ANTONIO:

Shylock, although I neither lend nor borrow

Sy taking nor by giving of excess,

I’ll break a custom. Is he yet possess’d

How much ye would?

SHYLOCK:

Ay, ay, three thousand ducats.

ANTONIO:

And for three months.

SHYLOCK:

I had forgot; three months; you told me so.

Well then, your bond; and let me see; but hear you;

Methought you said you neither lend nor borrow

Upon advantage.^**

5.01  Throughout much of history, money lending was considered immoral. Money lending to facilitate a lawsuit was simply unthinkable. In the search for justice and truth, it was believed that opposing parties should be assisted by professional counsel and funded by their own personal assets.¹ The process, in other words, should be untainted by business incentives. Under this view, claim funding by a party who has no relationship to the dispute is at best an unwanted intrusion and at worst a corruption or commodification of justice.²

5.02  Even committed, modern capitalists seem ill-at-ease with third-party funding. As one reporter from Forbes magazine wrote: ‘Dress it up as you like, there’s something about all this secret meddling in other people’s bitterest disputes and profiting from them that doesn’t sit well.’³ There is, in the words of one commentator, something ‘fishy’, an ‘ick factor’, to third-party funding (p. 178) that does not fit with our conventional views about justice and adjudication.⁴ For these reasons, third-party funders are often described in unflattering terms, such as ‘vulture investors’,⁵ ‘Oz-like’ controllers of the arbitral process ‘from behind a curtain’,⁶ gamblers,⁷ or loan sharks.⁸

5.03  Just as Antonio in The Merchant of Venice reconsidered his aversion to lending and borrowing, however, numerous jurisdictions are also reconsidering historic prohibitions against litigation financing. Several factors account for this trend. At the most fundamental level, as the cost of pursuing claims has become prohibitively expensive in some systems, funding from third parties has become a means of facilitating access to justice that would otherwise be out of reach.⁹ Beyond hapless individuals who cannot pursue personal claims, commercial entities are also increasingly reluctant to tie up precious capital to pursue a claim that may or may not prevail when money can otherwise be invested in other business activities.

5.04  More generally, third-party funding is expanding as part and parcel of a more global and systemic deregulation of the legal profession. To comply with obligations under the General Agreement on Trade in Services (GATS), various national reforms have been allowing lawyers greater flexibility.¹⁰ Deregulation in some jurisdictions has fuelled pressure in other jurisdictions to similarly liberalize so that their firms can perform effectively on the world stage.

5.05  As part of these efforts, some jurisdictions have begun expressly permitting law firms to operate in ‘multi-disciplinary practices’ (MDPs) or Incorporated Legal Practices (IPLs, as they are known in Australia), most typified by the large accounting firms. Consistent with permitting collaboration with non-lawyers in these organizations, Australia and the United Kingdom now also expressly authorize public trading of financial interests in law firms.¹¹(p. 179)

5.06  The cumulative effect of trade liberalization in legal services has been more express discussion and treatment of legal services as an economic venture, not only a sacrosanct ‘profession’ that serves, but stands apart from, the marketplace.¹² With the breakdown of the often-artificial line between what constitutes the ‘practice of law’ and law-related business services, it has become easier and more palatable to view legal claims as ‘assets’. Contractual relationships that allow investment in legal claims, under this view, seem less objectionable.¹³ Inter-jurisdictional competition that had spurred law firms to press for breaking down prohibitions that still exist in some jurisdictions on lawyer–non-lawyer affiliations, now increasingly focuses on historical restrictions on third-party funding.¹⁴

5.07  In addition to trends within the legal profession, market forces have also contributed to increase both demand for and interest in dispute financing. The economic downturn in 2008 pushed many companies into economic dire straits, if not the threat of bankruptcy. They needed to maximize assets, including legal claims, while maintaining cash flows.¹⁵ Meanwhile, various economic investment firms are seeking ‘investments that are not directly tied to or affected by the volatile and unpredictable financial markets’.¹⁶ At a time when traditional financial markets have proven unstable and returns are down, claim funding is bragging about enviable rates of return. Third-party funders aim for a ‘three times’ return, meaning a return of every dollar invested plus two more dollars.¹⁷ When variables in outcomes are taken into account, funders claim upwards of a 100% total return over a five- to six-year period for their investment portfolios.¹⁸

5.08  For all these reasons, it is perhaps no small wonder that several jurisdictions now allow the practice. The United Kingdom and Australia expressly allow, and even glorify, third-party funding.¹⁹ Meanwhile, in all civil jurisdictions in Europe, with the exceptions of Greece and (p. 180) Portugal, third-party funding is legal. In certain jurisdictions, like Germany, Switzerland, and the Netherlands, the practice is thriving.²⁰

5.09  An increasing number of firms in these jurisdictions are using, or are contemplating using, third-party funding for international arbitration cases, which creates competitive pressures for their rival firms based in jurisdictions like the United States, where it is still largely prohibited.²¹ Even jurisdictions such as Singapore, which have been staunchly prohibitive of third-party funding, may be feeling pressure to create special carve-outs for international arbitration.²²

5.10  Reciprocal to these various trends, international arbitration is proving to have an irresistible allure for third-party funders. International arbitration cases are particularly attractive because of the prevalence of high-value claims,²³ the speed of proceedings,²⁴ the potential for reduced evidentiary costs and streamlined procedures, the ability to control variables such (p. 181) as expertise of the decision-maker, and the highly enforceable nature of arbitral awards.²⁵ Icky or not, therefore, third-party funding is now a global phenomenon and seems to be a permanent fixture in international arbitration.

5.11  The arrival of third-party funding affects all participants in international arbitration, and those effects are certain to increase over time. Parties who do not directly engage third-party funders will find themselves opposing other parties who have engaged them. Law firms that do not coordinate with funders will likewise have opposing counsel who are coordinating with them. All law firms will be competing in a marketplace in which millions and millions of dollars in law firm earnings come from funders and an increasingly large number of firms work with funders.

5.12  Arbitrators, meanwhile, may hope to remain unaffected by parties’ funding arrangements. They will inevitably, however, be called on to rule on costs issues that can be affected by the presence of funders, and potentially other rights of parties and obligations of counsel in light of funder participation. Moreover, the involvement of funders in the arbitrator selection process or other aspects of a funded party’s case strategy will raise the potential for arbitrator conflicts of interest.

5.13  Arbitral institutions might prefer to consider these matters outside their purview, but they too will be affected. In light of the possibility of funding future disputes, savvy parties may well start incorporating provisions regarding the participation of funders into their arbitration agreements. Such agreements might impose duties of confidentiality that effectively preclude disclosure necessary to engage a third-party funder, disclosure of the presence of a third-party funder in any future case, or obligations regarding costs in the event of participation by a funder.

5.14  One special category of arbitration cases that has attracted particular attention by both funders and their critics is investment arbitration. Funders are interested in these cases because of the potential for massive recoveries. Critics are concerned, however, that significant new funding in investment arbitration cases will aggravate an already exploding caseload that creates a disproportionate burden on States.²⁶ Funders can, theoretically, provide support either for claimants or responding parties.²⁷ Funding claimants, however, provides much greater upside than funding responding parties. In fact, despite the possibility of funding for responding parties, anecdotal research suggests that such respondent-side funding has not yet occurred in investment arbitration, apart from the interest group funding in the Philip Morris case. Against this backdrop, the arrival of third-party funders has the potential to alter the entire landscape by significantly increasing the number of claims. Investors may now obtain financing to seek relief for claims they might otherwise not have pursued. The (p. 182) resulting concern is that third-party funding will further distort perceived disparities in investment arbitration that favour investors over States.²⁸

5.15  Third-party funders are not as yet systematically present in arbitration cases to the same extent as attorneys, arbitrators, experts, or arbitral institutions. Their increasing presence, however, raises a host of legal and ethical questions that can affect all these actors, as well as the larger framework of the international arbitral regime. Their interaction with the ethical obligations of these various actors also highlights that third-party funders appear to be the group most distinctively untethered from any formal professional regulation.

5.16  While even most funders apparently agree that the industry cannot remain completely unregulated,²⁹ to date there is no clear sense of what could or should be done. This chapter lays groundwork for the international arbitration community to develop that sense, and from there build a meaningful regime for regulating third-party funder participation in international arbitration.³⁰

5.17  The chapter begins in Section A by providing an overview of the mechanics of third-party funding; Section B examines ethical issues that third-party funding raises for attorneys representing parties who receive funding, and explores the implications of third-party funding on arbitrator disclosure obligations. Finally, Section C examines initial efforts at self-regulation for third-party funders and contemplates future directions for third-party funding.

5.18  Globally, dozens of prominent institutions now fund legal claims.³¹ Included among them are not only specialized litigation funding firms, but also insurance companies, investment banks, and hedge funds that all compete in the same market. Collectively, these funders are capitalized well into the billions. Even just among international arbitration cases, funding is flourishing.³² Funders are reporting that upwards of 10% of their investments are in international arbitration disputes,³³ both commercial and investment arbitration.

5.19  This Section examines the nature of third-party funding, offering a working definition in Subsection 1. Subsection 2 then describes the mechanics of third-party funding as (p. 183) background to discussion in Section B of the various professional and ethical issues implicated by third-party funding.

