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.

Third party funding is increasingly used in international arbitration even though the cost can be significant. A new case has established that a winning claimant could recover the cost of obtaining third party funding as a cost in the arbitration.

Third party funding is increasingly used by claimants in international arbitration even though the cost can be significant.  To the surprise of many, the English Commercial Court recently held in Essar v. Norscot1  that a winning claimant could recover from the losing respondent the cost of obtaining third party funding as a cost in the arbitration.  So, what exactly is third party funding and what are the implications of Essar v. Norscot for parties involved in international arbitration?

What is third party funding?

Broadly speaking, it is funding provided to a claimant by a non-party to the arbitration to cover the claimant’s legal fees and expenses incurred in the arbitration.

A claimant may seek third party funding out of necessity (if otherwise it cannot afford to bring its claim) or for commercial reasons (for example, to ease cash flow or to lay off risk).

In recent years the third party funding industry has grown and there are now many institutions, including specialised third party funders, banks and insurers, that provide finance to fund arbitration.

Many different types of funding arrangement have evolved. The basic arrangement involves a funder providing cash to a claimant in a one-off case for a return. This is typically a fixed percentage share of around 30-50% of any damages recovered, or a multiple of around three to four of the funding to be provided, or a combination of both. Third party funding therefore comes at a significant cost to the claimant although the funding is not repayable by the claimant if its claim fails.

Funders do not provide funding lightly. They generally conduct extensive due diligence including into (i) the merits of claims that they are asked to fund, (ii) the likelihood (or not) of the respondent being able to pay any damages awarded, and (iii) the possibility of successfully enforcing any award in the claimant’s favour. In view of the risks involved, funders do not generally fund claims where the likely recovery is below €10 million.

Costs awards in international arbitration

To put Essar v. Norscot into context, it is worth recalling the costs awards that may be made in international arbitration.

First, which party pays the costs of the arbitration? This can vary. The arbitral tribunal may direct each party to pay its own costs, or may direct that costs follow the event, i.e., that the losing party should pay or contribute towards the costs of the winning party in bringing (or successfully defending) a claim. A recent report by an ICC Commission on decisions on costs in international arbitration (the ICC Report on Costs) noted “Despite the fact that the ICC and at least half of the other major institutional rules contain no presumption in favour of the recovery of costs by the successful party, it appears that the majority of arbitral tribunals broadly adopt that approach as a starting point, thereafter adjusting the allocation of costs as considered appropriate.”² There is also a range of awards that arbitral tribunals may make in between these two extremes.

Second, what sort of costs are recoverable? This depends on the law of the seat of the arbitration and the rules governing the arbitration but generally they include lawyers’ fees and expenses, expenses relating to witness and expert evidence, arbitrator’s fees and the costs of the arbitral institution such as the ICC, as well as “other costs” incurred by the parties for the arbitration. As will be seen below, the court in Essar v. Norscot found that costs incurred by Norscot to obtain third party funding were “other costs” and that an arbitral tribunal had the power to order Essar to pay them.

The decision in Essar v. Norscot

Facts

Norscot brought an arbitration claim against Essar for repudiatory breach of an operations management agreement. The arbitration proceeded under ICC arbitration rules with a seat in England. Norscot obtained funding from a third-party funder, Woodsford, who advanced Norscot the sum of £647,000 to finance the arbitration. The funding agreement entitled Woodsford, in the event of Norscot succeeding in its claim, to a fee of 300% of the funding or 35% of the recovery, whichever was the higher.³

The arbitrator was highly critical of Essar’s behaviour before and during the arbitration, finding that Essar “had set out to cripple Norscot financially” and that Norscot “had no alternative, but was forced to enter into the [third party] funding” if it was to “secure justice”. The arbitrator accepted expert evidence that Woodsford’s rates were market standard.

The sole arbitrator awarded Norscot damages and costs, including indemnity costs because of Essar’s behaviour, so that, by the time the case came before the court, Essar was liable to Norscot for around US$12 million.

In relation to costs, the sole arbitrator noted that the principal sources of his jurisdiction were (1) the English Arbitration Act 1996 (the Act) including Section 59(1)(c) which defines the “costs of the arbitration” to include “the legal and other costs of the parties”, and (2) the ICC Rules including Article 31(1) which defines the “costs of the arbitration” to include the “reasonable legal and other costs incurred by the parties for the arbitration”.⁴ The sole arbitrator found that the combined effect of the Act and the ICC Rules gave him wide discretion as to what costs he could award to the winning party.

Having found that Essar, by its unreasonable conduct, had forced Norscot into a position where it had no alternative but to obtain third party funding, the arbitrator awarded Norscot around £1.94 million in respect of the Woodsford funding costs as reasonable “other costs”.

Essar applied to the English Commercial Court for the award to be set aside under Section 68(2)(b) of the Act because of “serious irregularity” which arose (Essar argued) because “other costs” in Section 59 did not include the cost of third party funding, so the arbitrator had no power to award them and had exceeded his jurisdiction by doing so.

