This article was written by Patric McGonigal.
With recent developments in Singapore and Hong Kong and recent arbitration case law dealing with the recovery of costs, third party funding (“TPF”) appears ready to make a significant difference to the way in which risk and cross-border arbitration disputes are managed in Asia, including in Japan.
Following is a recap of the key elements of TPF and summary of recent developments in the context of international arbitration.
What is TPF?
TPF (sometimes called ‘litigation finance’) is an alternative method of funding legal proceedings where a commercial funder with no connection to the case will pay some or all of the costs of pursuing a claim in return for an agreed share of any damages awarded if the case is won.
Traditionally, TPF was something that allowed parties with a strong legal case but who were in a weak financial position to take on more powerful opponents with greater resources. Now however, TPF is also being used by the very entities it might once have been used against as a way of taking the costs and uncertainty of major arbitration off balance sheets and making it possible to use capital in other areas of the business – in short, TPF is a new financing structure which turns a claim into an asset.
It works because legal fees as well as any disbursements are covered by the funder on an ongoing basis – the funded party remains in control of conducting the case but does not have to put in place a budget to cover the costs of doing so. Moreover, if it becomes necessary, the funder may also provide security for the other side’s legal costs.
This provides the business with financial certainty such that it can then draw a line under the dispute and move on by deploying its resources in other ways, on other deals. At the same time, the claim can still be pursued and there is still the possibility of making a discounted recovery in damages.
If the case is lost, the legal fees are covered, usually through an indemnity or an ‘after the event’ (“ATE”) insurance policy and so there is no exposure to any unexpected costs if things do not go as planned. Therefore, the risk of an adverse costs order is neutralised, and payment of the insurance premium is usually paid by the funder.
Given its increasing popularity, TPF is now provided by a wide range of institutions e.g. specialised funders, insurers, investment banks and hedge funds. However, unlike with traditional financing provided by banks, insurers etc, no interest or premium is paid to a third-party funder.
Therefore, in addition to TPF presenting an opportunity to turn a claim into an asset, it also removes the cost to the business of realising that asset (albeit that the asset itself is discounted in return for obtaining TPF). The business therefore has a choice in terms of how best to make use of its capital – either funding a claim or investing it elsewhere.
Advantages of TPF
Legal proceedings are generally expensive and difficult to budget as much of what happens depends in part on the approach of the opponent; whether they are particularly aggressive or obstructive. This is especially so if the stakes are high. The level of costs can fluctuate unexpectedly and while experience helps to predict when this might be, it is rarely possible to be definitive. Few businesses like uncertainty and as a result, many do not have the appetite or budget to pursue a claim even if the merits of the case are strong. TPF provides a solution to this by strengthening a company’s risk management and turning a potential risk into an asset which can be sold-off in part or in full in return for a proportion of any damages that are recovered. TPF provides certainty when managing risk.
Removing cash flow issues
A Conditional Fee Arrangement (“CFA”) is also a funding arrangement and comes in various forms. Some only involve the payment of legal fees if the case is won but, in most cases, so that the risk is shared between the law firm and client, the funded party will agree to pay a significantly discounted level of legal fees as well as a success or enhanced fee if the case is won. The success fee can then be funded out of the monies recovered from the other side. However, what this means is that unlike with a TPF arrangement, the funded party is usually required to pay a percentage of fees throughout the proceedings, so that a budget must still be put in place and cash flow still remains an issue until the dispute is resolved.
Similarly, the funded party does not pay any premium or disbursements during the proceedings. In contrast, under a CFA with ATE insurance, the funded party must pay premium and disbursements throughout the life of the claim until it is resolved. And even though the insurer may refund such disbursements (but not premium) if the case is lost (and a recovery cannot be made against the other side), the funded party is still expected to pay such costs up front as the claim progresses.
As a matter of strategy, there are two important aspects of TPF that can help to accelerate resolution of a dispute. First, the disclosure of the existence of a TPF arrangement can force an opponent to reconsider its position. This is because if a party obtains funding, it means that an independent third party has reviewed the claim and concluded that the funded party is likely to win. Otherwise, the funder would not be willing to invest in the claim. Second, the fact that a claimant has TPF means that the level of costs at stake are likely to be much higher as the funder will seek to recover on its investment. Therefore, notice that TPF funding has been obtained can also help to accelerate resolution of the claim.
While not a reason to obtain TPF, the objective review process conducted by a potential third-party funder can help to further inform strategy and how best a case should be run. Although a funder will not take over control of how a case is conducted, the funder’s review can work as a de facto second opinion on the merits of a case and its strategic management.
