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26 January 2017
High cost of funding
Recovery of costs against funders
Conflicts of interest
Confidentiality and privilege
Improper influence over proceedings
Is regulation the answer?
This update sets out the debate over third-party funding, looks at the concerns that are commonly raised and suggests how parties can best minimise risks associated with funding.
The benefits of third-party funding are well known. Funding can provide access to justice for under-resourced parties (as is often the case in investor-state disputes), enabling them to pursue proceedings which a lack of financing would otherwise have prevented. For parties that are adequately resourced, funding can offer a more convenient financing structure, allowing capital which would otherwise be spent on legal fees to be allocated to other areas of their business during the proceedings. However, despite the benefits, there are concerns about funding and there is a level of risk involved. Clear insight into the potential downsides and sufficient risk preparation are therefore essential when making a decision on funding.
Could funding give rise to an increase in unmeritorious claims? The opposite could well be more likely; funding arrangements could act as a control on unmeritorious claims. Because the return is dependent on the success of the case, funders have no desire to take on weak – let alone unmeritorious – cases. They conduct due diligence on each case, weighing the merits of the parties' respective claims and the likelihood of recovery before deciding whether to make an offer of funding. Parties may even benefit from this further analysis of the merits of their case (in addition to the analysis conducted by their legal advisers), particularly where funders have seasoned arbitrators on their review boards.
If a party is successful, most funders will expect to recoup the sum funded plus a substantial fee. This can be a percentage of the damages recovered (often 20% to 40%), a multiple of the amount advanced by the funder or a combination of the two. That said, if a party would otherwise be unable to pursue proceedings without funding, recovering 60% of the claim may be better than nothing.
Obtaining third-party funding can involve significant upfront costs. A party's legal team must:
Some or all of these costs may be wasted if an offer of funding is not made or if multiple funders have been approached. However, some funders may agree to cover these costs; a point to consider when negotiating with the funder.
In addition, parties that have obtained third-party funding are often vulnerable to a security for costs application, which – even if unsuccessful – can drive up the costs of the proceedings. The existence of funding can be a factor considered by the tribunal when making its decision on an application, although it is not the sole determining factor.
In English litigation, a third-party funder of an unsuccessful litigant may be liable to contribute towards the costs of the other side, though such contribution is limited to the amount of funding provided. In the context of arbitration, the outcome is not quite as simple. The tribunal may not have jurisdiction to make a costs award against a funder, given that it is unlikely to be a party to the arbitration agreement. Whether the tribunal has jurisdiction will depend on the procedural law and rules governing the particular arbitration. Either way, if an unsuccessful party cannot meet an adverse costs award or order, the successful party may find itself unable to recover the full amount (or any amount) from the funder. A party whose opponent is funded should therefore consider whether to make an early application for security for its costs.
Third-party funding arrangements may result in undisclosed conflicts of interest – perceived or actual. This can occur, for example, where there is a prior relationship between the funder and a party or law firm involved in the proceedings or between the funder and an arbitrator. Such conflicts can result in costly satellite disputes, including challenges to the arbitrator's appointment and applications for disclosure of funding arrangement. Parties seeking third-party funding should consider whether to disclose those arrangements and if so, how and when. Again, the applicable law and rules of the arbitration will play a determinative role.
Rules of privilege vary across jurisdictions, as do approaches to the confidentiality of arbitration. Before entering into correspondence with third-party funders, these issues must be considered under all applicable laws. Failure to do so risks having to disclose such communications – which often contain confidential or privileged material – at a later date. Parties should enter into confidentiality or non-disclosure agreements with prospective funders. They should also consider what material needs to be shared, to strike a balance between limiting risk and meeting the funder's need for adequate information, both when considering whether to make an offer for funding and throughout the proceedings.
Maintenance and champerty are historic common law rules barring third parties with no legitimate interest in the proceedings from supporting or maintaining proceedings in return for a share of the proceeds. In jurisdictions where these rules still apply, third-party funding is prohibited.
Even in jurisdictions where there is an increasingly relaxed attitude to these doctrines, there can be concerns over the influence that funders may have over proceedings. As a funder has a direct financial interest in the outcome of a dispute, there is a risk that it might seek to interfere with the conduct of the proceedings. It is easy to imagine where tensions could develop – for example, if it is in a funder's interest, it might pressure a party to agree to settlement even if this is not in the party's best interest. Another concern is that – if the terms of the funding agreement allow – a funder might withdraw funding on limited notice, leaving the party unable to continue the arbitration. To avoid these concerns, the funding agreement should ensure that the funder does not have excessive control and may not unreasonably withdraw funding.
In England (one of the largest funding markets alongside the United States, Australia and Germany) a voluntary Code of Conduct for Litigation Funders has existed since 2011 covering capital adequacy requirements for funders, as well as rights to terminate or control proceedings. The Association of Litigation Funders is the body responsible for overseeing this self-regulation. However, only seven funders are members of the association, leaving a large proportion unregulated. This poses questions over the viability of self-regulation.
The Queen Mary University of London 2015 International Arbitration Survey reported that a significant majority of respondents (71%) thought that third-party funding required regulation. This may be a reflection of the fact that a lack of mandatory regulation puts a greater burden on parties – both those seeking funding and those facing a funded opponent. A party seeking funding must undertake due diligence on its funder (eg, to ensure that it has adequate available capital to meet the cases in its portfolio) and carefully negotiate the funding agreement. A party facing a funded opponent is often obliged to incur costs protecting its position with regard to recovery of costs. These additional burdens come at a time when parties are often under significant pressures – time, financial and business.
The international arbitration third-party funding market operates adequately without mandatory regulation. But given the increase in cases that are funded, the number of new funders entering the market and the globalisation of the industry with many funders operating across multiple jurisdictions, there may be grounds for introducing external regulation. A number of jurisdictions and arbitration institutions are considering this issue. However, the concern is that different standards could be set in different jurisdictions and under different arbitral rules. It would be far preferable – for parties and the funding industry – to have minimum common standards. The question is what those would look like and how this would be achieved.
For further information on this topic please contact Matthew Kirtland at Norton Rose Fulbright LLP's Washington DC office by telephone (+1 202 662 0200) or email (email@example.com). Alternatively, contact Sherina Petit, Cara Dowling or Andrew Sheftel at Norton Rose Fulbright LLP's London office by telephone (+44 20 7283 6000) or email (firstname.lastname@example.org, email@example.com or firstname.lastname@example.org ). The Norton Rose Fulbright website can be accessed at www.nortonrosefulbright.com
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