Is Arbitration Finance right for you?

Hogan Lovells
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Hogan Lovells

[co-author: Dara Lipovac]

We are often asked about arbitration finance, so here are nine jargon-free answers to frequently asked questions.

Would arbitration finance help us?

  • Opening up opportunities / managing risks. Arbitration finance can enable you to bring good claims while reducing or eliminating the costs on your balance sheet, preserving your legal budget or freeing up resources to use elsewhere in your business.

  • Additional expertise. Your legal advisors should provide an objective and impartial view on the claim but a potential funder will add a slightly different perspective when it carries out its analysis. This can help guide your thinking on how best to advance your position. An experienced funder will also be able to provide informed input on the choice of counsel, experts and arbitrators.

  • The trade-off. In return for taking risks, funders take a significant share of recoveries - typically the amount the funder has invested, plus 20-40% of the recoveries or a multiple of the investment sum (usually 2.5 to 4x) - and will negotiate rights to influence how the claim is managed.

What are the first things to think about?

  • Start early. Although funding can be put in place very quickly in the right case, particularly where urgent finance is a genuine need, many processes take weeks or months to conclude.

  • Get advice / do your homework.

    • Check if funding is permitted. Although funding is allowed in many jurisdictions, it is prohibited in some and regulated in others. Take advice on whether financing arbitration is permitted in the relevant jurisdictions (essentially, the arbitral seat and jurisdictions where you might want to enforce the award) and, if so, what (if any) regulations apply.

    • You or your advisor should (i) check each potential funder’s criteria (which will be on their website) and (ii) do due diligence on the funder’s financial standing and general reputation.

  • What the process looks like. You should enter into confidentiality agreements with potential funders before disclosing any case materials to them. You will generally need to provide your enforcement strategy (which doesn’t have to be long but does have to be considered), your legal team’s advice on the merits, any expert reports on quantum, key case documents, and a budget. Typically, you will have discussions about the case and potential investment terms, before (if those discussions go well) agreeing a term sheet including financial terms and a period of exclusivity for the funder to complete its due diligence and for negotiation of the funding agreement.

Is our claim suitable?

Types of cases funders look to invest in. As funders have significant investments at stake and typically very limited control over the arbitration, their selection criteria are usually quite strict.

First and foremost, if your claim succeeds, will you be able to recover? Is the other side likely to pay voluntarily and, if not, is your enforcement strategy likely to succeed?

Some funders require your claim (or counterclaim) to be at least £10 million - others are willing to consider lower values. Most will also consider the level of funding required and the costs-to-claim value ratio, so they can be confident that their potential returns justify investing time and resources in the potential deal and there is sufficient value in the claim to keep the funded party incentivised. They will also assess how likely the claim is to succeed, how long it is likely to last, and how confident they are in the team running the claim.

What if our claim is not for damages?

Although most funded claims are for damages, if the claim has a clearly assessable value and the funder can be comfortable that it will recover its entitlement if the claim succeeds, many funders will be prepared to consider funding the claim.

What should we look out for when negotiating a funding agreement?

There are many issues to consider but two to which you should pay particular attention are:

  • Controls around settlement. The funder has a legitimate interest in ensuring that sensible commercial decisions are made about settlement. However, it should not have sole control of settlement decisions or be entitled to withdraw funding if it doesn’t like your decision, provided that your decision is reasonable.
  • Funder termination rights. Funders will typically seek to include rights to terminate funding, for example in the event of a Material Adverse Change to the prospects of recovery. To provide yourself with protection, you should try to negotiate a clause that provides for any disagreement between you and the funder to be decided by an independent assessor.

Will we need to disclose the funding arrangement?

  • It depends on the seat of the arbitration and the arbitral rules. Leaving aside general duties to disclose e.g. to your shareholders, unless the law of the arbitral seat or the institutional rules require, you generally don’t need to disclose the existence of funding arrangements. Different arbitral institutions have, however, adopted different approaches – for example, the LCIA and SIAC Rules do not require disclosure but it is mandated under the ICC and HKIAC Rules.

  • Sometimes it is better to disclose. Actual or perceived conflicts of interest may arise, due to a past or present relationship between the funder and one of the parties to the arbitration, including an arbitrator. Disclosing your funding arrangement early could avoid costly satellite disputes, such as challenges to the tribunal. It may also encourage your opponent to settle, as funders generally look very hard at claims before deciding to finance them.

  • Security for costs applications. There is a risk that if the other side knows about the funding arrangement, it will apply for security for costs. This is because the Tribunal has no jurisdiction to order a funder to pay costs, as it is not a party to the arbitration agreement. However, security for costs is relatively rare in arbitration, funding by itself is not a proper ground for security to be ordered, and there are ways to address any issues that do arise, such as the funder agreeing with the other side to be bound by any costs orders against the funded party.

What happens if the claim fails?

Although it will be a disappointment, provided that you have complied with your obligations under the funding agreement and subject always to the terms of that agreement, the funder will bear the loss with no recourse against you.

What happens if the claim succeeds?

“Success” means recovering funds, so there may be much to be done after a positive award, including enforcing the award in different jurisdictions and executing it against the other side’s assets.

Some funders have particular experience in enforcement, which can complement your legal advisors’ expertise. You should ensure that the funding agreement is clear as to who will have control over enforcement processes and how they will be funded.

Funds received will typically be paid into an escrow or law firm account and paid out to all of the parties according to their respective entitlements under the funding arrangements.

Are there other alternatives?

There are many other potential ways of de-risking arbitration, such as Conditional Fee Agreements (CFAs), Damages-Based Agreements (DBAs), and a variety of insurance products, including adverse costs cover and own-side disbursement cover, as well as forms of political risk cover where you have a good claim but there are likely to be political challenges around enforcing an award.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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