Findings

His Honour Judge Waksman QC in the Commercial Court:

• Noted by reference to English case law that “serious irregularity” under Section 68(2)(b) of the Act only applies where a tribunal purports to exercise a power which it does not have, not where it erroneously exercises a power that it does have. The court found that the arbitrator had the power to award costs and therefore, even if he was wrong in his construction of “other costs”, there was no serious irregularity within the meaning of Section 68(2)(b).

• Regarded as “highly pertinent” statements in the ICC Report on Costs relating to the recovery of third party funding costs, including:

“The successful party will itself ultimately be out of pocket upon reimbursing such costs to the third party funder and may therefore be entitled to recover its reasonable costs, including what it needs to pay to the third party funder, from the unsuccessful party. The tribunal will need to determine whether these costs were actually incurred and paid or payable. …”

And

“The requirement that the cost be reasonable serves as an important check and balance in protecting against unfair or unequal treatment of the parties in respect of costs, or improper windfalls to third party funders. Tribunals have from time to time dealt with this when assessing the reasonableness of costs in general, sometimes including the success fee in the allocation of costs and sometimes not, depending on their view of the case as a whole.”

• Found that the arbitrator had the power to award third party funding costs because “as a matter of language, context and logic” they fell within the definition of “other costs”. The decision whether or not to award such costs then fell with the arbitrator’s general costs discretion.

• Noted that the arbitrator’s exercise of this discretion was subject to the check and balance of the overall requirement of “reasonableness”. Further, although the exercise of such discretion was not under challenge:

“This was a case, perhaps unusual, where the arbitrator ruled in detailed and robust terms that Essar drove Norscot to this expensive litigation because of its own reprehensible conduct …. Norscot had no option, but to obtain this funding from this third party funder. As a matter of justice, it would seem very odd … if the arbitrator was not entitled under s. 59(1)(c) to include the costs of obtaining third party funding as part of “other costs” where they were so directly and immediately caused by the losing party.”

• Dismissed Essar’s application to set aside the award.

The implications of Essar v. Norscot

• How significant is a party’s conduct?

One of the reasons the arbitrator awarded Norscot its third party funding costs was that Essar’s conduct resulted in Norscot having no choice but to seek third party funding to obtain justice. The court approved this exercise of the arbitrator’s discretion to award costs, even though the exercise of this discretion (as opposed to the power to award such costs in the first place) was not under challenge.

What is now unclear is whether or not an arbitral tribunal may exercise its discretion to award third party funding costs if the funding was not strictly necessary for the claimant to bring the claim. What if a claimant has sufficient funds to pay its arbitration costs but seeks third party funding for commercial reasons? In this situation an arbitral tribunal may find third party funding costs unreasonable and refuse to award them.

• Costs or damages?

There is an argument that third party funding costs should not be claimed as costs at the end of the arbitration but instead as damages to be pleaded and proved in the arbitration itself. This has been the view of a task force of the International Council for Commercial Arbitration and Queen Mary University of London in a draft report issued before Essar v. Norscot.⁵ For third party funding costs to be successfully claimed as damages, a claimant would at a minimum have to (1) disclose the funding arrangement early in the arbitration which may risk an application by the defendant for security for costs (the stage at which Norscot disclosed the existence of its agreement with Woodsford is not stated in the Essar v. Norscot judgment) and (2) successfully show causation and foreseeability. This might be possible if, for example, a claimant can show that it had no choice but to obtain third party funding because of the claimant’s conduct, but if the claimant has chosen to obtain third party funding for other commercial reasons, it may struggle to show causation and foreseeability. In this case, it may wish to rely on the decision in Essar v. Norscot but, as noted above, the precise circumstances in which an arbitrator may exercise discretion to award third party funding costs is unclear.

• Could other forms of funding be recovered as “other costs”?

Depending on the jurisdiction in question, funding such as CFAs⁶ and DBAs⁷ may be available. Does Essar v. Norscot mean that the related costs are recoverable in international arbitrations seated in England as an “other cost”? This would be ironic since Lord Justice Jackson in his review of civil litigation costs in England and Wales found that CFAs were a major contributor to disproportionate costs and recommended that success fees should cease to be recoverable from unsuccessful opponents in civil litigation.⁸

• A warning for respondent parties.

In international arbitration there is currently no general obligation for a funded party to disclose the fact of its funding arrangement to the arbitral tribunal or the opposing party although there are increasing demands for greater transparency in this regard. If the funded party chooses not to disclose the existence of funding during the arbitration but, at the end of the arbitration, claims the funding costs from the respondent as a cost of the arbitration, the respondent will face a significantly larger costs exposure than it may have anticipated. Essar v. Norscot may prompt respondent parties to request early disclosure of third party funding agreements.

Conclusion

The English Commercial Court in Essar v. Norscot held that an arbitrator in an ICC arbitration with a seat in England has the power to award a winning claimant its third party funding costs as a cost of the arbitration. The precise factual circumstances in which the arbitral tribunal may exercise its discretion to award such costs are unclear, but will likely include cases where a tribunal determines such costs to be reasonable and where, because of the respondent’s conduct, the claimant has no choice but to seek third party funding to obtain justice.