THE AUTHOR:
Alain Grec, Director & Co-Founder at Profile Investment
Third-Party Funding in Arbitration: A Series on Key Aspects and Best Practices
– Part 6 –
Discover our in-depth series examining third-party funding (TPF) in arbitration. Each installment sheds light on essential aspects of TPF—from foundational principles to funders’ decision-making and collaboration with legal counsel. Through this series, gain insights into how TPF facilitates access to justice, ensures disciplined budget management, and helps claimants pursue cases with confidence.
When young professionals meet up in the evening to play football, depending on whether there are enough of them for one to act as the referee, two different collective behaviours often appear. On the one hand, in the absence of a referee, most players will tend to play fairly and respect the rules. On the other hand, in the presence of a referee, treacherous and borderline strategies tend to appear more frequently.
These behaviours similarly can be seen in the context of regulation more generally.
Litigation Financing and the Challenges of Regulation
The rise of litigation financing has gone hand in hand with the rise in awareness by corporations that they can transfer legal costs from their books to a third party. Since Third Party Funders (“TPF”) provide financial investment that allows strong cases to be appropriately financed on a non-recourse basis, the parties seeking funding and their legal team naturally expect the Funder to comply with a number of basic requirements. These include competence and experience in legal disputes, reliable capital commitment, transparency as to the governance and provenance of the funds, respect of the principle of legal privilege and conflicts of interest clearance.
The Litigation Financing industry is one of the few in the financial sector that is so closely intertwined with the dispensation of justice, which is governed in legalese and assessed by the application of relevant statutes, acts, regulations and case law. As a result, third party litigation financing requires practitioners to be “bilingual” in asset management mechanisms and legal dispute resolution – this explains why most litigation financers are composed of both financial and legal experts. This unique characteristic of the TPF toolbox for the resolution of disputes explains the particular care of the stakeholders, the regulators, and the institutions to ensure that the deed of justice as such is not impacted. This is indeed of upper importance, but it is worth thinking twice before generating inconsistencies vs the initial objective.
Let’s take some examples:
Conflict of Interest and Disclosure Challenges
Along with the development of TPF, arbitration institutions as well as governmental bodies have tried to define the framework and constraints under which potential negative impacts to the pursuit of justice can be avoided: this is, for example, the looming conflict of interest where a TPF is funding a matter where lawyer X is involved as counsel to the funded party, and at the same time the same TPF is funding another matter where X is appointed as one of the arbitrators, and the TPF in a cynical world making use of its dual relationship with X to influence the second matter.
To avoid such a situation, many arbitral institutions and certain domestic legislations require the disclosure of the presence of a funding agreement as well as the identity of the funder. The problem, however, is that the TPF is not a party to the dispute: only the funded party is bound by this obligation, but it has no knowledge of the other funding agreements of the TPF or any close relationships of its TPF with key stakeholders in the dispute resolution procedure.
Now comes the question of the extent of the disclosure: in its draft regulations, the EU Commission envisages the disclosure of the full content of the funding agreement to the tribunal, possibly including the opposing party. The requirement on one party to disclose their financial arrangement to the court and to the opposing party has been routinely rejected in most jurisdictions and/or arbitration rules. Reference is made here to the legislation in force in Singapore and in Hong Kong about Litigation Financing (Eken C., A detailed comparison of third-party funding regulations in Hong Kong and Singapore, January 2022), and to rules adopted in recent years by various arbitration institutions like SIAC, HKIAC, CIETAC, ICC, VIAC among others.
The direct consequence of these draft EU regulations if enacted unamended is that the tribunal becomes aware of elements reflecting the case assessment of the funder shared with the funded party (e.g. when the remuneration structure reflects quantum thresholds), but also provides the opposing party with elements potentially enabling it to derail the case or to engage in dilatory or guerrilla tactics. In both cases the result is that it jeopardizes the equitable treatment of the parties, and affects the neutrality of the tribunal, two fundamental principles of justice.
