To Pay or Not To Pay, or What to Pay?
Dispute resolution funding by a third party leads to interesting scenarios as regards security for costs. There are viable arguments both for and against considering third-party funding, including potential abuse of such measures on both sides – by respondents trying to derail proceedings, and by third-party funders trying to avoid liability under an adverse cost award, should security for costs not be granted. The disclosure obligations often triggered by the funding agreement, both in terms of security for costs and potential conflict of interest, become paramount. Of equal importance is adoption of a flexible test to balance claimants’ need for access to justice and respondents’ need for protection against frivolous claims. This article addresses the impact of third-party funding on security for costs.
There is a rising concern about how a tribunal can control the conduct of a third-party funder who is not party to the proceedings, so not directly under the jurisdiction of the tribunal, but who has control over one of the parties through its financing. The difficulty for arbitral tribunals is that they do not have any such power. However, tribunals can order security for costs in appropriate, rather exceptional, circumstances thereby indirectly resolving the issue. Use of this method eliminates the practical risk of a so-called hit and run arbitration.[iii] This context has also been described as an ‘asymmetrical situation’[iv] and as the ‘gambler’s nirvana’.
An order that a litigant or party to an arbitration should provide security for costs is a typically common law and particularly English legal mechanism. It protects respondents against claimants who may not be able to pay an adverse cost award at the end of the trial[v] or arbitration,[vi] having financed the claim through third-party funding. The English Civil Procedure Rules,[vii] the English Arbitration Act 1996[viii] and the London Court of International Arbitration Rules[ix] all have provisions for costs order as forms of interim relief to meet this eventuality.
The main risk of such an order is stifling meritorious claims, in as much as non-compliance of an order may result in dismissal of the claim.[x] Arbitrators must therefore balance the claimants’ right of access to justice and respondents’ need for protection. The following arguments are put forward against considering third-party funding when assessing an application for security for costs:
- If third-party funding is not a factor in assigning costs against unsuccessful claimants, it is should also not be a factor at the earlier stage of determining security for costs.
- This would encourage respondents to systematically apply for security, thus delaying the proceedings and increasing the risk of abuse and of stifling genuine claims.
- Claimants benefiting from third-party funding would be in a worse position than parties using other funding arrangements, which is inequitable.[xi] It does not appear that other means of borrowing, such as bank loans, conditional fee agreements or contingency fee agreements have been taken into account when determining security for costs.[xii] Claimants using third-party funding would also be prejudiced by having to re-negotiate the funder’s fee as a result of the security for costs order.
Conversely, one may argue that third-party funding may be taken into account when assessing an application for security for costs for the following reasons:
- The existence of a third-party funding agreement is part of a claimant’s possibly vexatious claim, which arguably justifies a security for costs order.
- There are decisions where tribunals have observed that third-party funders should be ready to fund security for costs.[xiii]
A security for costs is more likely to be granted by a tribunal where the claimant’s arbitration fees and expenses are being covered by a third-party funder, but the claimant would not be able to meet any adverse cost award. Both arbitrators and commentators note that these are particularly compelling grounds to order security for costs.[xiv] This is so because if the claims are successful, the funder wins. If a costs award is rendered against a funded party, the funder cannot be ordered to bear such costs.[xv]
In particular, Noah Rubins has similarly noted that ‘[f]or [the] sake of clarity, financing by a third party might well be considered as a separate factor, given particular weight in light of the potential for abuse such an arrangement indicates’.[xvi] However, tribunals should be mindful that a respondent could apply for security for costs for simply strategic reasons and in bad faith, or it could be the Respondent that drove the Claimant to impecunity; but that may become a matter to be deliberated at merits phase.
If a funder undertakes to pay security for costs for the Claimant, it might exert bearing on arbitrators’ rulings on multiple preliminary issues. It is a concern that funders may take the benefits of arbitration without being subject to the risk of the costs of arbitration. Disclosure of third-party funding agreements is, thus, arguably necessary for the tribunal to assess whether the funded party should be subject to an order for security for costs.[xvii] At the same time, even if security is not part of the funding agreement, the chances of a funder refusing to advance further money are allegedly low, since it has already agreed to fund the arbitration and would not wish to undermine its investment.
To enable management of this issue, rules requiring upfront and straightforward disclosure of a funder are paramount. Australia has enacted such a rule of upfront disclosure.[xviii] Arbitral institutional may take a cue here, like the LCIA has.[xix] Early disclosure allows for the efficiency and integrity of the arbitral process. Late disclosure has serious consequences, especially at the award enforcement stage.[xx]
Disclosure should also include key terms of the funding service agreement and even the agreement itself in particular circumstances. Claimants should be required to inform respondents whether the funder has agreed to satisfy an adverse costs order by the tribunal. Also, the tribunal should be aware of the terms regulating withdrawal of funding and rate of return. The draft report on security for costs by the ICCA – Queen Mary Task Force on TPF provides for disclosure of those terms of the funding agreement which will likely affect the decision on security for costs.[xxi]
Another reason for both points to be observed by the parties throughout the case is that the involvement of a funder may give rise to conflicts of interest issues for the arbitrators. For example,[xxii] an arbitrator can advise the claimant’s funder, or an arbitrator’s law firm may have a significant relationship with the latter.
