Third-Party Funding and Security for Costs – Resolving the Arbitral Hit-and-Run

Keywords – arbitration, third-party funding, security for costs, material change, consent approach, foreseeability

Third-Party Funding (“TPF”) is no longer a novelty in investment and commercial arbitration. Its interplay with security for costs (“SfC”) has also been well-discussed. In essence, SfC has emerged as one possible solution to the “arbitral hit-and-run” – a TPF-specific situation where a successful respondent holding an adverse costs award is unable to enforce the same on account of the claimant being impecunious [1] and the claimant’s funder not being bound by such award. While there are other solutions to this problem (such as the claimant taking after-the event (ATE) insurance, [2] the funder making himself contractually bound or being statutorily bound [3] to an adverse costs award, etc.), SfC remains the primary adversarial recourse for a respondent fearing an arbitral hit-and-run. 

By this point, the basics are clear – TPF may be one of the factors to account for while deciding an SfC application but is not by itself an indicator of the claimant’s impecuniosity or of foul play. A respondent applying for SfC must first and foremost demonstrate that the claimant will not be able to satisfy a future adverse costs award in its favour. [4] Tribunals will ordinarily also look at the prima facie merits of the case, while being careful to avoid pre-judging the dispute. [5] 

Crucially, in commercial arbitration, there is an additional test that is adopted by a majority of arbitral tribunals. [6] Termed the “material change of circumstances” test, [7] it requires respondents applying for SfC to demonstrate that the claimant’s present impecuniosity is the result of a material and unforeseeable change in the claimant’s financial situation since the conclusion of the contract. This requirement stems from the “consent approach” to commercial arbitration – if the respondent agreed to arbitrate with an impecunious party, it need not be protected against that very fact when such party initiates arbitration. [8] This article aims to examine this test in further detail in the specific context of TPF.

As regards material change, while TPF does not change the claimant’s financial situation per se, it can push up the expected cost of the arbitration by providing an otherwise impecunious claimant the funds necessary to obtain higher-quality representation and pursue cost-intensive litigation strategies. [9] In most circumstances this would cause a respondent to incur materially higher defence costs than it would have incurred in the absence of TPF (although this can be difficult to estimate). [10] Thus, the presence of a funder can, at least in principle, cause a material change in the claimant’s ability to satisfy a future adverse costs award by increasing the expected quantum of such award (and taking it further away from the claimant’s financial capacity). However, a funder also has a natural business interest in keeping legal costs low, and it therefore makes good sense to require a respondent to actually demonstrate that the presence of TPF (or indeed any other factor) has caused a material change since the conclusion of the contract. [11]

As stated above, under prevalent standards, a respondent relying upon the presence of TPF for its SfC request would also have to establish that either the presence of the funder or the material change it brought about was unforeseeable at the conclusion of the contract. In other words, a respondent would have to demonstrate that it was unforeseeable that it would be at the risk of an arbitral hit-and-run at all, or at least that the quantum/extent of the hit-and-run was unforeseeable. This is where things get a bit sticky. As regards the mere presence of a funder, it has been pointed out that the increasing prevalence of TPF will, especially in developed funding markets, make it increasingly difficult for respondents to claim that the presence of a TPF was entirely unforeseeable at the conclusion of the contact. [12] The alternative is for such respondents to establish that the material change caused by the funder in the costs of the arbitration was unforeseeable. Once again, the respondent would have a tall order – it would have to prove that although some third-party funding was foreseeable, the particular form or extent of funding in question, which was necessary to bring about the material change, was not. 

This is obviously an unsatisfactory state of affairs. The foreseeability limb of the “material change of circumstances” test is imposing a nearly impossible burden on respondents facing the threat of an arbitral hit-and-run by virtue of the presence of TPF. [13] This is often a sign that some re-thinking is required.

One solution, proposed by Redfern & O’Leary (albeit on slightly different grounds), is to disregard the “material change of circumstances” test altogether in SfC applications regarding TPF. [14] Another solution, adopted by an ICC Tribunal in a much-debated Procedural Order dated 3 August 2012, [15] was to simply consider whether the presence of funding “constitutes a fundamental change of circumstances which would justify granting security for costs”, without looking into whether this change was foreseeable or not. The Tribunal applied a broader test of fairness and granted SfC, inter alia, in light of certain provisions in the funding agreement. This decision has been widely criticised, and it has been noted that the Tribunal may not have ordered SfC if it had applied the test of foreseeability instead of resorting to a broader fairness test. [16]

This author sees another possible answer to the conundrum – one that treads a middle ground and makes it possible to retain foreseeability as a standard without making it unduly difficult to obtain SfC. In this view, the following two changes need to be made in cases involving TPF. First, the burden of proof on the specific aspect of foreseeability must be shifted to the claimant. [17] Second, the claimant, in trying to prove that TPF was foreseeable, must point to the specific facts and circumstances of the case, rather than relying on the prevalence of TPF in commercial arbitration generally. [18] 

In this model, once a respondent demonstrates the claimant’s impecuniosity, the prima facie merits of its case and the fact that TPF has caused a material change in the claimant’s ability to satisfy an adverse costs award, the tribunal will turn to the claimant to demonstrate that this change was foreseeable at the conclusion of the contract. The claimant must do this with reference to specific facts and circumstances of the case (such as pre-contract communication favourably discussing TPF, news reports of the claimants taking funding in the past, funding being common-place in the specific industry in question, etc.).

