The Basics, Status Quo and Traversing the Rough Seas – Influence of Third-party Funding on Adverse Costs and Beyond

The Basics, Status Quo and Traversing the Rough Seas – Influence of Third-party Funding on Adverse Costs and Beyond

Authors - Kaushiki Chauhan & Arjun Mahesh Guru

University - National Law University, Delhi

Abstract

This essay delves into the intricacies of third-party funding whilst focusing on its effect on adverse costs and impleaded liability. Third-party funding can be a boon to a party in a dispute who is in dire need of pecuniary infusion so as to allow for a viable dispute settlement in the arbitration realm. However, it can also transform into a bane for the party who chooses to accept such funding. One avenue wherein it can work in the negative is if the funded party fails to succeed in the dispute. Funders only reap monetary benefits of their investment when the party they fund emerge successful in the arbitral proceedings. Sans success, all prospects of a pay-day diminish. Furthermore, instances of funders being impleaded onto proceedings to process adverse costs works against their favour. The personality of a funder is then targeted, for a party who is unfamiliar with the merits and cause of a dispute cannot be held liable. Through analysis of local judicial precedent, the essay further deals with the relationship of a funder vis-à-vis the principles of corporate veil, alter ego, and the nature of non-signatories.

Introduction

Third-party funding (TPF) is a practice in the field of arbitration where a third-party takes on the financial responsibilities of one of the parties involved in the legal proceedings. This arrangement can be a lifeline for parties who are struggling with the substantial costs of arbitration. By shouldering the financial burden, TPF enables these parties to pursue justice without being hindered by daunting legal expenses.

Third-party funders play a crucial role in TPF arrangements. These entities, often equipped with sophisticated evaluation mechanisms, meticulously assess the viability of prospective cases before extending financial support. Typically gravitating towards cases with promising success probabilities and substantial reward potentials, these funders not only provide monetary backing but also furnish strategic counsel and access to a vast network of legal professionals to enhance the chances of success for the funded party. Third-party funders are often interested in investing in cases with a high probability of success and substantial potential awards.  Common across some jurisdictions, funders typically charge a fee based on the amount invested or are entitled to a percentage of the awarded sum. The funder assumes the financial burden of the case and only recovers its investment if the arbitration is successful. Third-party funding also encourages settlement negotiations by giving parties the financial confidence to pursue a claim and potentially increasing the pressure on respondents to settle.

However, amidst the myriad benefits TPF offers, questions arise regarding the potential liabilities of third-party funders, particularly concerning adverse costs. This essay embarks to explore why third-party funders should not be held liable to bear adverse costs in arbitration and even if they are, this liability should not be extended at the enforcement stage. Despite the deterrent nature of adverse costs, imposing this burden on funders poses significant challenges and risks.

The Potential Chilling Effect on Investment

From a bird’s eye view, one of the risks associated with third-party funding is that it can potentially transform arbitration proceedings into business ventures, an unethical practice, as the justice system should not be synonymous with profit-seeking endeavours. Allowing profit-driven entities to finance arbitration claims might result in the commercialization of the arbitral and legal processes. Since the claimant understands that they must ultimately share any successful award with the third-party funder according to the terms of the funding agreement, there may be a temptation to employ all available tactics to maximize the award or settlement amount beyond what they might have been willing to accept without third-party funding. On a similar line of argument, holding third parties liable for adverse costs from the third-party's perspective could transform arbitration proceedings into high-stakes gambling ventures. To bear the costs of an adverse award creates complications for funders, forcing them to weigh the potential financial gains against the risk of adverse costs. This would ideally lead to speculative investments and undermine the integrity of the arbitration process. Such an outcome would erode trust in the fairness and reliability of arbitration as a means of dispute resolution.

In the context of India, the ethical considerations underlying TPF are crucial for maintaining the integrity of the legal system and ensuring fair access to justice. The 1876 Privy Council decision in Ram Coomar Coondoo v. Chunder Canto Mookerjee provides valuable guidance in this regard. The court held that “agreements of this kind ought to be carefully watched, and when found to be extortionate and unconscionable, to be inequitable against the party; or to be made, not with the bona fide object of assisting a claim believed to be just, and of obtaining a reasonable recompense therefore, but for improper objects, as for the purpose of gambling in litigation, or of injuring or oppressing others by abetting and encouraging unrighteous suits, so as to be contrary to public policy, effect ought not to be given to them.”

The pronouncement then underscored the need to balance promoting access to justice through third-party funding with safeguards against unethical behaviour that could infringe upon public policy. This would potentially fall under the purview, and violate the litmus tests, of champerty and maintenance doctrines.

In medieval England, champerty and maintenance were considered illegal activities.Champerty involves an agreement by a third-party to finance a lawsuit in exchange for a share of the proceeds if successful, while maintenance refers to improper support or promotion of litigation by a third-party without any legitimate interest. In India, these activities were not explicitly made offences. While not explicitly outlawed, champerty and maintenance were still relevant in Indian courts for assessing the validity and enforceability of agreements based on public policy and morality. Despite not being criminal offences, they could render agreements void if found to be against public policy.

