Third party funding in international investment arbitration

Concerns about Third Party Funding (TPF) have been the subject of much attention recently. Without subtracting from the merits of TPF, a frank consideration of the pitfalls and risks faced by users of TPF in investment-arbitration is long overdue.

Acknowledging the complex nature of third party funding, Khouri, Hurford and Bowman in a recent article provide a ready definition of the phenomenon:

"Third party funding arrangements for high value claims do not conform to a template. … However, in general terms, third party funding involves a commercial funder agreeing to pay some or all of the claimant´s legal fees and expenses associated with a dispute in return for reimbursement of the funder´s direct outlays and a share of any sum recovered from the resolution of the claim ..."

Until recently TPF was prohibited in the common law system and it is in fact still punishable in some jurisdictions. "Maintenance, champerty and barratry", three forms of TPF of litigation, were outlawed because they were deemed to increase litigiousness. It indeed follows that more cases would make it to court with the aid of a third party funder, than if claimants themselves had to finance cases upfront.

In recent years international and investment arbitration has emerged as an attractive new area for TPF, because of the enormous amounts involved in these kinds of disputes. A steady increase in the participation of TPF in recent investment arbitration disputes has indeed also been registered. S & T Oil Equipment and Machinery vs Romania; Abaclat vs Argentina; Teinver vs Argentina; Fuchs vs Georgia; Kardassopoulos vs Georgia; and Cristallex vs Venezuela are but only an illustrative list of disputes heard before ICSID that were all funded by third parties.

TPF in international investment arbitration presents problems similar to those in other litigation areas. Some of the main pitfalls are listed below:

  • Excessive charges: the excessive cost funders charge for accepting the risk of funding litigation precludes many companies from engaging a third party funder in arbitration. Funders recognize charging users between 40 to 60 cents of a dollar for every dollar at stake.
  • Attorney–client relationship: the funder potentially has the power to choose the lawyer. Indeed the funder also has the leverage to become an important provider of work, attracting the favor of lawyers and undermining attorney loyality to a client. In addition, funders present themselves as efficient administrators, not only by choosing skillful lawyers but also by purporting to monitor and keep strict control of lawyers’ work and fees. The latter could encourage companies (and potentially also States) to pay a risk premium rather than to commit their own funds to finance a dispute. Taken to its logical conclusion, this could lead to counsel being chosen by a group of financiers, which has perverse implications for the legal profession.
  • Veto power in settlement transactions: funders have influence on settlement transactions which may prevent the amicable settlements between the Parties. Since funders need to recover their investment and obtain a profit, a settlement can be thwarted by the TPF if there is insufficient room for them to be wholly compensated. The power of funders to oppose a settlement exclusively based on economic considerations is a concern that transcends arbitration and supports the argument of critics that TPF may encourage litigation.
    • In addition, two structural elements are unique to international investment arbitration:
  • Challenges to enact legislation to regulate lawyers practicing in different jurisdictions: The international character of investment arbitration and the spread of regulatory power add another dilemma. As lawyers of different nationalities are involved in these disputes, multiple national bar institutions are responsible for the regulation of professional ethics. While the intervention of these bar associations theoretically implies more complete control and surveillance of attorneys' professional duties, in reality exactly the opposite is achieved, with the concurrent powers of different professional bodies in different jurisdictions resulting in a lack of control and regulation. Tribunals are now more frequently invoking the inherent powers doctrine in matters that go beyond the dispute between the parties. They have become concerned with possible conflicts of interest and other ethical problems affecting the Parties in dispute or their counsels.
  • Possible opposition from sovereign States to funders' enjoying benefits accorded to investors under Bilateral Investment Treaties (BITs): the attitude of States towards TPF participation in investment disputes is as yet untested. It can be envisaged not to be a positive one, judging from States´ reactions to speculative transactions in the areas of investment arbitration and Sovereign litigation. Argentina, without specifically referring to the effects of TPF, has expressed its discontent with the speculative nature of those who indirectly benefit from the rights granted under BITs to foreign investors. If those admonishing words had been expressed regarding hedge funds that acquired a rendered award to profit from a possible compensation payment, the approach cannot be expected to be different to disputes which are brought – in whole or in part – by funds that also benefit from the outcome of these cases.
    • TPF has emerged as a matter of growing prominence in the international investment arbitration environment. The stakes are high, with mult-million dollar amounts involved in these types of disputes. Indeed, there is compelling need for TPF to be subject to closer regulation, including by arbitral tribunals under the inherent powers doctrine. In the absence of a formal regulatory framework to give more effective direction to TPF it can be expected that tribunals will increasingly intervene directly to address potential conflicts of interest and other ethical red herrings involving TPF that emerge in investment disputes.

