THIRD PARTY FUNDING IN ARBITRATION

Gopika Kalidas, a distinguished graduate from Alliance Law School, Alliance University, Bangalore. Read More

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Overview of Arbitration

Arbitration is a well-known alternative dispute resolution (ADR) procedure in which opposing parties agree to resolve their problems through an arbitral tribunal rather than litigation in national courts.  It is frequently utilized in commercial, investor-state, and international conflicts because of its efficiency, secrecy, and impartiality.  However, arbitration hearings can be costly, requiring large financial resources to fund attorney bills, arbitrators’ salaries, and expert witnesses.

Introduction to Third-Party Funding (TPF)

Third-party funding in arbitration refers to an arrangement where an external entity (the funder) finances the legal costs of a party involved in arbitration in exchange for a share of the potential proceeds if the claim is successful. This form of funding is particularly beneficial for claimants who may have meritorious claims but lack the financial means to pursue them. Third-party funding is a financial arrangement in which an independent third party, unrelated to the dispute, provides financial assistance to one of the parties in exchange for a portion of the award or settlement proceeds. The funder assumes the financial risk, meaning that if the case is unsuccessful, the funder absorbs the loss and does not recover its investment.

The use of TPF has expanded significantly in international arbitration, particularly in investor-state disputes and complex commercial disputes. As a result, it has attracted both interest and scrutiny from arbitration institutions, regulators, and stakeholders.

TPF has made considerable gains in international arbitration, notably in high-value commercial disputes and investor-state arbitrations.  It improves access to justice by allowing parties to pursue claims that they would otherwise be unable to afford.  At the same time, it raises additional issues with transparency, conflicts of interest, and ethical problems.  As a result, some arbitral institutions and countries have moved to regulate TPF to guarantee that processes are transparent and fair.  The increased use of TPF represents a shift in the arbitration landscape, changing how parties finance and approach dispute resolution on a global scale.

Evolution of TPF in Arbitration

TPF in arbitration has changed dramatically over the last several decades, from a specialized financial arrangement to a widely used method in international dispute settlement.  Historically, the concept of external financial assistance for litigation and arbitration was viewed with suspicion due to theories like as champerty and maintenance, which barred third parties from paying legal conflicts for profit.  However, when arbitration became the favoured mechanism for resolving complex commercial and investor-state disputes, the requirement for financial support in high-cost processes drove TPF’s eventual adoption. The turning point occurred in the late twentieth and early twenty-first centuries, when countries such as the United Kingdom, Australia, and the United States began to ease limitations on litigation and arbitration financing, recognizing its importance in enhancing access to justice.

As arbitration expanded internationally, institutional and legislative frameworks began to adjust to the growth of TPF.  Initially, there was minimal regulation, and funders operated essentially uncontrolled.  However, concerns about transparency, conflicts of interest, and ethical considerations prompted more investigation from arbitral institutions and national authorities.  To avoid conflicts of interest and increase impartiality in processes, premier arbitral institutions such as ICSID, SIAC, ICC, and HKIAC have implemented rules mandating disclosure of TPF agreements throughout the last decade. Meanwhile, Singapore and Hong Kong have approved legislation to regulate TPF, enabling it to be used in arbitration but requiring restrictions to guarantee ethical conduct.

Today, TPF is not only generally recognized, but it is also evolving, with novel funding models including portfolio funding, contingency-based financing, and AI-driven case evaluations impacting the future of conflict resolution.  As the need for financial support in arbitration rises, TPF is projected to evolve further, combining economic interests with the requirement for justice and integrity in arbitration.

The Use of TPF

The use of TPF in arbitration has increased dramatically during the last two decades, notably in international commercial and investor-state conflicts.  TPF enables financially limited claimants to pursue viable arbitration claims without incurring the initial expenditures of attorney fees, tribunal expenses, and expert witness fees.  In a TPF agreement, a third-party funder gives financial assistance in exchange for a piece of the final award or a fixed return.  This funding approach is especially beneficial for claimants who lack the wherewithal to participate in lengthy and costly arbitration hearings, therefore levelling the playing field with well-funded replies.

Businesses and investors utilize TPF as a strategic tool in addition to financial support.  Many firms with appropriate resources use TPF to decrease lawsuit risk and allocate cash more efficiently.  Law firms are also increasingly collaborating with funders through portfolio funding agreements, allowing them to handle several cases without financial hardship.  TPF also plays an important role in high-value conflicts such as construction, intellectual property, and energy industry arbitrations, where costs might be prohibitively expensive.

However, despite its benefits, the use of TPF poses legal and ethical questions, notably over transparency, conflicts of interest, and the extent to which donors dominate the arbitration process. As the practice evolves, arbitral institutions and authorities are striving to set more specific standards to combine the benefits of TPF with the requirement for fairness and integrity in arbitration.

