Recovery of third-party funding in international arbitration

Dr Wolfgang Kuhn
Heuking Kühn Lüer Wojtek, Düsseldorf
w.kuehn@heuking.de ¹

In my capacity as chairman of the 'Committee on Arbitration' of the International Bar Association, I called the first 'International Arbitration Day' on 25 September 1997 in New York. The event was strongly promoted and supported by my vice-chairman at the time, David Rivkin from Debevoise & Plimpton, New York, who got the support of William K. Slate II, President of the American Arbitration Association. At the event Bill Slate gave a welcome speech and made sure that about hundred US-lawyers, mostly from New York, attended and made this first IBA 'International Arbitration Day' an overwhelming success.

The international arbitration faculty was presented by its most well-known speakers, such as Marc Blessing, Jan Paulsson and Bernardo Cremades. The program covered arbitration issues, such as Arbitrability, Interim Relief, Hearing Management, Confidentiality, Enforcement, Mediation and (last but not least) Costs.

The determination and allocation of cost in international arbitration was a hot topic at the time and remains so to this day. In dispute in particular is whether laws and rules should be amended to prohibit the recoverability of third party success-contingent premiums or fees.

Background

Third party funding (TPF) refers to the funding of the costs of either bringing or defending a claim by an outside party not included in the proceedings. It is a contingency arrangement in which the funded party’s repayment of the funded amounts depends on its success in the proceedings. If the funded party is successful, that party has generally agreed to pay the third party funder a lump sum amount or a percentage share of amounts awarded, a so-called premium or success fee. This can easily be double or triple the amount actually contributed by the third party funder. However, TPF is typically provided on a non-recourse basis; if the claim is unsuccessful, the claimant is not liable to pay back the funder’s investment.

Another issue to be scrutinised separately is the issue that a claimant is not protected against the risk that a claimant will be ordered to pay an opposing party’s cost by an arbitral tribunal (again carrying along risk and cost of third party financing by the opposing party).
The last few years have shown an increase in TPF arrangements within international commercial arbitration. Forced to reckon with this new reality, states, bodies and arbitral institutions have begun to directly address TPF within their laws, directives and rules. The current lack of consensus as to the treatment of TPF has created an added element of uncertainty within international arbitration practice and proceedings.²

This uncertainty was heightened by the 2016 Essar v. Nassar decision by the High Court of England and Wales, which upheld an arbitrator’s decision to award full recovery of a successful party’s TPF arrangement, including the premium or success fee.³  Analytically, there is and there should remain a distinction between the funds actually advanced by a third party funder and a premium or success fee contingent on the outcome of a proceeding. The key issue is whether the arbitrator has a clear legal basis upon which to grant recovery of this premium or success fee.

The recoverability of the success fees or premiums payable under a third party funding agreement as costs in arbitration can be criticized on three fundamental and overlapping bases. First, the distinction between funds actually advanced by the third party funder and a premium is crucial. Secondly, the arbitrator’s discretion is defined and limited by law and should focus primarily on the allocation of costs rather than the definition of the recoverable costs. Finally, an award for the full recovery of third party funding fees should only be made on a clearly defined legal basis. 

The discretion bestowed upon an arbitrator to award fees relates principally to the allocation of costs between the parties and not on defining what is or is not a cost. This is instead the province of legal regulations and arbitral rules. And it is only upon such a regulation or rule that recovery of TPF premiums or success fees should be awarded. This was not the case in Essar. It has yet to be seen whether Essar will remain an outlier in international commercial arbitration as it should. However, without rules or consensus as to the construal of TPF and recovery, a risk remains that such fees will be awarded in future instances.

Essar v. Nassar and its implications

In September 2016, the English Commercial Court affirmed the discretion of an arbitrator to award full recovery of a party’s TPF arrangement as a function of the successful party’s costs. The TPF arrangement in the underlying arbitration required payment of a premium in the event of success equal to three times the GBP 647,000 amount advanced by the funder or 35 per cent of damages, whichever was greater.⁴  This contingency premium or success fee amounted to over GBP 1.94 million.⁵ The arbitrator found that he was able to award the TPF premium or success fee as ‘other costs’ under the applicable arbitration act which referred to ‘legal or other such costs’.⁶ The reviewing judge in Essar agreed, writing ‘I unhesitatingly conclude that the arbitrator’s interpretation of ‘other costs’ was correct, in that it extended in principle to the costs of obtaining third party legal funding. Whether then to award it is a matter of discretion’.  And yet, an important distinction was not made, the distinction between the costs proffered by the third party funder for the arbitration proceedings and the payment of a premium required in the event of success in those proceedings. The characterization and difference between the two was not seen to be relevant but is of crucial importance.

