UK: The Gift Of Gold - Recovery Of The Costs Of Third Party Funding In Arbitration

On 15 September 2016 the Commercial Court gave its decision in Essar Oilfields Services Limited v Norscot Rig Management PVT Limited [2016] EWHC 2361 (Comm). A headline in The Times (27 October 2016) described the decision as a "game changer". This probably puts it too high, but the case certainly highlights an important practical distinction between litigation and arbitration, which those who are responsible for drafting and negotiating dispute resolution clauses and managing disputes would do well to remember.

The case confirms that arbitrators have the power to award a party not just its legal costs, but also the cost of third party financing for those costs - which cannot be recovered in court litigation. Good news for third party funders and the businesses which use them, less so for businesses which might find themselves on the receiving end of claims which are financed in this way.

Funders

A small number of investment funds specialise in providing non-recourse funding to prospective claimants. The funder will agree to provide the claimant with money to fund a claim in court or arbitration claim. If the claim is successful, the claimant must pay a substantial sum to the funder, typically a multiple of the funding provided, or a proportion of the monies recovered.

Costs in English High Court litigation

The Civil Procedure Rules 1998 ("CPR") apply to all civil proceedings in the courts of England and Wales. They are frequently amended. Many rules are supplemented by a "Practice Direction" and these are frequently changed or supplemented. The leading published version of the CPR and Practice Directions runs to around 6,000 pages with commentary. The CPR includes extensive, detailed and highly formalistic rules about costs.

The general rule is that the unsuccessful party will be ordered to pay the costs of the successful party. A complication arises because of what are known as "Part 36 Offers", whereby parties to litigation may make offers to settle, in a particular form, on a "without prejudice" basis, which will only be shown to the judge once the claims have been decided.

The detail of how these work is somewhat beyond the scope of this article. But, broadly, a claimant which recovers less than a defendant had previously offered to pay will generally not recover its own costs, and will have to pay the defendant's costs, from the date of the offer. A defendant which is ordered to pay more than a claimant had previously offered to accept will generally be ordered to pay a greater proportion of the claimant's costs, and a higher rate of interest, as from the date of the offer.

A court may order that costs be paid either on the "standard basis" or the "indemnity basis". In both cases, the court will disallow costs which were "unreasonably incurred or unreasonable in amount". When costs are to be assessed on the "standard basis" the court will only allow costs which are "proportionate to the matters in issue", and costs which it was "reasonable to incur".

The way that the English courts treat costs seems somewhat at odds with the approach it takes to compensation. If a party breaks a contract or commits a civil wrong and so causes me loss, I am entitled to recover that loss, insofar as I could not reasonably have acted to avoid it. If the defendant wishes to avoid paying some part of the claimed loss, it is for the defendant to prove that the claimant could reasonably have acted to avoid it. The courts tend to treat any argument that the claimant could reasonably have acted to avoid loss with a healthy degree of scepticism.

If the wrongdoer denies liability, and I am forced to pursue the matter in court all the way to a judgment, then one might have thought the costs of my doing so were as much the wrongdoer's fault as the rest of my loss - and so I should recover that too. Why should I be left out of pocket because the wrongdoer did not pay what he owed, and forced me to go to my lawyers?

The reality is that - while the successful claimant who has acted reasonably will recover all his loss - he rarely, if ever, recovers all the legal costs which he has been forced to incur in order to get the money he is owed. Invariably, a proportion of the costs claimed will be disallowed as either having been "unreasonably incurred", "unreasonable in amount" or "disproportionate".

There is a lack of data about what proportion of the costs claimed by a successful party is typically recovered. The appendices to Lord Justice Jackson's Review of Civil Litigation Costs: Preliminary Report (May 2009) included a schedule of recent cases supplied by the Commercial Court Users Committee showing that, where costs had been awarded or settled, parties had recovered anything between 40% and (very rarely) 100% of their costs, with the mean recovery being around 70%. Lord Justice Jackson also referred to a submission from TecSA setting out data from recent Technology and Construction Court decisions. His Lordship commented that "... the percentage of costs recovered by the winning party is generally quite high, often in the region of 75% or more". Anecdotal evidence suggests that a successful party's recovery is more typically of the order of 60 to 70% of total costs, and it is common practice for lawyers to advise clients to expect costs recovery in that range.

It appears that some successful litigants spend 25% to 40% more on their claim than the courts consider it would be "reasonable" or "proportionate" to have spent. It might be thought that this is unfair, and that the wrongdoer should be responsible for whatever it has cost the successful party to enforce its rights. The other side of the coin is that it seems equally unfair to give the successful party (or their lawyers) free reign as to how much they will spend on the litigation. The unsuccessful party (who may well have litigated in good faith) should have some protection from having to pay costs that are excessive or exorbitant. The only way in which a balance can be struck that protects both the unsuccessful and the successful party is through a review of costs by the Court. That said, however, whether a discount of between 25% to 40%, regularly applied, strikes the right balance is a different question.

