Draft Report of The ICCA-Queen Mary Task Force on TPF in International Arbitration: Comments, Recommendations and Proposals for Replacement Language

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Abayomi Okubote, PhD Student, Queen’s University, Canada & Joshua Karton, Associate Professor of Law and Associate Dean, Queen’s University, Canada (anonymous)

Part A: Background

In recent years, third-party funding (TPF) has come to dominate public discourse within the global arbitration community. Despite the ethical issues thrown up by TPF, its popularity keeps increasing. This upward trajectory has raised national and international concerns and has triggered debates on the need for some form of regulation. The paucity of empirical data on the use of TPF in international arbitration, and the varying approaches to regulation by key stakeholders, multiply the complexity of designing appropriate regulations. At the heart of these debates, however, is a general consensus that, while the risks to arbitrators’ independence and the integrity of proceedings posed by TPF are real, arbitral awards must be insulated from frivolous challenges that would add cost and delays and undermine confidence in the arbitral process.

In response to the call for regularization and regulation of TPF in international arbitration, some countries have already amended their arbitration laws, and some arbitration institutions are in the process of amending their rules. It is therefore laudable that the ICCA-Queen Mary Task Force (the Task Force) has provided the draft Principles and Best Practices for consideration by parties, funders, counsel, and arbitrators. Broadly, the Principles should offer both “carrots and sticks” to the parties that rely on them. The carrots will incentivize parties to perform their obligations under TPF and more general ethical regulation, whilst the sticks will help to provide control over funded proceedings.

Below, we set out observations on the draft Principles mixed with proposals for replacement language. We have focused only on the Principles regarding disclosure and conflicts of interest, cost and security for costs, and privilege. Due to the diverging views between Task Force members on the final form the guide to best practices should take, we have not provided any comments on them. 

Part B: Comments and Recommendations

Principles regarding Disclosure and Conflicts of Interest:

The Task Force has proposed alternative options for the articulated principles on disclosure and conflicts of interest. The Report notes that alternatives were offered due to continued differences of opinion among members of the Task Force. We have assessed the proposed alternative options and support the option that better exemplifies our “carrots and sticks” approach. 

Disclosure

The two alternative options on disclosure are –

Alternative A: a party should, on its own initiative, disclose the existence of a third-party funding arrangement and the identity of the funder to the arbitrators and an arbitral institution or appointing authority (if any), either as part of its first appearance or submission, or as soon as practicable after funding is provided or an arrangement to provide funding for the arbitration is entered into.

Alternative B: arbitrators and arbitral institutions shall have the authority to, during the selection and appointment process, expressly request that the parties disclose whether they are receiving support from a third-party funder, and if so, the identity of the funder.

The difference in the two alternative options (a reflection of the main point of departure amongst the Task Force members), rests on whether the existence of a third party funder should be a matter of routine but non-mandatory disclosure by the funded party or should be left to the mandatory order of the arbitral tribunal or arbitral institution.

Whilst Alternative A suggests a general presumption of disclosure by a funded party but does not actually require disclosure, Alternative B simply confirms the authority of an arbitral tribunal or arbitral institution to request disclosure of such information. We note, as an aside, that the authority to make such orders should be seen as inherent in the tribunal’s mandate or implicitly conferred as part of the tribunal’s powers to make orders respecting evidentiary disclosures and its duties to render an enforceable award and to investigate and disclose relationships that would give rise to a conflict of interest. The rationale for Alternative B is that disclosure is more likely to happen if it is based on a mandatory order by an arbitral tribunal rather than on a non-binding soft law type obligation, particularly considering the confidentiality provisions typically found in funding agreements.

We begin from the perspective that there should be mandatory disclosure of funding arrangements, irrespective of whether it is a routine disclosure by the funded party or ordered by the arbitral tribunal. The QMUL/White & Case 2015 International Arbitration Survey (QMUL Survey) confirmed the need for mandatory disclosure. In line with the views of the majority of respondents to the QMUL Survey, Singapore and Hong Kong have already amended their laws to impose mandatory disclosure obligations. Hopefully, other countries will follow this approach. The takeaway from the foregoing is that Alternative A is, on the whole preferable, if for no other reason than that Alternative B would merely reaffirm a power we believe that tribunals inherently possess. However, the phrase “should on its own initiative” used in Alternative A, needs to be amended. Mandatory disclosure of a TPF relationship is essential to prevent annulment of an award or refusal of enforcement following a belated revelation of a relationship between an arbitrator and an undisclosed funder. We have provided replacement language for the phrase in our drafting recommendation below.