Cases Where TPF is Used

TPF is predominantly used in arbitration cases where legal costs are high, and the claim value is substantial. Some common types of cases include:

1. International Commercial Arbitration– Arbitration is a popular method for resolving cross-border disputes among businesses and multinational corporations. TPF enables enterprises to pursue claims against well-resourced opponents without draining financial reserves.
2. Investor-State Dispute Settlement (ISDS)- Investors employ TPF in ISDS lawsuits to bring claims against sovereign nations under investment treaties. Given the high expense of ISDS procedures, the TPF allows investors to file claims against governments for suspected treaty violations.
3. Construction and Infrastructure Disputes– Large infrastructure projects frequently result in arbitration disputes between contractors, subcontractors, and governments. TPF enables construction companies to finance legal claims without disrupting their cash flow.
4. Intellectual Property and Technology Disputes– Companies in the technology and pharmaceutical sectors utilize TPF to pay arbitration claims for patent disputes and licensing agreements.
5. Energy and Natural Resources Disputes– High-value conflicts over oil, gas, and renewable energy projects are common in the energy sector. TPF is regularly used to pay claims against governments or corporate organizations.

 The Process of TPF

The process of obtaining TPF typically involves the following steps:

1. Case Evaluation and Due Diligence

• The claimant delivers the case specifics to the funder.
• The funder evaluates the legal merits, estimated compensation, enforcement of the award, and any dangers.

2. Funding Agreement Negotiation

• If the funder agrees to proceed, both parties discuss financial conditions, including the funder’ portion of the award.
• The agreement also addresses concerns of secrecy, control over legal strategy, and termination provisions.

3. Disbursement of Funds

• The funder covers legal fees, tribunal charges, and arbitration-related expenditures once the agreement is concluded.

4. Arbitration Proceedings and Award Recovery

• If the claimant wins the arbitration case, the funder will get their agreed-upon part of the judgment. If the action is unsuccessful, the funder bears the financial loss.

Advantages of TPF

1. Increased Access to Justice– Many claimants with compelling claims lack the financial capacity to pursue arbitration. TPF enables them to seek legal recourse without incurring upfront costs.
2. Risk Allocation and Financial Flexibility– Arbitration hearings are costly and risky. TPF transfers financial risk from claimants to funders, allowing corporations to focus on core business activities rather than legal expenditures.
3. Enhanced Negotiation and Settlement Power– Well-funded claimants are more likely to decline modest settlement offers from responses. The inclusion of a third-party funder indicates that the claim has been thoroughly reviewed and judged solid, raising the pressure on the opposing party to settle.
4. Validation of Legal Claims– Funders do thorough due investigation before investing in a case, ensuring only credible claims are funded.

 Challenges of TPF

1. High Costs and Reduced Claimant Recovery– Funders often request a considerable portion of the reward, ranging from 20% to 50%. This decreases the amount that the claimant eventually receives.
2. Influence Over Legal Strategy and Settlement Decisions– Certain funders may desire influence over lawsuit strategy and settlement discussions. This might lead to disagreements between the funder and the claimant’s legal team.
3. Conflicts of Interest– Funders may have concealed contacts with arbitrators and opposing parties, leading to doubts about impartiality.
4. Lack of Regulation and Transparency– Many countries lack specific regulations for TPF arbitration. Lack of disclosure requirements raises questions about fairness and openness.
5. Enforcement Risks– Even if a claimant wins, it might be challenging to enforce an award against an unwilling respondent. Before committing to support a lawsuit, funders analyze the enforcement risks.