ESG Regulations and Their Unintended Effect on Access to Justice
Litigation Financing is one of many asset classes which comprise the vast universe of asset management. In order to direct savings to the financing of environment friendly and sustainability based investments governmental and regulatory bodies do work at dissuading regulated investment funds and asset managers from investing in sectors categorised as potentially harmful to the environment or the climate (regulated marketing guidance, layers of control, labelling etc …): reference is made here for example to EU Sustainable Finance Disclosure Regulation, the EU Taxonomy Regulation; and Environment Social Governance (“ESG”) amendments to the UCITS, AIFMD and MiFID2 rules to stick to Europe. This move particularly noticeable since the Paris agreement on Climate (in force since 4 November 2016) strongly orientates asset management entities towards ESG criteria and makes it increasingly repulsive to involve an investment related even indirectly to industries categorised as adverse to the protection of the planet (i.e. coal industry, oil extraction etc…). See EU rules 2019/2088 (SFDR / Disclosure) and 2020/852 (Taxonomy).
For the sake of illustration let’s take a small size equipment supplier (Party X) that has contracted with a large international Coal mining group (Party Y), incorporating a standard model arbitration clause into their agreement. X alleges that Y causes them harm in breach of certain contractual obligations. However, party X is so financially weakened by the breach that it cannot afford the lawyers, experts, and procedural costs required to seek compensation through arbitration. Unfortunately, owing to the above-mentioned context, a TPF willing to adhere to the market guidelines will reasonably avoid financing the case, even if it is meritorious.
A well-known saying is that the road to hell is paved with good intentions. That is very much the situation described above. The good intention of SFDR, Taxonomy or MIFID2 is to protect sustainability and planet environment. However, the contra-intuitive result is that it provides a veil of impunity where larger entities in the said sectors can take advantage of smaller suppliers without David getting any support against Goliath.
The Misconception of Third-Party Influence in Arbitration
Arbitration institutions and governmental bodies are not all aligned on the need for transparency and disclosure concerning the presence and substance of third-party funding with respect to dispute resolution. In addition, among arbitrators and lawyers, pro and contra considerations are feeding never-ending discussions.
The ICCA-Queen Mary College Task Force on Third-Party Funding In International Arbitration aimed at educating about what TPF is about and which best practices it should induce.
Certain jurisdictions and arbitration institutions have favored the principle of disclosure, implemented in legislations (Singapore, Hong Kong, Australia, Dubai ) and rules of arbitration institutions such as ICSID, ICC or SIAC, among others
Looming there is the idea that hidden finance is potentially dangerous because the terms of the financing may give control of the proceedings to a third party. This is the origin of the old principles of Maintenance and Champerty (England) as well as Retrait litigieux (France).
Here, it is worth spending some time to understand what actually is at stake. The mission entrusted to the tribunal with any commercial dispute, the dispensation of justice, leads to assessing a fair compensation for the damage suffered by a victim of contractual breach(es) to be substantiated and confirmed.
If we just consider the dispensation of justice, it is reasonable for the arbitrators or the judges to worry about potential hidden interests of a third party that may erode or dilute the autonomy and integrity of one of the parties in the commercial terms governing the financing. This is a legitimate and reasonable concern: judges and arbitrators need to receive comfort that the parties before them are not being unreasonably controlled by third parties, whatever they are (TPF or not TPF).
However, once a judge or tribunal is satisfied that the parties before them are free of unreasonable third-party control for the integrity of the dispute, then the fact that one party is backed by the financial means of a third party should have no influence on the arbitrators’ decision in respect of compensation for loss.
Therefore, once the autonomy and the respective parties’ standing are cleared, rendering justice and determining fair compensation is related uniquely to the contractual framework, the factual emergence of the dispute, the legal merits as well as the determination of the substantiated damages deserving compensation, if any.
This is why acting as a judge or as an appointed arbitrator is not only a question of skills but also of rigorous strength of discernment: knowing that one party is financially supported by a TPF should leave no incidence on the definition of the fair compensation due for suffered damages once cleared that the autonomy of the said party is not impacted.