5.20  Despite increasing recent activity, our view of third-party funders remains hazy. Funders generally treat their investment portfolios as proprietary information,³⁴ most funding agreements are secret, and funders’ presence in legal disputes is usually undisclosed.³⁵ In a few international arbitration cases, the presence of third-party funding has become public. Apparently only in two cases, however, was disclosure by design.³⁶ In other cases, disclosure has been the result of disputes between the funder and the funded party and/or its counsel.³⁷ As a relatively new practice that operates in the shadows of an active case, the basic operational mechanics of third-party funding are not well known or well understood.

5.21  Perhaps because of this opacity, significant disagreement exists about the exact nature of third-party funding and, consequently, whether and how it should be regulated. As with any new phenomenon, the inclination is to search for similar activities as points of reference. Several possible analogues have been suggested: ‘Is this new form of economic activity best understood as an ordinary commercial lending contract, a form of insurance, a commercial joint venture, venture-capital financing, or an alternative lawyer-client fee arrangement?’³⁸ With no clear answer in sight, even funders themselves apparently disagree over the definition of exactly what they are.³⁹

5.22  One reason why third-party funding is difficult to define is that economic interests in a party or a dispute can come in many shapes and sizes.⁴⁰ Arrangements may be structured as (p. 184) debt instruments, equity instruments, risk-avoidance instruments, or as full transfers of the underlying claims. Some agreements permit or require active participation of the third-party funder in key strategic decisions in the case, while other agreements are limited to periodic updates.

5.23  Conventional definitions are limited to agreements entered into after a dispute has arisen, but they can be entered into either before or after the case is filed. Moreover, many funding arrangements are not necessarily entered into between the principal funder and the party. Funders often create ‘special purpose vehicles’ that are separate corporate structures from the funders themselves to facilitate the funding arrangement.⁴¹ In some situations, funders may provide financing directly to law firms. In addition to variations in structure, the conditions for funding and for recovery by a third-party funder also vary significantly. A typical agreement provides for funders to receive a percentage of recovery, and the percentage increases with the passage of time since the initial investment.

5.24  Even when funding agreements are entered into directly between a client and the funder, it is not simply a bilateral relationship. The funding arrangement involves a symbiotic relationship with the party’s law firm.⁴² Law firms encourage, facilitate, and more often than not initiate parties’ application for third-party funding to cover their fees or reduce their own risk if the case involves contingency fees. Informal agreements, with various degrees of specificity, often exist between funders and law firms. These agreements, as well as the primary funding agreements with parties, may involve specified reductions in a law firm’s contingency fee or hourly rates; they may establish flat fee billing or some hybrid fee structure.⁴³

5.25  Although most third-party funding arrangements are entered into for profit, that is not always the case. For example, in the investment arbitration case brought by Philip Morris (p. 185) against Uruguay, The Bloomberg Foundation and its ‘Campaign for Tobacco-Free Kids’ provided outside financial support for the Uruguayan government.⁴⁴ Although technically within the definition of third-party funding, this arrangement seems to have much more in common with pro-bono support for legal causes than legal profiteering usually associated with the term ‘third-party funding’.

5.26  Despite the myriad possibilities, and potential that additional variations will develop and flourish, to date one model largely predominates in international arbitration.⁴⁵ This relatively fixed model allows for a working definition of third-party funding for the purposes of this chapter. In the context of this discussion, third-party funding is defined as the financing of an arbitration by a party who has no pre-existing interest in the dispute, on the basis that, if the funded party is successful in the dispute, the funder will be paid out of the proceeds of any amounts recovered as a consequence of the dispute.⁴⁶ Ultimately, this definition may be too narrow to capture the full range of relevant agreements, but it is a helpful model for analysing the relevant legal issues.

5.27  As noted in the introduction, one potential benefit third-party funders bring to dispute settlement is an ability to engage in a disinterested, dispassionate assessment of claims. This differentiates them from both the client and its attorney. A client, no matter how sophisticated, is inevitably influenced in its claim assessment by its own business incentives and perceptions about the facts underlying the claim. The objectivity of a party’s lawyers is not necessarily free from obstruction either. Their role as advocates and obligation of loyalty, as well as their own potential to earn hourly fees from the case, makes it difficult for them to assess claims from a wholly independent perspective. Funders, by contrast, have both structural detachment and financial incentives to engage in a uniquely exacting, independent, and fine-tuned assessment of the case.(p. 186)

5.28  Top funders report an average review-acceptance rate of 10-1, meaning that for every 10 cases reviewed, they only agree to fund one case.⁴⁷ In deciding whether to accept a case, they assess its legal, factual, practical, and (sometimes) political variables to determine risks, likelihood of success, and potential rate of return. In making this assessment, funders are not only free from many of the pressures that can cloud a party’s or law firm’s assessment of the same claim. They are also subject to pressures from shareholders to pick claims that are likely to deliver high rates of return.

5.29  In assessing claims, funders bring a level of sophistication and precision that is almost shockingly unknown and unmanageable by even large, sophisticated multi-national companies and the world’s most sophisticated law firms.⁴⁸ Third-party funders create a risk-assessment model or matrix that takes into account the percentage likelihood of different outcomes in light of specific factors, such as the jurisdiction of the claim, strength of the claimant’s legal arguments, strength of facts supporting the arguments, extent of loss flowing directly from the respondent’s conduct, a claimant’s motivation, commitment and honesty, the experience of the claimant’s legal team, the respondent’s ability/likelihood to pay, reasonable duration to obtain an award, and costs of bringing the claim.⁴⁹

5.30  Data for the matrix is obtained through meticulous due diligence by the funder, its legal team, and accountants. The analysis entails inquiries of the claimant’s lawyers regarding timing and evidentiary issues, and compilation and assessment of all material documents. As discussed in greater detail later, these material documents may include confidential information. Based on this matrix, the funder determines the likelihood of estimated returns on investment over a period of years, which will be weighed against other investments in the funder’s overall portfolio.

5.31  Given their precision in assessing cases, verified by impressive rates of return, third-party funders seem to be a type of ‘super-lawyer’. Most funders, however, would reject this appellation. Funding agreements expressly and repeatedly disclaim that the funder is providing legal services or that the agreement creates an attorney-client relationship.⁵⁰ There are numerous reasons for funders’ resistance to lawyer status, but the gap between super-lawyer and non-lawyer highlights some structural questions about exactly how third-party funders operate.

5.32  In its ‘super-lawyering’ assessment of the case, the funder makes assumptions about particular legal arguments or positions, as well as particular characteristics about the potential arbitrators or experts.⁵¹ After all that effort, a funder seems unlikely to remain passive if a client’s counsel were to adopt strategies at odds with these assumptions. There must, in other words, be an overwhelming interest in debating or at least sharing a funder’s analysis of the case with the party or its counsel, or both. The problem is that, in some jurisdictions, most particularly the United States,⁵² sharing or providing such advice would be considered the illicit practice of law by a non-attorney.(p. 187)

5.33  Despite their efforts, various concerns about funders teeter on this thin and sometimes wobbly line between super-attorney and non-attorney.⁵³ Funding agreements expressly deny the existence of an attorney-client relationship at a structural level. But express denial does not necessarily negate the creation of a de facto attorney-client relationship. The premier litigation funders are founded and staffed by lawyers who, as noted, engage in exacting analysis of the funded cases. If an attorney is providing substantive legal advice about critical strategy issues to a party and the party is expressly acting on that advice,⁵⁴ it is strained and formalistic to say no legal services are being provided simply because of a repeated incantation to that effect.⁵⁵

5.34  Funders seek to avoid being designated as attorneys so they do not run foul of certain attorney regulations or find themselves subject to obligations and potential liabilities that funders prefer to avoid, such as malpractice liability. But if a party’s attorneys are following advice and direction of funders, there may be other theories that impose obligations and potential liabilities. For example, in the United States, some courts have found that when insurers direct or control counsel for an insured, that counsel is acting as the insurer’s agent and the insurer is therefore vicariously liable for any malpractice of counsel.⁵⁶ While theories of agency and vicarious liability may seem like creative interpretations, they aim at the practical problem of what happens if an insurance company is directing counsel to engage in conduct that is professionally incompetent.⁵⁷

5.35  One unique feature of international arbitration, in contrast to domestic court litigation, is that the line between attorney and non-attorney is less important, and in most instances non-existent. As described in Chapter 1, counsel for parties in international arbitration do not need to be locally licensed and local ethical rules are not generally deemed to apply to counsel appearing in international arbitral proceedings.⁵⁸ More importantly, it is not necessary or presumed in international arbitration proceedings that a party’s representative will be a licensed attorney in any jurisdiction. This detachment of national attorney regulation, (p. 188) and flexibility regarding the formal status of party representatives in international arbitration, may create potentially important opportunities, which are discussed later in Section B.

5.36  The seeming unseemliness of third-party funding is what inspired ‘those benighted Puritans of yore’⁵⁹ as well as modern regulators to ban these practices through a number of rules and doctrines. The medieval doctrines of champerty and maintenance have been both a shield (as a contract defence) and a sword (making such financing a crime), the doctrine of usury provides a ready defence against enforcement of a funding contract, and various ethical rules prohibit or limit attorney collaboration with third-party funders.⁶⁰ This Section examines issues that arise under national law with funders in relation to parties in Subsection 1, and attorneys in Subsection 2. Each subsection concludes by considering how these various national laws may affect third-party funding of international arbitration claims. Subsection 3 analyses the special considerations that arise regarding third-party funders and international arbitrators.