Testing the foreseeability of TPF in general terms makes little sense when it is not a factor innate to the business transaction of the parties, but an ever-present possibility of intervention of an outside hand. At the same time, in the suggested model, the possibility is left open for the claimant to point to specific facts and circumstances of the case that made TPF foreseeable to this respondent, thus retaining the “consent approach” to commercial arbitration.

One may well ask why shifting the burden of proof is necessary once we have introduced this change in the standard (reliance on specific facts and circumstances only). After all, why not let the respondent retain the burden of proof – and point to specific facts and circumstances that made TPF un-foreseeable to it. The answer, in my opinion, lies in the very nature of the arbitral hit-and-run, and what the respondent has had to establish to reach this point in the discussion. Even in cases without any hint of bad faith or abusive conduct by a funded claimant, the situation in question is fundamentally asymmetrical. The respondent contracted with a pauper, who has since remained a pauper but has brought a claim fit for a prince. The party that has made this possible is outside the arbitral tribunal’s jurisdiction. Therefore, the arbitral hit-and-run represents a situation where the consensual nature of commercial arbitration can be turned on its head (deliberately or otherwise) to frustrate an adverse costs award of the tribunal. As a matter of policy, by establishing the three major factors listed above, the respondent would amply demonstrate the threat of an arbitral hit-and-run and consequently, a case for SfC. The argument that this situation was foreseeable to the respondent must therefore be viewed as something of an exception or defence, to be taken by the party putting it forward, i.e. the claimant. It will also perhaps be easier for a claimant to point to specific facts and circumstances that made TPF foreseeable, compared to a respondent who will have to show the negative communication/understanding of TPF being unforeseeable in order to discharge its burden.

Fair and reasonable standards must be adopted to prevent incongruous situations arising from TPF. This may be the only way to keep TPF free from excessive regulatory intervention. 

ENDNOTES

[1] We are assuming, for the purposes of this piece, that the claimant has taken TPF because it is impecunious. This is because the danger of an arbitral hit-and-run arises only in such cases. Perfectly solvent parties also take TPF as a way to manage their liquidity. We are not concerned with such cases, as such a claimant is capable of satisfying an adverse costs award and there is no danger of an arbitral hit-and-run. 

[2] See Eskosol S.p.A. in liquidazione v. Italian Republic, ICSID Case No. ARB/15/50, Decision on Termination Request and Intra-EU Objection (7 May 2019).

[3] Report on “Third Party Funding for Arbitration” by the Law Reform Commission of Hong Kong (12 October 2016), ¶ 7.31.

[4] Author’s comment (n 1). 

[5] CIArb Guideline on Applications for Security for Costs (Article 2) (29 November 2016); ICCA Reports No. 4: Report of the ICCA-Queen Mary Task Force on Third-Party Funding in International Arbitration, ICCA Reports Series, Volume 4 – Chapter 6 (April 2018).

[6] Queen Mary (n 5), 168.

[7] ibid 172.

[8] XXX INC., incorporée dans une île des Caraïbes v. YYY S.A., incorporée dans un pays d’Amérique latine, ICC Case No. 15951/FM, Procedural Order No. 2 (29 May 2009).

[9] ‘Chapter 9: Security for Costs and Third-Party Funding’, in Jonas von Goeler, Third-Party Funding in International Arbitration and its Impact on Procedure, International Arbitration Law Library, Volume 35; Waincymer, Procedure and Evidence in International Arbitration, 650. 

[10] ibid.

[11] One way to do this, and also reduce the speculation inherent in such SfC applications, is for the respondent to make the SfC request slightly later than it ordinarily would. The respondent should then be able to demonstrate that the claimant’s legal costs have thus far been materially higher than they would have been had the claimant not been funded, and that the respondent’s costs have consequently been higher as well. 

[12] Von Goeler (n 9), 348.

[13] In reaching this conclusion, we are concerned only with developed funding markets where it has been suggested that the general prevalence of TPF makes it ipso facto foreseeable, thereby compromising the logic of the foreseeability standard. This article does not concern India, for example, where funding is still not widely prevalent, and this one-size-fits-all argument has not skewed the foreseeability threshold against respondents. The solutions proposed herein are also geared towards the former situation, though it can be argued that shifting the burden of proof on foreseeability to the claimant may make sense in the Indian setting as well.

[14] Alan Redfern and Sam O’Leary, ‘Why it is time for international arbitration to embrace security for costs’, in William W. Park (ed), Arbitration International, (Oxford University Press 2016, Volume 32 Issue 3) 397 – 413

[15] X v. Y and Z, ICC Case, Procedural Order (3 August 2012).

[16] Von Goeler (n 9), 348.

[17] It may be clarified that this is entirely different from what was proposed by Mr Gavan Griffith QC in his assenting opinion in RSM Production Corporation v. Saint Lucia, ICSID Case No. ARB/12/10, Decision on Request for Security for Costs (12 August 2014). Mr Griffith proposed to shift the burden of proof on all aspects of the SfC (from the time the existence of TPF was established) to the claimant. 

 [18] While distinguishing a specific factor from a general one can pose problems, a general metric may be that all arguments more specific than the general prevalence of TPF in a specific jurisdiction or legal system are fair game. I have listed some examples of specific circumstances in the next paragraph.

Aaditya Gambhir is an alumnus of National Law University, Delhi, and a former Associate in the Dispute Resolution Team at Khaitan & Co. He is set to join a law chamber in Delhi soon.

The views and opinions expressed in the article are those of the author(s) solely and do not reflect the of official position of the institution(s) with which the author(s) is /are affiliated. Further, the statements of the author(s) produced herein should not be construed as legal advice.