Third-Party Funding in International Arbitration: Balancing Access to Justice and Ethical Considerations

Introduction

To begin with the concept of Arbitration being performed internationally, we first need to understand what it stands for. By agreement of the parties, a disagreement is presented to one or more arbitrators who render a legally binding decision on the matter. This process is known as arbitration. Instead of going to court, the parties choose arbitration as a private conflict settlement process.[1] It is a dispute-resolution process in which the parties select a neutral third party to resolve their claims. Usually, parties consent to arbitrate disputes to save money, time, and complexity associated with going to court. Domestic consumer and employment contracts frequently contain arbitration clauses requiring parties to submit to arbitration for the resolution of any disputes.[2]

What is International Arbitration?

International arbitration is an important and growing legal field as arbitration provisions within treaties often establish the sole method by which signatories must resolve disputes arising under the treaty.[3] Similar to domestic court litigation, international arbitration is conducted before private adjudicators known as arbitrators as opposed to a domestic court. It is a private, enforceable, consensual, neutral, binding, and private method of resolving international disputes that is usually quicker and less expensive than going via domestic legal channels. International arbitration is the primary means of settling international disputes since, in contrast to domestic court rulings, arbitration decisions are enforceable in almost every nation on earth. With the development of international arbitration, parties with disparate legal, linguistic, and cultural backgrounds can now settle their differences amicably and legally, usually without having to follow the formalities of their own legal systems’ procedural requirements.[4]

Third-Party Funding under International Arbitration

Third-party funding (TPF) – also known as litigation funding or litigation finance – is a way for a claim holder or claimant in international arbitration to finance the costs associated with pursuing that arbitration. In exchange for providing capital to cover arbitration costs, the funder will stand to receive a portion of the final arbitral award if the dispute is decided in the claimant’s favor.[5] “Any person or entity contributing funds [to the defense] of [a] 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” is referred to as a third party funder. In other words, any costs incurred by a party in disputing or defending the arbitration proceedings are borne by the party who is not a signatory to the arbitration agreement.[6]

Growing Prevalence and Significance of TPF in International Arbitration

In arbitration, third-party funding is becoming more and more prevalent. TPF has spread over the globe and grown to become a multibillion-dollar sector of the economy.[7] Some of the most commonly cited benefits of third-party funding are increased access to justice, financial management, and efficiency.[8] One of the most important benefits of third-party funding in international arbitration is that it allows for increased access to justice. International arbitration may not always follow the common perception that arbitration is more cost-effective than litigation. Due to the costs of the arbitrators’ salaries, legal expenses, expert fees, and the arbitration institution, international arbitration can frequently be exceedingly costly and burdensome for the parties. Parties’ growing reliance on third-party finance has been attributed, in part, to the rising expenses of international arbitration. The availability of third-party funding allows parties who have meritorious claims, but limited financial resources the ability to seek adjudication when they would normally not be able to afford it[9].TPF can enhance access to justice, reduce costs, and improve efficiency.[10] It can be expensive to engage in international arbitration. Particularly for complicated international commercial arbitrations and investment arbitration procedures, this is accurate. Though effective management and knowledgeable legal representation can result in significant financial savings, it is frequently a third party that provides a claimant with the resources they need to pursue their claim and, ultimately, obtain justice. As a risk-hedging strategy or as a source of outside cash, other claimants employ third-party finance. They are able to use this to put their own money into other ventures.

Before determining whether to support a certain case, third-party funders conduct a case evaluation or even thorough due diligence.[11] The reasons for opting for TPF are inter alia:

It is possible that the parties to the arbitration lack the necessary financial resources to participate in an extensive and intricate arbitration. The parties may be reluctant to use their own funds to support these drawn-out legal actions due to the uncertainty of winning or getting the compensation they are claiming, which would drain their own funds.[12].

Mechanics of Third Party Funding:-

Generally, investment banks, hedge funds, insurance companies, and pension funds, fund such arbitration proceedings. TPF in arbitration is a fairly novel concept and hence, unregulated. TPF is administered through an agreement. TPF agreements can be broadly categorized into two kinds, viz. ‘Single Case’ funding and ‘Portfolio’ funding. Whereas portfolio financing covers several claims made by a single customer, single-case funding only covers one claim or action.[13]

When is it appropriate to use a TPF agreement?

