The English Commercial Court has now confirmed in two separate decisions that an arbitral tribunal may award a winning claimant its third party funding costs. How significant are these decisions and it is time to rethink the potential reward and risk of international arbitration?

Introduction

The English Commercial Court has now confirmed in two separate decisions that an arbitral tribunal may award a winning claimant its third party funding costs. How significant are these decisions and it is time to rethink the potential reward and risk of international arbitration?

The First Decision – Essar v. Norscot (2016)[1]

This case concerned an ICC arbitration with a seat in England. The tribunal awarded Norscot its funding costs, i.e., the sum that Norscot owed to a third party funder for advancing sums for the purposes of the arbitration.

The tribunal found that provisions in the English Arbitration Act 1996 (including section 59(1)(c) which defines the ‘costs of the arbitration’ to include ‘the legal or other costs of the parties’) and the ICC rules of arbitration (article 31(1) of the applicable rules which defined the ‘costs of the arbitration’ to include the ‘reasonable legal and other costs incurred by the parties for the arbitration’) gave it a wide discretion as to what costs it could award to the winning party. In light of Essar’s conduct, of which the tribunal was critical, these included Norscot’s funding costs as reasonable ‘other costs’.

Essar applied to the English court to set aside the award under section 68 of the English Arbitration Act 1996 on the grounds that the arbitral tribunal exceeded its powers by awarding the funding costs and this constituted a serious irregularity. The English Commercial Court dismissed the application. It found that the tribunal had the power to award funding costs because as a matter of language, context and logic they fell within the definition of ‘other costs’ and the decision whether or not to award such costs then fell within the tribunal’s general costs discretion.

The decision in Essar raised a number of questions regarding the recovery of funding costs in arbitration including: how significant is a party’s conduct to this recovery (for example, does the conduct have to lead to the other party’s impecuniosity?), whether a tribunal may exercise its discretion if the funding was not strictly necessary to bring the claim (for example, where the claimant has sufficient funds to pay its arbitration costs but chooses to obtain third party funding for commercial reasons, such as to ease cash flow or hedge risk) and at what stage the funding should be disclosed.

The ICCA-Queen Mary Report on Third Party Funding in International Arbitration (2018)[2]

This Report was published after Essar v. Norscot and considers many questions relating to third party funding in international arbitration in light of its rapid evolution. The Report notes that there were (in 2018) very few reported cases dealing with the award of funding costs[3] and that, under the majority of arbitration rules, a party may recover costs which it has ‘reasonably’ incurred in the arbitration, with three caveats.[4] First, the tribunal may not in fact have the power under the applicable laws (or rules) to award funding costs. Second, the amount of funding costs must generally be reasonable and this will depend on the circumstances. Third, if a tribunal decides to award funding costs, this should ordinarily be possible only if details of the funding costs are disclosed from the outset of the arbitration or at an early stage because ‘ordering an unsuccessful respondent to pay funding costs constitutes a significant shift in the risk associated with the outcome of the arbitration’.[5]

Disclosure of Funding Arrangements: Revisions to Arbitral Rules

Various arbitral institutions have amended their rules to require parties to disclose the existence of a third party funding arrangement. For example, Article 11(7) of the 2021 ICC Rules requires parties, in the context of assisting arbitrators with their duties regarding conflicts of interests, to ‘promptly inform the Secretariat, the arbitral tribunal and the other parties, of the existence and identity of any non-party which has entered into an arrangement for the funding of claims or defences and under which it has an economic interest in the outcome of the arbitration’.[6]

The Second Decision – Tenke v. Katanga (2021)[7]

In this case, Katanga commenced an arbitration against Tenke in respect of claims arising from contracts[8] for services at a mine in the Democratic Republic of the Congo. The contracts and the arbitration clauses were subject to English law and the arbitration proceeded under ICC arbitration rules with a seat in London. Katanga obtained funding for the arbitration from a related company (Logos Agvet Limited which was controlled by a shareholder of Katanga) on terms which included payment of a success fee. Katanga disclosed the existence of this funding only in the cost submissions stage of the arbitration and sought to recover the success fee as part of its costs in the arbitration.

