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Third-party funding of investor–state disputes: At what cost?

The economic turmoil unleashed by the pandemic is expected to lead to a boom in the number of ISDS claims. Law firms are not the only ones hoping to profit from the surge.

April 16, 2021

7-minute read

As the costs and payouts of international arbitration rise, speculative financiers are attracted to investor–state dispute settlement (ISDS) as a potentially rewarding investment opportunity. Third-party funding is a growing trend in the world of ISDS. Essentially, funders, predominantly hedge funds or finance firms, agree to cover an investor’s litigation fees in exchange for a percentage of the arbitral award, should the tribunal decide in favour of the investor. Repeat funders, such as Burford Capital and Omni Bridgeway, have taken notice of the rapidly increased use of third-party funding. Omni Bridgeway quadrupled its earnings from litigation investments, reporting AU$ 170 million in proceeds from litigation funding in 2020 in comparison to AU$43 million in 2019.

The economic turmoil unleashed by the pandemic is expected to lead to a boom in the number of ISDS claims. Law firms are not the only ones hoping to profit from the surge. Businesses, while reluctant to tie up their own funds in lengthy and expensive arbitration proceedings, are dedicated to finding new ways to restore their profits. As new firms enter the market and existing funders hold more capital, third-party funding provides business with an additional incentive to pursue ISDS claims. According to the international law firm Freshfields, funders are eager to “provide [the] much-needed ammunition to cash-strapped litigants, thereby fueling the waves of litigation,” and profiting from the crisis.

The rising demand for litigation funding in ISDS has triggered considerable debate among supporters and critics of investment arbitration. Proponents of ISDS argue that third-party funding can be advantageous for smaller investors, who would otherwise lack the resources to raise a claim against government. By shifting liability for costs to the funder, they claim, litigation funding removes risks to investors that might impact their financial stability in the future.

However, this argument makes a flawed assumption that funders compensate investors for all arbitration costs. In fact, when investors do not succeed in their ISDS claims, arbitration tribunals will issue a cost order against the claimant, not the funder. For this reason, third-party funding has been described as a “new industry of mercantile adventurers,” who only share in the success of the investment but bear no risks of adverse costs.

There are also heightened concerns about the consequences of litigation funding for the integrity of the ISDS system. Third-party funding has been accused of enhancing the bargaining power of private interests in an already investor-friendly forum. “Such a business plan for a related or professional funder is to embrace the gambler’s Nirvana: Head I win, and Tails I do not lose,” explained arbitrator Gavin Griffith in an arbitration proceeding.

Improper influence over the outcome of proceedings

Historically, common law jurisdictions enforced rules of maintenance and champerty, which barred third parties, with no legitimate interest in the proceedings, from supporting the litigation and collecting a share of proceeds. As courts gradually relegated these doctrines, critics of third-party funding have voiced increased concerns about the influence exercised by funders and their unrestricted impact on decisions to settle, or not settle, ISDS cases.

Based on a search of UNCTAD’S ISDS Navigator, I found 34 cases (26 concluded and eight pending) where third-party funding was a factor in the proceedings or where the claimant voluntarily disclosed they were receiving external funding. Cases where the respondent state received external funding is excluded from this data. Of the 26 concluded funded claims, only 4% resulted in settlements, compared to 20% across the 740 total concluded cases in the UNCTAD dataset.

Opponents of third-party funding of ISDS theorize that funders, who have an interest in maximizing their returns, have a strong interest in seeing the claim through to an award. Although the sample data supports this theory, it does not capture the settlements of disputes that are not publicly known, nor does it reflect funded claims that remain undisclosed. Due to the lack of transparency, it is difficult to conclude whether funded cases settle at different rates than non-funded cases.

Nonetheless, a closer look at funded claims reveals the tension that exists between funders and claimants. For instance, in Siag v Egypt, the claimant, a tourism and hotel management firm, entered into a contingency-fee agreement with their legal representatives at the international law firm King & Spalding, which entitled the lawyers to 20% of the final award. After the tribunal decided in favour of the investor, Siag refused to reimburse the law firm.

When Egypt sought annulment of the award, the claimant, against the advice of their third-party funder, entered into a $80 million settlement with the Egyptian government. In doing so, the claimant escaped obligations under the contingency arrangement with King & Spalding. In response, the law firm initiated a contract-based arbitration against the claimant, which ultimately resulted in a confidential settlement. In a separate arbitration, the claimant was ordered to pay one of his legal advisors nearly US$2 million.

Privilege, secrecy and conflict of interest

Third-party finance is a largely unregulated industry, subject only to voluntary codes of conduct and guidelines. In the absence of prevailing international standards, arbitrators are granted considerable discretion to decide whether or not third-party funding should remain confidential. From the same sample of 34 funded ISDS claims as above, we can see that arbitral tribunals have adopted inconsistent approaches to the disclosure of third-party funding. Again, these are only the publicly-known disputes (pending and concluded) where third-party funding was raised as an issue during the proceedings or where the claimant voluntary disclosed it was receiving external funding.

