The ICCA-Queen Mary Task Force on Third-Party Funding in International Arbitration recently released a draft of its report. As the world’s largest provider of finance for commercial litigation and arbitration, Burford offers its perspective on the report which, while doubtless well-meaning, is deeply flawed and presents a serious risk to the competitiveness of arbitration against litigation.
The report proposes to add procedural hurdles that will impose cost and delay compared to commercial litigation. That will further reduce the attractiveness of arbitration—especially as the issues over which the report wrings its hands generally are not issues that national courts perceive as significant. As just one example, widespread litigation funding steams ahead in the English courts, without any sort of disclosure. The Court of Appeal recently noted that “litigation funding is an accepted and judicially sanctioned activity” and in the US the situation is the same.
At the outset, we acknowledge the sheer extent of the Task Force’s effort. Almost 50 Task Force members were involved in a four-year process leading to the draft report. During that time, as the Task Force report notes, the market for third-party funding of arbitration has both grown and evolved, moving from a predominantly single-case funding model in which impecunious claimants sought third-party capital out of necessity into a more varied landscape in which claimants, respondents, law firms and others increasingly utilize external finance in arbitration for a range of reasons and adopting a variety of models.
Unfortunately, therein lies the report’s fundamental problem. The Task Force’s objective at its 2013 creation was to “identify the issues that arise in relation to third-party funding in international arbitration, and to determine what outputs, if any, would be appropriate to address them” (emphasis added). But during the years in which the Task Force conducted its work, the ground it sought to study shifted profoundly. The report thus reads as a relic of another era, when “third-party funding” was something much narrower than it is today. The result is rather like someone spending years earnestly considering typewriter regulation after the invention of the PC.
Many in arbitration still think of “third-party funding” as the payment of the legal fees in a single matter in exchange for a share of the ultimate recovery. But that is just the tip of the iceberg today. Burford committed to $488 million of new arbitration and litigation financing in the first six months of 2017 alone, and less than 10% of those commitments were for single-case funding. Yet the report can’t get away from its focus on the single case, despite proclaiming a broader approach, and its single-case approach does not work in the broader landscape.
The report also discloses significant areas of disagreement among Task Force members, on topics ranging from disclosure and conflicts of interest to even more fundamental matters, such as definitions of various terms. The Task Force deserves praise for its candor in admitting these continued differences in the report itself—but the admissions call into question its fundamental endeavor and ultimately its utility, especially given the presence on the Task Force of a number of members who had made their views and prejudices known previously. The report also suffers from glaring conflicts between its various authors and their commercial interests. A chapter on accessing third-party funding is written by the head of a funding broker, for example, and unsurprisingly repeatedly exhorts the use and advantages of brokers. (The Task Force also declined Burford’s offer to participate in its work, depriving it of the perspective and factual data of the largest player in the space.)
An unworkable definition is fatal to the Task Force’s efforts
The report starts on a promising rhetorical note, by acknowledging that there is much more going on in the world of legal finance than the payment of legal fees for under-capitalized claimants. It also correctly notes the reality that in the same breath as “third-party funding” one needs to address other forms of risk management, like insurance. The Task Force describes its approach as intentionally broad, in order to reflect financing in its “modern” form.
But as the report moves from rhetoric to substance, it fails to arrive at a workable definition of the subject it proposes to study. The reason for this failure is the report’s insistence on using the terminology of law instead of the terminology of capital and finance to define what are unarguably capital flows. By retaining the language of law (cases, costs, claimants, respondents) the report was then left with no option but to try to draw definitional lines using those legal concepts—but those lines lead to nonsensical results. Applying the task force’s definition to the wide variety of current structures in which capital providers are participating in arbitration outcomes leaves some instances of significant economic participation and control outside the definition of “third-party funding,” while sweeping in other instances involving far less participation and control by the third party. Worse still, the report casually includes some newer models, such as portfolio financing, without any consideration of how any of this might work in practice. This is a general issue with the report: stopping at the theoretical and not examining the impact of its theories on real world arrangements.