Let’s imagine for the sake of illustration the case of impecunious parties (e.g. insolvent companies under liquidation administration), where the support of an external funder may prove in practice to be the absolute prerequisite for access to justice. Any drifting from the principles presented above, inducing any downsizing of the amounts to be awarded owing to the presence of an external financial support would question the legitimacy of an award or judgment, rendering it susceptible to being challenged or appealed, and before all would harm twice the successful funded claimant, i.e. lower compensation combined with higher costs owing to the fair remuneration under the funding scheme (although adequately defined and invested). Rather, this could even raise the question as to whether part of the external funding cost shouldn’t be considered as an extra and unwarranted burden on the funded party, also deserving compensation.
These are only 3 illustrations among many others of how unfit reasoning can give rise to harmful inconsistencies and unsubstantiated conspiracy theories.
Finding the Right Balance: Market Forces vs. Regulatory Oversight
It rather seems that certain regulatory frames or administrative artifices, are less effective than natural market rules. If a litigation financer attempts to unreasonably control the outcome of proceedings, going beyond the provision of financing based on careful due diligence, it can be expected that this may be reflected accordingly in the related judgement or award. The result is not only painful (direct impact on the return on investment) but also with respect to the investors, the crucial source of equity capital. Market forces would punish the litigation financer who sought to exert more control than could reasonably be expected. Furthermore, TPF practice shows that misalignment between the funded party and the financing entity is never in the effective interest of the funder, as it remains a “third party”.
What is perhaps needed is a more holistic approach for those within the legal profession and the litigation financing to understand the vital and different roles both serve on the legal landscape. For example, on the constant lookout for opportunities to strengthen its position as a world leading dispute resolution hub, Singapore successfully identified the relevant issues and hurdles. It implemented the necessary regulations and guidance to allow the growth and success of third-party funding in the best interests of the litigants in connection with a vast program of education (lawyers, judges and arbitrators, executives in companies) with a view to grow Singapore as a full-fledged hub for international dispute resolution.
A number of jurisdictions would benefit from following Singapore’s model, which set up, in record time, a nearly optimal landscape which the Minister of Law continues to seek to adjust as needed, similarly to the Hong Kong model.
Could that be of inspiration for the EU Commission and regulatory bodies… It rather seems that certain regulatory frames or administrative artifices, are less effective than natural market rules. If a litigation financer attempts to unreasonably control the outcome of proceedings, going beyond the provision of financing based on careful due diligence, it can be expected that this may be reflected accordingly in the related judgement or award. The result is not only painful (direct impact on the return on investment) but also with respect to the investors, the crucial source of equity capital. Market forces would punish the litigation financer who sought to exert more control than could reasonably be expected. Furthermore, TPF practice shows that misalignment between the funded party and the financing entity is never in the effective interest of the funder, as it remains a “third party”.
What is perhaps needed is a more holistic approach for those within the legal profession and the litigation financing to understand the vital and different roles both serve on the legal landscape. For example, on the constant lookout for opportunities to strengthen its position as a world leading dispute resolution hub, Singapore successfully identified the relevant issues and hurdles. It implemented the necessary regulations and guidance to allow the growth and success of third-party funding in the best interests of the litigants in connection with a vast program of education (lawyers, judges and arbitrators, executives in companies) with a view to grow Singapore as a full-fledged hub for international dispute resolution.
A number of jurisdictions would benefit from following Singapore’s model, which set up, in record time, a nearly optimal landscape which the Minister of Law continues to seek to adjust as needed, similarly to the Hong Kong model.
Could that be of inspiration for the EU Commission and regulatory bodies…
ABOUT THE AUTHOR
Alain Grec is Director and Co-Founder of Profile Investment, a company specialized in third party litigation funding (predominantly commercial international arbitration) with more than 15 years of experience under the Luxembourg regulation of Alternative Investment Funds.
Alain is also heading a complementary business line of external assessment and valuation of litigations for companies, investment funds or auditors.
Alain has held various positions within the banking group Natixis, where he was Head of the German branch of Natixis (1994-2002), as well as Head of Development of its Corporate and Investment Financing bank between 2005 and 2009. He has also lectured in various French university courses, symposiums or seminars as they pertain to his specialisms in international arbitration, notably in Montpellier (D.U. Arbitrage).
*The views and opinions expressed by authors are theirs and do not necessarily reflect those of their organizations, employers, or Daily Jus, Jus Mundi, or Jus Connect.