In a majority of funded claims, such as RSM v Saint Lucia and EuroGas Inc v Slovak Republic, the tribunal merely ordered the claimant to disclose the source of its funding and the identity of the funder, at the request of the respondent state. In both cases the terms of the agreement were deemed irrelevant to the proceedings.

By contrast, the tribunal in Muhammet Cap v Turkmenistan approved the government’s request and ordered the funded claimant to disclose the identity of the third-party funder and, for the first time, the terms of the funding arrangement. The tribunal’s decision emphasized that full disclosure was vital to “the integrity of the proceedings so as to determine whether any of the arbitrators [were] affected by the existence of the third-party funder.”

Full disclosure can therefore prevent inadvertent conflicts of interest that may arise between arbitrators and guard the independence and impartiality of the tribunal. Opponents also vow that third-party funding bars the tribunal from identifying the true party to the case and hinders its ability to fairly decide on the allocation of costs at the end of any arbitration. Most importantly, in communicating the terms of the agreement, the tribunal is better positioned to assess the financial viability of the claimant and their capacity to compensate the respondent state, should the claimant be defeated.

The issue of security for costs

If a claimant is perceived to be nearly insolvent and unable to pay an adverse cost award, the respondent can request a security-for-cost order. If the tribunal approves, the claimant is required to pay a sum of money in advance of the final award, to ensure that the respondent is not left with an unenforceable cost order. However, investment tribunals have been unwilling to issue security-for-cost orders, despite the fact that both the UNCITRAL Arbitration Rules and ICSID Convention authorize the practice.

Much like the ISDS system as a whole, whether or not a tribunal will grant a security-for-cost request remains unpredictable. There are no hard-set rules, no precedence, that might delineate the relevancy of a third-party funder in security-for-cost decisions. Tribunals in EuroGas Inc. v Slovak Republic and Guaracachi Inc. v Bolivia, for example, minimized the role of third-party funding, concluding in their security-for-cost analyses that the presence of a funder cannot, on its own, warrant an order on costs.

Conversely, RSM Production Corporation v. Saint Lucia is the first known case where the claimant was ordered to post security for costs. The decision affirmed that third-party funding is a relevant consideration in determining whether to order security for costs. Gavan Griffith’s assenting reasons assert that, “once it appears there is third party funding of an investor’s claims, the onus is cast on the claimant to…make a case why security for cost orders should not be made.”

The persistent refusal to issue security orders, coupled with limited disclosure of claimants’ financial health, leaves respondents, who often happen to be developing nations, with limited recourse to recoup their arbitration costs. Security for costs, as argued by critics of third-party funding, also acts as a systemic checkpoint to deter frivolous claims and address the obvious asymmetry between funded investors and the state.

Emerging trends in third-party funding

As the risks of litigation funding become increasingly apparent, some states have called on the global community to consider banning the practice, at least until the ISDS system can be reformed to correct its perceived imbalances and biases. Argentina and the United Arab Emirates have gone one step further, banning third-party funding in their 2018 bilateral investment treaty. Countries, such as the United States, who restrict funding of domestic claims, have been criticized for not maintaining the same approach in international arbitration. Opponents of third-party funding argue that, by acting in concert to enforce a global ban, states can minimize risks of alienating foreign investment through unilateral bans.

Regional institutions such as the Hong Kong International Arbitration Centre (HKIAC) and the Singapore International Arbitration Centre (SIAC) are leading the reforms. SIAC rules expressly grant tribunals the power to order the disclosure of the identity of the funder, the details of the funder’s interest in the outcome of the proceedings, and/or whether the funder has agreed to be liable for adverse costs. Likewise, HKIAC amended its rules to make disclosure mandatory at the initial stages of arbitrations or, where the funding arrangement is entered into after the commencement of the arbitration, within 15 days thereafter.

Several recent investment treaties include provisions addressing third-party funding, including the Canada–European Union Comprehensive Economic and Trade Agreement (CETA) and the Canada–Chile Free Trade Agreement (CCFTA). Both agreements introduced disclosure requirements (for the identity and address of the litigation funder), though the CETA Investment Court System is not yet in place, as all EU member countries must first ratify the agreement.

While regional efforts show signs of progress, third-party funding must be tackled on a global scale. The UN’s Working Group III has been tasked with collecting statements from states and to develop standards to abate the structural imbalance in ISDS between states and investors. The group has yet to release guidelines and regulations, but its sessions to date suggest a complete ban on third-party funding is unlikely.

Topics addressed in this article

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