5.37  With sophisticated commercial parties who negotiate at arm’s length, contract law doctrine generally imposes few substantive limitations, and courts and arbitrators rarely consider those limitations in the absence of fraud.⁶¹ Funding of legal claims, however, has historically been an exception. Agreements to fund legal claims have generally been regarded as implicating a range of public policy issues. How those national laws and policies apply in international arbitration is uncertain, as analysed further later.

5.38  Traditional doctrines of maintenance, champerty, and barratry constrain third-party funding agreements in many common law jurisdictions. The doctrine of maintenance prohibits ‘[i]mproper assistance in prosecuting or defending a lawsuit given to a litigant by someone who has no bona fide interest in the case; meddling in someone else’s litigation’.⁶² Champerty, a type of maintenance, traditionally prohibited ‘an agreement to divide litigation proceeds between the owner of the litigated claim and a party unrelated to the lawsuit who supports (p. 189) or helps enforce the claim’.⁶³ Barratry, a similar doctrine, is defined as ‘[v]exatious incitement to litigation’.⁶⁴

5.39  While champerty and related doctrines have been relaxed or discarded in many jurisdictions, in other jurisdictions they continue to act as a legal bar to a contract for third-party funding. For example, in Australia, recent decisions of the High Court have eliminated specific champerty and maintenance actions with respect to litigation funding, although the doctrines may be applied within a narrow public policy objection to enforceability.⁶⁵ In the UK, maintenance and champerty have not been completely eliminated, but they do not necessarily preclude third-party funding generally.⁶⁶ In Canada, maintenance and champerty remain causes of action in tort. There is an exception for legitimate business arrangements, which some argue should include third-party funders.⁶⁷ Although there is little precedent, South African courts also appear to have a liberal attitude toward third-party funding.⁶⁸

5.40  The individual jurisdictions in the United States take a variety of approaches. A minority of states, such as Massachusetts and South Carolina, have completely abandoned champerty.⁶⁹ Comparatively, New York, which has limited champerty, would bar third-party funding only if such funding were made for the primary purpose of bringing an action or proceeding.⁷⁰ At the other end of the spectrum, many states, like Delaware, deem any transaction champertous where an assignee has no interest in an assigned cause of action prior to the assignment.⁷¹ For those jurisdictions in which these doctrines are still applicable, they may limit or bar third-party agreements.(p. 190)

5.41  Local prohibitions against usury may also affect the validity of funding agreements. Because the third-party funder takes on the risk that a party will not make a recovery in arbitration, a third-party funder may seek a high rate of return in the event that a party makes a successful recovery.⁷² In some jurisdictions, the rate of return associated with a third-party funding contract can, under certain conditions, constitute usury. For example, some American courts have ruled that, if the client’s recovery is effectively guaranteed at the time the third-party funding was obtained, the resulting third-party funding contract is void as usury because, in essence, the funding was provided with an absolute promise of repayment at a usurious rate.⁷³

5.42  These various doctrines are generally considered mandatory law in the jurisdictions that adhere to them. As mandatory law, these doctrines theoretically prohibit parties from entering into agreements that would violate them. There are several reasons to believe, however, that such prohibitions may not operate, or operate with the same force, when the claim being funded is an international arbitration claim and the funding agreement includes an international arbitration clause.⁷⁴

5.43  The last section examined how various national substantive law doctrines prohibit or limit third-party funding agreements. It is not clear, at a purely doctrinal level, whether these doctrines apply to claims that are subject to arbitration, not litigation. Moreover, even if national doctrines purport to apply in arbitration, the complex interplay of procedural and substantive law raises doubts about what, if any, practical effect those national laws would have on international arbitrations.⁷⁵ While full exploration of these issues is beyond the scope of this chapter, a general overview is helpful to illustrate the level of uncertainty about how third-party funding is regulated in international contexts and the challenges involved in effectuating meaningful regulation within international arbitration.

5.44  The starting point for this enquiry is the national law of the arbitral seat of the underlying dispute, which some commentators contend may provide the basis for annulling an award if the law of the seat bars third-party funding under champerty and related doctrines.⁷⁶(p. 191) Notwithstanding commentators’ projections and funders’ avoidance of arbitrations seated in these jurisdictions, there are several reasons to doubt that champerty and related doctrines of the seat would or could be properly applied to annul an arbitral award.

5.45  As a threshold matter, there is a question of whether local prohibitions based on champerty and related doctrines apply in international arbitrations. These substantive doctrines were developed to protect public courts from vexatious litigation.⁷⁷ The same concerns do not apply with respect to claims being pursued in arbitration. Lord Denning long ago opined that the doctrine of champerty extended to ‘…any contentious proceedings where property is in dispute which becomes the subject of an agreement to share the proceeds’.⁷⁸ Courts in various jurisdictions, however, are split about whether this analysis is correct.

5.46  Even before England expressly permitted third-party funding in litigation, English courts acknowledged that the doctrine of champerty did not extend to arbitral proceedings.⁷⁹ Courts in Hong Kong have similarly concluded that champerty does not apply to claims brought in arbitration.⁸⁰ These decisions are consistent with more general efforts of jurisdictions to compete to be arbitration-friendly and attract more international arbitration business.

5.47  For those US jurisdictions that still adhere to champerty prohibitions, courts do not appear to have exempted agreements that pertain to claims to be arbitrated as opposed to litigated.⁸¹ In Singapore, courts have been soundly committed to the notion that the doctrine of champerty is a complete bar not only to litigation but also arbitration proceedings seated in Singapore.⁸² Most commentary seems to end its analysis about the effect of champerty and related doctrines here, but this is only the first, and in many ways least important, step.

5.48  Even if these substantive prohibitions apply to agreements to fund claims that are subject to arbitration, it is uncertain what, if any, effect those substantive prohibitions would have on the arbitral proceedings themselves or on resulting awards. The mandatory law of the seat can be a basis for annulling an award, but generally only the mandatory procedural law, not mandatory substantive law of the seat. Champerty and related doctrines are traditionally regarded as substantive law that can implicate tort or criminal sanctions or be interposed as a defence to an action between the parties to a champertous contract. They are not, however, (p. 192) generally regarded as a basis for refusing relief in the underlying case to which the funding agreement contract relates⁸³ or for affecting other aspects of procedure.

5.49  The substantive law of the legal seat of an international arbitration can be a basis for annulling an arbitral award, but ordinarily only when that application of that law in an award violates public policy.⁸⁴ Champerty and related doctrines, however, are by their own terms aimed at the individuals or the funding agreements themselves. As such, they can result in remedies against the funder and the funding agreement, but not generally the outcome of the funded dispute. This limitation on remedies for champerty is consistent with general policies against interfering with the finality of court judgments or awards.

5.50  In addition to policies in support of the finality of adjudicatory outcomes, targeting judicial judgments or arbitral awards would also be too indirect to be an appropriate remedy. An analogy to a more familiar area can illuminate why. A classic example when an award may be annulled as against public policy is if it runs foul of the antitrust or competition law of the seat. But an award resolving a downstream dispute between a seller and an end user would not be subject to annulment simply because the seller had originally purchased the goods pursuant to a contract that was void as anti-competitive. Public policy, in other words, aims at the original tainted agreement (here the original sales agreement), not all subsequent related transactions (the downstream resale agreement to the end user). Similarly, champerty and public policy generally aim at the underlying champertous agreement, not the outcome of the dispute it funded. This limited remedy is also justified to avoid affecting parties who are unrelated to or even unaware of the original champtertous agreement. Under this view, annulment based on local prohibitions against champerty would require courts to extend the doctrine of champerty beyond current meaning and effect, and extend public policy as well.⁸⁵ International trends, meanwhile, are moving in the opposite direction as national courts are increasingly reluctant to annul awards based on local public policy.⁸⁶ This trend is demonstrated by the general enforceability of awards that involve contingency fees and punitive damages, which some systems would treat as against public policy in local litigation.⁸⁷(p. 193)

5.51  This analysis of the limits of champerty finds indirect support in the fact that even the high-profile Singapore cases affirming application of champerty prohibitions extraterritorially and in international arbitration have addressed only the enforceability of the funding agreement or punishment for the funder. These decisions do not address the annulment or confirmation of a resulting judgment or an award seated there.

5.52  Under similar reasoning, it is even less likely that a jurisdiction—even one in which champerty and related doctrines exist in full force—would refuse to recognize and enforce an arbitral award because a party received outside funding. Generally, the substantive law of the enforcement jurisdiction is not a basis for refusing recognition and enforcement of an award. Accordingly, only a finding by a court that the mere presence of a third-party funder contaminated the award with a public policy violation would justify non-enforcement of the award.⁸⁸ As already examined, since champerty and related doctrines generally only invalidate the funding agreement, not the outcome of the dispute, this result seems unlikely.

5.53  In the United States, for example, public policy is generally determined by reference to federal policy.⁸⁹ There is no federal policy against champerty,⁹⁰ let alone a policy that is ‘well-defined, deeply held, and rooted in basic notions of morality and justice’⁹¹ so as to justify denial of enforcement on the grounds of public policy under the New York Convention.

