direct economic interest in, or a duty to indemnify a party for, the award to be rendered in the arbitration.”

Increasing Funding Demand

With the rising costs of arbitration and the tightening of legal budgets, it’s no wonder that demand for TPF has increased significantly in recent years. The financing of claims by professional funders has not only shifted the risk of adverse litigation outcomes away from the litigant but has also improved access to justice for impecunious claimants.

Companies are now less hesitant to pursue legitimate claims in order to preserve cash flow and control risks. To put it another way, TPF is not limited to individuals who are financially disadvantaged. As a result of the increased demand for TPF, a slew of new funders have entered the worldwide litigation financing market, which surely demonstrates the industry’s rapid growth.

Why Is Funding Sought and By Whom?

Claimants, funders, lawyers, and maybe financing brokers are the main participants in lawsuit funding. Legal fees, expert fees, arbitrator’s fees, arbitral institution fees, and costs related to enforcement processes or appeals are typically covered by funding.

While claimants constitute the majority of TPF recipients, law firms may also use the service in some countries. TPF for responders is also evolving and becoming more available in the event of a counterclaim, notwithstanding its rarity. However, because responses are funded, there are difficulties in reimbursing the funders in the case of a successful defence. The defence of a claim may be included in the portfolio agreement in some situations.

The Dispute Funding Process

Third-party funding arrangements can vary in type, structure, and characteristics from case to case. For one reason or another, the majority of cases presented to any specific TPF are denied. There are few publicly available figures, as well as assertions made by some donors, that implies an 80 percent or higher rejection rate.

The funder’s board or investment committee will decide whether to finance a claim after conducting extensive due diligence (typically involving external attorneys and, if necessary, damages or technical experts) and receiving approval from the funder’s board or investment committee.

Funders are concerned about the case merits, the proposed investment’s fiscal matters, and the enforceability of any judgement. A good indication of a sound claim with a well recoverable margin between the anticipated damages recovery and the estimated budget for legal fees and charges is required for a TPF to examine a prospective opportunity.

Return Structures

A TPF that provides “non-recourse” finance expects to make many returns on its investment. This reflects both the high-risk character of the investment and the funders’ expectations for the Internal Rate of Return (“IRR”). The funder’s return (or success fee) may be calculated as a percentage of the “claim proceeds”(the amount recovered by way of damages or settlement) or as a multiple of the cash invested. A combination of these may be used in some arrangements. The arbitrator accepted that the expense of third-party funding was acceptable in the historic case of Essar v. Norscot, which was supported by the English High Court.

Legislations And Code of Conduct

The regulation of TPF is still a source of contention. Only two countries have taken measures to restrict TPF in international arbitration, notwithstanding common-law rules prohibiting “champerty” and “maintenance.” On the 10th of January 2017, the Singapore Parliament enacted the Civil Law (Amendment) Bill (No. 38/2016), allowing TPF to conduct international arbitration and associated processes in Singapore.

The Hong Kong Legislative Council passed the Arbitration and Mediation Legislation (Third Party Funding) (Amendment) Ordinance, 2017 on June 14, 2017, allowing TPF of arbitration and mediation in Hong Kong.

Meanwhile, the Treasurer of the Commonwealth of Australia declared on May 22, 2020 that litigation funders in Australia will be subject to financial regulation, which will require them to hold an Australian Financial Services License (AFSL)

While not formally regulated, Lord Justice Tomlinson stated in Excalibur Ventures LLC v. Texas Keystone Inc, the Court of Appeal ruling in the costs appeal:

‘Litigation funding is a widely acknowledged and judicially sanctioned activity that is seen as being in the public interest.’

Similarly, the Supreme Court of India has established the legal permissibility of third-party funding in litigation in Bar Council of India v. AK Balaji, opining that

“It appears that there are no restrictions on non-lawyer third parties sponsoring litigation and being reimbursed after the case is resolved.”

In addition, a few Indian states, including Gujarat, Maharashtra, Madhya Pradesh, Uttar Pradesh, Andhra Pradesh, Orissa, and Tamil Nadu, have formally recognized TPF by amending Order XXV Rule 1 of the Code of Civil Procedure, 1908, which allows courts to secure litigation costs by asking the financing party to join the case and depositing the costs in court.

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