While Indian courts regularly referred to these principles to evaluate third-party financed litigations, the prevalence of champertous agreements in pre-independence India was hindered by socioeconomic factors and low literacy rates. Despite the clarity provided by judicial precedents on the enforceability of champertous agreements, the law remained silent on regulating such agreements. Even recommendations, such as those from the Civil Justice Committee, focused on providing remedies for victims rather than regulating champerty. Existing laws and decisions primarily addressed enforceability rather than regulation. Per communem scientiam, any agreement aimed at circumventing legal provisions is unlawful and unenforceable. While TPF transactions are not inherently problematic, their champertousnature necessitates careful regulation to ensure fairness and prevent abuse which would be flared up if parties are necessarily made to take on a gamble for the most meritorious case. As societal norms evolve, public policy must adapt to improve the legal framework surrounding TPF transactions.

TPF enables the disputant to pursue the arbitration claim in the arbitration sphere, without which opportunity the disputant would not be able to bring the claim. Having an illegitimate or illegal basis for enabling the disputant to pursue the claim would undermine the mechanism through which this right is pursued. The primary aim of allowing Third-Party Funding in arbitration is to promote access to justice. Imposing adverse costs on third parties would undermine this fundamental objective. If third parties were at risk of bearing adverse costs, potential funders may shy away from financing meritorious cases due to the heightened financial risk involved. This would defeat the purpose of TPF, limiting access to justice for those who need it most.

Consent and Juridical Standing in the Arbitration sphere

In the context of arbitration agreements, consent is paramount. Allowing adverse costs to be imposed on third-parties who have not consented to be bound by the arbitration agreement violates this principle. In India, where arbitration is largely seen to be governed by the principle of party autonomy, extending adverse cost liability to third-parties would be inconsistent with the foundational principles of arbitration law.

In the case of Tomorrow Sales Agency v SBS, the High Court of Delhi made a ruling regarding the liability of a third-party funder in arbitration proceedings. The court held that the funder could not be held responsible for adverse costs because it was not a signatory to the arbitration agreement. The High Court emphasized that enforcing an arbitral award against a non-signatory (the funder) would go against the principles of party autonomy and consent, held fundamental to arbitration. The court stressed that the funder could only be bound by the arbitral award if it had been compelled to arbitrate and was a party to the proceedings and that the court lacked the procedural authority to involve third-parties solely to satisfy a cost award. It noted the absence of an explicit code of conduct for third-party funding in India, contrasting with jurisdictions like the UK, Hong Kong, and Singapore where an express code of conduct for TPF is present.

However, a question to then ponder on is what would be the standing of the bench when the third-party funder is an entity in corporate relation with one of the parties to the arbitral dispute. Would the corporate veil be then dropped, allowing for the principle of alter ego to be applied, thereby impleading the funder as a party to the contract? What then would the standing of the funder at the time of enforcement of the award be?

A third-party funder’s interest is economical, sans legal. While a degree of control may be exercised over the defence or claim post arbitration, economic involvement cannot be construed as, and equated with, consent to arbitrate. A detailed analysis of every case on the basis of facts mandates such requirement owing to the factual settings. Taking after the lex mercatoria principle, scholars in this field are divided into two categories – mercatorists and non-mercatorists – often finding themselves in debate over the position of third-party funders. While both categories of scholars deal individually with the status of non-signatoriesin this regard, the latter aim to operate contractual and non-contractual bases of legality to determine the status. The former on the other hand, work with an informal method reliant on transnational legal principles finding a standing in the independence of their own principle.

In Chloro Controls India Pvt. Ltd. v. Severn Trent Water Purification Inc. and Ors., the apex court in India made a ruling that a party, not a signatory to an arbitration agreement could be subjected to the same in “exceptional cases”. The context here involved dispute/s when transactions arbitrated upon were with a Group of Companies wherein there existed a clear intention to bind the said non-signatories to the arbitration agreement and subsequent proceedings. Moreover, the relationship must be such that there must be a “direct commonality of the subject matter and the agreement between parties” must be “a composite transaction”. The Queen Mary Task Force on Third-Party Funding in International Arbitration opined on the unlikelihood of third-party funding in arbitration to mutually co-exist with theories revolving around non-signatories. As established, consent is a primary condition for an arbitration in the positive sense. By virtue of third-party funders maintaining their distance from the commercial relationship of the parties and limiting it to foreseeing and expecting a financial/economic advantage from the proceeding/s, an absence in involvement of the performance of the underlying contract subsists. While on the off chance, third-party funders involve themselves in the proceedings, such involvement cannot be misconstrued to establish implied consent. Consent by conduct to the arbitration agreement herein must be express. It is also a matter of public policy, for when there exists an alarming level of control over the funded claim, the agreement of funding may be struck down on considerations of policy. Party autonomy and consent apply even to the agreement between the funder and the funded party. While it is natural for a third-party to have an interest in the proceedings allowing for a lucrative pay-day around the corner, a funder (on the off-chance) who exercises full control over the arbitral proceedings may qualify to be liable to be joined and directly liable for adverse costs.

However, successful resolution of the arbitral proceedings only guarantees a return on investment by the third-party and does not bring parity between the party/ies to the dispute, and the funder. Albeit situations that involve joinders, rules across jurisdictions mandate the existence of a prima facie establishment of binding the underlying arbitration agreement to include the funder and the parties. More so, under Indian law, ad-hoc arbitrations do not as yet provide for parties to apply for joinders in such situations. The trajectory in the domestic market is therefore yet to be seen and what may or may not lie ahead rests with the bench.