On the issue whether disclosure of funding relationships should be a routine exercise by the funded party or should be made pursuant to an order of the tribunal or arbitral institution, cues may be taken from existing national laws on TPF and applicable international arbitration rules. Notably, Standard 7(a) of the IBA Guidelines on Conflicts of Interest, while imposing disclosure obligations on parties, provides in pertinent part that “… the party shall do so … at the earliest opportunity.” Similarly, under Section 98T of Hong Kong’s Amended Arbitration Ordinance, the duty to disclose “the fact that a funding agreement has been made” and “the name of funder” is imposed on the funded party. It therefore seems best to leave disclosure to the party receiving the funding (being in the best position to provide the information), rather than by the order of the arbitrator(s), who may decide not to order disclosure and thereby leave their award unnecessarily vulnerable to challenge.

This position would not impair the power of arbitrators to order parties to disclose a TPF relationship, including the identity of the funder; tribunals may and should make such orders if they have reason to suspect the existence of an undisclosed relationship. .

Nevertheless, imposing disclosure obligations on the funded party is important. It will impress upon funders that, while the terms of their funding deals are proprietary business information that should be protected, the existence of the funding arrangement is of concern to the tribunal and is not a purely private matter. Whilst we assume that some funders may push back on this, we do not think such objections will be reasonable, given that one of the underlying objectives of TPF regulation is to insulate the award from annulment or non-enforcement based on the existence of a conflict of interest.

In order to incentivize funded parties to disclose the existence of the funding arrangements and the identity of the funders at the earliest possible stage of the proceedings, the Principles should include clear language (possibly in the form of a proviso) that the existence of a funding relationship shall not in itself constitute a ground for challenging an arbitrator, nor in itself justify a request for security for costs. This proviso will obviate the risk of unnecessary delay that may arise from frivolous challenges raised following disclosure of a funding relationship, and will motivate parties to disclose funding arrangements.

Drafting Recommendation

We recommend that the Task Force should adopt Alternative A but should amend the phrase “should on its own initiative” and add a proviso. We have proposed the replacement and proviso language in italics below.

Alternative A: a party shall disclose the existence of a third-party funding arrangement and the identity of the funder to the arbitrators and an arbitral institution or appointing authority (if any), either as part of its first appearance or submission, or as soon as practicable after funding is provided or an arrangement to provide funding for the arbitration is entered into. The existence of a funding relationship shall not in itself constitute a ground for challenging an arbitrator, nor in itself justify a request for security for costs.

 

Definition of “third-party funder”

The Task Force has articulated two alternative definitions of “third-party funder” for the purpose of assessing conflicts of interest, to wit:

Alternative A: for the purposes of assessing potential conflicts of interest, the terms “third-party funding” and “insurer” refer to any natural or legal person who is not a party to the dispute but who enters into an agreement either with a disputing party, an affiliate of that party, or a law firm representing that party, in order to finance part or all of the cost of the proceedings, either individually or as part of a selected range of cases, and such financing is provided either through a donation or grant or in return for remuneration dependent on the outcome”

Alternative B: for the purpose of assessing potential conflicts of interest, the terms “third-party funder” refers to any natural or legal person who is not a party to the dispute but who enters into an agreement either with a disputing party, an affiliate of that party, or a law firm representing that party, in order to finance party or all of the cost of the proceedings, either individually or as part of a selected range of cases, and such financing is provided either through a donation or grant or in return for remuneration dependent on the outcome”

The difference in the two definitions lies in whether insurers and insurance contracts are included within the scope of the definition. The rationale given for Alternative B is that “exclusion of insurers was a structural feature of dispute settlement that should not be tampered with and could be maintained as separate from the issue of third-party funding”. It was recommended that insurers should not be considered in the definition, in the absence of special consideration of the particular market and regulatory issues that prevail in the insurance industry.

