Divergent reform approaches on litigation funding in investment treaty arbitrations
The use of litigation funding in international arbitration has attracted increased attention, scrutiny, and in some cases, critique, in recent years.
As the Report of the ICCA-Queen Mary Task Force on Third-Party Funding in International Arbitration (the “Report”) observed, there has been “an upsurge in the number of third-party funders, the number of funded cases, the number of law firms working with third party-funders, and the number of reported cases involving issues relating to funding;” and moreover, has been increasingly used in commercial disputes, but also in investment treaty disputes.
That is why, as the Report observes, “third-party funding has increasingly drawn the attention of commentators and scholars, and even more recently of arbitral institutions, national regulatory authorities, and state trade negotiators.” In particular, a number or arbitral institutions and bodies such as ICSID and UNCITRAL have undertaken efforts to address the use of litigation funding in their rules or as part of attempts to reform investment-treaty arbitration, which has undoubtedly seen a rise in the use of litigation funding by parties.
The approaches taken by major arbitral institutions differ on the extent of disclosure required from parties with respect to litigation funding. No institution appears to have seriously considered restricting or prohibiting entirely the use of litigation finance. Rather, in modernizing their rules and procedures, the institutions have reflected the growing acceptance of third-party funding as an important tool for market participants. However, imposing restrictions or a prohibition has been a surprising outlier suggestion put forward by one of UNCITRAL’s Working Groups.
ICSID has adopted rules requiring disclosure of litigation funding
Most recently, on 21 March this year, ICSID enacted sweeping reforms to its rules and regulations, as well as its rules of procedure. The reforms addressed the issue of disclosure, which has been at the centre of debates on the use of litigation funding in international arbitration especially as it relates to conflicts of interest implicating members of an arbitral tribunal. Indeed, other arbitral institutions have already addressed this issue, including the Singapore International Arbitration Centre, the China International Economic and Trade Arbitration Commission, the Hong Kong International Arbitration Centre, and the ICC. ICSID has now brought its practices broadly in line with these other forward thinking and modern institutions.
Rule 14(1) of the new ICSID Arbitration Rules requires a party to file a disclosure notice at the beginning of the arbitration or immediately after concluding a funding arrangement, and requires that party to disclose not just the name and address of the entity providing the funding, but also the identity of the entity that ultimate controls the funding vehicle.
This recently-enacted ICSID rule tracks the overall approach by other major arbitral institutions – allowing the use of litigation funding, but imposing disclosure obligations on parties that use it in the arbitration proceedings.
The reason for requiring the disclosure of the existence of litigation funding to an arbitral tribunal is to ensure transparency and avoid any circumstance which could result in a conflict (i.e., where a tribunal member has a relationship with the funder which has invested in the arbitration). This is sound reasoning and a welcome development in the use of litigation funding for treaty arbitration.
UNCITRAL has suggested an outright prohibition on the use of litigation funding in investment treaty cases
Like ICSID, UNCITRAL has attempted to address the use of litigation funding in its efforts to reform investment treaty arbitration.
The “Draft provisions on third-party funding” reform for investor-State disputes (the “UNCITRAL Draft”) released by Working Group III of UNCITRAL, suggest sweeping provisions ready for inclusion in investment treaties that either prohibit or restrict the use of third-party funding in treaty arbitrations. UNCITRAL’s efforts however have arguably missed the mark.
The UNCITRAL Draft suggests three options for the wholesale prohibition of litigation funding, including by inserting in investment treaties a general prohibition on its use, or making the submission of a claim or the tribunal’s jurisdiction conditional on the claimant not using litigation funding.
The Working Group sought to justify their recommendation for prohibition to “address the [purported] concern that third-party funding aggravates the structural imbalance in the ISDS regime and increases the number of ISDS cases, frivolous claims as well as the amount of damages claimed.” In response to criticism that a prohibition on litigation funding would act to limit the capacity of small and medium enterprises from arbitrating against States, the Working Group then suggests recourse to (unidentified) legal aid mechanisms.
However, the Working Group did not explain what it meant by “structural imbalance” and failed to point to any evidence in investment treaty cases regarding that imbalance. Importantly, it ignored the many instances where the balance overwhelmingly tips in favor of States – such as when States use their tools to outright expropriate investments. States also often have greater resources at their disposal, may have greater control over evidence, documents, or witnesses in their territory (where the treaty breaches occur), and may have the capability to exert pressure on the claimant and potential witnesses through various means. Moreover, the Working Group did not refer to any data showing that there has been a rise in frivolous claims and the amount of damages claimed, and the link of that purported increase to third-party funding. Even more, the UNCITRAL Draft stated that the Working Group had difficulty in compiling any relevant data.
It is an old and now discredited argument to say that the use of litigation funding results in the rise of frivolous claims. To the contrary, the business model of litigation funders disincentivizes investment in frivolous cases based on weak legal theories or overblown quantum estimates. If the case fails, the funder will lose its investment. That is precisely why litigation funders have robust, rigorous internal processes that assess the suitability of cases for funding. There is no commercial reason for third-party funders to invest in frivolous cases or support fantastical damage claims.
The use of litigation funding in investment treaty arbitrations is likely here to stay
The prohibition and regulation models suggested by UNCITRAL have been heavily-criticized, including by countries where major arbitration hubs are located, such as the United States and Singapore.
However, if one looks at the approach taken by major arbitral institutions, litigation funding is likely to stay in investment treaty arbitrations. Major arbitral institutions have amended their rules by providing for the disclosure of the identity of the litigation funder and the fact that a party is using litigation funding – the debates centre on the extent of disclosure, not whether litigation funding (which is simply another form of corporate finance) should be allowed at all.