Third party funding in investment arbitration: The india story Deb Aratrika1 1Faculty Associate, KIIT School of law Abstract One of the most highlighted events in recent times that gained prominence in both commercial as well as investor state arbitration is Third Party Funding (TPF). TPF is nothing but the provision of funds by companies made available to both the claimant and the respondent in the arbitration and the third partyfunder is of a character that has no connection to the underlying dispute resolution. He is, in simple words, a natural or legal person, who though not a party to the arbitration himself, enters with an agreement with one of the parties to finance the entire costs of the proceedings in return for a share of the spoils, which is usually a percentage ofproceeds of a successful arbitration. While those in support of TPF state that it broadens the access to justice because in investment arbitration especially, the respondent being the host state, the claimant investor is often not in a position to provide himself with the huge amount offinance including the cost ofproceedings as well as arbitrator fees; those not favoring TPF on the other hand often argue that it increases the frivolity of claims of investors especially and poses a risk to a conflict of interest. TPF is a phenomenon that is commercially gaining popularity in all the major jurisdictions of the world. Even developing countries while signing their BITs prefer a clause where they can have access to third party funding in the event of any arbitration taking place. However, India as a country has not incorporated TPF as part of its new Model BIT. In the light of that, this paper will explore the scope of TPF in the existing law and the erstwhile Arbitration and Conciliation Act, 1996. TPF however has been a subject matter of controversies from various angle; primarily questions have been raised regarding the impact that TPF might have on the independence of arbitrators and jurisdiction of the tribunal While disclosure of TPF will increase transparency in the entire dispute resolution process, such disclosure will raise a doubt in the opposite party’s mind that the claimant or the respondent whosoever is accessing third party funding, will not have financial capacity to pay if the award goes against them. TPF is generally accepted by a claimant investor who invokes arbitration primarily because his investment or assets have been expropriated by the host state. This paper will explore the various instances where third party funding becomes an easy way for access to justice. It will also point out the impact that it has on the arbitral proceedings, independence of arbitrators and finally, the enforcement of the award. TPF also has certain drawbacks that might defeat its entire purpose and thereby not prove to be beneficial to the funded party. The above issues are to be discussed in details in this paper with reference to recent judgements that highlight certain major concerns in this regard. Top Keywords Third party funding, Investment arbitration, Investors, Tribunal, Resolution. Top |
Introduction A relatively recent phenomenon that has become one of the ‘hot topics’ in international investment arbitration is the mechanism of Third Party Funding (TPF). Although this form of external financing has been prevalent in litigation in several jurisdictions, however its presence in the field of international arbitration has been contemporary with only a few years of history and it is evolving into a very popular and thriving practice by attracting the attention of the international legal community. Due to the globalization of international commerce which led to the unprecedented growth of international investment and commercial disputes over the last few decades, investor state arbitration as a phenomenon grew inevitably and as a result, the practice of TPF found a place in the collective consciousness of the global industry participants. |
As commonly referred to in the industry jargon as the ‘funded party’, these include parties with financial difficulties to prosecute their meritorious claims who use TPF as a possibility to finance their disputes and in return provide the funder a certain percentage of compensation, provided, the end result of such an arbitral dispute is in their favour. Thus, to summarize, we can say that the third party funder is a person or an institution who invests his capital in a claim which he deems to be or has a possibility of obtaining a successful arbitral award with a motive of earning profit and has to substantial interest other than one of a pure pecuniary nature with the issues of the dispute as well as the parties. However, the mechanism of third party funding acts as a support system to the distressed claimants and defendants and boosts the overall growth of the arbitration regime.2 |
Though it is undeniable that the mechanism of TPF has become widely popular due to its clear advantages, it cannot be said that this structure is devoid of its shortcomings and problematic issues. The main objection often raised against third party funders is that there is virtually no uniform regulation that can govern this type of financing and such funding is adhered to mainly by virtue of private agreements entered into between the funded party and the third party funder, thereby, there is no mandatory disclosure obligations with regard to the same at the time of proceeding. On the other hand, TPF is gaining popularity mainly because it increases access to justice for impecunious claims which would otherwise be not addressed for lack of finance.3 |