Recovery of TPF costs
An added advantage of TPF in arbitration is that unlike with court proceedings, it was confirmed in England in 2016 that it is possible to recover TPF costs in arbitration. The case was Essar Oilfield Services Ltdv Norscot Rig Management Pvt Ltd and concerned a dispute relating to operations on an offshore drilling platform. It resulted in Norscot being awarded damages in an ICC arbitration of USD12m plus costs on an indemnity basis – including TPF costs of GBP1.941m.
TPF of GBP647,000 had been provided on the basis that Norscot would repay the funder 300% of the level of funding provided – considered a standard funding arrangement in the market.
The TPF costs were held to be recoverable by reference to s.59(1)(c) of the Arbitration Act 1996, as well as article 31(1) of the ICC Rules which deal with the recovery of costs by a successful party. S.59(1)(c) includes the phrase, “legal and other costs”, the meaning of which was interpreted to be sufficiently wide to include the recovery of TPF costs (i.e. as in “other costs”).
Similar wording can be found in the rules of many international arbitral institutes. For example, in Singapore, SIAC’s Rule 37 provides that “The Tribunal shall have the authority to order in its Award that all or part of the legal or other costs of a party be paid by another party.”
It remains to be seen whether the courts in Singapore or Hong Kong will follow the English courts’ lead, but it is clearly open to them to do so and in addition to using TPF, this should act as yet another incentive for parties to choose arbitration over court proceedings.
Similarly, while ATE insurance premium paid to cover the risk of an adverse costs order has not been recoverable in court proceedings since 2013 , it can be recovered from the losing side in arbitration (subject to issues of reasonableness and proportionality).
Third-party funders are generally prohibited from asserting any control or influence over any case that they are funding but in practice, there may be some loss of autonomy. This is primarily in the context of settlement discussions in that funders will usually retain a right of approval in relation to any potential settlement and there may be some disagreement as to whether a case should be settled.
In order to obtain funding, it is necessary to prepare a case so that it can be reviewed by a potential third-party funder. This can be expensive, and the related costs may be wasted if funding is not then provided. Also, even if funding is obtained, the pre-funding preparation costs are usually not covered by the funder and depending on when they are incurred, may not be recoverable in damages if the case is won.
Security for costs
While there may be a strategic advantage in disclosing the existence of TPF in that by doing so an opponent may be encouraged to settle, it is equally possible that such notice may simply trigger a request for security for costs on the basis that the funded party cannot pay its own legal fees.
In court proceedings, it is possible for a funder to be ordered to pay costs equivalent to the amount of funding that it provided. However, in arbitration, a tribunal will not normally be able to make an award of costs against a third-party funder as funders are not a party to the arbitration agreement. Therefore, the question of who will pay costs if the case is lost can result in a request for security.
However, in practice, an application for security is assessed without reference solely to the fact that TPF has been provided as there are various potential reasons why TPF is obtained - the fact that the funded party may be struggling financially is only one of them. The terms of the TPF agreement (specifically, whether the funder has agreed to provide security and whether ATE insurance cover for adverse costs has been obtained) will be just one of several other factors taken into consideration when a tribunal assesses a request for security.
Reduction in value of asset – TPF is expensive
TPF is relatively expensive and so is not suitable for all cases. In return for funding a claim, a third-party funder typically takes a 20% to 40% share of the damages awarded or a multiple of the funding provided. These costs are not recoverable in court proceedings. And even though they may be recoverable in international arbitration where tribunals have a greater discretion in assessing costs, it is inevitably a matter for the tribunal’s discretion and so cannot be guaranteed.
Other Potential Issues
Confidentiality & privilege: In order to obtain TPF, potentially sensitive information may need to be provided to the potential third-party funder. It is therefore important to ensure that the other side is not then able to obtain disclosure on the basis that privilege has been waived. The applicable laws and rules governing issues of confidentiality and privilege will differ depending on the seat of the arbitration. In common law jurisdictions, it is possible to retain privilege on the basis of litigation privilege (lawyer’s communications where the dominant purpose is the conduct of litigation) and/or common interest privilege. However, in all cases, it is important that a confidentiality or non-disclosure agreement is first put in place with the funder.
Conflicts of interest: TPF arrangements may lead to undisclosed conflicts (perceived or actual) if there is a pre-existing relationship between the third-party funder and lawyers or between the funder and an arbitrator(s). Therefore, even if the applicable laws/rules do not require disclosure of the existence of TPF, it may be something to consider so that any potential challenges to the proceedings or resulting award can be avoided.
Factors considered when TPF is sought
Generally, funding is only provided in cases where damages are sought i.e. it is only available to claimants, or defendants with a counterclaim.
As any dispute can represent a high-risk investment, normally an investment to quantum ratio will apply which will mean that only claims in excess of about USD10m will qualify for funding – although, funders are now beginning to look at ways in which groups of lower value claims may be funded on a combined investment basis.
