Posted on Apr 08, 2013
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Third party funding in international investment arbitration
Concerns about Third Party Funding (TPF) have been the subject of much attention recently. Without subtracting from the merits of TPF, a frank consideration of the pitfalls and risks faced by users of TPF in investment-arbitration is long overdue.
Acknowledging the complex nature of third party funding, Khouri, Hurford and Bowman in a recent article provide a ready definition of the phenomenon:
"Third party funding arrangements for high value claims do not conform to a template. … However, in general terms, third party funding involves a commercial funder agreeing to pay some or all of the claimant´s legal fees and expenses associated with a dispute in return for reimbursement of the funder´s direct outlays and a share of any sum recovered from the resolution of the claim ..."
Until recently TPF was prohibited in the common law system and it is in fact still punishable in some jurisdictions. "Maintenance, champerty and barratry", three forms of TPF of litigation, were outlawed because they were deemed to increase litigiousness. It indeed follows that more cases would make it to court with the aid of a third party funder, than if claimants themselves had to finance cases upfront.
In recent years international and investment arbitration has emerged as an attractive new area for TPF, because of the enormous amounts involved in these kinds of disputes. A steady increase in the participation of TPF in recent investment arbitration disputes has indeed also been registered. S & T Oil Equipment and Machinery vs Romania; Abaclat vs Argentina; Teinver vs Argentina; Fuchs vs Georgia; Kardassopoulos vs Georgia; and Cristallex vs Venezuela are but only an illustrative list of disputes heard before ICSID that were all funded by third parties.
TPF in international investment arbitration presents problems similar to those in other litigation areas. Some of the main pitfalls are listed below: Excessive charges: the excessive cost funders charge for accepting the risk of funding litigation precludes many companies from engaging a third party funder in arbitration. Funders recognize charging users between 40 to 60 cents of a dollar for every dollar at stake. Attorney–client relationship: the funder potentially has the power to choose the lawyer. Indeed the funder also has the leverage to become an important provider of work, attracting the favor of lawyers and undermining attorney loyality to a client. In addition, funders present themselves as efficient administrators, not only by choosing skillful lawyers but also by purporting to monitor and keep strict control of lawyers’ work and fees. The latter could encourage companies (and potentially also States) to pay a risk premium rather than to commit their own funds to finance a dispute. Taken to its logical conclusion, this could lead to counsel being chosen by a group of financiers, which has perverse implications for the legal profession. Veto power in settlement transactions: funders have influence on settlement transactions which may prevent the amicable settlements between the Parties. Since funders need to recover their investment and obtain a profit, a settlement can be thwarted by the TPF if there is insufficient room for them to be wholly compensated. The power of funders to oppose a settlement exclusively based on economic considerations is a concern that transcends arbitration and supports the argument of critics that TPF may encourage litigation.
In addition, two structural elements are unique to international investment arbitration: Challenges to enact legislation to regulate lawyers practicing in different jurisdictions: The international character of investment arbitration and the spread of regulatory power add another dilemma. As lawyers of different nationalities are involved in these disputes, multiple national bar institutions are responsible for the regulation of professional ethics. While the intervention of these bar associations theoretically implies more complete control and surveillance of attorneys' professional duties, in reality exactly the opposite is achieved, with the concurrent powers of different professional bodies in different jurisdictions resulting in a lack of control and regulation. Tribunals are now more frequently invoking the inherent powers doctrine in matters that go beyond the dispute between the parties. They have become concerned with possible conflicts of interest and other ethical problems affecting the Parties in dispute or their counsels. Possible opposition from sovereign States to funders' enjoying benefits accorded to investors under Bilateral Investment Treaties (BITs): the attitude of States towards TPF participation in investment disputes is as yet untested. It can be envisaged not to be a positive one, judging from States´ reactions to speculative transactions in the areas of investment arbitration and Sovereign litigation. Argentina, without specifically referring to the effects of TPF, has expressed its discontent with the speculative nature of those who indirectly benefit from the rights granted under BITs to foreign investors. If those admonishing words had been expressed regarding hedge funds that acquired a rendered award to profit from a possible compensation payment, the approach cannot be expected to be different to disputes which are brought – in whole or in part – by funds that also benefit from the outcome of these cases.
TPF has emerged as a matter of growing prominence in the international investment arbitration environment. The stakes are high, with mult-million dollar amounts involved in these types of disputes. Indeed, there is compelling need for TPF to be subject to closer regulation, including by arbitral tribunals under the inherent powers doctrine. In the absence of a formal regulatory framework to give more effective direction to TPF it can be expected that tribunals will increasingly intervene directly to address potential conflicts of interest and other ethical red herrings involving TPF that emerge in investment disputes.
This discussion note is based on Ignacio Torterola, "Third Party Funding in International Investment Arbitration".
All opinions expressed here are Mr Torterola's own and should not be attributed to Foley Hoag LLP or the Government of Argentina.
See also IPFSD clauses:
6.2 Investor-State dispute settlement