The cost of
arbitration
The arbitration community stated and proved
over the years all the advantages of choosing arbitration as dispute resolution
mechanism over Court systems. Some of the benefits vary from country to
country, depending on the characteristics of the judicial infrastructure of
each nation. Some of the features that attracted contracting parties to
arbitration are
·
neutrality
(specially in international cases, where parties prefer not to be in the
national courts of the other side),
·
having
a dispute resolved in faster than in courts (true in many countries),
·
confidentiality;
·
possibility
of choosing the arbitrators, which allow to have specialists in charge of the
proceedings;
·
cost
and benefits;
·
others.
Arbitration became preferred method of dispute
resolution in international contracts between corporations and, in many
countries, it became a tool to attract investors as well, by the use of
Bilateral Investment Treaties and multilateral treaties. In domestic cases, it is
a solution where local courts are unable to provide specialized response in
timely manner to complex business disputes.
In the other hand, at the same time arbitration
becomes increasingly popular, the costs became increasingly higher as any other
“product” that has an increase in demand. The offer side also grew, but only a
few arbitral institutions and big name arbitrators dominate the market, making
arbitration more expensive than local courts. Additionally, since disputed
facts and business contracts are getting more complex over time, costs with
experts had increased exponentially. And, again, there are not too many experts
that are comfortable with arbitration cases, thus, the increase in price of
experts´ opinions was a result of the imbalance between offer and demand.
Despite the increase in cost, the cost/benefit
analysis continue to direct parties to arbitrations, because costs of
opportunity are decreased by speed of the solution and smaller transaction
costs. The number of arbitration clauses is not decreasing over time, which
means it continues to be worthwhile. Arbitration is the best way to solve
business disputes, especially in countries where the judiciary is very slow or
corrupted.
What happens, then, if one side cannot pay the
costs of the proceedings? The answer is that arbitration will not happen and
the party is stuck with the problem; or one of the parties (usually the one who
is more interested in the solution) pays for the whole thing, expecting to
recover the costs by enforcing the award; or, finally, parties seek third party
funder for the dispute.
Role of third party
funding
Third party funding, thus, has the important
role of making arbitration possible for parties who do not have liquidity or
resources to pay the costs of arbitration. Many cases funded by third parties
are related to companies facing a restructuring process to turnaround a
troubled business. These corporations do not have money to pay for all the
costs of the arbitration, but they may have good chances of winning the claim.
This also occurred in the realm of investment arbitrations. International
investment disputes involve enormous amount of money and the costs are
proportional to the size of the dispute. In this sense, a third party funder
financed Uruguay (a small Latin American country with limited resources) in the
case against Philipp Morris about tobacco regulations.
Moreover, it is becoming a tool of legal risk
management. This means that the third party funder splits the risk with the
party. This contract works similarly to a contingency fee agreement in the
sense that the funder only gets paid in case of success. Therefore, the parties
are sharing the risk of a loss and increasing the chances of a win, based on
the support that funders provide to the financed parties. This means that the
third party funding agreement is not a loan, because it is a risk contract. It
is a contingent agreement, where the funder invests in a dispute and get
returns if the funded party wins the dispute. Nevertheless, businesses are
creative and it would not be a surprise to find some mix features of a loan and
third party funding agreement in some contracts. There are also insurance
related to funding arbitration, but they do not qualify as third party funding
as usually described.
The financer usually pays part or all the costs
of arbitration, including attorney fees, arbitrators´ fees, administrative fees
of the arbitral institution and expert fees. The level of intervention in the
legal strategy of the dispute varies according to the practices of each funder.
In any case, it is common that third party funders provide all legal support
for the funded party in order to achieve greater chances of success. In this
sense, they participate in major decisions regarding the case, for instance,
the indication of arbitrators and the evidence a party should present. This
level of participation make some jurists classify them as “quasi” party in the
arbitration, because they are not formally a party, but they have direct
interest in the result of the proceedings[i].
In the other hand, some funders prefer to grant
freedom to the funded party´s attorney and his client to define the legal
strategy, requiring full disclosure about the strategy and any change in the
course of the dispute.
Finally, the third party funder will generally
have a say on settlement offers, especially to protect a minimum level of
return of the investment.
Criticisms
In common law jurisdictions, there were two
doctrines imposing limitations on third party funding of litigation cases. The
doctrines of champerty and maintenance stated that third party funding was
against public policy. The objective was to avoid excessive litigation.
Scholars argued that it would discourage pre-trial settlement and increase the
number of cases. Judges had the idea that law should exist to prevent conflicts,
not to encourage them. In the other hand, this changed dramatically in the last
10 to 15 years. Some scholars defended that solving disputes in courts is
actually desirable, because it is a civilized form of solving conflict (in this
sense, see Jason Lyon - REVOLUTION IN PROGRESS: THIRD-PARTY FUNDING OF AMERICAN
LITIGATION)[ii].
