Navigating the Third-Party Funding Conundrum: A Regulatory Blueprint – Part 2
This article has been authored by Arnav Roy & Harshil Shriwas, 3rd year law students at National Law University, Delhi.
Need for Regulation and the Indian scenario
The regulatory models across jurisdictions initiate a debate over the extent of regulation other than the regulatory model to be adopted. This allows a value-judgement to be made in light of the jurisdiction’s arbitral policy, financial framework and economic activity. Further, TPF’s extensive due diligence, monitoring and in depth-assessment provides it a unique position amongst other funding relations such as banking transactions,[26] thus requiring specialised rules catering to the sector.
The foremost and a common occurrence across regulations is capital adequacy of the funder. For instance, capital adequacy requirement under the European Law requires adequate capital to fund all stages under the arbitration and all liabilities which the funder is committed to.[27] The requirement primarily stems from the duty of the funder to bear the cost of proceedings to the extent of funding provided in the agreement.[28]
This also leads to the contested issue of security costs from the funder, if the party itself is likely to be impecunious and hence unable to pay the costs awarded. Tribunals over the years have held in favour of financial aid from funder for security, especially if the claimant is unable to bear even the procedural costs of arbitration.[29] This has naturally led to resistance by the funder due to the additional liability it imposes on the funders.[30] Nonetheless, regulators have reserved the power to order for security from funders,[31] though exercising the power sparingly to allow space for funders, while still ensuring accountability.[32]
The role of Third-Party Funders (TPFs) in such scenarios raises complex legal questions, especially in India where TPFs are not considered as parties to the arbitration.[33] This distinction was notably affirmed in the case of Tomorrow Sales Agency Private Limited vs. SBS Holdings,[34] where the court ruled that third parties, who have not consented to be part of the arbitration proceedings, cannot be legally compelled to pay arbitral awards or provide security for costs. The judicial stance poses challenges, particularly when the funded party is financially incapable of fulfilling such obligations themselves. The current legal framework in India does not hold TPFs accountable for arbitration costs or awards, which potentially undermines the financial safeguards that the security for costs provision aims to provide.[35]
The second, and prominent of the issues caused by the presence of the funder is of the potential conflict of interest. The disclosure of the funder’s identity allows the opposite party a check over any conflict of interest[36] and an opportunity to challenge the appointment of the arbitrator and seek the replacement of the tribunal. This also falls in line with impartiality of arbitrator under domestic provisions.[37] A provision to the contrary, can lead to unnecessary burden upon the opposite party who would not only be subject to procedural unfairness but would also lead to issues in enforcement.
To address this issue, a Task Force of The International Council on Commercial Arbitration (ICCA) and Queen Mary University[38] have recommended that parties or their representatives disclose any TPF arrangements to the arbitral institution. This disclosure should include the identity of the funder and should occur as soon as the funding agreement is made[39] or as early in the arbitration process as possible. Importantly, this disclosure is not considered to fall under legal privilege,[40] emphasizing the importance of transparency over confidentiality in this context.
The extent of this disclosure has been limited to the identity of the funder, primarily to avoid any conflict of interest.[41] The disclosure requirements still vary across jurisdictions such as under the European law which requires complete disclosure of the unredacted copy of the funding agreement to the Tribunal.[42] The measure when compared to similar disclosure requirements is other regulations, seems expansive and arbitrary due to the burden it imposes on the funder, threat it may pose to arbitrator’s assessment of the case and funding agreement’s confidentiality. Nevertheless, complying with the jurisdictional disclosure requirements and assorting to self-disclosure still remains preferable for funders due to the issues of enforcement of award or challenge to tribunal impartiality which may arise at a later stage.
The arguments in the controversial case of SBS Holdings[43] also raised the issue that the funder despite having wide economic interest and obtaining control of the agreement, is not bound by the arbitration agreement and thus fall outside the tribunal’s jurisdiction.[44] On the other end, the funders also need to exercise some control over the dispute to ensure smooth case monitoring and ensure cooperation from the funded party.[45] The issue has led to conflicting opinions in different jurisdictions. While the Courts in U.S. and Australia endorse significant control by the funders ,[46] the English courts have held in favour of the client controlling the case.[47] The approach adopted by the U.S. goes a step further by holding funders exercising significant control as deemed parties to the litigation, thus ensuring accountability on the part of funders.[48]
This also elicits the issue regarding the grounds of termination of the agreement to ensure that the funder does not back-off from its obligations, amidst the arbitral process. The Hong Kong regulations for instance allow termination in case the funder is dissatisfied with the proceedings, the funder anticipates an unfavourable award or in case of a breach of the funding agreement by the funded party.[49] This provides wide powers to the funder to recede from its obligations, thus inviting regulatory action, the feasibility of which in Indian context remains an issue.