A two-prong test
A two-prong test should be used by tribunals in considering for security for costs. The respondent should prima facieshow that:
- the claimant appears unable or unwilling to satisfy any adverse cost award; and
- the claimant is relying on third-party funding to finance its claims.[xxiii]
If the answer is yes to both points, the burden of proof would then shift onto the claimant to show that security for costs is not warranted.
For the first prong, there are several indicators like the party is in financial difficulties[xxiv] or lacks assets of its own.[xxv] More generally, if a claimant could not have participated in the arbitration but for the involvement of a funder then it is a strong indication as to the inability of claimant to satisfy an adverse cost order.[xxvi] A final point for the first prong would be the apparent unwillingness – as opposed to inability – of a party or its funder to satisfy an adverse cost award. This may be indicated by a party’s prior conduct and/or declarations; and/or the absence of a funder’s binding obligation in the funding agreement to cover an adverse cost order.[xxvii]
The idea, or the need, should be to prevent arbitral hit-and-runs, while also respecting a party’s right of access to justice. As recent as on 27th January 2020, an ICSID Tribunal[xxviii] – in a majority decision – awarded security for costs order in favour of Turkmenistan and against the Insolvency administrator of the Claimant as the Claimant could neither offer any objective assurance that the Claimant could meet an adverse costs award, nor was the Claimant’s funder bound by agreement to cover such costs. Because the issue here was not of risk but of a certainty, that the Respondent would not be able to collect costs, the Tribunal deemed it fit to order in favor of the Respondent. The revisit and recall of the decision by the same tribunal, a few months later, again paves way to a larger debate.
To sum up, tribunals may use security for costs as an indirect way to control the conduct of a third-party funder that is otherwise not under their jurisdiction. Given this, rules on upfront disclosure shall have to be introduced or uniformly developed, obliging a party to disclose existence of a funder as well as all details of the arrangement that might influence a tribunal’s decision on the security for costs application. In case claimants resort to third-party funding, tribunals should consider if they appear unable or unwilling to satisfy any adverse cost award, which may be evidenced by financial difficulties, lack of assets, prior conduct and/or declarations. Should this test be met, the burden ought to shift to claimants to prove that security for costs is not warranted.
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[i] Assistant Professor, Jindal Global Law School (India)
[ii] Candidate, JD/White & Case International Arbitration LLM, University of Miami School of Law
[iii] Jean Kalicki, ‘Security for Costs in International Arbitration’(2006) 3(5) Transnational Dispute Management < https://www.transnational-dispute-management.com/article.asp?key=827>.
[iv] Philippe Pinsolle, ‘Third Party Funding and Security for Costs’ (2013) 2Paris Journal of International Arbitration, 399.
[v] English Civil Procedure Rules, r 44.3(2) (a).
[vi] English Arbitration Act 1996, s 61(2).
[vii] English Civil Procedural Rules, r 25.12.
[viii] English Arbitration Act 1996, s 38(3).
[ix] London Court of International Arbitration (LCIA) Rules, r 25(2).
[x] English Arbitration Act 1996, s 41(6).
[xi] William Kirtley and Koralie Wietrzykowski, ‘Should an Arbitral Tribunal Order Security for Costs When an Impecunious Claimant Is Relying upon Third-Party Funding?'(2013) 30(1) Journal of International Arbitration 17, 20-21.
[xii] ibid 23.
[xiii] Kirtley and Wietrzykowski (n 16) 26.
[xiv] Kalicki (n 8).
[xv] See RSM Production Corp. v Saint Lucia (13 August 2014) ICSID Case No. ARB/12/10, Decision on Saint Lucia’s Request for Security for Costs, Assenting Reasons of Gavin Griffith12–13.
[xvii] Maxi Scherer, ‘Third party funding in Arbitration: Out in the Open?’ (Commercial Dispute Resolution News,2012) < https://www.cdr-news.com/categories/arbitration-and-adr/out-in-the-open-third-party-funding-in-arbitration>.
[xviii] Federal Court’s Practice Note CM17, revised on 9 Oct. 2013, art 3.6.
[xix] An example is LCIA Arbitration Rules 2014, art 25(2).
[xx] Darwazeh and Leleu (n 2) 136.
[xxi] ‘ICCA-QMUL Task Force on TPF in International Arbitration Subcommittee on Security for Costs and Costs’ (Draft Report, 1 November 2015) 18 <https://www.arbitration-icca.org/media/6/09700416080661/tpf_taskforce_security_for_costs_and_costs_draft_report_november_2015.pdf>.
[xxii] Darwazeh and Leleu (n 2) 132-133.
[xxiii] Darwazeh and Leleu (n 2) 143.
[xxiv]See X S.A.R.L., Lebanon v YA.G.(4 July 2008) Procedural Order No. 3, International Court of Arbitration of the International Chamber of Commerce Germany; ‘ASA Bulletin’ (2010) 28(1) Kluwer Law International 21.
See, also, Swiss Entity v Dutch Entity (20 November 2001) HKZ Case No. 415-Award; ‘ASA Bulletin’ (2002) 20(3) Kluwer Law International 467-471
[xxv] Gary B. Born, International Commercial Arbitration (Kluwer Law International 2014) 2496.
[xxvi] Darwazeh and Leleu (n 2) 144.
[xxvii] See Pinsolle (n 9).
[xxviii] Dirk Herzig as Insolvency Administrator over the Assets of Unionmatex Industrieanlagen GmbH v. Turkmenistan (ICSID Case No. ARB/18/35)