Generally speaking, a TPF agreement can be applied in the following circumstances: The claimant can no longer afford the litigation/arbitration procedure because of the extent of the defendant’s damages. The claimant wants to concentrate on operating its business rather than squandering time and money on the lawsuit/arbitration process, even if it is solvent and may be able to pay the litigation costs. The claimant is prepared to sell the claim’s rights for a lump payment in order to swiftly raise money. The claimant is bankrupt and might not have the resources to prosecute a claim.[14] Three main stages are usually involved: (1) preparing the claim and contacting possible funders; (2) signing a term sheet and taking part in a funder’s investigation; and (3) selecting to invest and agreeing on the parameters of the funding arrangement.

1. In order to obtain money from TPF, claimants need to compile information and create a thorough case analysis. A few possible donors are approached, and knowledgeable legal counsel assists in putting together the claim. Factors such as budget, recovery capacity, strength of legal claims, and losses are taken into account by funders. To safeguard legal privilege and confidentiality, a non-disclosure agreement is signed.
2. A number of funders evaluate the packed claims that claimants submit to them. Provided they are convincing, they offer a term sheet that forms the basis of negotiations for the arbitration funding arrangement. To make sure that proposed funding documents are compatible, funders perform thorough due diligence, checking information, and examining claimants, attorneys, and engagement letters.
3. After a satisfactory due diligence examination, the funder’s investment committee makes the decision to invest or not. Negotiations begin when the funder makes an offer with suggested parameters following approval. Once the conditions have been agreed upon by both parties, a binding arbitration financing agreement is signed. Effectively crafted funding agreements include all aspects of the funding structure before, during, and after the dispute, including recovering funds. The chosen method for releasing funds to the claimant’s counsel during the dispute is crucial.[15]

Legal and Regulatory Framework of Third-Party Funding in International Arbitration

TPF occurs when a third-party funding source for litigation or arbitration offers monetary assistance to help people or businesses file lawsuits or mount defenses. In most jurisdictions with a common law system, such arrangements were traditionally illegal or void, most notably on the grounds of being contrary to the legal doctrines of maintenance and champerty. However, there has been a shift away from this antiquated viewpoint in recent years, and TPF is now allowed for international arbitrations and court cases connected to international arbitrations in a number of jurisdictions.[16]

The use of outside funds in domestic legal procedures is subject to strict regulations in many jurisdictions. However, there isn’t presently a specific regulation governing its application in the context of international arbitration. The ICCA Task Force examined the topic of regulation and the feasibility of imposing international best practice recommendations on the use of third-party funding while deciding on the format of its report on third-party funding. Nonetheless, it thought it best to offer restricted assistance on a few topics in order to foster a better understanding of third-party funding and make it easier to handle the problems that third-party funding raises in international arbitration.

Arbitrations held in countries viewed as being supportive of third parties are preferred by third-party funders. Legislation has been introduced in a few jurisdictions, most notably Singapore and Hong Kong, to specifically permit third-party sponsorship of international arbitration. Essentially eliminating the common law torts of champerty and maintenance, the Civil Law Amendment Act and the Civil Law (Third-Party Funding) Regulations 2017 were passed by Singapore’s parliament. These regulations also allow third-party funding for international arbitration and related proceedings, such as enforcement and mediation proceedings.[17] Generally speaking, the pertinent jurisdiction will be the arbitration’s seat. At the moment, the US, UK, Australia, Germany, France, Singapore, Hong Kong, and the Netherlands are thought to be funder-friendly jurisdictions. Nonetheless, opinions about third-party fundraising are shifting in various legal systems.[18]

Despite the fact that international arbitration covers a wide range of claim types and overlaps with various legal systems and jurisdictions, there are enough similarities for it to be properly covered in a quick supplement to this guide. A practitioner thinking about a deal involving third-party finance for international arbitration must take into account a number of potentially pertinent nations. The law of the jurisdiction where the arbitration will take place, the law of the underlying agreements, any applicable international treaties, the law of the jurisdiction where the award will be enforced, and possibly the laws of the home jurisdictions of the parties’ attorneys are just a few examples of the factors that may need to be taken into account. Because of this, this addition is inevitably constrained and aims to emphasize some of the typical problems and strategies in the context of international arbitration and third-party finance.[19] In order to maintain accountability, openness, and moral behavior throughout the arbitration process, third-party funding must be closely monitored. The control of conflicts of interest, rigorous examination of financing agreements, comprehensive due research on funders, and frank disclosure of funding arrangements are just a few of the steps that must be taken to achieve this. Fairness and integrity are maintained in part by funding arrangements that are transparent and continuously evaluated for their impact on arbitration procedures. In order to foster professionalism among arbitrators, attorneys, and other parties involved, it is imperative that regulatory requirements and ethical standards be followed. This calls for ongoing oversight and training programs. By making these efforts, interested parties can keep a close eye on third-party funding and protect the legitimacy and effectiveness of the arbitration procedure.