Section 42-A of the Arbitration and Conciliation Act[50] mandates that all parties involved in arbitration—including the arbitral institutions and arbitrators—must keep the proceedings confidential, with the exception of awards which may need to be disclosed for enforcement purposes. Further, Section 126 of the Indian Evidence Act of 1872[51] outlines the professional confidentiality obligations of legal practitioners such as barristers, attorneys, pleaders, and vakils. It specifically prohibits these practitioners from disclosing any communications made by their clients or advice given during the course of their professional duties, unless such disclosure is necessary to prevent an illegal act or to expose a crime or fraud that started after their employment began. The statute safeguards the confidentiality of the client-lawyer relationship, including all related information and documents handled during legal proceedings.
Despite these stringent confidentiality measures for legal professionals, the relationship between litigants and Third-Party Funders (TPFs) is not covered under the legal framework. While it is common practice for a party involved in arbitration to share confidential information with a funder, this exchange falls outside the purview of Section 126, since funders are neither recognized as legal advisors or parties to the arbitration nor are parties to the legal proceeding, thus falling outside the purview of both legislations. This creates a significant legal gap, due to lack of confidentiality obligations on the funder.
A Regulatory Framework for India
India finds itself in a unique position owing to the developing arbitral space, the pro-arbitration approach adopted by the courts and the lack of any regulation in the domain. The regulatory approach for India has to be carefully balanced to provide a facilitative framework in the unattractive funding markets of India.[52]
Capital adequacy on part of the funders is necessary as it ensures that the funders are able to meet their contractual obligations at all stages of the proceedings. A requirement necessary to ensure, the arbitral process in not terminated merely due to lack of funds especially in a third-party funded arbitration. The condition for capital adequacy can be closely analyzed with the security requirements.
Security for costs is a measure to ensure that the amount of the award to the successful party is covered.[53] The security costs though expressly provided to not to be furnished by the funder as per the SBS Holdings Case,[54] should be extended to the funder. The argument stems from balancing the benefit reaped by funder with the risks borne by the opposite party, with the exceptional remedy of security costs, which tribunals have been cautious in granting even in cases of impecuniosity of the party.[55] The threshold for security costs considersactors such as concrete risk of default by the party, assets held by the party, the impact of costs on access to justice and the integrity of the proceedings.[56] Similar threshold has been identified by Gary Born, in his work on International Commercial Arbitration.[57] Thus, a framework allowing the tribunal to examine the situation and award for costs would prevent the risk of ‘hit and run arbitration’, while still preventing excessive burden on funder due to the exceptional nature of remedy. Further, the funder through the party should be allowed defenses akin to those for Interim Measures in such awards for security.[58]
The disclosure of the presence of funder presents another important issue for consideration by any regulation. In the Indian context, with nascent litigation funding trend, it would be more appropriate to grant the tribunal the power to call for discovery, similar to the Singapore counterpart.[46] Further, the disclosure of the presence of funder, rather than the agreement itself would serve the cause to prevent any effect on assessment by arbitrator as well as to secure the confidentiality of the funding agreement.[59]
The confidentiality of the proceedings can be ensured by extending the scope of Section 42A of the Arbitration and Conciliation Act[60] to the funders. The provision casts a duty of confidentiality upon the parties and the arbitrator. Ensuring confidentiality while safeguarding the procedure would not result in any harm to the funder.
The direct control of the tribunal or a regulator over the funder would be over-regulation over the funder. Ex-parte order’s against the funder such as in Excalibur Case,[61] would only reduce funder’s confidence in the regulatory machinery. It would be rather preferable to impose statutory obligations upon the funder through a code, the compliance of which can be overseen by the tribunal. Compliance in such cases can be observed by compelling the party to the dispute to ensure action by the funder.
Lastly, the termination of funding agreement should be strictly allowed with respect to the contractual obligation agreed by the funder and the funded party. The authors consider that any guiding regulation such as in the Hong Kong regulations,[62] though widely worded may lead to unnecessary trespass on the independence of parties to formulate contractual clauses. This may result in disincentivizing the funders, in a nascent funding market.
Conclusion
The fast paced emergence of Third-Party Funding in India, warrants necessary regulations to facilitate the development of arbitration in India. The regulatory regime to be adopted has to balance the interests of funders in a growing market, while also taking in account the susceptibilities of the funded party and the opposite party due to the presence of the funders. To achieve such delicate balance, India can resort to statutory obligations on funders through introduction of a code, with the arbitral tribunal overseeing compliance. Even with presence of the code, it would not be advisable to bring funders under direct control of the tribunal but route the compliance through the funded party. The TPF having economic interest in successful resolution of the dispute would be compelled to observe the guidelines without being impleaded as a party to the dispute. The approach would take in account the concern raised by the court in SBS case while also preventing ‘arbitral hit and run’ which can have wide adverse impact on the confidence of parties on arbitration as a process.