5.54  In addition to the probability that funded awards can effectively evade national law when such an award is challenged, funding agreements are also likely beyond the reach of the law of the seat (and by extension enforcement jurisdictions). Funding agreements are ancillary to arbitration agreements. As a result, funding agreements do not generally have any formal relationship to the legal seat, and even less to the enforcement jurisdiction. The ability of the legal seat to impose criminal sanctions or invalidate a funding agreement would necessarily involve extraterritorial application of national law. Only if one of the parties to the funding agreement (the funder, the party, or the attorney) were a local citizen, or the agreement bore some other relationship to the seat, would extraterritorial application of laws against champerty be a reasonable extension.⁹²(p. 194)

5.55  In the typical situation, however, none of the parties to the funding agreement would be locals. Funding agreements are typically governed, as a result of choice-of-law provisions, by law other than that of the substantive law of the seat and presumably by law under which third-party funding is permissible. Finally, the funding agreement would separately designate that any arbitration arising out of the funding agreement itself be seated in a jurisdiction in which third-party funding is permissible. To work around this legal arbitrage, courts of the seat would have to engage in considerable jurisdictional overreach to apply extraterritorially their own substantive law to invalidate the funding agreement.

5.56  Notwithstanding general assumptions about the applicability of national prohibitions against third-party funding arrangements in international arbitration, careful planning can ensure that both awards and funding agreements escape all potential scrapes with national prohibitions. Even more than other actors in international arbitration, third-party funders, their agreements, and the awards produced pursuant to those agreements, seem to float in a protected ether and out of reach of all national regulation.

5.57  Even where it is not prohibited under substantive doctrinal law for parties to enter into agreements with funders, such agreements can raise a host of potential issues relating to the ethical obligations of the attorneys representing those parties. These issues can effectively preclude funding agreements in those jurisdictions. Again, however, the effect of national ethical rules in international arbitration remains uncertain. Recall the analysis in Chapter 1. Most national ethical rules are unclear about whether they extend extraterritorially, and most jurisdictions do not impose local ethical rules on attorneys appearing in locally seated international arbitrations. Accordingly, to the extent national ethical rules impose limitations on third-party funding arrangements, it is uncertain how those limitations will apply in international arbitration. Nevertheless, they are important benchmarks to consider.

5.58  Professionalism is founded on the notion of independence.⁹³ For attorneys, professional independence and the rules and regulations enacted to support it are premised on an essential belief that a confidential relationship between lawyer and client is essential for effective representation. Rules requiring professional independence are designed to protect clients, the public, the legal system, and the legal profession by ensuring that lawyers exercise independent judgment.⁹⁴ This commitment has traditionally been interpreted to require that lawyers ‘must avoid the corrupting influence of nonlawyers (other than, of course, their own clients); clients are best served by lawyers who preserve their “professional independence” by avoiding unholy alliances with the laity’.⁹⁵(p. 195)

5.59  A number of practical features of funding arrangements raise both questions about attorney independence and application of rules designed to ensure it. As an essential starting point, as explained previously, in determining whether to fund a case, a funder undertakes its own investigation into the merits of the claim. Third-party funding agreements often require the claimant’s lawyer to keep the funder advised of major developments and in some instances can require the funder’s consent with respect to important decisions regarding the progress of the case, most importantly issues relating to settlement.⁹⁶ In some instances, a third-party funder may request clarification of case details and suggest (potentially insist on) alternatives to the current legal strategies being pursued by the funded party’s counsel.⁹⁷ As one commentator explains, some providers seek a veto right: ‘[One funds provider] had to approve the filing of the lawsuit; controlled the selection of the plaintiffs’ attorneys; recruited fact and expert witnesses; received, reviewed, and approved counsel’s bills; and had the ability to veto any settlement agreements.’⁹⁸

5.60  While it may be possible for clients to delegate some of their rights to funders, such assignment may also raise questions about the attorney’s role and professional independence. For one, a funder’s right to control litigation decisions creates ambiguity as to whom the attorney actually represents—the original client, the funder, or both. Even if not acting as the funder’s attorney per se, it is possible that the attorney could be deemed for certain purposes to be the funder’s agent, which some courts have found to be the case in some insurance contexts.⁹⁹ This ambiguity may be particularly onerous where the funder has retained its own independent legal representation, and that representative disagrees with the attorney’s strategic choices.¹⁰⁰

5.61  Funding agreements may also require the lawyer to acknowledge a duty to pay a portion of the proceeds pursuant to a judgment or settlement. Some commentators argue that this latter obligation may compromise or undermine the lawyer’s duty of loyalty to the client, which would ordinarily mandate remission of funds to the client.¹⁰¹ A related concern is that funders may (p. 196) object to certain expenses, such as the employ of expert witnesses, which an attorney exercising independent judgment would deem important but a funder aiming at a quick settlement would not.

5.62  While these issues seem unique to third-party funding, they are strikingly similar to concerns raised in other situations in which a non-party pays for legal representation. For example, in either classic insurance contexts¹⁰² or contingency fee arrangements, in which insurers or attorneys may similarly prefer to press for quick settlement.¹⁰³

5.63  Law firms often directly seek outside investment to fund their client’s claims. Some of the agreements may involve sharing what would otherwise be attorney fees and sharing recovery from final awards and settlement agreements. The problem with these arrangements is that any contractual requirements for attorneys to split fees with third-party funders may conflict with national prohibitions that exist in some jurisdictions against attorneys sharing fees with non-lawyers.¹⁰⁴ Rules against fee-splitting are intended to protect attorney independence, prevent lay persons from the unauthorized practice of law, and discourage unwarranted direct solicitation of clients.¹⁰⁵ Much akin to champerty, the rationale is that investors—unburdened by attorney ethical obligations—could be tempted to abuse the legal process for frivolous, collusive, or otherwise unscrupulous gain.

5.64  Currently, financers avoid these prohibitions by contracting directly with claimants, rather than attorneys, or by incorporating and listing as a different entity or in a different country.¹⁰⁶ In contracts with parties, the claimant could either delegate directly to the investor his or her (p. 197) right to a portion of the award, or agree to pay the investor its share after receiving the entire award. Under the latter approach, funders incorporate separate limited liability companies or some other legal entity in order to obtain the original claim on the basis of an assignment or a transfer of ownership to the special purpose vehicle from the party that owns the claim. The funder then has a profit-sharing arrangement with the original claimant.¹⁰⁷ The legality of these types of arrangements remains uncertain in some jurisdictions.¹⁰⁸

5.65  Funders often seek access to confidential information to assess and monitor cases. This access to confidential information raises two distinct issues. On the one hand, neither parties nor funders want funders’ access to such confidential information to be treated as a waiver of the attorney-client or work-product privilege.¹⁰⁹ Most countries have strict rules limiting information that attorneys may divulge to non-clients.¹¹⁰ Some jurisdictions recognize a common interest exception to attorney-client privilege.¹¹¹ The exception, however, is far from uniform across jurisdictions and its application to confidential communications in international arbitration remains manifestly uncertain.

5.66  In the UK, the exception has been extended to after-the-event insurers¹¹² and some commentators speculate that it would likely apply to third-party funders.¹¹³ Similarly, in Australia, (p. 198) it is possible that the common interest exception to waiving the attorney-client privilege applies to the funder.¹¹⁴ In the United States, by contrast, most courts decline to apply the common interest exception to communications to those who share common legal (not economic) interests.¹¹⁵ Given the uncertainties, attorneys are advised to be careful to comply with all jurisdictional requirements for confidentiality waivers, such as full disclosure that the waiver may limit other attorney-client evidentiary privileges.¹¹⁶

5.67  In comparison, as examined in Chapter 3, civil law countries do not have a general ‘attorney-client privilege’ but instead protect the substance of the attorney-client relationship with rules of ‘professional secrecy’ and related rules.¹¹⁷ These rules may impose more stringent duties on attorneys against communicating case- or client-related information to a third party. For example, in Switzerland, since 2011, the client and third parties may refuse to disclose all ‘attorney correspondence’ to the extent that it relates to the representation of a party, on the basis of this attorney secrecy.¹¹⁸ Under French and Belgian law, the attorney’s duty of confidentiality cannot be divided or waived by the client, whereas under German law, the attorney is released from its duty of confidentiality if instructed by the client to communicate the matter to a third party.¹¹⁹

5.68  Even if a party’s confidential information can be shared with third-party funders, it is less clear whether the third-party funder would thereafter have an obligation to retain the party’s information as confidential. Perhaps more importantly, attorneys also have other obligations ancillary to their confidentiality obligations that do not apply to funders. For example, in most systems, attorneys have obligations to avoid conflicts of interest and to refrain from using confidential information for purposes that are contrary to their client’s interests.¹²⁰ No established sources impose similar duties on third-party funders who acquire confidential information.(p. 199)

5.69  As explored in Chapters 1 and 3, the applicability of national ethical rules is more attenuated in international arbitration settings. Their application is further complicated by the fact that opposing counsel in the same case may not be bound by the same national ethical rules.¹²¹ Existing ethical ambiguities mean that even familiar issues relating to third-party funding—such as professional independence, rules relating to fee splitting, and confidentiality—can potentially take on new life in international arbitration.¹²²

5.70  For example, in international arbitration, the ambiguities and definitional problems about how client confidences affect third-party funders may be less problematic. As explored in more detail later, parties have much more latitude to retain representatives of their choice, and those representatives are not necessarily presumed to be licensed attorneys. Moreover, attorney-client privilege is subject to assessment at an international level, and prevailing practices harmonize national traditions. In other words, in international arbitration funders who act as ‘super-lawyers’ may not need to maintain a stance as non-lawyers to comply with national regulations, but if they are deemed to be non-lawyers, internationally determined attorney-client privilege protections may still be extended to them. The uncertainty and flexibility surrounding attorney ethics in international arbitration creates potentially unique perils for third-party funding participation, but also potentially unique opportunities to build a regime for developing effective means of regulating their participation at the international level.