Challenges and Controversies Surrounding Third-Party Funding

One issue with third-party sponsorship is the possibility of conflicts of interest. Funders could theoretically exert influence over arbitration proceedings. Such behavior could affect the funded party’s independence.[20] Because it is confidential, arbitration is appreciated. Third-party funding, however, raises more questions about the disclosure of third-party fundraising agreements and complicates the situation even further. If kept secret, it can give rise to conflicts of interest, which might mean contesting the arbitrator’s appointment or asking for payment security. For example, if the funder and the arbitrator have a past history, this kind of conflict may arise. However, there may be strategic drawbacks for the party being sponsored if the presence and specifics of the financial arrangements are revealed. It’s hard to strike a balance between these competing objectives. Disclosure of third-party funding agreements is mandated by certain arbitral institutions and countries. Nonetheless, there may be differences in the amount of information that must be disclosed, which could result in contradictions and make it difficult to ensure openness while protecting privacy.[21] The identity of the third-party funder is typically ordered to be disclosed by arbitral tribunals; but, the specifics of the funding arrangement—which are typically unrelated to arbitrator conflicts—rarely need to be disclosed.[22] The general principle that funders should be disclosed poses the question of who is responsible for making such disclosures. Since third-party donors are not parties to the arbitration, arbitral tribunals cannot order them to reveal their participation in the process. As a result, the parties are usually responsible for disclosing information, whether voluntarily or in response to an arbitrator’s request or a tribunal’s order.[23]

Arbitral tribunals usually do not have the authority to levy fees against third-party funders because arbitration is a consensual process. Having no formal role in the proceedings, these financiers are not parties to the arbitration agreement. Nonetheless, this poses a problem for the prevailing states, who are unable to recover expenses from an impoverished claimant or pursue reimbursement from a third-party funder that was first willing to assume some of the risks of the 

Concerns about the growing number of investment arbitration cases and the possible financial burden on states have been brought to light by the growth of third-party funding. States are frequently parties to investment treaty arbitration as respondents, and they are typically precluded from bringing counterclaims. Therefore, even when a state wins the case, it generally does not receive compensation and has to bear the costs of its own defense. So, if the availability of funding increases the number of cases brought, this could pose a unique burden on states, particularly small states and those facing domestic economic challenges.[24]

Apart from the problem of having a conflict of interests, disclosure, etc, there are other pertinent problems surrounding the realm of Third Party Funding under International Arbitration

This method can be said as an expensive method as the successful claimant will have to pay a large number of his recoveries for damages to the funder as the remuneration for the funds provided by him for litigation.

• Autonomy:- The sponsored party may lose some autonomy even if the funder has no authority or influence over the arbitration processes; this is particularly true when it comes to settlement-related problems, as the funder retains the ability to make judgments on these items.
• Costs:-. Presenting the case to a funder can result in a significant financial outlay. If the application is not funded, then this kind of investment will be wasted. However, in the event that they are successful in obtaining money, the funder will not bear any liability for expenses related to case packaging. As part of the claim package, the funder will receive the essential paperwork so that internal specialists or attorneys may properly analyze the case. Additionally, crucial details include the respondent’s financial stability, the location of any assets, and their perspective on arbitration.
• Speculative:- Due to the extreme uncertainty surrounding the outcome, both the funders and the parties may feel speculative while providing funds for a specific side in the arbitration process. At the same time, it is highly unpredictable. Furthermore, it is challenging to govern TPF because there are so few laws and rules pertaining to it.
• Lack Of Legislative Reforms:- Many nations, including India, are unsure of the effects and repercussions and as a result have not passed laws supporting TPF. Hong Kong and Singapore have just passed new TPF legislation. Even if the majority of nations do not agree with this idea, Asian nations’ perspectives are beginning to shift.[25]

Conclusion

The balance between promoting access to justice and maintaining ethical standards in arbitration. Third Party Funding aids in enhancing access to justice and mitigating the financial risks for the claimants. But it also increases the problem of ethics and transparency. Balancing all these aspects is very important for ensuring effective and fair arbitration. As this evolves a collaboration amongst the funders, claimants, and regulators along with the arbitrators is important for having a just international arbitration system.