A funder will review the merits of a claim for itself and is unlikely to provide funding if it does not consider the prospects of success to be good.
Similarly, a funder will need to know the state of the other side’s financial position: are they financially stable or is payment of an award and costs likely to be an issue; where are the opponent’s assets located – is it a difficult jurisdiction, will enforcement be an issue; and is TPF permitted under the law of the intended enforcement jurisdiction – is a challenge based on public policy likely to be an issue?
TPF in Singapore and Hong Kong
TPF legislation was enacted in Singapore in March 2017 and mirrors the position in London, Paris, Geneva. It is also similar to legislation that has been enacted in Hong Kong which comes into effect on 1 February 2019 .
It permits TPF in arbitration as well as in proceedings in court if they arise out of arbitration (e.g. enforcement proceedings) and mediation .
In this regard, a funder is any party which provides funding ‘in return for a share or other interest in the proceeds or potential proceeds of the proceedings’ – a funder must also maintain a paid-up share capital of not less than S$5m or hold the equivalent value in assets in Singapore. These rules exclude funding for respondents (unless counter-claiming) and non-commercial funders or those based outside Singapore.
With respect to Hong Kong, the government has published a Code of Practice for TPF on 10 December 2018. It applies to any TPF arrangement made on or after 7 December 2018. The Code deals with capital adequacy requirements, conflicts of interest, access to independent legal advice by the funded party, control of the proceedings, confidentiality and liability for adverse costs (including security for costs).
As with England & Wales, TPF is not regulated in HK and so non-compliance with the Code will not expose a party to proceedings. However, the Code is admissible as evidence before a Hong Kong seated tribunal or Hong Kong court, which can take into account failure to comply with any provision of the Code if relevant to a question in the proceedings (e.g. where an issue as to the funder’s conduct arises).
As regards the recovery of TPF costs, rather than leave any doubt relating to the interpretation of what the recovery of “other costs” might mean, the Hong Kong International Arbitration Centre has made clear in its new rules (2018) that an “arbitral tribunal may take into account any third party funding arrangement in determining all or part of the costs of the arbitration”.
TPF in Japan
As yet, there is no active market for TPF in Japan. However, most Japanese corporates engaged in cross-border transactions tend to choose Singapore as their preferred seat for international arbitration. Hong Kong is also sometimes used when transacting with Chinese parties. As such, with the recent developments in TPF in Singapore and Hong Kong, not only is TPF now available to Japanese parties that wish to bring an arbitration claim in Singapore or Hong Kong (or indeed London etc), but it is likely they will in any event soon develop a greater awareness of the advantages of TPF and start using it as a tool to help manage risk within their businesses.
As regards the legal framework for TPF in Japan, there exists a degree of uncertainty. TPF is not expressly prohibited, but a lack of clarity exists in relation to: (i) the assignment of claims – which may be treated as the creation of a trust and therefore prohibited; and (ii) the requirement that only attorneys are permitted to provide legal services or act as an intermediary in legal proceedings. However, in practice, neither scenario is likely to prove an issue – TPF cases are normally not assigned and funders normally do not seek to control the conduct of a claim.
Moreover, the relevant Japanese legislation does not have any extraterritorial effect and so any uncertainty surrounding the legality of TPF in Japan will not impact access to TPF for claims commenced overseas in places such as Singapore and Hong Kong. Bearing in mind that as highlighted, the vast majority of cross-border disputes involving Japanese parties are resolved outside of Japan (and increasingly so in Singapore), the availability of TPF in Singapore and Hong Kong presents another valuable risk management tool for Japanese corporate counsel to consider.
While TPF may traditionally only have been considered in cases where a party with a strong claim had insufficient funds to pursue legal proceedings through to a conclusion against a better resourced opponent, TPF is now being used as a strategic risk management tool, providing businesses with options as to how best to use their capital. Moreover, it is a facility which is open to Japanese corporates involved in international arbitration. This is because:
1.TPF removes budgetary and cash flow concerns and provides certainty to the business in terms of planning.
2.TPF provides a low risk opportunity to pursue expensive legal proceedings where outcomes cannot be guaranteed.
3.TPF turns a claim into an asset and allows for capital to be deployed else wherein the business.
4.As a matter of strategy, disclosing the fact that a claim has TPF may encourage a difficult opponent to reconsider its position and accelerate settlement – TPF exposes an opponent to the risk of higher costs plus it is a sign that an independent third-party thinks the claim has merit.
5.The costs of TPF may be recovered from an opponent in arbitration (but not court) proceedings if the claim is successful.
6.TPF is becoming ever more popular and with recent legislative changes in Singapore and HK, it is now even more accessible for Japanese parties when arbitrating cross-border disputes.