Premiums or success fees are of a different nature than funds actually furnished for an arbitration and therefore should not be considered recoverable costs. Article 37(1) of the 2012 ICC Rules (which was in 2018 identical to Article 38(1) of the 2017 Rules)) defines costs as ‘the reasonable legal and other costs incurred by the parties for the arbitration’⁸  Pointedly, premiums or success fees are not incurred for the arbitration, ie in order to bring or defend a claim, but instead are incurred as a result of success in the arbitration proceedings. Unlike a loan upon which interest is incurred and must be paid regardless of the outcome, a premium or success fee is contingent on the outcome of the arbitration proceedings.

The award of costs by an arbitrator is not unconstrained. An arbitrator’s discretion must be exercised within the limits of the applicable law. Thus, there must exist a legal basis upon which to award the costs in question. There are two separate but interconnected inquiries: the fixing of costs and decision as to how to allocate those costs. This dichotomy is illustrated, for example, in the 2018 DIS Arbitration Rules, wherein Article 32 defines what is included as ‘costs of the arbitration’ and Article 33 imbues the arbitrator with the ability to exercise discretion as to how those costs are to be allocated between the parties. According to ICC Rules, what comprises a cost to be fixed depends on the definition of ‘legal and other costs’ and must be ‘reasonable’. So, while an arbitrator may have broad discretion, this discretion relates to the allocation of costs.

Accounting for the conduct of the parties during the arbitration is a matter to be considered in the allocation of costs, not what comprises a cost. One must also be careful not to justify the award of TPF contingency fees as a matter of justice, such as the egregious behaviour of a party, which was an issue in Essar. If it is the case that a party’s conduct caused another party to enter into a TPF arrangement and incur losses as a result, that is a question of compensatory damages and not a question of costs. Where it can be argued that the funding was a result of the losing party’s breach and would not have been incurred but for that breach, then, as commentator Jonas Von Goeler explained, ‘this would constitute a claim for substantive damages flowing from breach of contract, not a reimbursement of procedural cost’.⁹  Unless the parties have agreed to settle their dispute ex aequo et bono wherein an arbitrator is expressly given the power to apply principles of fairness notwithstanding the applicable laws and rules, an arbitral award is bound by said laws and rules and arbitrators are thus re-strained from exceeding the limits of their discretion.¹⁰

There are also important policy concerns related to the shifting of contractual risks that must be considered in any discussion of full TPF funding recovery. Commercial arbitration is a consensual agreement at its core. Parties consent to submit their disputes to arbitration. With this comes an implicit consent to the ability and discretion of the arbitrator to allocate costs according to applicable laws and rules. It is a stretch to say that this implicit consent regarding the allocation of costs extends to an assumption of the risk that a party may be made to pay the funding costs of its opposition and be made responsible for a business arrangement that is solely the province of the opposition party and that party’s outside funder. A party undertakes a third party funding arrangement at its own risk as a contract between itself and its funder. If this funding arrangement were to be made fully recoverable as a cost of the arbitration proceedings, then the arrangement would become a risk-free undertaking for the funded party while transferring the risk of additional cost liability onto the other party without the other party’s consent and without that party having bargained for any benefit. This flies in the face of practical and long-held contractual principles.

The Essar decision failed to appreciate the legal and policy implications that speak against full recovery of TPF arrangements. As illustrated above, unless specifically based in the law, such recovery should not be permitted. 

Developments in TPF and looking forward

Since Essar, TPF became a reality in international commercial arbitration and jurisdictions are beginning to directly address its existence and states have mixed responses regarding the involvement of TPF in arbitration. This started with developments in two of Asia’s arbitration hubs, Singapore and Hong Kong, which have expanded the scope and position of TPF in international commercial arbitration practice. 

In March 2017, Singapore reformed its Civil Law Act to allow for TPF in international arbitration subject to certain criteria. Not long after in June 2017, Hong Kong passed an amendment ordinance to its Arbitration and Mediation Legislation allowing for TPF in arbitration proceedings seated in Hong Kong. These are no small developments. A 2015 survey conducted by Queen Mary University of London, found that Hong Kong and Singapore are the third and fourth most preferred venues for international arbitration, respectively.¹¹ 

Despite both laws allowing TPF arrangements, the two differ in definition of an allowable third party funder. Singapore’s law restricts the meaning to essentially include only commercial funders while Hong Kong allows a broader definition, which can include not only professional funders but any party without a personal interest in the arbitration proceeding. 