[1] ‘What Is Arbitration?’ (WIPO) https://www.wipo.int/amc/en/arbitration/what-is-arb.html#:~:text=Arbitration%20is%20a%20procedure%20in,instead%20of%20going%20to%20court.  Accessed 22 June 2024

[2] ‘Arbitration’ (Arbitration | Duke University School of Law) https://law.duke.edu/lib/research-guides/arbitration  accessed 22 June 2024

[3] Ibid

[4] ‘What Is International Arbitration? • Arbitration’ (International Arbitration, 26 November 2021) https://www.international-arbitration-attorney.com/what-is-international-arbitration/  accessed 22 June 2024

[5] ‘Attorneys Explain Third Party Funding in Arbitration’ (Hughes Hubbard & Reed) https://www.hugheshubbard.com/news/third-party-funding-in-international-arbitration#:~:text=Third%20Party%20Funding%20(TPF)%20%E2%80%93,associated%20with%20pursuing%20that%20arbitration.  accessed 22 June 2024

[6] Garg A, ‘[The Viewpoint] Regulating Third Party Funding in Arbitration in the Indian Context’ (Bar and Bench – Indian Legal news) https://www.barandbench.com/law-firms/view-point/regulating-third-party-funding-in-arbitration-in-the-indian-context  accessed 22 June 2024

[7] Attorneys Explain Third-Party Funding in Arbitration(n 5 )

[8] Massini K, ‘ Risk Versus Reward: The Increasing Use of Third Funders in International Arbitration and the Awarding Security for Costs ’ (2015) 7 Arbitration Law Review

[9] Ibid

[10] Li X, ‘Third-Party Funding in International Arbitration an Analysis of Policy Challenges and Practical Considerations’ (SCIRP, 17 January 2024) https://www.scirp.org/journal/paperinformation?paperid=131692  accessed 22 June 2024

[11] (Third-party funding in International Arbitration) https://www.schoenherr.eu/content/third-party-funding-in-international-arbitration  accessed 22 June 2024

[12] Garg A, ‘[The Viewpoint] Regulating Third Party Funding in Arbitration in the Indian Context’ (n 7 )

[13] Ibid

[14] Tirado J, ‘Third-Party Funding: What You Need to Know ’ [2023] ALM

[15] Attorneys Explain Third-Party Funding in Arbitration (n 5)

[16] Hambury J, ‘Jurisdiction Guide to Third Party Funding in International Arbitration’ (Pinsent Masons, 16 August 2023) https://www.pinsentmasons.com/out-law/guides/third-party-funding-international-arbitration accessed 22 June 2024

[17] Morris C and Howells J, ‘Third-Party Funding in International Arbitration’ (Lexology, 21 November 2023) https://www.lexology.com/library/detail.aspx?g=8d6bfebe-09cf-4679-a028-96a29e40b1b7  accessed 22 June 2024

[18] ‘QuickGuide – Third Party Funding in International Arbitration’ (Ashurst, 15 June 2022) https://www.ashurst.com/en/insights/quickguide-third-party-funding-in-international-arbitration/  accessed 22 June 2024

[19] Morris C and Howells J, ‘Third-Party Funding in International Arbitration’ (n 18)

[20] LLC AL, ‘The Drawbacks of Third-Party Funding for Arbitration • Aceris Law’ (Aceris Law, 14 April 2024) https://www.acerislaw.com/the-drawbacks-of-third-party-funding-for-arbitration/#:~:text=Factors%20such%20as%20ethical%20concerns,pursuit%20of%20third%2Dparty%20funding.  Accessed 22 June 2024

[21] Ibid

[22] Li X, ‘Third-Party Funding in International Arbitration an Analysis of Policy Challenges and Practical Considerations’ ( n 11 )

[23] Ibid

[24] Li X, ‘Third-Party Funding in International Arbitration an Analysis of Policy Challenges and Practical Considerations’ ( n 11 )

[25] ‘Challenges Faced under Third Party Funding in Arbitration’ (Legal Service India – Law, Lawyers and Legal Resources) https://www.legalserviceindia.com/legal/article-3694-challenges-faced-under-third-party-funding-in-arbitration.html accessed 22 June 2024