Reference:
[26] J Lyon, ‘Revolution in Progress: Third-Party Funding of American Litigation’ (2010) 58 UCLA Law Review 571, 593.
[27] Responsible Private Funding of Litigation, EUR PARL Doc, 2020/2130(INL) (2022).
[28] Arkin v. Borchard Lines Ltd. & ors, [2005] EWCA Civ 655.
[29] Otto Sandrock, ‘The Cautio Judicatum Solvi in Arbitration Proceedings or The Duty of an Alien Claimant to Provide Security for the Costs of the Defendant’ (1997) 14 Journal of International Arbitration 34.
[30] Christopher Bogart, ‘RSM v. St Lucia: Why the Majority got it Wrong on Security for Costs’ (Global Arb Rev, September 2014).
[31] European Commission, Draft of Chapter II (Investment) of the Transatlantic Trade and Investment Partnership (17 September 2015).
[32] Judith Gill and Matthew Hodgson, ‘Costs Awards- Who Pays?’ (2015) 10 Global Arb. Rev. 4.
[33] Tomorrow Sales (n 6).
[34] Ibid.
[35] ICCA & QMUL Task Force on Third-Party Funding, ‘Report of the ICCA-Queen Mary Task Force on Third-Party Funding in International Arbitration’ (ICCA, April 2018) 117.
[36] RSM Production Corporation v Saint Lucia, ICSID Case No ARB/12/10, Decision on Claimant’s Proposal for the Disqualification of Dr Gavan Griffith QC.
[37]Arbitration and Conciliation (Amendment) Act, No. 33 of 2019, §12(4).
[38] ICCA Report, (n 35)
[39] Ibid
[40] Ibid
[41] EuroGas Inc and Belmont Resources Inc v Slovak Republic (ICSID Case No ARB/14/14)
[42] Responsible Funding (n 27), Art. 16.
[43] Tomorrow Sales (n 6).
[44] Edouard Bertrand, ‘The Brave New World of Arbitration: Third-Party Funding’ (2011) 29(3) ASA Bulletin 613.
[45] A Goldsmith and L Melchionda, ‘Third Party Funding in International Arbitration: Everything You Ever Wanted to Know (But Were Afraid to Ask)’ (2012) 53 IBLJ 57.
[46] Cash and Carry Pty Ltd v Fostif Pty Ltd (2006) 229 ALR 58, 88-89 (High Court of Australia).
Abu-Ghazaleh v Chaul 36 So 3d 691, 693 (Fla Dist Ct App 2009) (United States District Court of Appeal of Florida).
[47] Mark Roe, ‘Third Party Funding: An Introduction’ (September 8, 2020)
[48] Visoly v. Security Pacific Credit, 768 So. 2d 482 (Fla. Dist. Ct. App. 2000).
[49] China International Economic and Trade Arbitration Commission (CIETAC) Arbitration Rules 2024.
[50] Arbitration and Conciliation (Amendment) Act, No. 33 of 2019, §42A.
[51] Indian Evidence Act of 1872, § 126
[52] Litigation to Arbitration: Why is India An Unattractive Market for Third-Party Funding? https://www.ndtvprofit.com/law-and-policy/litigation-to-arbitration-why-is-india-an-unattractive-market-for-third-party-funding [accessed 10 May 2024].
[53] Gary B. Born, International Commercial Arbitration (Kluwer Law International, The Hague, Netherlands, 2014) 2495.
[54] Ibid
[55] South American Silver Limited v The Plurinational State of Bolivia (PCA Case No 2013-15), Procedural Order No 10 (11 January 2016) para 59.
[56] Berger B, ‘Arbitration Practice: Security for Costs: Trends and Developments in Swiss Arbitral Case Law’ (2010) 28(1) ASA Bulletin 7-15
[57] Gary Born, (n 53) 1296.
[58] Alison Ross, ‘Burford offers indemnity coverage for adverse costs award’ (Global Arb Rev, October 2015).
[59] Michael Hwang & Andrew Chin, ‘Discovery in Court and Document Production in International Commercial Arbitration—Singapore’ in International Chamber of Commerce, Special Supplements (2006).
[60] Guaracachi America, Inc. & Rurelec PLC v Plurinational State of Bolivia (UNCITRAL, PCA Case No 2011-17).
[61] Arbitration Act, (n 50)
[62] Excalibur Ventures L.L.C. v Texas Keystone Inc & Ors [2015] EWHC 566 (Comm).
[63] Code of Practice for Third Party Funding of Arbitration (2018).