The tribunal accepted that the funding costs were ‘other costs’ by virtue of section 59(1) of the English Arbitration Act. The tribunal considered whether the funding costs were reasonable because of the inter-company nature of the funding and also as to the amount.[9] It considered that the funding choice was not inherently unreasonable in the circumstances and awarded Katanga its funding costs.

Tenke challenged the award under section 68 of the Arbitration Act 1996 on the grounds of serious irregularity.[10] This included a challenge to the award of funding costs as being an excess of power (section 68(2)(a)).

Tenke made a number of arguments in respect of its challenge to the award of funding costs.[11] These included that, when the Arbitration Act 1996 was passed, it could never have been intended that ‘costs of the arbitration’ or the ‘legal or other costs of the parties’ (as these phrases appear in the Act) would encompass a fee paid to a funder or costs relating to a loan taken out to pay for legal fees; a fee payable to a funder is not recoverable in English court litigation and there is no reason to think that Parliament intended a different rule to apply to arbitration; the decision in Essar was wrong and met with surprise and concern in the field of international arbitration; but the present case was much worse because the funding was not even provided by a regulated third party funder but by a company related to Katanga; there was no finding that Katanga needed the funding to pursue the arbitration; and, if the award was permitted to stand, it would encourage claimants to take out shareholder loans so that shareholders could recover ‘fees’ safe in the knowledge that (unlike third party funders in court litigation) they were beyond the reach of the arbitral tribunal and courts if the claimant did not win the arbitration.

The English Commercial Court was not persuaded. It followed the reasoning in Essar and rejected Tenke’s challenge.[12]

A Rethink of Reward and Risk?

Increasingly claimants are seeking third party funding either so that they have the money to bring the claim in the first place or for other commercial reasons such as hedging risk. Where a specialised funder is concerned, the basic arrangement usually involves the funder providing funding to the claimant for a return, which may be a fixed percentage share of around 30-50% of monies recovered, or a multiple of around two to four of the funding to be provided, or a combination of both. The cost of the third party funding to the claimant can therefore be significant.

In the Tenke and Essar decisions summarised above, the English Commercial Court upheld the award of funding costs by two arbitral tribunals with very different facts. Accordingly, it seems there is an argument, at least in English law and provided the applicable arbitration rules permit it, that a winning claimant may recover from a losing respondent its funding costs as an ‘other cost’ if it can persuade the tribunal that (1) it was reasonable for that party to have recourse to the particular type of funding in the circumstances of the case, and (2) the amount of the funding costs was reasonable.

For the losing respondent, this may constitute a significant and highly unwelcome shift in the risk associated with the outcome of the arbitration in particular if the funding arrangement is disclosed by the claimant only towards the end of the arbitration.

Conclusion

Third party funding is increasingly a feature of international arbitration. As the cases above show, a winning claimant may be awarded its funding costs and a losing respondent may be liable for those funding costs, even if the funding arrangement is not disclosed until late in the arbitration, subject only to a test of reasonableness. The funding costs may be significant. Parties should therefore consider and monitor the possibility of third party funding during the course of any international arbitration.

[1] Essar Oilfields Services Limited v. Norscot Rig Management PVT Limited [2016] EWHC 2361 (Comm). See also the article ‘A Surprise Award of Third Party Funding Costs’ published in our newsletter of February 2017.

[2] International Council for Commercial Arbitration and Queen Mary University of London, ‘Report of the ICCA-Queen Mary Task Force on Third-Party Funding in International Arbitration’, April 2018. This 272-page Report contains a wealth of discussion and information on the subject of third party funding.

[3] Report, p151. In addition to Essar v. Norscot, the Report mentions ICC Case No. 7006, ICSID Case No. ARB/08/2, ICSID Case No. ARB/05/15, and SCC Arbitration No. 24/2007.

[4] Report, p158.

[5] Report, p158 to p159.