While more consideration of the particularities of insurance contracts may be warranted, the potential influence that an insurer may exercise over arbitral proceedings, particularly where the insurer has an interest in the outcome of the dispute, justify disclosure of insurer relationships in the same manner as more straightforward funding relationships. Conflicts of interest can arise where the insurer has funded multiple cases in which the same arbitrator was appointed, where the arbitrator has significant shareholdings in the insurance company, or in the extreme situation where an arbitrator is a member of the insurer’s board of directors. As rightly underscored by the Report, it would be difficult to articulate a rationale for why a conflict may exist if a third-party funder was involved in multiple cases in which the same arbitrator was appointed but the same activity by insurer would not similarly constitute conflict.

Notably, there are insurance policies that pay out in the event that a losing party is ordered to pay the other side’s costs. The structure of these policies and their premiums vary among insurers. Whilst some insurers typically request that the premium be paid up front, most insurers require the premium to be paid at the conclusion of the dispute, and only upon a successful outcome. This arrangement is sufficiently analogous to “standard” TPF that it creates the same risks of conflict of interest if some relationship exists between the insurer and an arbitrator. Distinguishing between insurance and non-insurance funding will often devolve into an ineffable exercise in hair-splitting, which is best avoided because different tribunals will inevitably reach inconsistent decisions. We therefore recommend that insurers be included in the definition of third-party funder for the purpose of assessing conflicts of interest.

For these reasons, we agree with the Alternative A for the definition “third-party funder”.

 

Principles regarding Costs and Security for Costs:

The Task Force has proposed principles on costs and security for costs. We agree substantially with the proposed language but below give some comments on our precise points of agreement and disagreement.

Costs

Allocation of costs in funded arbitration claims continues to be one of the most fiercely debated issues since TPF emerged. One point that is fairly settled, however, is that an arbitral tribunal has broad discretion to award costs unless the arbitration rules or the parties’ agreement state otherwise. We take a slightly different view from the position of the Task Force that a tribunal may, in exceptional circumstances, consider the cost of funding when allocating the costs of the arbitration. Our view is that cost of funding should not be considered at all by a tribunal in allocating costs of the arbitration. The funded party’s primary obligation under the funding agreement is to repay the funder. Such liability is not a cost of the arbitration, and as a matter of principle should not be imposed on the opposing party. Excluding funding costs from cost of the arbitration will help to curtail prohibitive increases in the cost of the arbitration, and awards that are unenforceable in practice.

We also differ slightly from the Task Force’s suggestion that a successful funded party might be able to claim funding costs as damages against the unsuccessful party in a separate claim. We acknowledge that the evidentiary requirements to prove causation and foreseeability would be difficult tests to meet under most national substantive laws, but beyond this, we respectfully do not see how maintaining a separate action for the funding costs will operate in practical reality.

On the matter of the third-party funder’s success fees, we disagree with the ICC Report on Costs in International Arbitration and agree with the Task Force’s suggestion that it would be unreasonable to require a losing respondent to pay a success fee agreed between a funded party and its funder. A success fee paid to a funder is entirely the product of a bargain between funder and funded, and has nothing to do with the actual prosecution of a claim against the non-funded party. We also agree that the oft-cited decision in Essar Oilfield Services Ltd v. Norscot Rig Management Pvt Ltd [2016] EWHC 2361 (Comm.), ought not to be taken as an authority or guide for arbitrations seated outside England, as the decision was based on the English Arbitration Act 1996 and the English “indemnity rule”. Whilst the substantive law of the seat is an important factor in the determination of whether a tribunal should grant success fees as part of the costs of arbitration, arbitrators should not as a general matter of policy grant success fees as part of costs of arbitration. We believe this consideration will also reduce incentives for non-funded parties to bring frivolous challenge applications upon disclosure of funding arrangements.

Lastly, we agree with the Task Force’s proposal that a tribunal lacks the power to issue a cost order against a third-party funder; any award against a third-party funder, like any non-signatory to an arbitration agreement, will be unenforceable against the third party. We are aware of Article 35 of SIAC Investment Arbitration Rules, which allows a tribunal to order payment of a party’s costs by another party, taking into account any third-party funding arrangements. The policy motivating Article 35 is difficult to justify in light of the traditional doctrine of privity of contract and the fundamental importance of consent in arbitral jurisdiction. Only the express consent of both parties and the funder—or one of the well-established grounds for extending arbitral jurisdiction to a nominal third party—would suffice to bring the funder within the tribunal’s jurisdiction to order payment of costs.