Legal Issues of TPF

1. Lack of a Uniform Regulatory Framework– One of the most significant legal issues in TPF is the lack of a consistent regulatory framework across countries. Some governments and arbitration organizations, such as Singapore, Hong Kong, and ICSID, have implemented transparency requirements and TPF-specific legislation, whilst others operate completely uncontrolled.  The lack of standardized regulations generates ambiguity for arbitration participants, since funders may have varying legal duties depending on the arbitration seat or the contract’ controlling legislation.
2. Disclosure and Transparency Obligations– A critical legal question in TPF is whether the presence of a third-party funder should be revealed to the opposing party and the arbitral panel. Transparency is crucial for maintaining the impartiality of arbitration processes.  Some claim that reporting TPF agreements helps to avoid conflicts of interest and protects the process’s integrity.  Others argue that compelled disclosure might jeopardize confidentiality and subject claimants to strategic disadvantages.  Arbitral organizations such as ICSID and SIAC have implemented rules requiring disclosure of TPF agreements, although there is no uniform agreement on the level of disclosure necessary.
3. Conflicts of Interest– Conflicts of interest can occur in arbitration when arbitrators have unreported links with third-party donors. Given that many arbitrators are associated with legal firms or investment corporations, there is a possibility that they have financial links or past transactions with a funder engaged in the case.  If such conflicts are not declared, they may result in challenges to the arbitral ruling and raise questions about impartiality.  Some arbitral organizations have attempted to address this issue by asking parties to reveal the identities of their donors so that arbitrators can undertake conflict checks.
4. Control Over Legal Strategy and Proceedings– Another major legal worry is the extent to which third-party funders have control over arbitration procedures. Ideally, claimants should retain complete control over their legal strategy; nonetheless, funders, as financial supporters, may seek to influence important choices such as legal counsel selection, settlement discussions, and even claim withdrawal.  This raises concerns regarding party autonomy and the impartiality of legal counsel.  Some fundraising agreements include stipulations that allow funders to engage in strategic decision-making, which may provide ethical quandaries for attorneys who have a duty of allegiance to their clients rather than external financiers.
5. Confidentiality and Privilege– Arbitration is frequently selected for its confidentiality, although TPF expresses worry over the dissemination of protected information. When claimants seek money, they usually share sensitive legal records and case strategy with potential sponsors.  This raises the issue of whether such conversations are protected by legal privilege.  Some jurisdictions view lawsuit or arbitration funding negotiations as privileged, whereas others do not.  If sensitive material is given without proper legal safeguards, the other party may use it against the claimant, compromising the arbitration’s impartiality.
6. Enforceability of Awards and Security for Costs– In circumstances where claimants get TPF, respondents may allege that they lack financial means and would be unable to pay adverse cost awards if the action is lost. This has resulted in an increased usage of security for costs orders, in which tribunals force supported claimants to give financial security to pay prospective cost liabilities.  However, demanding security for expenses may limit access to justice by putting further financial strain on claimants.  Courts and tribunals must strike a balance between respondents’ interests in collecting costs and claimants’ rights to pursue arbitration without excessive financial impediments.

Ethical Issues of TPF

1. Ethical Duties of Lawyers and Funders– The inclusion of third-party funding creates ethical problems concerning attorneys’ professional responsibilities in arbitration. Lawyers owe their clients an obligation of loyalty, secrecy, and independence.  However, when a funder is involved, attorneys may be pressured to align their advice with the funder’s interests rather than that of the claimant.  This might lead to ethical quandaries, particularly if the funder attempts to influence litigation strategy or settlement decisions that may not be in the claimant’s best interests.  Law companies must manage these ethical problems with caution, ensuring that their primary responsibility remains to the client.
2. Impact on Settlement Decisions– One of the most contentious ethical concerns in TPF is the extent to which donors can influence settlement discussions. Funders have a financial stake in the outcome of the dispute and may favor a settlement that maximizes their profits over one that best satisfies the claimant’s interests.  In other circumstances, claimants may choose to accept a lesser settlement offer for commercial reasons, but funders may object if it does not correspond with their financial goals.  This contradiction raises questions regarding party autonomy and the ethical implications of permitting external funders to direct the path of arbitration.
3. Risk of Frivolous or Unmeritorious Claims– Critics of TPF believe that it may encourage bogus claims by allowing funders to support weak or speculative lawsuits in the hopes of winning a settlement. This might result in a rise in arbitration claims, burdening tribunals and respondents with excessive legal fees.  While funders perform due investigation before investing in a case, there is still a danger that speculative claims may be pursued with the goal of obtaining settlements from defendants who prefer to avoid lengthy arbitration.  To address this risk, several countries have suggested stronger TPF legislation in order to avoid arbitration processes from being abused.
4. Ethical Concerns Related to Profit Motives– A bigger ethical question over TPF is whether it is acceptable for third parties to benefit from legal conflicts. Critics contend that TPF commercializes arbitration, undermining its primary goal of providing justice.  They argue that arbitration should be used to resolve disputes equitably, rather than as an investment tool for financial interests.  On the other hand, proponents of TPF believe that it improves access to justice by allowing claimants to pursue genuine claims that they would not otherwise be able to pay.  The ethical concerns of profit-driven funding continue to be debated in the arbitration community.

Balancing the Benefits and Risks of TPF

While TPF raises serious legal and ethical concerns, it also provides enormous benefits by allowing claimants to seek arbitration.  To balance the benefits and hazards, arbitration institutions, legal practitioners, and regulators must strive for more openness, ethical protections, and equitable regulatory frameworks.

• Mandatory Disclosure Rules: Requiring disclosure of TPF agreements can help to resolve conflicts of interest and enhance openness in arbitration.
• Ethical Guidelines for Lawyers and Funders: Clear ethical guidelines should be created to control the interaction of funders, attorneys, and claimants.
• Settlement Influence Regulation: Steps should be taken to guarantee that claimants have complete autonomy during settlement talks.
• Judicial and Arbitral Oversight: Tribunals should be able to assess TPF agreements and ensure that they do not unfairly affect the arbitration process.

