1/31/2022
When the parties decide to elect arbitration as the means to settle disputes arising out of a contract, their decision is usually guided by the various advantages that arbitration has over the Judiciary, such as: expertise of the arbitrators, flexibility and celerity of the proceedings. However, there is an aspect that is generally regarded as an obstacle: the costs associated with the arbitration proceedings.
Although there are studies showing that, in the long term, arbitration is more cost-effective than lawsuits, there is no denying that the initial costs and those inherent to the development of the arbitration proceedings – which include registration, administration, arbitrator’s, lawyer’s and expert’s fees – are quite relevant and even insurmountable to some.
In times of economic crisis, such as the one we are currently living in as a result of the COVID-19 pandemic, companies’ finances are affected and become unstable. As such, if they are involved in an arbitration proceedings, they may have difficulties in bearing its costs. In these cases, a viable solution is resorting to third-party funding.
Third-party funding takes place when a party seeks capital to cover its expenses with the arbitration proceedings. In return, the funder – which can be a financial institution, an insurance company or one of the funds specialized in the financing of disputes – receives part or the totality of the credits eventually obtained by the financed party in the arbitration.
Usually, the following types of financing are available in the market: (i) financing of part or the totality of the costs necessary for initiating arbitration proceedings, with the funder being remunerated only if the financed party obtains a favourable outcome in the arbitration proceedings; (ii) loan of the necessary amount to cover the costs of the arbitration proceedings, with the funder being remunerated by (a) a previously established interest rate, regardless of the outcome of the arbitration and (b) a bonus in case of a favourable outcome; or (iii) acquisition, at a lower cost, of all amounts granted by an arbitration award to the financed party, with the funder taking the risk of being remunerated by promoting the enforcement of the award.
The funder’s involvement with the arbitration proceedings and its interest in the outcome of the dispute have consequences, the most relevant of which is the duty to disclose to the Arbitral Tribunal and the opposing party the involvement of a third party funder. The reason for doing so is to allow them to assess whether there is any conflict of interest with the funders. It also allows the Arbitrators to make an informed decision on the need for a bond if there are elements indicating that there is a risk that the financed party will fail to fulfill its obligation to reimburse the counterparty in the event of loss[1].
The disclosure obligation, however, is a small burden compared to the numerous benefits that the funding provides. Third-party funding has no downsides, as it works both as a form of short-term investment for funders and as a way to allow parties to pursue their rights – via arbitration proceedings -, which would otherwise not be possible. Such practice is most definetely promising and shall experience a considerable growth in the coming years.
[1] The disclosure obligation has already been regulated by several institutional arbitration rules, such as CAM-CCBC, CIETAC, HKIAC, ICSID, Milan Chamber of Arbitration and SIAC.