An example may assist. A law firm offers its services to its clients on a contingent basis and amasses a pool of ongoing contingent arbitration matters. The firm would like to borrow against that pool rather than waiting for the cases all to resolve and pay. In such a financing transaction, the firm will pledge an interest in its future fees as security for the capital provided. The firm’s clients are unaware of the transaction; it is a routine financing matter. The law firm can obtain the capital it seeks from either Burford or a commercial bank, like Citibank. The only difference between the two offerings is that Citi will expect personal guarantees from the firm’s partners if the pool of cases does not provide enough capital for repayment, whereas Burford will limit its recourse to the pool. On this subject, the task force says that its third-party “definition comprehends funding of a portfolio of claims held by business or represented by a law firm, or in financing provided to a law firm and collateralized by funds anticipated to be received from cases represented by that firm”.
Really? Why? No reason is ever given—but when we turn to disclosure, this cavalier inclusion of an entire line of business for both banks and specialty finance providers has far-reaching implications. Indeed, it is preposterous to expect the law firm to tell all of its clients about its internal financing decisions, let alone then to disclose the existence of those financing arrangements to every tribunal involved in every case in which it represents a party. And to what end? So that an arbitrator then can try to determine if she, or anyone in her firm, has ever been involved in any other fashion with Citibank?
The report similarly ignores the substance of funding transactions and focuses instead on their form, with aberrant results. For example, a funding contract to provide financing for an arbitration is third-party funding according to the Task Force’s definition, but an equity investment of the same amount into a vehicle that holds only the claim and will use that capital to pay legal fees is not. Those are functionally and economically equivalent transactions, and it is nonsensical to treat them differently—to say nothing of simply inviting clever deal structuring if the Task Force’s approach becomes de rigeur in the arbitration community.
So, unfortunately, the report begins with a flawed definitional approach, which of course then infects what follows.
The hot issues in arbitration—disclosure and costs
Perhaps the two most discussed issues concerning arbitration finance are costs and disclosure. The Task Force recommends a sensibly light touch as to costs issues—advocating, for example, that applications for security for costs be determined irrespective of the presence of funding.
On the issue of disclosure, however, the Task Force report is murkier in its reasoning. In fact, it presents “alternate options” that reflect disagreement on the issue of disclosure within its ranks and indeed the persistent confusion that exists in certain quarters of the arbitration community. On one side, the report notes, “most” of the Task Force members support mandatory disclosure of the fact of funding and the identity of the funder by the funded party as a matter of course (but without solving the thorny issues raised above). On the other, some members of the Task Force believe it sufficient to confirm the authority of arbitrators and arbitral institutions to request disclosure of such information as needed, without the general presumption of disclosure in every instance.
Again, the Task Force gets credit for honesty, but such an open admission of dissension on such an important topic calls into question its fundamental endeavor.
To be clear: Disclosure in arbitration exists so that arbitrators can check for potential conflicts and thereby preserve the integrity of the award and minimize the risk of post-award challenge. Disclosure has a narrow and limited purpose, and tribunals must be vigilant not to let parties abuse disclosure for their own strategic purposes. When it comes to third-party finance, the drumbeat around disclosure has intensified in recent years despite the paucity of successful challenges to awards based on the lack of disclosure of third-party funding. There is no history of successful challenges to awards based on the failure to disclose the presence of external interests in arbitration. Indeed, a survey of case law reveals not a single instance in the world of any court setting aside or refusing to enforce an arbitral award because of a lack of disclosure of third-party financing.
The report suggests that those on the Task Force advocating mandatory disclosure of funding have purposefully defined “funding” to avoid unfairness (e.g., insurers are included in the definition) and to reflect the reality that funding may be provided as part of a portfolio arrangement. The concept of fairness is welcome, but in simultaneously recommending a flawed definition of “third-party funding” and a disclosure obligation, these members of the Task Force are laying the ground for unneeded cost and delay in arbitration, and therefore a strong disincentive for parties to choose arbitration as a means of dispute resolution from amongst the other available options.
Although there is a lot of funding happening in arbitration, it is dwarfed by the funding activity in litigation. Indeed, court systems have generally accommodated the presence of this important new part of dispute resolution in stride, with much less handwringing and angst than is present today in the arbitration world. The reality is this: Capital is here, clients want it, and it’s time to get on with figuring out how best to use it instead of navel-gazing and academic debate. Otherwise, the arbitration community just hands civil litigation one more reason for clients to back away from arbitration, which already often fails to fulfill its early promise of “better, faster and cheaper.”