Arbitral Institution’s Approach to TPF

Arbitral institutions have taken various methods to regulating TPF in arbitration, with some mandating disclosure of financing arrangements and others remaining mute on the subject. ICSID has developed one of the most extensive frameworks for TPF.  According to the 2022 Arbitration Rules, parties must reveal the existence of TPF and the identity of the funder at an early stage of the proceedings.  This is intended to increase openness, prevent conflicts of interest, and enable arbitrators to do adequate conflict checks.  Similarly, the Singapore International Arbitration Centre (SIAC) and Hong Kong International Arbitration Centre (HKIAC) have enacted explicit regulations mandating the disclosure of TPF, showing an increasing tendency toward institutional regulation.

Other organizations, such as the International Chamber of Commerce (ICC) and the London Court of International Arbitration (LCIA), have adopted a more flexible approach.  While they do not compel obligatory disclosure, they do urge parties to voluntarily disclose financing arrangements in order to prevent potential ethical issues and procedural problems.  The ICC, for example, has released advice for arbitrators to ask about potential conflicts of interest involving third-party funding, but it stops short of making disclosure a statutory obligation.  The LCIA recognizes the rising prevalence of TPF but has not yet implemented binding disclosure regulations, leaving the matter to be dealt on a case-by-case basis.

Despite disparities in methodology, the overall tendency of arbitral institutions is toward increasing openness and control of TPF.  The dispute over whether obligatory disclosure should be the standard continues, with excessive regulation potentially discouraging funders from backing reasonable claims.  At the same time, concerns about fairness, ethical issues, and conflicts of interest are forcing organizations to establish more specific standards.  As the use of TPF grows, arbitral institutions will likely improve their regulations further, finding a balance between access to justice and protecting the integrity of arbitration processes.

The Trends of TPF

TPF in arbitration is quickly developing, with more funders, claimants, and law firms realizing its strategic significance.  One notable trend is the increasing institutionalization and regulation of TPF, with arbitral organizations like ICSID, SIAC, and HKIAC implementing disclosure rules to improve transparency and prevent conflicts of interest.  Furthermore, nations like as Singapore, Hong Kong, and the European Union have established or are establishing regulatory frameworks for TPF.  As the number of investor-state conflicts and high-value commercial arbitrations grows, funders are getting more sophisticated in their case selection, frequently relying on AI and data analytics to evaluate case merits and enforcement risks.

Another notable tendency is the expansion of TPF outside typical commercial and investor-state conflicts.  TPF was originally utilized for high-stakes commercial cases, but it is now being employed in environmental conflicts, human rights arbitration, and class action arbitrations.  Furthermore, new funding methods are emerging, such as portfolio funding (where funders invest in numerous cases at the same time) and law firm financing, which provides financial support to whole legal teams to handle multiple arbitrations.  These changing tendencies indicate that TPF will continue to change arbitration by enhancing financial flexibility, improving access to justice, and introducing new conflict settlement dynamics.  However, continuous discussions about ethics, disclosure, and regulatory control will be critical to establishing TPF’s future in arbitration.

Conclusion

The growing use of TPF in arbitration has drastically altered the dispute resolution environment by boosting access to justice, lowering financial risks for claimants, and allowing corporations to pursue genuine claims without emptying their resources.  While TPF offers obvious benefits, such as financial flexibility and strategic litigation management, it also raises questions about transparency, conflicts of interest, and ethical quandaries.  The lack of a consistent legislative framework has resulted in discrepancies in how different arbitral institutions and countries address TPF, providing possibility for confusion and potential abuse.  Striking a balance between permitting TPF to assist arbitration and guaranteeing fair and ethical conduct is an issue that must be addressed via ongoing regulatory evolution.

To address these problems, arbitral institutions and legislators may consider enacting uniform required disclosure standards for TPF agreements.  This will provide openness by allowing arbitrators and opposing parties to examine any conflicts of interest while preserving the integrity of arbitration processes.  To maintain party autonomy, clear ethical norms should be in place that outline the amount of funders’ involvement in litigation strategy and settlement decisions.  Another crucial issue that deserves attention is the security of privileged and secret information communicated with funders, which ensures that legal communications are safe and do not prejudice the sponsored party.

Looking ahead, TPF in arbitration is anticipated to experience more regulation, diversity, and innovation in funding arrangements.  As more nations acknowledge the benefits of TPF, they should create balanced legislative frameworks that highlight its good elements while addressing ethical concerns.  Furthermore, the arbitration community must maintain open lines of communication with funders, legal practitioners, and institutions in order to improve best practices.  TPF can continue to play an important role in arbitration while maintaining the integrity of the dispute resolution process by promoting openness, ethical responsibility, and fair financing access.

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