[6] See also for example the SIAC Investment Arbitration Rules (2017) which at article 24(l) give the tribunal the power in certain circumstances to ‘order the disclosure of the existence of a Party’s third-party funding arrangement and/or the identity of the third-party funder and, where appropriate, details of the third-party funder’s interest in the outcome of the proceedings, and/or whether or not the third-party funder has committed to undertake adverse costs liability.’ See also the HKIAC Administered Arbitration Rules (2018) which require the Notice of Arbitration and Answer and any Request for Joinder and Answer to include ‘the existence of any funding agreement and the identity of any third party funder …’ (articles 4.3, 5.1, 27.6 and 27.7) and sets out further provisions regarding the notice that is required if a funding agreement is made (article 44).

[7] Tenke Fungurume Mining SA v. Katanga Contracting Services S.A.S. [2021] EWHC 3301 (Comm).

[8] Katanga commenced two arbitrations but these were later consolidated.

[9] [2021] EWHC 3301 at para 68.

[10] Tenke advanced four grounds for its challenge; failure to adjourn the arbitration to allow a visit to the construction site; failure to adjourn the arbitration notwithstanding the illness of its leading counsel, the costs award; and the award of compound interest.

[11] [2021] EWHC 3301 at para 76.

[12] [2021] EWHC 3301 at para 92. The court noted that in light of Willers v Joyce, the court should ‘generally follow a decision of a court of co-ordinate jurisdiction unless there is a powerful reason for not doing so’.  It agreed with the court in Essar that, at its highest, the award of funding costs would be an erroneous exercise of an available power and so not susceptible to challenge under section 68. If there had been an error of law, there was a remedy under section 69, but in the present case that remedy had been excluded by agreement. [2021] EWHC 3301 at para 95.

This article examines the 'subject to contract' label in English law, its use to avoid premature binding agreements, and its interpretation in two recent court cases, highlighting that its effect depends on the specific circumstances.

‘Subject to contract’ in English law

Parties who are negotiating a contract may use the label ‘subject to contract’ to ensure that they do not enter into a binding agreement before they are ready to do so. This can be particularly important in English law when a binding agreement can be reached (with a few exceptions) without any particular formalities. However, the label is not unassailable and whether it has the required effect will always depend on the circumstances.

The English Court of Appeal has explained the meaning of ‘subject to contract’ as follows:

‘What it means is that (a) neither party intends to be bound either in law or in equity unless and until a formal contract is made; and (b) that each party reserves the right to withdraw until such time as a binding contract is made.’[1]

Parties may make their contract negotiations ‘subject to contract’ but then – deliberately or otherwise – waive their reliance on this so that they are bound despite the absence of a formal written agreement. On this, the English Supreme Court has stated:

‘Whether in such a case the parties agree to enter into a binding contract, waiving reliance on the ‘subject to [written] contract’ term or understanding will again depend upon all the circumstances of the case, although the cases show that the court will not lightly so hold.’[2]

In construction contracts, issues may arise where a contract is being negotiated ‘subject to contract’ but work begins before a formal contract is executed. On this, the English Supreme Court has stated:

‘… in a case where a contract is being negotiated subject to contract and work begins before the formal contract is executed, it cannot be said that there will always or even usually be a contract on the terms that were agreed subject to contract. That would be too simplistic and dogmatic an approach. The court should not impose binding contracts on the parties which they have not reached. All will depend upon the circumstances.’[3]

The circumstances were examined in the two cases considered below. As will be seen, in both cases the ‘subject to contract’ protection was ultimately upheld.

Joanne Properties Ltd v Moneything Capital Ltd [2020] EWCA Civ 1541

The Court of Appeal had to decide whether the parties had entered into a binding settlement agreement in written communications passing between their respective solicitors.

The communications reflected negotiations regarding the allocation of proceeds from the sale of land. They were variously headed ‘subject to contract’, ‘without prejudice and subject to contract’ and ‘without prejudice save as to costs’.

Eventually, Moneything sent to Joanne a written document headed ‘subject to contract’ setting out terms for the allocation of these proceeds. Some of these terms had not been previously discussed. Joanne did not reply. Moneything applied to the court for an order in those terms. Joanne replied that there had been no binding settlement because the negotiations had been ‘subject to contract’.

The judge at first instance decided that there had been a binding settlement despite the words ‘subject to contract’. One reason for this was the judge’s view that, although there remained certain administrative matters to be agreed, they were not material for the purposes of the settlement.

