Third-party funding in investor-state arbitration

Posted in Oil and gas Mining Power Renewables Infrastructure Eastern Africa Western Africa Central Africa Southern Africa Northern Africa Blog post

Statistics published by the International Centre for Settlement of Investment Disputes (ICSID) at the end of last year show that one in every five cases registered in 2016/7 involved an African state counterparty. Of those cases, a third related to the oil and gas or mining sectors.

In this resource rich continent where a number of major mineral producing countries have seen political and then legal change over recent years, the number of investor-state claims is perhaps not surprising. Investors whose rights have been infringed or assets expropriated as a result of state intervention are seeking legal redress. The quest for justice, however, can be prohibitively expensive for some.

The costs of bringing an investor-state arbitration can be significant. According to an OECD report (Government perspectives on investor-state dispute settlement: a progress report, December 2012), parties can expect to spend on average USD 8 million each on pursuing an ICSID claim. For small and mid-size investors in the extractive industries, who may have already spent millions of dollars in upfront costs related to their projects, these costs may be a bar to accessing justice, particularly where company assets have been expropriated. Even for large, well-capitalised companies, the costs and risk of pursuing investor-state arbitration can still be a deterrent. With the third-party funding market now entering maturity and having never been better resourced, claimants are increasingly turning to third-party funding to finance their arbitration costs. According to anecdotal reports, as well as statements by funders, claimants in the majority of all ICSID cases now enquire about third-party funding before lodging a claim.

Third-party funders come in many forms, with not only specialist third-party funding boutiques but increasingly hedge funds, investment banks and law firms, entering the market. A third-party funder will generally cover the claimant’s legal fees and expenses in return for a share of any sum recovered from the settlement or damages award; this means the funder’s investment is repaid only if the claim is successful.

Claimants looking to further hedge their risk may also consider obtaining After The Event (ATE) insurance, which covers their down-side risk of having to pay the state’s costs in the event they lose the case. In yet further innovation in this field, Arbitration Award Default insurance is also becoming more common. Policies will cover the risk of the state defaulting on the arbitral award – the insurer will pay, up to the limit of cover, the amount that the state failed to pay within a certain period of time from the final due date.

Third-party funding, however, it not without potential pitfalls.

  1. There can be significant upfront costs associated with applying for funding. A claimant’s legal team will need to provide information to potential funders to satisfy their (generally detailed) due diligence on both the case merits (jurisdictional and substantive) and likely return on investment. That process alone can be expensive and time consuming, and if a number of funders are approached, the costs are multiplied. Claimants will also need to put in place non-disclosure agreements with all potential funders and carry out due diligence on the funders themselves. These costs will be wasted if the application for funding is rejected.
  2. Where funding is agreed in principle, a claimant’s legal team will then need to negotiate bespoke terms of funding. These need to be carefully considered not only to ensure that the payment terms are commercially viable on various possible alternative outcomes, but also to ensure that the funder is not able to unreasonably terminate the funding arrangement and that the funder’s level of control and input over the running of the claim is appropriate. There will also be ongoing costs of keeping the funders updated about the proceedings as they proceed.
  3. Once a claim has been issued, claimants should expect to have to disclose (at a minimum) the existence of third-party funding and the identity of the third-party funder. Whilst disclosure is not currently mandated under the ICSID Rules, tribunals are likely to order disclosure if it is not volunteered in order to determine whether there is any arbitrator conflict of interest. Claimants have, however, faced wider requests for disclosure, including for the terms of the funding itself and details of arbitration documents disclosed to funders. There are also the related costs associated with dealing with these applications.
  4. Even if disclosure is volunteered, claimants need to bear in mind the strategic implications of disclosing the existence of funding – on the one hand, it can be a positive thing as funders generally will not fund meritless cases, but on the other it may lead to challenges brought by the defendant to the arbitrators on grounds of conflicts and applications for security for costs.
  5. The latter application is a relatively commonplace response where third-party funding is disclosed. Defendants may (often fairly) assume that a third-party funded claimant is impecunious. As costs orders in arbitration generally cannot be made against a third-party funder (given they are not a party to the arbitration), many defendants consider security for costs orders as necessary to ensure that they are not left unable to recover their costs in the event of successfully defending the claim. In ICSID cases, tribunals may require proof of additional elements such as abusive conduct or bad faith, in addition to impecuniosity before ordering security, though the approach varies from case to case. From a claimant’s perspective, there are the legal costs associated with dealing with an application for security to meet, as well as the potentially significant costs of satisfying any order for security if it is made. It may be that the funder is willing to cover these additional costs, but that is not always the case, so it should be considered up front, ideally when agreeing the level and terms of funding.
  6. Finally, claimants should bear in mind that regulation of third party funding (including whether or not it is legal) varies from jurisdiction to jurisdiction, but in general it is a largely unregulated area.In the next blog we will look at the considerations for a defendant facing a funded claim.

Despite the potential downsides, third-party funding and insurance is increasingly used for pursuing high value claims in international arbitration and with funders offering increasingly innovative terms it is certainly something that should be on the agenda when a claimant discusses a potential claim with its legal team.

The Inside Africa team would like to thank India Furse, Associate, for her contribution to this blog post.

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