5.71  In addition to parties and counsel, third-party funding in international arbitration also raises special concerns about arbitrator impartiality, disclosure, and potential conflicts of interest. Several factors amplify the potential for arbitrator conflicts of interest: the increase in the number of cases involving third-party funding, the highly concentrated segment of the funding industry that invests in international arbitration cases, the symbiotic relationship between funders and a small group of law firms, and relatedly the often close relations among elite law firms and leading arbitrators.¹²³ Against this backdrop, conflicts can materialize out of several possible scenarios.

5.72  The most obvious potential for conflict is if an individual arbitrator is repeatedly appointed in cases involving the same third-party funder. Once the frequency of repeat appointments by a particular party or law firm reaches a certain threshold, it is generally regarded as raising possible concerns about influence or inter-dependency. For this reason, the IBA Guidelines require that when an arbitrator has had more than two appointments in the last three years (p. 200) by the same party¹²⁴ and three or more appointments in the last three years by the same law firm,¹²⁵ the repeat appointments must be disclosed. They are not necessarily a basis for disqualification, but they raise sufficient concern to warrant disclosure and to raise the spectre of possible disqualification.¹²⁶

5.73  Third-party funders also raise some unique concerns that are distinct from those that arise with either law firms or parties. For example, take the case of one party (P1) that is funded by funder (F) and X is the presiding arbitrator in one arbitral dispute (A1), but X also serves as counsel to the claimant in another unrelated second arbitration (A2) and the claim is funded by the same funder F. The fact that X’s fees in A2 are paid by F and that X is likely to have significant contacts with F on the basis of the funding agreement raises concerns beyond simple repeat appointments. The financial arrangement and ongoing contacts arguably raise questions about X’s impartiality and independence with respect to the claimant in A1 that would make it inappropriate for X to sit as an arbitrator in A1.¹²⁷

5.74  The resolution to the problem illustrated in this example seems self-evident, but only if X is aware of the existence of a funding agreement. Currently, parties have no obligation to reveal the participation of third-party funders in a dispute. The simple presence of a funder in an international arbitration case is therefore most often unknown or unknowable. More importantly, the nature of funders’ relationships with attorneys and funded parties is generally unknown, as is the funder’s level of involvement in case management and strategy, including the selection of arbitrators or expert witnesses.

5.75  Even if unknown at the initial stages, the existence of the funding agreement may be discovered later. A number of circumstances create the possibility of disclosure: if a dispute arises between the client or the law firm and the funder; if financing is suspended or funding caps are reached that require explanations from a party about their financial situation; or if need arises to respond to a challenge by an opposing party that a claim of financial distress is unfounded because of a suspected funding arrangement.¹²⁸ Any of these scenarios can lead to disclosure about the presence of a funder.

5.76  Later discovery of a third-party funder whose links with an arbitrator should have been disclosed may require that the arbitrator step down or risk rendering an award that may be set aside or refused recognition and enforcement as a result of the conflict. Even if discovered after the close of proceedings, a conflict that should have been disclosed can still be a potential ground for attacking an award, even if the arbitrator was ostensibly unaware of the funding arrangement.¹²⁹

5.77  In the United States, although exceedingly rare, discovery is sometimes permitted in set aside or enforcement proceedings. One of the few areas where discovery has been granted is when one party alleges arbitrator partiality or misconduct and requires assisted investigation to (p. 201) prove the allegation. Discovery has been granted in a few cases when such allegations were credible and the objecting party made some preliminary factual showing of potential bias.¹³⁰ The existence of an agreement between a party and a funder who has significant ties to an arbitrator or the arbitrator’s firm might be sufficient to meet that threshold.

5.78  The evidence adduced could prove ultimately that the arbitrator did not actually know about the participation of the funder, and hence could not have been biased by it, but that outcome is not necessarily a victory. An absence of specific knowledge by an arbitrator is not universally recognized as negating allegations of bias, particularly when circumstances create inappropriate financial relationships from which an arbitrator clearly benefitted, even if unknowingly. The enquiry would be messy and expensive. The outcome is unlikely to make any of the participants very happy.

5.79  In sum, for arbitrators to assess the potential for conflicts and make necessary disclosures, third-party funders’ participation in particular international arbitration cases will necessarily have to be disclosed, and specific rules to address how and when relationships with arbitrators must be disclosed, and when they are sufficient to constitute a conflict of interest that warrants disqualification, need to be created.

5.80  Despite the potential for conflicts, the current version of the IBA Guidelines says nothing about repeat appointments with respect to third-party funders, or any other potential (p. 202) bases for conflicts. A sub-committee of the IBA Task Force responsible for the Guidelines has been constituted and, as this book is going to press, is considering what, if any, modifications to the Guidelines are warranted or needed. For reasons discussed in greater detail later, however, it is not self-evident how existing Guidelines could or should be applied to third-party funders. More importantly, deriving clearer Guidelines inevitably implicates issues that are beyond the scope of the IBA Task Force, such as whether and when the participation of a third-party funder must be disclosed in an arbitration. One funder has publicly argued that the participation of third-party funders in international arbitration should never require disclosure and categorically cannot create a conflict of interest for arbitrators.¹³¹ Although rhetorically vigorous in presentation, the substantive support for this view lacks any real legal analysis. The primary argument appears to be that, since existing disclosure rules do not specifically identify third-party funders, there are no rules requiring disclosure.¹³² This sort of ipso facto reasoning appears to be an ‘oversimplification’ of this—in the author’s words—‘complex’, ‘multi-faceted’, and ‘fast evolving financial area’.¹³³

5.81  Whatever else may be uncertain about third-party funding, it seems reasonably clear that a position advocating against any disclosure obligations regarding the presence of third-party funders, and categorically denying the potential concerns for arbitrator conflicts, will not carry the day. If nothing else, other third-party funders have been publicly supportive of the need for third-party funding participation to be disclosed and have acknowledged the need to be risk-adverse, particularly with regard to potential arbitrator conflicts.¹³⁴ In the meantime, courts, legislatures, and bar authorities are now beginning to take up these and other questions regarding third-party funders in litigation contexts. The absence of any public decisions or express rules to date, in other words, suggests only the newness of and relative uncertainty about this phenomenon. It does not imply that no rules are appropriate or that they will not be forthcoming.

5.82  Unfortunately, for reasons described earlier in this chapter and analysed with regard to regulation of other participants in Chapters 2, 3, and 4, rules developed at the national level will not provide ready answers for international arbitration. The remainder of this section lays out a preliminary framework for analysing the issue of third-party funders and potential (p. 203) conflicts of interest for arbitrators, and the final section of this chapter analyses the current state of regulation of third-party funders.

5.83  The necessary starting point for analysis with respect to potential arbitrator conflicts is the IBA Guidelines, which as described in Chapter 2, are an essential touchstone for all participants when they evaluate potential arbitrator conflicts. The Guidelines, however, were written before the advent of third-party funding as it exists today, and therefore do not expressly address third-party funding relationships. The range of potential forms of funding arrangements, discussed at the beginning of this chapter, indicate that the first challenge will be to decide how to characterize or define third-party funding in order to analyse how and when conflicts might arise, and to identify potential conflicts that require arbitrator disclosure or raise the potential for disqualification.

5.84  This chapter began with a working definition of third-party funding based on the prevailing model that exists in international arbitration—the non-recourse loan for the purpose of financing a claim that need only be repaid in the event that the claim is successful. Even limiting the enquiry to this working definition, it is not at all obvious what the relevant points of reference are for evaluating potential conflicts. In some respects, a third-party funder’s position is aligned with and analogous to that of a party since the fortunes of both are tied to the outcome of the case. In other respects, third-party funders function similar to law firms, in steering case strategy, including selecting arbitrators. As analysed earlier, relationships with and repeat appointments by both parties and law firms can trigger disclosure requirements.

5.85  A competing view, advanced by several scholars studying third-party funding in US litigation,¹³⁵ is that the appropriate baseline analogue for third-party funding is equity financing or venture capital financing.¹³⁶ This analogy is similar to that advanced by the funder-author quoted earlier.¹³⁷ The remainder of this section engages in a functional analysis (which previews the Functional Thesis presented in Chapter 6) to test this analogy to equity investors in assessing when funder participation should trigger arbitrator disclosure requirements.(p. 204)

5.86  For funders, the allure of analogizing funders themselves to equity investors is that, presumably, equity investors are only required to be disclosed once they reach a sufficient threshold of ownership in a party. This analogy is justified, some funders argue, because venture capitalists and private equity investors may (and sometimes do) control aspects of case management in ways that are similar to third-party funders. Sometimes, the argument goes, outside investors may even be more active in controlling case strategy, including arbitrator selection, than third-party funders. Under this view, there is no reason to separate third-party funders out for special treatment with regard to arbitrator disclosure obligations, as some have suggested should be the case.¹³⁸

5.87  The IBA Guidelines are formulated to address the risk of bias for arbitrators that are implicated in certain structural relationships and activities. In this regard, they apply to equity investors when such investors are a ‘controlling entity’ constitute an ‘affiliate’ of a party. Under this approach, disclosure regarding third-party funders would be determined based on the extent of their economic interest alone, and not their form or the form of their investment. While this approach seems to have some initial appeal, the analysis that follows reveals why the analogy between third-party funding and other outside investors is inapt.