 

Security For Costs

On the matter of security for costs in funded arbitrations, we agree with the Task Force that the existence of TPF does not ipso facto imply that a funded party is impecunious. The argument that it does so imply is based on an overly simplistic conception of funded proceedings as “David vs. Goliath” affairs. Financially robust claim holders may seek funding for various reasons, including sharing of risks and balance sheet solvency. Impecuniosity of a funded party should therefore not be assumed and used as basis for delaying proceedings through frivolous applications for security for costs.

We agree that the terms of a funding agreement should generally not be subject to a disclosure order and should only be relevant in assessing the extent to which the funder has agreed to cover an adverse cost order. In this regard, capital adequacy of the funder to meet an adverse cost award, whether by is own right or under an ATE policy, may be relevant in assessing whether security for costs should be provided. The implication of the foregoing is that if a non-funded party makes an application for security for costs; the solvency of a funder and the cover for adverse costs contained in the funding agreement are considerations relevant to the tribunal’s decision on whether to grant security for costs. We note the approach suggested by the Task Force that a funded party, its counsel, or the funder be allowed to provide the tribunal with an affidavit stating its identity and specifying whether under the funding agreement it has undertaken to be liable for an adverse costs order. Whilst this approach appears sound in theory, its feasibility in practice needs further consideration.

We take a slightly different view from the Task Force’s position that when a respondent requests security for costs, an arbitral tribunal should consider indicating to the respondent that, should the claimant prevail on the merits of the case, the respondent will be held liable for the costs reasonably incurred by the claimant (funded party). In our respectful view, this proposal appears punitive in nature and detracts from the underpinnings of security for costs as a means of ensuring that a claimant is able to pay the legal costs of a prevailing respondent. Given that tribunals should only grant security for costs when the respondent has a prima facie chance of success on the merits and there is reason to believe that the funded party [or its funder] may not be able to pay an eventual costs award, the proposal for indemnification by the respondent becomes surplusage.

 

Principles on Privilege:

The Principles on privilege proposed by the Task Force sufficiently capture the issues arising from privilege and disclosure of confidential information as between the funder and funded party, but do not include protection of the non-funded party’s privileged information potentially disclosed during a transaction or arbitration and shared with the funder by the claim holder. Sharing of confidential and/or sensitive information with the prospective funder may be necessary for the funder to make an informed investment decision, and therefore aligns with basic commercial principles. That said, there must be a limit to the nature and extent of the disclosable information. A balance must be struck between the claim holder’s right to disclose information to funders for the purpose of securing funding and the respondent’s right to protect its privileged and other confidential information.

There are four possible ways of addressing this balance:

  1. The funded party entering into a non-disclosure agreement with a funder before sharing any information. Whilst this is standard practice, it may not provide the necessary comfort to the non-funded party, as there is no direct obligation by the funder to the non-funded party;
  2. Execution of a tripartite confidentiality agreement amongst the funder, funded party, and non-funded party. Whilst this might seem to be a complete solution, it will be difficult if not impossible to have the parties and funder execute a confidentiality agreement after a dispute has arisen. More importantly, the non-funded party may be averse to this arrangement, since the funder may unjustly benefit from the confidential information, even if a tripartite agreement prevents the funder from disclosing it to its other clients or to competitors of the non-funded party;
  3. Empowering the tribunal to impose orders as to confidentiality on the third-party funder. This may be of no practical utility as the third-party funder is not a party to the arbitration and is not under the jurisdiction of the tribunal; or
  4. Encouraging parties to include in arbitration agreements a provision limiting the information that may be disclosed to a third-party funder in the event of a dispute. This may be a useful option for parties, although the ability of a party to secure funding without disclosing to funders at least some information about the underlying transaction is doubtful in practice.

Each of the four possible means of addressing the balance has its downside. It is clear that there must be a limit to the nature and extent of the information that may be disclosed by a party to prospective funders, but further study is needed to weigh the pros and cons of each approach.