Susanna Taylor recently spoke on a panel discussion organised by the Hong Kong International Arbitration Centre (HKIAC) and Norton Rose Fulbright on the topic of Outcome Related Fee Structures. This article summarises some of the thoughts expressed during that discussion.
In 2022 both Hong Kong and Singapore introduced outcome related fee structures for use in arbitration. Singapore introduced conditional fee arrangements (CFAs) by way of the Legal Profession (Amendment) Act 2022 and the Legal Professional (Conditional Fee Agreement) Regulations 2022 and Hong Kong introduced both CFAs and damages based agreements (DBAs) by the Arbitration and Legal Practitioners Legislation (Outcome Related Fee Structures for Arbitration (Amendment) Ordinance 2022 and the Arbitration (Outcome Related Fee structures for Arbitration Rules 2022. This article will explore what those changes mean for the funding of arbitration in the region and how the shape of third party funding may be affected by the changes.
Why were Outcome Related Fee Structures introduced for arbitration in Singapore and Hong Kong?
Both Singapore and Hong Kong have traditionally prohibited maintenance and champerty, being the financial support for a dispute by a third party to that dispute. That prohibition previously prevented law firms from risk sharing with a claimant by way of either:
1. CFAs, where a law firm agrees to hold back some or all of its fees and to only be repaid (together with an uplift) from a successful outcome; or
2. DBAs, where a law firm agrees to be paid a percentage of the financial recovery from the dispute achieved by the claimant.
Third party funding was expressly permitted for arbitration in Singapore in 2017 and in Hong Kong in early 2019 (pursuant to legislation which was introduced in 2017). The impetus for this legislative change was the recognition of the fact that both Singapore and Hong Kong are hubs for the resolution of commercial disputes in the region, particularly by way of arbitration. Third party funding was introduced in Singapore and Hong Kong to ensure that both of these jurisdictions remained attractive venues for the resolution of arbitral disputes.
Third party funding was legal and used in other common law dispute resolution hubs around the world, and there can be little objection to the use of third party funding in commercial arbitration. Arbitration can be extremely expensive and it is difficult to see why, when sophisticated commercial parties elect to have their disputes resolved by means of a private mechanism, there should be any prohibition on how they choose to fund those disputes.
Following the growing use of third party funding for arbitration in Singapore and Hong Kong and the extension in 2021 in Singapore to allow third party funding both in domestic arbitration and certain proceedings in the Singapore International Commercial Court, a move was made to also allow solicitors to offer their clients greater choice in respect of fees by using Outcome Related Fee Structures. In Singapore, the reasons provided for the introduction of CFAs in 2022 were as follows:
1. To bring Singapore into line with other jurisdictions where CFAs are available such as the UK and Australia;
2. To enhance access to justice by allowing claims to be brought which may otherwise not have been pursued; and
3. To discourage frivolous claims as the lawyers will only be paid (or fully paid) upon the claim being successful.
The reasons given in the Law Reform Commission Consultation Paper for the introduction of CFAs and DBAs in Hong Kong is 2022 were to ensure that Hong Kong could compete with Singapore, which had introduced similar measures in May 2022. Taking into account Hong Kong’s status as a major arbitration centre, the changes were therefore targeted at ensuring that its competitiveness be maintained and not reduced.
What are the implications of the introduction of Outcome Related Fee Structures for third party funding? Does this reduce the need for third party funding or create new opportunities for third party funders as to how finance is provided?
LCM funds in many jurisdictions across the world and Outcome Related Fee Structures are a feature of the landscape in many of these jurisdictions. We do not believe that their existence lessens the need for third party funding but rather, may create more flexibility in the funding structures that are available. Outcome Related Fee Structures are unlikely to replace third party funding for a few reasons, including:
1. Even if a law firm is acting on a CFA or a DBA, the disbursements or out of pocket costs need to be met. In arbitration in particular, these costs can be very large. Not all law firms will be willing to meet these disbursement costs even if they are acting on an Outcome Related Fee Structure, and third party funding is available to ‘plug this gap’ for disbursement expenses.
2. Not many law firms outside of the US are set up to take on a large amount of risk; in particular, partnership structures are based on the distribution of profit to partners regularly. There will therefore always be a category of law firms that are unwilling to act on the basis of Outcome Related Fee Structures.
3. In the case of partial CFAs, clients facing financial constraints may nevertheless require the support of a litigation funder to ensure payment of the discounted fees to their lawyers during the life of a dispute.
Rather than detract from the need for third party funding, Outcome Related Fee Structures actually create opportunities for creative third party funding products, which in turn may allow a wider variety of claims to be funded. For example, many third party funding structures involve the lawyers acting on a CFA to risk a portion of their fees in exchange for an uplift. Such a structure may allow third party funding to be offered in circumstances where traditional funding may not otherwise be available because the case is not large enough to satisfy the funder’s requirement of proportionality between the claim size and the funding commitment. If the size of a claim was, say, $20M and the total budget for the law firm’s fees was $4M, the funding of the whole of the budget may be rejected by a funder. However, if the lawyers agreed to act on a 50% CFA such that the funder’s commitment was only $2M, this may allow third party funding to be obtained.
Similarly, DBAs allow third party funding to take a variety of different forms. If a lawyer agrees to act on a DBA for a client, then that lawyer obtains the right to an agreed percentage of the claim proceeds should the claim be successful. A third party funder can then provide finance to that law firm secured against this DBA interest in the claim proceeds, which allows the law firm to receive cash flow for the duration of the claim. If the claim is successful, the DBA percentage would be split between the law firm and the funder.
If the law firm has a portfolio of DBA claims, the funder might provide funding for all of these claims in exchange for a portion of the lawyer’s DBA entitlement across the claim portfolio. With this approach, the funder’s risk may be reduced (as it is not concentrated in the outcome of a single claim) and the funder may be able to offer a lower funding premium based on this reduction of risk.
Key take away
Rather than sounding a death knell for third party funding, the introduction of Outcome Based Fee Arrangements in Singapore and Hong Kong creates an opportunity for funding to be provided for arbitration in more flexible and creative ways, which can meet the requirements of both claimants and their lawyers.