Top Definition of Third Party Funding In spite of being a thriving practice that has been constantly evolving in the international arbitration regime, the understanding of TPF is still very opaque and hazy to us. In the words of Scherer, “the exact definition of third party funding, however, remains elusive and its legal and ethical implications in international arbitration, mostly unexplored”.4 It is noteworthy that there is still no common consensus as to what constitutes TPF or regarding its definition. While some classify it as commercial contracts entered between two private parties, others have called it insurance contracts, the third party funder being the insurer of the funded party, financing his claim. According to Cremades, "the reason why it is so difficult to reach a firm definition for litigation or arbitration funding derives from the many forms in which it manifests itself."5 |
The International Business Law Journal organized two roundtable discussions on TPF6. However, the participants of the same failed to reach a consensus regarding the definition of TPF. Thus we can say that, in the absence of any straight forward answer to defining TPF, many definitions are still being created by experts and scholars in this area, adapted from recent precedents and the entire framework is becoming clearer with every passing day. In order to understand the definition more clearly, we need to look at the forms in which TPF is available to the parties - both in the strict as well as broad sense. |
TPF sensu stricto When we try to understand third party funding in the strict sense, it is deemed to mean and include a financial arrangement between the client (claimant in an arbitral proceeding) and an institutional corporation, more precisely, the third party funder whereby the later agrees to cover the former’s legal costs and other expenses associated with the legal claim and in return for that, gets a substantial portion of the proceeds derived from a successful arbitral award. The TPF in this regard is said to have only an interest of a pecuniary nature and has no close connection with either the dispute or the parties. Hedge Funds, financial institutions and other institutional funders mainly constitute the market participants of TPF and their sole business is to invest their capital in a claim that they deem to be meritorious and has a strong possibility of resulting into a successful arbitral award.7 TPF sensu lato TPF in the broader sense is not just limited to financial arrangements or agreements stated above, but it also extends to any kind of financial solution that is offered to a client regarding the funding of the arbitral proceedings in a given matter. Attorney financing, legal expenses insurance, loans, assignment of a claim, and donations are the different types of financial solutions often rendered to a client by a TPF. Top Scope of Third-Party Funding In India Although TPF in investment arbitration has emerged as a global practice, its scope in India has not yet been explored. In a developing country like India, where not every organization is financially armed to battle its own dispute, it becomes difficult for a party with a potentially meritorious claim to arrange for financing of its dispute due to the high costs. In a scenario like this, any third party financing is of extreme help to a financially weak claimant to back up his claim. |
Top Under what circumstances do we need TPF in India? Excessive Costs The credibility of arbitral awards in India have been profusely affected by the unrealistic costs associated with it. It may often happen that a party who is in a financially disadvantageous position may not be too keen to express his reservation regarding payment of high costs of the arbitrator and that in itself will cause prejudice in favour of the other party who readily agreed to pay the fees.8 Under Sec 11(14) of the Arbitration and Conciliation Act, 1996 as amended by Arbitration and Conciliation (Amendment) Act, 2015, the High Court of each state is empowered to fix capitation fees of the arbitrator by considering the rates specified in Fourth Schedule.9 However, the same is limited in application to domestic arbitrations and not international commercial or investment arbitration for that matter. Assessing the potential of a dispute It is often argued by the opponents of TPF that it encourages parties to initiate frivolous unwarranted claims which otherwise would not have been raised. Thus, more than increasing the access to justice, it creases unnecessary burden on the tribunals. In the India, the 1996 Act states that the Tribunal has power to impose penalty if the instituted claim is found to be frivolous.10 But again, the application of this part of the Code is limited to domestic arbitrations seated India and thus has little relevance in terms of our discussion. It is however, pertinent to note that, the third party funder is a professional having the skills to judge the viability of a claim before he invests his money in a certain dispute. Thus, he conducts a proper due diligence, takes into consideration factors such jurisdiction and the extent to which the State encourages arbitration in its jurisdiction and thus improves the overall the bargaining position of the party.11 Recent Trend of funding developing countries in investment arbitration Investment arbitration in India is mainly governed by bilateral and multilateral investment treaties that India signs with other nations. India is not a party to ICSID Convention, nor does the Mumbai Centre for International Arbitration (MCIA) Rules talk about TPF specifically. TPF has not been barred in India otherwise, or given any recognition. In the middle of such ambiguity, a funder will not be able to assess if TPF is at all recognised in India, or if he chooses to fund a dispute seated in India or finance the Indian government in its counter claims, what would be the correct implications of it. While the