5.88  A first distinction between an equity investment in a commercial party, on the one hand, and funding a claim owned by that party relates to how the latter amplifies or concentrates the financial impact of the investment vis-à-vis the claim. The same dollar value of private equity investment in a company has a very different, much less concentrated, effect than third-party funding aimed directly at a dispute owned by that company. To take a simple example, consider a party whose overall value is US$100, US$10 of which is the value of a claim owned by the party. If an investor makes a US$1 investment in the party, that investment would give an investor an indirect 1% interest in the party’s claim, as represented in Figure 5.1:

Under these circumstances, we may not be concerned if the identity of an investor with a mere 1% interest in a party is not disclosed.

5.89  Now, consider instead if a third-party funder takes the same US$1 and invests it directly in the arbitration claim belonging to a party that is worth US$10. Now, instead of an indirect (p. 205) 1% interest in the claim, with that same US$1 investment, the funder now has a 10% direct interest in the claim, as illustrated in Figure 5.2:

As this figure illustrates, a private equity investor would have to invest US$10 in a party to obtain the same level of interest in the dispute that the third-party funder has. That raises the question of whether any relevant relationship between an arbitrator and the third-party funder must be disclosed. Would an investor’s 10% ownership interest in a party be sufficient to trigger some disclosure obligations under the IBA Guidelines or other applicable law? The answer, it turns out, is not so clear.

5.90  The IBA Guidelines, as well as other sources,¹³⁹ generally require arbitrators to disclose relevant relationships not only with parties, but also with entities that are related to those parties. Yet, exactly which related entities have to be disclosed remains somewhat ambiguous. The IBA Guidelines define the relevant related entities as ‘affiliates’ of parties, a term they reference 33 times in the Guidelines.¹⁴⁰ Despite the prevalence of the term, the definition of ‘affiliate’ is provided rather off-handedly in footnote 5. That definition provides only that ‘the term “affiliate” encompasses all companies in one group of companies including the parent company’.¹⁴¹

5.91  The problem with the footnote 5 definition is that both ‘affiliate’ and ‘group of companies’ are terms of art used in various legal systems but often given different definitions for different purposes even within a single legal system. In the United States, for example, statutes, regulations, and case law offer a definition of such terms, but they do so for specific purposes (p. 206) and usually with respect to a specific area of law, such as tax, accounting, corporate law, or antitrust. Within the United States, corporate law and securities regulation have several different tests that apply depending on the jurisdiction and subject matter.

5.92  In some instances, multiple corporations are treated as one in order to hold a parent corporation liable for the debts of a subsidiary under the doctrine of ‘piercing the corporate veil’.¹⁴² Meanwhile, seemingly related notions of persons ‘acting in concert’ or as a ‘group’ have been used to define the scope of application of the disclosure obligations for ‘beachhead’ acquisitions under section 13(d) of the 1934 Securities and Exchange Act. In the example of section 13(d), the relevant definitions are tied to regulatory underpinnings with specific purposes relating to disclosure; although also an issue of disclosure securities disclosure rules have an entirely different purpose than disclosure for arbitrator conflicts of interest.

5.93  Most definitions of similar terms also aim to get at whether the related entity actually controls the party that is the target of the primary enquiry. But the notion of control itself can be highly ambiguous. Control may mean an absolute majority of the voting shares (i.e., 50% plus one share), or there may be control also with a lower participation if no other shareholder holds more shares and the ownership structure is not concentrated (sometimes called ‘de facto’ control). Also in other legal systems, even when the notions of ‘control’, ‘affiliated persons’, or ‘groups of companies’ exist and have a statutory definition, often more than one definition exists for different purposes. For example, under Italian law, different notions of control exist for corporate law and for antitrust purposes,¹⁴³ which are different yet again from the general regulation of ‘groups of corporations’ under German law.¹⁴⁴

5.94  The IBA sub-committee faces significant challenges in refining and clarifying its definition of ‘affiliate’. Even a clearer definition of corporate relationships will not provide effective guidance for third-party funders because they are unconstrained by corporate governance rules that otherwise limit the effect of affiliates on corporate decision-making regarding case management and strategy regarding a particular claim.

5.95  Existing IBA Guidelines extending disclosure to affiliates are aimed, even if imprecisely, at requiring disclosure when a related entity may affect the corporate decision-making of a party, specifically when that affiliate might exercise some degree of control over the party’s decision-making regarding case management strategy. In assessing control, not only percentage ownership matters, but also how that ownership allows exercise of control over corporate decision-making, including case management.

5.96  Corporate decision-making is generally subject to corporate governance rules and structures that order and limit affiliated companies’ participation in corporate decision-making. Corporate governance rules oblige a company’s managers and directors to exercise independent judgment regarding the objectives of a company’s claims.¹⁴⁵ Under these rules, (p. 207) low or de minimis ownership through private equity investment, such as the 1% interest in the illustration in Subsection i, would make it difficult if not impossible for an investor to dictate company policy, including policy regarding management of a dispute.¹⁴⁶ Owners or ‘affiliates’ can appoint managers and directors, if they have sufficient voting power, but even then corporate governance rules impose on those managers and directors fiduciary and related obligations to exercise independent judgment in managing corporate affairs, including claims held by the corporation.¹⁴⁷ A funding agreement, in contrast to equity ownership, operates at a sub-corporate level. It may grant certain decisional prerogatives to a funder that will obviate, post-agreement, application of otherwise-applicable corporate governance rules. Managers and directors of a sophisticated commercial entity can certainly decide that the company’s interests are best served by ceding control over a claim in exchange for funding. Outside funding may facilitate pursuit of the claim that would otherwise not be possible or that would put too much strain on the company’s cash flow. However, the decision to enter into a funding agreement means that future decisions regarding that claim are no longer subject to ordinary corporate governance rules. As a result, a funder can exercise a degree of control over corporate decisions about a claim that exceeds the degree of control that could be exercised by an equity investor with the same level of financial interest.

5.97  Going back to the earlier Figures 5.1 and 5.2, it is not only that a funder has an effectively higher percentage interest in a party’s claim than an ordinary investor with an investment at the same dollar value. The form of the investment also allows the funder to by-pass corporate controls that would otherwise limit an investor’s ability to control decision-making regarding the claim, including arbitrator selection. Thus, whether an investor’s 10% interest in a party is considered sufficient to make it ‘an affiliate’ and so trigger disclosure obligations under the IBA Guidelines (and other national and international stands), a 10% interest in a dispute by a funder provides a much greater opportunity for control and should be treated differently.

5.98  In addition to structural distinctions, it is also important to consider the intentionality behind dispute funding that is absent in general equity funding. Even assuming the same level of investment and ignoring the differing effects on corporate decision-making, third-party funding is distinguishable because the funder has intentionally identified the claim as the target for investment. The investment decision of a third-party funder, in other words, implies a specific, undiversified, interest in the dispute. This interest is distinct from the interest a general investor would have in a dispute, absent some extraordinary circumstance (p. 208) that would make the dispute of central importance to the corporation. Given this special interest in the dispute, a third-party funder arguably has a stronger incentive to provide oversight in management of the dispute. As described earlier, funder agreements and practices vary widely, so it may not be that in every case a funder acts on this incentive. The fact that not all funders may act on this incentive does not eliminate the potential concerns about conflicts raised by intentionality.

Rule 37.6 applies only to amici, and not to parties. It is arguably a closer analogue to third-party funding than Rule 29.6, however, because it focuses on investment directly in the dispute. It aims, in other words, at identifying financial interests that create the potential for control over the amicus brief that are separate from traditional corporate governance mechanisms.

5.100  While the common supposition is that funders are pursuing a profit motive, nothing precludes funding by an interested party intent on affecting the outcome of a dispute for some other purpose. Hence Rule 37.6, which aims to ensure that the identity and interests of amici are represented in the caption and the contents of the brief. The fact that no rule comparable to Rule 37.6 currently applies to parties themselves may simply reflect the newness of third-party funding, and the fact that it is still prohibited in most jurisdictions in the United States. It is not difficult to imagine that the rule might change when third-party funding becomes more diffuse and prominent in US litigation.

5.101  In sum, the concentrated effect of funding on a claim, combined with the intentionality and corporate governance issues described earlier, suggest that third-party funding in the aggregate creates a more increased risk of bias than equity investments at the same level.

5.102  With these observations about the limits of proffered analogues to equity investors, it is useful to consider the issue not through possible analogies, but instead in light of the purpose of disclosure standards regarding conflicts of interest. As discussed in greater detail in Chapter 8, actual bias is almost impossible to measure, let alone prove, particularly ex post and with evidence independent of the substantive decision-making at issue.¹⁴⁸ For that reason, conflict-of-interest standards are generally established to protect against heightened risk of bias, not actual bias.