The Court of Appeal did not agree. It found that there was no binding settlement. It noted in particular that ‘parties could get rid of the qualification of ‘subject to contract’ only if they both expressly agreed that it should be expunged or if such an agreement was necessarily to be implied’.[4]

The Court of Appeal found that there was no express agreement that the ‘subject to contract’ qualification should be expunged and no reason why such an agreement should be implied. It found that the label ‘subject to contract’ had been used at various stages in the discussions by the parties’ solicitors who must have known the meaning of these words.

The Court of Appeal also considered that the judge at first instance had undervalued the force of the ‘subject to contract’ label; the judge had focused on whether the agreed terms were sufficiently complete to amount to an enforceable contract but this was the wrong question. The correct question was whether the parties intended to enter into a legally binding arrangement at all.

The Court of Appeal concluded ‘As the cases show, where negotiations are carried out ‘subject to contract’, the mere fact that the parties are of one mind is not enough. There must be a formal contract, or a clear factual basis for inferring that the parties must have intended to expunge the qualification. In this case there was neither.’[5]

Aqua Leisure International Limited v Benchmark Leisure Limited [2020] EWHC 3511 (TCC)

The English High Court had to decide (among other things) whether the parties had agreed to enter into a binding settlement agreement without the need for all terms to be reduced to writing.[6]

A dispute had arisen between the parties in respect of the construction of a waterpark and this dispute was the subject of an adjudicator’s award. The sums awarded did not however represent the full amount due to Aqua and so the parties met to discuss settlement of the entirety of their dealings. The settlement discussed would essentially comprise Benchmark making a series of payments to Aqua, the parent company of Benchmark providing a guarantee to Aqua, and Aqua carrying out some warranty work.

After those discussions, Aqua sent Benchmark an email recording a ‘payment resolution’ which was expressed to be ‘without prejudice and subject to contract’. The email ended with the words ‘please confirm your agreement to this settlement by return’. Benchmark replied with the single word ‘agreed’ and Aqua replied ‘meantime we will contact our lawyer to draft the settlement and guarantee wording … which [we] will forward to you as the binding agreement once signed by all the parties’.

Following this, Benchmark paid Aqua certain sums. Some of these payments were made on dates which complied with the ‘payment resolution’ and other payments were made but not on compliant dates. Benchmark did not pay all of the sums set out in the ‘payment resolution’. Aqua started warranty work.

After some, but before all, of these payments had been made, Aqua sent Benchmark a ‘deed of settlement and payment guarantee’ for Benchmark’s ‘review and completion’. In the deed of settlement, Aqua gave Benchmark credit for payments already made.

In the following five months, Aqua chased Benchmark for payment six times. Eventually, Benchmark replied to say that it would not provide a guarantee from its parent company. Benchmark had by that time not paid all of the adjudicator’s decision or all of the sums set out in the ‘payment resolution’.

The question the court had to decide was ‘whether there is a reasonable prospect of establishing at trial that the parties agreed to enter into a binding contract (a new contract) without the need for all terms to be reduced to writing.’[7]

Aqua argued that the compromise agreement was expressly made in the context that it would not become binding until it was reduced to writing (‘subject to contract’). As it was not reduced to writing, it was never binding.

Benchmark argued that the ‘subject to contract’ proviso was waived because both parties ‘obviously considered’ themselves bound by the ‘payment resolution’ and conducted themselves in reliance on that common understanding and their conduct indicated a waiver of the ‘subject to contract’ condition so that a new contract was entered into.

The judge found nothing that allowed him to conclude that a new contract had been made. He found that this was ‘a paradigm example of why the court “will not lightly hold” that negotiations and agreements are “subject to contract” had been superseded’; that the parties had agreed that there would be no binding contract until the terms were reduced to writing and signed off; the presence of an agreement that was acted on was not without more enough to indicate that the parties intended to be bound; and fundamentally ‘everything that happened during the course of the parties’ dealings with one another [including payments being made and work being performed] happened at a time when the ground rules applied [i.e., that the agreement was ‘subject to contract’].’[8]

Accordingly, there was no agreement which barred the right to enforcement of the adjudicator’s award.