world is debating on the scope of obligations to disclose TPF Agreements, we are far behind in even knowing it, let alone acknowledging it. In order for TPF to have a distinct scope in India, it is thus essential for MCIA to come up with clear institutional rules that provide basic guidelines for TPF. Many investors have resorted to invoking claims against India under the BITs that they may have concluded with India. A French telecom company brought an arbitral claim against the Indian government owing to hindered operation at a port in India.12 The most notable of these cases is the White Industries Case, which has been previously mentioned by the author; where India was directed to pay an award of 4 million.13 In a situation like that, India is at a very volatile position due to the signing of several of these BITs and multilateral investment treaties. Legalizing TPF will give an opportunity to the Indian government to receive financial assistance in the form of grants, aids and donations while initiating counter claims without any expectation of recovery. Possible scope in the existing law While it is undeniable that TPF is not legally recognised in India under the Arbitration and Conciliation Act, 1996, it can be argued by virtue of some provisions that the existing law already provides enough scope for TPF to flourish as a practice. Sec 12 of the Act puts a mandate upon the arbitrator to disclose any information that might hinder the impartiality and independence of the arbitrators.14 Thus if an arbitrator has any economic interest in the outcome of the dispute, his independence will be said to be compromised. In order to serve more clarity on the matter, the Fifth and Seventh Schedules lays down examples of certain relationships between the arbitrator, counsel and parties that might hinder the transparency of the entire process by doing away with the criteria for impartiality. The Supreme Court of India recognised the Porter and Magill Test as a reasonable assessment to cognize whether the fair- minded and informed observer, having considered the facts, would conclude that there was a real possibility that the tribunal was biased.“15 This provision was primarily inserted so that no element of bias can exist in the arbitral process and no party can exercise any form of relative advantage over the other. Thus, even though there has been no mention of any provisions mandating disclosure of third party funding agreements in the Act or the institutional rules, this disclosure can be extended to that of third party agreements if any, signed between the party and the funder. Since this Act, essentially governs domestic and international commercial arbitration, it is suggested by the author that the same principles could be adopted in investment arbitration, especially in the dispute resolution clauses of BITs and other treaties. Thus a regulatory system needs to develop identifying conditions of mandatory disclosure that will help preventing conflicts of interest between the parties, funders and arbitrators.16 Additionally, Sections 917 and 1718 entitles a right to a party to secure their costs as an interim measure at the time of the proceedings, in accordance with section 31A(1)19 of the Code. However, in the absence of any express provision for security of costs for third-party funders in India, the existing statute is insufficient to compel a third party funder to pay security for costs. The Indian legislature is silent and as a consequence of that, no express provisions related to third party funding has found a stable place in the existing legal regime. Disclosure norms and security for costs have been accorded some protection under the erstwhile Arbitration and Conciliation Act, 1996 but due to its inapplicability to investment arbitrations primarily governed by BITs, and an inadequate regulatory mechanism, parties in various situations are exploited by funders while TPF is carried on illegally and silently. It is high time that the arbitration community at large, both at the domestic as well as international level, witnesses legalized corporate funding in the country and such a contentious issue like TPF is raised. India must acknowledge the exponential growth in TPF such that it rightly takes advantage of its benefits while regulating the same to mitigate the associated risks. The legislature’s obliviousness to recognizing contemporary laws must not become an impediment to its own vision of transforming India into a pivotal seat of arbitration.20 Top The Way Forward Considering the newness of the TPF industry, it is obvious that there is absence of adequate regulation and there has not been an overriding appetite by the market and others for regulation. Slowly major jurisdictions of the world, like USA, UK, Australia etc. are coming up with regulations for solving issues arising from it both at the national and international level. Since the major players in the regulation of TPF are arbitral institutions and they possess the expertise of drafting model arbitral rules, the author would like to suggest that it will be fit for them to play a role in maintaining the integrity of the TPF industry in terms of suggesting to them the code of conduct that is to be followed by the market players including funders and funded party, the requisite disclosure obligations and the general corporate governance norms that the industry must abide by in order to maintain a transparent and honest practice. Although the third party funder is in most cases not a party to an arbitration agreement unless explicitly admitted to the proceeding by the tribunal, the latter in exercise of its ordinary jurisdiction does not have a standing or can pass orders in respect to the third party. This lacunae can often be misused by the funders to their advantage and absolutely unregulated behavior exposes the entire industry to risks of fraud and misfeasance. Therefore, it is even more essential to check their behavior in order to ensure that proper practice is maintained.21 |