(p. 209) 5.103  The level of participation of third-party funders in the prosecution of any particular claim is ultimately an empirical question, and may differ from case to case. The potential variability suggests that third-party funding raises unique concerns about conflicts. One complexity to developing meaningful guidance is that there are both quantitative and qualitative aspects to the issue. Efforts to amend the IBA Guidelines may need to take into account variations in funding arrangements that alter some of the assumptions relied on based on the working definition adopted here. A precise standard for disqualification may be elusive or may depend on additional facts regarding individual funding arrangements. Relevant additional factors may include such variables as the level of involvement in case management by a funder in a particular case (whether enshrined in the funding agreement or a de facto practice), whether any confidential information was obtained (or could be presumed to be accessible) in either relationship, as well as the level of funding relative to the value of a law firm, the regularity of funding arrangements with that firm, and other financial factors.

5.104  Even in the current absence of clarity about when disqualification based on relationships with funders might occur, existing ambiguities should not impede disclosure of the presence of funders in disputes so that potential conflicts can be considered. General Standard 3 of the IBA Guidelines instructs that any doubt as to whether an arbitrator should disclose should be resolved in favour of disclosure.¹⁴⁹ Some funders (and parties and firms working with them) may prefer not to have to disclose the participation of funders, or regard it as unnecessary to have arbitrators disclose relations with them. That approach creates potentially undue risks for disruption of proceedings and effective challenges to final awards, as well as concerns about the legitimacy of arbitration itself.

5.105  The extraordinary range of relevant variables that may affect assessment of non-disclosure at the award enforcement stage and the absence of established precedent makes the risk of the latter impossible to assess. That ambiguity creates unnecessary risk to the investment, or unnecessary cost in defending challenges to an award that may otherwise be more readily complied with. Both harms can be avoided simply by disclosing. To the extent funders attempt in individual cases to minimize risk, they should arguably prefer systemic rules that reduce risk. Moreover, funders have a separate interest in avoiding the development of bad precedents in this area.

5.106  An early judicial decision annulling or refusing enforcement to an award based on an undisclosed third-party funding conflict with an arbitrator would affect not only that award, but also likely global perspectives on these still-evolving issues. It may also affect perceptions about the fairness and legitimacy of international arbitration—a risk the international arbitration community is undoubtedly less willing to incur. It is not possible at this early stage to predict whether funding arrangements will be systematically subject to disclosure in international arbitration, or how and when arbitrators will be required to disclose possible conflicts. Nevertheless, the potentially negative consequences for arbitral proceedings and awards in the event of later discovery should provoke a sober reassessment of wishful thinking.

5.107  The primary thesis of this book is that international arbitration should expressly self-regulate its participants, including third-party funders. As previewed in the Introduction and Chapter 1, (p. 210) and taken up specifically in Chapter 6, this approach is related to, but distinct from, traditional notions of self-regulation of the professions in which institutions managed by members of a profession develop and enforce their own standards of conduct. ‘Self-regulation’ as used in this book is a proposal that professional regulation of participants in international arbitration be regulated at the international level and through existing arbitral processes and institutions. The need for regulation of third-party funding in international arbitration is perhaps more acute than for the other actors already examined because, on the one hand, the massive funds being injected into international arbitration practice have the potential to restructure the entire field. On the other hand, those who control those funds are completely unregulated and beyond the effective reach of any regulator.

5.108  National regulation of third-party funding arrangements to date operates mostly as an on-off switch, with some jurisdictions permitting the practice and others prohibiting it. Few jurisdictions provide much actual guidance or regulation regarding the nature or structure of third-party funding arrangements. The guidance that is provided does not necessarily address the special issues in international arbitration. Meanwhile, as analysed earlier, national law regarding third-party funding, even in the seat of arbitration and even laws of those jurisdictions that prohibit the practice, may have little or no effect on third-party funding. Earlier parts of this chapter surveyed the issues and potential risks raised by the absence of regulation. This last section analyses the role of self-regulation, both as it exists among third-party funders and how it might be developed by the international arbitration community.

5.109  In 2011, the first-ever attempt at voluntary self-regulation by litigation funders was published by the Association of Litigation Funders of England and Wales (ALF) for application to its members.¹⁵⁰ The ALF Code was welcomed as an attempt to address funding practices that raise ethical concerns, but it has also been criticized. The three main criticisms of the Code are that its standards are too vague and restrictive, that it is completely voluntary, and that it lacks meaningful enforcement mechanisms.

5.110  By its terms the Code requires compliance by all members with the Code’s ‘standards of practice and behaviour’, but membership in the ALF is voluntary. Substantively, the ALF Code consists of 10 general principles that regulate the formation, use, and termination of agreements concerning ‘funding of resolution of disputes within England and Wales’. As one commentator has pointed out, ‘[i]t is unclear whether this language refers solely to the location of the funder or the litigant being funded (“funding…within England and Wales”), or also to the situs of the dispute proceedings (“disputes within England and Wales”)’.¹⁵¹

5.111  With regard to relations with counsel, the ALF Code prohibits a funder from seeking ‘to influence the Litigant’s solicitor or barrister to cede control or conduct of the dispute to the (p. 211) funder’,¹⁵² and a funder must refrain from taking steps ‘likely to cause’ the party’s attorney to violate professional obligations.¹⁵³ The Code also provides that the funding agreement controls the extent to which the funder can provide input on decisions regarding settlement.¹⁵⁴

5.112  Clause 2 states that funders are entitled to a share of the proceeds for successful claims but prohibits them from seeking payment in excess of the proceeds of a successful claim. The ALF Code states, absent express agreement to do so, that funders are not required to provide security for costs, or to fund the payment of premiums for insurance against possible future awards of costs, or to finance such cost awards. The one exception to this limitation is if the funded party is in ‘material breach’ of the funding agreement. The Code does not define ‘material breach’, but in most funding agreements the party seeking funding makes representations and warranties. As predicates for the funder’s assessment of the claim, if these representations or warranties were determined to be false, that would most likely constitute a material breach.¹⁵⁵ In fact, in the few funder-party disputes that have become public, the breaches asserted by the funder involved alleged misrepresentations by the funded party.¹⁵⁶

5.113  In referencing the professional duties of attorneys, the ALF Code implicitly acknowledges that UK solicitors and barristers are permitted, subject to applicable rules, to engage in fee sharing and referrals. The Code establishes confidentiality obligations for funders and provides that the funding agreement controls the extent of the funder’s ability to provide input on the party’s settlement decisions.¹⁵⁷ The Code also provides that the funding agreement may provide for termination if the funder is reasonably dissatisfied with the merits of the dispute, reasonably believes the dispute is no longer commercially viable, or reasonably believes the party to be in material breach. While the Code offers no definition of what constitutes a ‘reasonable’ belief, it does limit funders’ discretion to terminate on these grounds.¹⁵⁸

5.114  One important distinction between the funding agreements contemplated by the Code and those pertaining to international arbitration is that the former provides for a binding opinion from a Queen’s Counsel to resolve any disputes,¹⁵⁹ whereas international arbitration funding agreements usually themselves provide for international arbitration to resolve any disputes. As discussed previously, the submission of funding agreement disputes to arbitration facilitates the enforceability of funding agreements that involve parties or disputes from jurisdictions that prohibit or involve uncertainty about third-party funding agreements or their provisions. It is also an important reason why funding agreements in international arbitration are subject to much less control by national laws or national authorities than litigation funding arrangements.(p. 212)

5.115  Several issues are left open by the ALF Code, most notably whether participation of third-party funders should be disclosed. This omission may reflect the fact that there remains disagreement within the funding community about disclosure, and a reluctance by some to commit to disclosure absent a legal mandate.

5.116  Although it is an important development, the ALF Code has also drawn some criticism. Most critics aim at the voluntary nature of the ALF Code and the lack of enforcement mechanisms. Two particularly strident critiques, one by the Institute for Legal Reform (ILR)¹⁶⁰ and one by the European Justice Forum (EJF)¹⁶¹ are emphatic that the Code cannot replace the development of formal, binding regulation. The former even goes as far as advocating a complete ban on third-party funding.¹⁶² While these critiques focus mostly on application of the Code to litigation funding, the concerns they raise, including the substantive critiques, also have implications for international arbitration.

5.117  In their criticisms of the ALF Code, the ILR and EJF both emphasize the potential for conflicts of interest created when legal counsel develops close relationships with third-party funders. Thus, while the Code imposes on funders an obligation to ensure that parties receive outside legal advice regarding the funding agreement, critics note that the Code does not provide assurances that the outside legal advisor will be free from any interest in the funding of the claim.¹⁶³ The critique, in other words, is that the Code does not require legal advice that is independent of the party’s existing counsel, which may have its own pecuniary interests in sustaining funding. As noted earlier, most often law firms themselves seek out or suggest funding for clients in order to continue representation.

5.118  In sum, the ALF Code may be a welcome first step by funders to clarify certain ‘best practices’ and signal what might be reasonable expectations. It can provide only limited guidance for international arbitration, however, because many unique issues arise in the arbitration context. While the ALF Code is an important and commendable step by funders in the UK, it cannot displace the need for similar efforts tailored specifically to the needs of international arbitration.

