Disputes are expensive particularly when involve large construction projects where there have been changes to the scope of work and cost overruns. Contractors face a difficult choice when trying to close the final account of either negotiating a resolution on any terms available or funding litigation which they cannot afford.

What can the contractor do in these ­circumstances? Do they just write off these losses? Or do they incur more debt in funding a substantial ­arbitration? Neither option is attractive. There may be, ­however, a third way which the construction industry is increasingly utilising which is to engage with a third party funder who provides cost support for the arbitration.

How does it work?

In broad terms, this type of arrangement works as follows:

  • The funder provides financing to the contractor;
  • This financing is used to fund the costs of the arbitration –covering the costs of the lawyers, experts, the arbitral ­tribunal and all other associated costs;
  • The funding is typically offered on a “non-recourse” basis, meaning that the funder has no recourse against the funded party if the case is unsuccessful;
  • If the case is successful, the funder will receive a return on their investment which paid from the claim proceeds that are recovered;
The basic economics

The basic economics of the funding arrangement are fairly straightforward.

Many small to medium sized companies who have claims against larger organisation would rather not spend capital on pursuing litigation. Instead, they would prefer to use those resources to pursue their normal business operations. Even if the company does decide to fund the matter, it is likely that it will be outmatched in resources by its opponent. Funding allows the claimant to continue its business while pursuing the arbitration without imposing a burden on cash flow.

Large corporations with strong balance sheets also use ­dispute funding, since this allows them to effectively manage their disputes without negatively impacting their balance sheets.

On the positive side, with the help of funders, claimants will be able to pursue meritorious claims whilst maintaining ­sufficient cash flow to continue to conduct their business as usual. On the negative side, where successful a share of the proceeds of the claim must be given back to the funders.

The decision to fund

The decision as to whether or not to support a claim will be taken following detailed due diligence by the funder. Funders are ­primarily concerned with the merits of the case, the economics of the proposed investment and the enforceability of any award. 
To ensure an adequate return on their investment, funding tends only to be viable for larger claims. In practice this means that the likely recovery level of USD 25 million tends to be a threshold, although this is by no means a fixed figure.

Control

The funder will inevitably want some level of control over the arbitration and the claimant’s decision-making process. They will be particularly interested in settlement opportunities, for example. For this reason, there will be certain safeguards built in to the relevant agreements to protect the funder’s ­investment. A third-party funding arrangement is not an unconditional agreement to fund the case to conclusion. In typical cases the funder will be provided with reports about the progress of the case, notification of any significant developments (e.g., ­settlement offers or new information which changes the case outlook) and direct access to the claimant’s legal team. In some instances, the funder may a very active role such as attending client meetings and/or hearings, being copied on correspondence and having input on strategic issues. 

Conflicts of Interest

The role of a funder may give rise to conflicts of interest, whether actual, potential or perceived.

For example, the situation could arise whereby the funder wishes to accept a settlement offer because it would provide them with the requisite return on their investment, but the ­claimant would receive nothing. For this reason, third-party funding arrangement are normally structured to allow the law firm to maintain a fairly clear line between the duties owed to the claimant and those owed to the funder. The claimant and the funder will enter into a separate arrangement under which the funder provides the claimant with capital in order to finance the arbitration. Under this approach, the claimant’s lawyer advises and owes duties only to the claimant (the funder typically having taken separate advice from its own external counsel).

Other conflicts of interest could also arise. For example, some funders are supported by insurance companies. Assuming that the insurance company has a panel of law firms, could one of those law firms act against the funded party in the arbitration? Or could a partner in one of those law firms act as an arbitrator? In reality, such an arrangement would be unlikely to give rise to an actual conflict of interest, although this will depend upon the relevant jurisdiction.

Partly to deal with these concerns, a recent draft report into third party funding by the International Council for Commercial Arbitration and Queen Mary University of London recommends that funding arrangements be disclosed at the outset. However, some commentators have said that such a disclosure could be capitalised upon for tactical advantage by parties wishing to challenge arbitrators or resist the ­enforcement of awards.

This report is currently in discussion phase and will be the subject of further updates in due course. At present the report’s recommendations are said not to apply to ­“maritime ­arbitrations” which (as the report puts it) “refers to the range of arbitration disputes that arise out of circumstances between parties engaged in maritime affairs, and/or to arbitrations brought pursuant to maritime arbitration rules, such as those of the London Maritime Arbitration Associations.” This ­preliminary decision is understood to be under review and it will be ­interesting to see if the exclusion remains at the time when the final report is published.

Conclusion

Third party funding is a very interesting addition to the ­dispute resolution landscape. For the right case and in the right ­circumstances, it can be an invaluable way for contractors recover losses without adversely effecting cash flow. However, like many things, this does come at a cost.

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