The rule was directed to court cases, but it was extended to arbitration through
interpretation. However, third party funding has been less challenged in arbitration
cases under those doctrines. Additionally, countries changed their laws or
adapted it to arbitration cases, because the concerns that originated the rules
of champerty and maintenance made less sense in arbitration, where normally the
parties are professional business entities[iii].
However, there are some issues arising in the context of arbitration, precisely
about confidentiality of dispute and disclosure of the third party funder to
the tribunal and the counter party.
Majority of disputes that goes to arbitration
have provisions of confidentiality among the parties and the tribunal. Parties
shall not disclose to public or third parties the contracts in dispute or the
terms of the dispute itself. A counterparty may have a legitimate concern that
a third party funder will use information not only for the purposes of the
dispute, but in future deals with other parties in detriment of the opponent[iv].
Thus, the first question would be whether it is
possible to contract with a third party to finance the arbitration. The general
answer is yes, because the standard confidentiality agreement allows parties to
reveal information in order to assure its legal rights. Take for example the
rule 30(1) of LCIA, providing that “[t]he
parties undertake as a general principle to keep confidential all awards in the
arbitration, together with all materials in the arbitration created for the
purpose of the arbitration and all other documents produced by another party in
the proceedings not otherwise in the public domain, save and to the extent that
disclosure may be required of a party by legal duty, to protect or pursue a
legal right, or to enforce or challenge an award in legal proceedings before a
state court or other legal authority”. Therefore, unless the parties’
agreement itself creates limitation of third party funding in the scope of the
exception to the confidentiality, it will fall in the exception of disclosure
required to protect or pursue a legal right.
According to von Goeler, in order to provide
sufficient protection to the parties, it must be only possible to reveal
information of the cases to third party funders if there are mechanisms
mandating the parties to take reasonable steps to assure confidentiality. This
would include, not only disclosure of third party funder, but also a disclosure
to the other side before seeking the outside financer (Jonas von Goeler, 2016 in Kluwer Arbitration Blog – infra “iii”).
The other issue is disclosure to the tribunal
and the counter parties. Contracts of third party finance of the arbitration
are usually confidential and the funding parties do not want to appear to the
tribunal and the other party. The problem is that not revealing a third party
to the tribunal prevents the arbitrators to assess whether they have potential
conflict of interests. Therefore, the lack of disclosure risks the validity of
the arbitral award at the end of the dispute, if later the counterparty
discovers a third party funder who is affiliated to one or more members of the
tribunal. In this sense, there is a strong argument that the funded party has a
duty to disclose the external financer to the other side, under the rules that
mandate the parties to act in the best way to assure an effective proceeding
that will issue an enforceable award (this duty is created by either principles
of contractual good faith, fairness, soft law and institutional rules of the
chambers of arbitration[v]).
However, in a recent event about third party
funding, Mr. Narghis Torres presented an argument against disclosure of third
party funding agreements to the tribunal. The rationale is that the funder
makes an extensive and expensive due diligence on the case and as a diligent
investor it would never pick a case without big changes of success. Even though
it is a risky investment, it is not gambling, and fund managers will be trying
to find the parties who have the best position in the dispute. In that sense,
the disclosure of the third party funding agreement would trigger a bias in the
tribunal in favor of the funded party. Even though it is an interesting point,
this argument has not found many supporters yet.
Conclusion
In sum, third party funding allows parties to
present cases when the immediate costs would be prohibitive to the party. In
addition, it works as a tool of sharing risks of disputes and a tool to support
the parties and increase the chances of succeeding in the arbitration
proceeding. Since investors will do an extensive due diligence on the case at
hand, the decision to take it or not also provide useful information on a
party´s decision on pursuing the case until the end or to think about
settlement. Nevertheless, third party funding raises legitimate concerns
regarding disclosure and confidentiality. Thus, parties and arbitrators must
act carefully in order to prevent annulment of awards and misuse of
confidential information.
[i] In
this sense, Marcelo Roberto Ferro in “Dia
Gaúcho da Arbitragem, p. 116”.
[iii] For instance, Singapore’s law
applied champerty and maintenance, but recently changed the law to attract more
arbitrations to the country. (see in http://kluwerarbitrationblog.com/2016/07/14/third-party-funding-and-arbitration-law-making-the-race-for-regulation-in-the-asia-pacific/)
[iv] More about these particular
issue in http://kluwerarbitrationblog.com/2016/07/21/show-case-ill-show-money-balance-conflicts-third-party-funding-aand-confidentiality-iin-arbitration-proceedings/ (Jonas von Goeler, 2016)
[v] See, for instance, the IBA
Guidelines on Conflict of Interest 2014 (Part II, 2.2.3), LCIA Rule 32.2 and
ICC rule 22.1.
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