In contrast thereto the Canada–European Union Comprehensive Economic and Trade Agreement (CETA) and the Canada–Chile Free Trade Agreement (CCFTA) (only) require disclosure of the identity and address of the funder.¹²  Canada’s national position with respect to TPF is more complex depending on the applicable civil or common law background of its procedural laws.¹³  On the other hand, considering the risk associated with external funding, the Argentina-United Arab Emirates Agreement for the Reciprocal Promotion and Protection of Investments 2018 prohibits TPF from its dispute settlement process.¹⁴ 

Recent commentators add an important new aspect to the debate whether TPF is acceptable: ‘the consideration of TPF in the order of security for costs justifies the funding fee as an arbitration cost’.¹⁵  MD Khairul Islam (2024) properly points out on page 263 of his article that the ICSID Arbitration Rules 2022 provide a wide definition of TPF and merely require disclosure of the involvement of any external funding in arbitration.¹⁶  However, his view that ‘the Funding fee as an arbitration cost may cause an unjust financial loss to a state party’ is unconvincing, as the state party in investor state arbitration in general is the financially stronger party in the dispute.

Therefore, these developments will no doubt increase the prevalence of TPF arrangements in international jurisdictions and allow claims previously unable to be brought to be funded and pursued in particular with respect to investor state arbitrations. 
That said, it could also be the case that with respect to normal commercial disputes some parties will avoid the selection of certain seats for arbitration such as Singapore or Hong Kong in an arbitration clause so as to avoid the uncertainties and risks currently associated with TPF arrangements in arbitration.

Conclusion

As Hong Kong, Singapore and other jurisdictions such as Australia or Ireland hedge their bets on the growth of TPF, it should necessarily and naturally follow that rules and laws adjust to ensure that TPF does not pervert arbitral practice. To preserve important legal and policy considerations, laws and rules should address TPF directly, including whether TPF premiums or success fees are recoverable. Any such regulation should address both recoverability of the amounts provided by a third party funder for the arbitration proceedings and exclude any premium or success fee from recovery.

In the meantime, commercial parties may consider including more detailed contractual provisions to avoid any unforeseen or undesired liability for the costs of third party funding.

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1  This article is based on the publication ‘The Full Recovery of Third-party Funding Costs in Arbitration: To Be or Not to Be?’ by Dr Wolfgang Kühn and Hanneke van Oeveren in Journal of International Arbitration, Wolters Kluwer of June 2018 and the support of Ulrike Gantenberg, Düsseldorf for a similar publication in 2018.
2  See recent commentators dated 6 March 2024, ‘What is Third Party Funding? How Is It Used in International Arbitration?’ by Hughes Hubbard & Reed (John M Townsend and colleagues – In Dispute Client Advisories) and MD Khairul Islam, ‘The impacts of third-party funding on cost decisions in investment arbitration’, Asia Pacific Law Review, 32(1), 259-278 (2024).
3  Essar Oilfields Services Ltd. v Norscot Management PVT Ltd. [2016] EWHC 2361 (Comm), hereinafter ‘Essar’.
4  Ibid.
5  Ibid.
6  Ibid.
7  Ibid.
8  Article 38(1) ICC Rules (2017), emphasis added.
9  Jonas Von Goeler, ‘Third Party Funding in Arbitration and its Impact on Procedure’, at 369 (2016).
10  Max Planck Encyclopedia of Public International Law (2009), ‘[t]he ancient concept of ex aequo et bono is based upon the idea of ‘fundamental fairness’ as a guideline principle in arbitration and other dispute settlement processes. Provided that the parties expressly agree, it enables judges and arbitrators to decide a case according to what—in literal translation of the original Latin phrase—‘is fair (or equitable) and good’ (Fair and Equitable Treatment ). That is also to say ‘in good conscience’ and notwithstanding the written law’.
11  2015 International Arbitration Survey: Improvements and Innovations in International Arbitration.
12  Article 8.26, Canada–European Union Comprehensive Economic and Trade Agreement (CETA) and Article G-23, Canada–Chile Free Trade Agreement (CCFTA).
13  See MD Khairul Islam, supra n. 2.
14  See Article 24, Argentina-United Arab Emirates Agreement for the Reciprocal Promotion and Protection of Investments (signed on 16 April 2018); see MD Khairul Islam, supra n. 2.
15  See MD Khairul Islam, supra n. 2, at 263.
16  Rule 14, ICSID Arbitration Rules (2022).