The regulation is mainly with an aim to check excessive fees, entering clauses in the funding agreement where the funder has a right to walk away in case of an unfavorable award, exercising too much control on the selection of arbitrators for the proceeding thereby deteriorating the impartiality and independence, unreasonable exploitation of attorney-client privilege etc. However it has to be kept in mind overzealous regulation could hamper the effectiveness and virtues of the industry and curtail the access to arbitration for financially challenged parties with meritorious claims.22 |
The question that often arises is: Whether TPF should be regulated by hard or soft law? Association of Litigation Funders of England and Wales took the first step towards developing a regulation for TPF when they came up with the Code of Conduct for Litigation Funders23; however it is a non binding regulation which is not applicable for the international arbitration funders. The reason behind discussing this code in this paper is primarily because it is one of the first phases in a long process of regulatory developments and since there is no similar code developed for arbitration practice as such except for recent legislations in 2017 passed in Singapore and Hong Kong, working under this Code can prove to be a learning experience for the arbitration community at large and for third party funders as well. Apart from that, there is a possibility that this Code might be made applicable for funders working in the arbitration industry as well.24 |
The third party funder should undertake corporate governance at two levels: Firstly, it should self regulate and perform internal governance and compliance steps on its own in order to prevent any illicit conduct on its part. Secondly, it also should ensure that the funded client has taken adequate precautions to avoid anything illegal. Apart from that, governance also requires disclosure obligations on the part of the funder in order to maintain transparency. But the author has already discussed the same in the previous sections and arbitral rules and other institutional organizations have addressed the same, as earlier mentioned.25 |
The Code of Conduct for Litigation Funders, somewhat attempts to bring application of corporate governance principles to third party financing litigation. The author would like to suggest that the same should be made applicable in the case of funders in investment arbitration as well; more so because unlike in litigation the judiciary oversees the conduct of lawyers and funders and acts as their watchdog, no such mechanism is available in international arbitration. |
This Code however in Clause 2.4 while explaining the role of funder within the scope of a Litigation Funding Agreement (LFA) explicitly states that a funder will meet the potential costs of resolving disputes by arbitration or any other forms of dispute resolution apart from litigation.26 This creates a confusion regarding the applicability of the Code as to whether it is implied that this Code can be used in arbitration proceedings. Irrespective of such existing ambiguity, and even in the absence of such application, it is no less relevant for our purpose of study. The Code incorporates ten principles that regulate different stages of a funding agreement. The most viable of them, being due diligence where it is suggested that the funded party as well as the funder should conduct due diligence exercises about each other and subject matter of dispute before entering into any kind of agreement, this is to avoid a situation where a funder does not have the opportunity to walk out of an agreement or suo moto terminate the same due to the dispute not being commercially viable at a later stage. Thus adequate disclosure requirements have to be made to prevent any ambiguity among all the players, namely, the funder, funded party, funded party’s lawyer and the arbitral tribunal. The Code also stipulates that the funder should maintain requisite financial capacity before entering into such agreement, should not exercise excessive control on the funded party so as to influence him and his lawyer at the time of a settlement or charge extremely high success fees from his client that would drain out most of the proceeds of the award. The Code mostly is structured in a manner that can afford maximum protection to the funded parties against their own funders who in most cases have huge net worth and exploit the former by using the same. At the same time, however, it suggests that the funder should be given opportunities to terminate the funding agreement if it culminates in total loss of his investment.27 |
Thus in conclusion, the author would like to state the TPF is a relatively new industry virtually in dearth of proper regulation, especially in the context of investment arbitration. It is undeniable that several efforts are being made in order to remove all existing uncertainties and ambiguities by various international arbitral institutions, it is in the opinion of the author that public participation and comments should be invited in this area before enacting any regulation because ultimately third party financing in investment arbitration is used by financially challenged claims whose rights have been abruptly breached under any investment protection treaty or BIT. It is only through active debates and discussions can we achieve maximum growth and definite answers to the questions identified in this paper by the author. |
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