5.119  As explored earlier in this chapter, international arbitration raises several unique issues relating to the participation of third-party funders. In addition to those issues explored earlier relating to professional conduct, there are also important structural challenges to regulating third-party funders. As an initial matter, arbitral tribunals are not likely to have jurisdiction over third-party funders. Disclosure of their involvement, however, may be essential for the effective resolution of certain issues, particularly issues relating to arbitrator conflicts and security for costs and awards for costs. In the future, parties may themselves seek to resolve this issue by incorporating into their arbitration agreements provisions that address specifically the potential participation of third-party funders.(p. 213)

5.120  In the meantime, significant challenges exist in determining the best manner and terms by which to regulate third-party funders in international arbitration. First, unlike lawyers, arbitrators, and experts, the presence of third-party funders is a very new phenomenon without clear national precedents or established practices that provide a clear starting point for analysis. This murkiness means that most efforts to understand third-party funding have to date been based on analogical reasoning. For assessing potential conflicts of interest with arbitrators, are funders more like parties, like law firms, or like equity investors? Is due diligence into claims the same as corporate due diligence relating to a merger? For assessing extension of the attorney-client privilege, are funders more like co-parties or co-counsel, commercial parties with a shared interest or unrelated third parties?

5.121  These inquiries recall the blind men’s elephant—each inquirer encounters a different aspect of funding, but none of the assessments fully capture its essence.¹⁶⁴ Even though each of the observed analogies carry some partial truth, they fail individually and collectively to understand the nature of the beast. The elephant metaphor is also apt because third-party funding is a proverbial elephant in the room even though, unlike the proverb, it is not simply being ignored, but its presence is largely hidden from view. This obscurity raises a second major challenge. More information is needed about actual practices to be able to assess the relevant issues. A clearer understanding of the nature, practices, and effects of third-party funders specifically in international arbitration is needed before meaningful regulation can be developed.¹⁶⁵ This challenge is especially acute given the tremendous variation in funding arrangements.

5.122  One principal challenge in determining appropriate mechanisms for regulating funders is that, in the absence of clear established experience, debates about third-party funding are often laden with empirical assumptions and predictions. There is little hard data, however, and little understanding of how existing starting points may change over time. One oft-repeated empirical assumption, for example, is that funders only take on ‘good’ cases.¹⁶⁶ This assumption provides a basis for third-party funding to have a ‘signalling effect’, which can indicate to opposing parties and arbitral tribunals that the claim has been carefully (p. 214) vetted and the funded party has a high probability of prevailing.¹⁶⁷ From this premise, some argue that concerns about funding of frivolous claims are unfounded. There have, however, already been some relatively high profile cases that have highlighted the possibility of ‘funder’s remorse’.¹⁶⁸ These cases suggest that ‘super’ or not, funders are not infallible.

5.123  It is also clear that all funders are created equal. The exceptionally high rates of return reported by some funders require careful screening of cases.¹⁶⁹ Other funders may underestimate the amount of due diligence required or simply not have the in-house expertise to assess effectively potential winning cases. In addition, future funders may be willing to accept higher risk for higher rates of return in long-shot cases, or simply to accept lower rates of return.

5.124  The effect of so-called ‘sub-prime’ claim funding¹⁷⁰ may be of greater concern in light of the prediction that ‘[i]n the not-too-distant future, it may well be that commercial litigations will be “bundled” and traded as securities on financial exchanges’.¹⁷¹ A derivatives market for funded claims could create the temptation, similar to those that led to the 2008 financial crisis, for funders to peddle sub-prime claims as high-return investments without investors having a meaningful ability to assess the risk of the bundled claims.

5.125  While the risks in the absence of regulation seem daunting, there are some vocal opponents to any form of regulation, even simply requirements that the presence of a third-party funder be disclosed. Some funders warn that increased transparency may diminish funding, increase abusive arguments aimed at ballooning case length and costs, or even influence tribunals with respect to ordering security for costs or assessing liability.¹⁷² Ultimately more information about these asserted concerns will be needed so that the costs of regulation can be evaluated against the potential gains.

5.126  Perhaps the first effort by the international arbitration community will be to sort out through market forces the reputable, reliable funders from the ‘cowboys’. Arbitrators, counsel, and arbitral institutions have invested massive amounts of time and energy to establish their own legitimacy and that of international arbitration more generally.(p. 215)

5.127  Funders who might be willing to take high risks for high stakes and to play fast and loose with the norms that promote legitimacy in arbitral processes may threaten the fruits of that hard work. Any damage caused would be borne by arbitration specialists, however, since funders could simply find new vehicles for their investment. For these reasons, the international arbitration community may well expect funders to invest not only in individual cases, but also in initiatives that strengthen and reify more generally the international arbitral regime and its perceived legitimacy.

5.128  Investment arbitration, a field that is already suffering challenges to its perceived legitimacy, raises some special concerns. States may be justifiably concerned that the availability of third-party funding will increase the overall number of investor claims, aggravating concerns that the number of cases is already alarmingly high. Some have even expressed concern that third-party funders to State-parties could, through a funding agreement, exert strategic control over public policy issues.¹⁷³

5.129  Finally, as a new phenomenon, it is not easy to predict how courts will respond if things go wrong in particular cases. While this chapter has examined how most standard funding arrangements remain squarely outside the reach of any national courts, some commentators have already begun imagining worst-case scenarios that may provoke national legislative or judicial action. Specifically, commentators have considered the prospect that third-party funding may be manipulated to be ‘a channel for laundering illegally obtained money’,¹⁷⁴ ‘cause pressure to be put on arbitrators ex ante during the proceedings’, to ‘finance liability actions against the arbitrators or arbitral institutions more readily than the parties which they funded’,¹⁷⁵ or use (misuse?) information obtained in a funded case in other cases or as leverage to play both sides of the same case.

5.130  This final concern may not be entirely hypothetical.¹⁷⁶ A litigation case against Chevron brought in Ecuador funded by a prominent third-party funder seems to provide a particularly colourful cautionary tale. In that case, the funder of the plaintiffs’ case later filed a declaration on behalf of Chevron against the plaintiffs at a time when it appears the funder still had a financial interest (later renounced) in the plaintiffs’ underlying claim.¹⁷⁷ It is (p. 216) alleged, but uncertain, that the funder’s declaration contained confidential information.¹⁷⁸ Subsequently, the funder even issued a ‘joint statement’ with Chevron denouncing the plaintiffs and their counsel in the underlying case.¹⁷⁹

5.131  Attorneys may, and in some instances are required to, withdraw from representing clients, particularly when the client has engaged in criminal wrongdoing and used the attorney’s services to do so.¹⁸⁰ Professional ethical rules, however, prohibit those attorneys from then affirmatively switching sides and using confidential information gained in the original representation against the former client.¹⁸¹ No such rules prohibit similar conduct by third-party funders.¹⁸²

5.132  Third-party funders are a fitting finale to this first Part of the book because the regulation of funders implicates many of the same challenges that arise with other actors, but in even more extreme and dramatic ways. On the one hand, as among arbitrators, counsel, and experts, funders are the group that are the least tethered to any meaningful national regulation. Their participation in international arbitration is also remarkably new by comparison to these other actors.

5.133  For these reasons, the issues relating to funders’ participation illustrate well the potential advantages of regulation being implemented at the international level and within international arbitral processes and mechanisms. In this respect, issues relating to third-party funders frame various themes that have been implicit in the first five chapters and will become explicit in Part II.

5.134  Professional regulation, particularly of attorneys, is often viewed in static terms, and based on an assumption that those being regulated operate in a professional netherworld insulated from market forces and financial interests. These assumptions pervade much discourse over professional ethics and regulations, even in the relatively enlightened world of international arbitration. This view of ethics colours the debate, discussed later in Chapter 8, over whether (p. 217) arbitrators are ‘justice providers’ or ‘service providers’. It is increasingly used as a baseline for charting that reported demise of lawyers and law firm practice, and it inspires much of the critique about party-appointed experts. This artificial separation of professional from market forces also inspires the critiques, discussed in the introduction to this chapter, about third-party funding as a commodification of justice.

5.135  While seeming to be a twenty-first century malady, the lament that justice is being lost to market forces has a long, distinguished history. In 1916, US attorney Julius Henry Cohen wrote a book The Law: Business or Profession?¹⁸³ In it, his insistence that we must maintain a stark dichotomy between ‘professions’ and ‘businesses’ echoed these various debates. Even back then, however, it was denied rhetorically, but in practice lawyers were active in market-based activities, not hermetically sealed away from them.

5.136  By way of example, attorney advertising has long been deplored as the seminal distinction between law practice as a profession instead of a business.¹⁸⁴ Even at a time in US history, however, when the ‘professional’ model was sacrosanct, such notables as Abraham Lincoln engaged in advertising and, while sitting as US Supreme Chief Justice, John Marshall provided a testimonial for an advertisement for an attorney, David Hoffman, who ironically was the soon-to-be author of the first American code of legal ethics.¹⁸⁵

5.137  Professional regulation that rejects the market function and market forces that influence and even animate any system of justice is doomed to be of limited utility. A more constructive and realistic approach is to craft substantive rules in light of the specific functions and activities that relevant actors actually engage in. Particularly with third-party funders, abstracted ideals are of little utility.

5.138  Recognizing the marketplace in which justice occurs also means that enforcement of professional norms should be embedded in the mechanisms that are most efficient at ensuring compliance, or remedying non-compliance. Part II of this book takes up the conceptual and practical challenges involved in implementing this prescription.