    This discussion note is based on Ignacio Torterola, "Third Party Funding in International Investment Arbitration".
    All opinions expressed here are Mr Torterola's own and should not be attributed to Foley Hoag LLP or the Government of Argentina.

    See also IPFSD clauses:

    6.2 Investor-State dispute settlement

    user Post Cancel

    Although the author does accurately note that third party funding is rising in the international investment arena – quoting various examples – and expands a bit on some of the concerns arising therefrom, the article incorrectly leads the readers to believe that third party funding is something which should not be permitted and which inadequately burdens the tribunals as there is no framework ready to embrace it.
    What must be considered is that each jurisdiction is quite unique and equally unique in its responses to third party funding. Australia is very open to third party funding and now the United Kingdom (from whence the key legal restraints mentioned, maintenance and champerty stem) fully embraces it as an equalizing method for those with meritorious claim lacking sufficient means to carry them forward. Indeed, even within the United States, there are several states who allow funding arrangements. This would be especially true for international investment arbitration which, arguably, falls outside the traditional boundaries given to those litigants before the court system. Of course, international investment arbitration is not a traditional dispute resolution system and provides the parties far more freedom than the courts; this is even true for those disputes premised on investment treaties (whether under ICSID or not).
    As already mention, the key legal restraints stem from the antiquated doctrines of maintenance and champerty, which originated in the United Kingdom and were carried forward via common law. Maintenance refers to the funding or providing of financial assistance to a holder of a claim when the funder or provider of financial assistance holds no connection or valid interest in the claim itself and champerty is essentially the same with the addition of the funder or financial provider having a direct financial interest in the outcome of the claim. The historical rationale for why maintenance and champerty were considered morally and ethically was premised on a time when a man would buy a weak claim and try to encourage a powerful lord to burst into court and – through intimidation – strongly encourage the success of said claim. Many jurisdictions have dropped these doctrines altogether or largely modified them, including many states within the United States. (For further on this, please see the text by Lisa Bench Nieuwveld and Victoria Shannon entitled Third Party Funding in International Arbitration, published by Kluwer Law International in 2011, in which a complete survey of the laws of all 50 US states was undertaken). And, yes, more claims would then come to fruition – increasing claims as asserted. But if a claim holder has a meritorious claim, does it not have a legal right to justice? Funders do take on a sizeable risk and in so doing look painfully close at the weight of the claim before backing it. In fact, it requires more than a likelihood of success. I would argue an extreme likelihood of success is required. Such claims are the raison d’etre of any dispute resolution system.
    If we are to focus on the framework in the United States to provide an example of how third party funding could adequately exist within the laws, why not look to the oft mentioned defense insurance industry example. Although not identical, certainly it can demonstrate how things can effectively be managed. Certainly those entrepreneurs who have heavily invested in a country and said country has in turn acted in such a way as to deprive the entrepreneur of its investment or inappropriately interfered without adequate compensation may consider access to justice a sufficient argument for working with third party funding. It would come to no surprise, of course, for a country being sued before a tribunal to feel rather differently. Perhaps I can refer you to the article recently published in the Transnational Dispute Management journal (see http://www.transnational-dispute-management.com/article.asp?key=1910) in which I more thoroughly consider the arguments proffered for and against using this framework and refer to other scholars who have authored similar arguments.
    In conclusion, it is very likely that, regardless of all stakeholder’s perspectives, third party funding is here to stay. Basic economics suggest, where there is a need, there is a supply.

    Reply

    Much enjoyed Torterola's review of pitfalls - however, as Lisa Bench Nieuwveld rightly pointed out, there are also opportunities here. Under the right conditions, TPF as such may be beneficial for enhancing access to justice and improving the quality of proceedings. Moreover, it seems to me that most of the challenges posed by TPF may be new to investment arbitration but they certainly are not to other forms of dispute resolution. That said, in the investment arbitration domain, TPF does necessitate the reconsideration of the principles of client-attorney relationship and the relationship between arbitrators and (often undisclosed) TPFs. A comparative overview such as the one I made earlier (see http://ssrn.com/abstract=2027114) may be helpful in analysing the various approaches.
    One of the further challenges for investment arbitration procedure is the combination of TPF and mass claim arbitration. I am curious to see how arbitration institutes will further develop their stance towards such potentially efficiency enhancing innovations.

    Reply