Funding costs in English high court litigation

For 13 years (from 1 April 2000 to 1 April 2013) the law allowed parties to recover for certain costs going beyond the normal fees which they had paid their lawyers. The detail of the legislation is no longer relevant but, very broadly:

1. Lawyers were allowed to enter conditional fee agreements ("CFA") whereby they would charge for their work on a "no win no fee" (or "no win lower fee") basis. If the client was unsuccessful in the litigation, the client would pay nothing, or would only pay its lawyers a discounted fee. If the client was successful, however, the client would have to pay the lawyer's usual fees, plus a premium or "success fee" of up to 100% of the lawyer's normal fee. An unsuccessful party would generally be ordered to pay any reasonable success fee which had been incurred by the successful party.
2. Litigants could obtain "costs insurance" (also known as "after the event" or "ATE" insurance) against the possibility that they might lose, and so have to pay the other party's legal costs. An unsuccessful party would generally be ordered to pay any reasonable premiums which the successful party had paid for costs insurance.

The legislation had also recognised that litigants might enter "litigation funding agreements" with third parties, whereby a funder would agree to fund litigation, and the client would agree to pay the funder if the client was successful in the litigation. The legislation had included a provision whereby one party could be ordered to pay for a payment which another party was liable to make under a litigation funding arrangement. This was never brought into force, and so while CFA success fees and ATE premiums were recoverable, the costs of litigation funding agreements were not.

In 2012, Parliament passed the Legal Aid Sentencing and Punishment of Offenders Act 2012. It provided (subject to certain exceptions) that costs orders could no longer require one party to pay: (i) a success fee which was payable by another party under a conditional fee agreement; or (ii) a premium which another party had paid for costs insurance.

The result is arguably to make litigation funding agreements more competitive, because now whether a prospective litigant funds its litigation via a CFA, ATE insurance or litigation funding agreement (or some combination of these) it is always going to have to bear the costs associated with whichever funding arrangement was used.

Costs in English-seated arbitrations

The law which governs arbitration in England and Wales is all to be found in the Arbitration Act 1996. It has never been amended. Printed out, it comes to around 60 pages, or 300 pages with commentary (about 0.05% of the CPR). It should therefore come as no surprise that the rules with respect to costs in arbitrations are vastly simpler than the regime which applies to court litigation.

The rules with respect to costs in arbitrations are to be found in sections 59 to 65 of the Arbitration Act 1996. The Act provides:

"59 Costs of the arbitration.

1. References in this Part to the costs of the arbitration are to -
   
   
   1. the arbitrators' fees and expenses,
   2. the fees and expenses of any arbitral institution concerned, and
   3. the legal or other costs of the parties.
2. Any such reference includes the costs of or incidental to any proceedings to determine the amount of the recoverable costs of the arbitration (see section 63).

1. The tribunal may make an award allocating the costs of the arbitration as between the parties, subject to any agreement of the parties.
2. Unless the parties otherwise agree, the tribunal shall award costs on the general principle that costs should follow the event except where it appears to the tribunal that in the circumstances this is not appropriate in relation to the whole or part of the costs."

Notwithstanding this simple scheme, it is common that (losing) parties in arbitrations will try to argue any issues about costs as if all the same rules which apply to costs in court litigation applied equally to arbitrations. A limited exception (of course) is where the losing party has failed to beat a "without prejudice" settlement offer. In that scenario, they might instead argue that such offers should not be treated analogously with the way that they are treated in court, under Part 36 of the CPR.

There is even less data about the rate of costs recovery in arbitrations than there is about court cases. Arbitration awards are rarely made public, and there are many, many fewer arbitrations. Anecdotal evidence, though, is that parties to arbitration awards typically recover a greater proportion of their costs than if the same cases had been brought in the High Court. There are a few possible reasons for this:

1. The rules which govern the award of costs in arbitrations are essentially facilitative: they set out what constitutes "costs of the arbitration", and make clear that arbitrators can award them. The greater part of the CPR rules about costs, on the other hand, are about what courts cannot award, what parties cannot recover and all the procedural hoops that parties must jump through if they want to try and do so.
2. Arbitrators are appointed by the parties whereas judges are not. Arbitrators are therefore rather more responsive to the parties' concerns. Arbitrators assess costs more robustly and award higher percentages to the successful party because that is what the parties actually want. Parties choosing arbitration want a swift and final resolution of their dispute, and they do not want to be arguing over costs for weeks and months, even if they happen to have lost the arbitration. Better to draw a line under the matter and move on.
3. Trial judges can easily have the detailed assessment of costs carried out by other, specialist, costs judges. Arbitrators may have rather less appetite for carrying out a line by line detailed assessment of costs.
4. Arbitrators are appointed by the parties, but on the advice of the parties' lawyers, and so has a vested interest in keeping the lawyers happy, at least to a point. Arbitrators may thus be more reluctant than judges to criticise the lawyers or to suggest that the costs the lawyers have charged are "unreasonable" or "disproportionate".

Facts of the Essar case

On 4 August 2007 Norscot Rig Management PVT Limited ("Norscot") and Essar Oilfield Services Limited ("Essar") entered an "operations management agreement" (the "Agreement").

A dispute arose between Norscot and Essar. Norscot alleged that Essar had committed a repudiatory breach of the Agreement, and claimed that as a result Essar was liable to Norscot in damages.

Norscot brought a claim by way of arbitration. The arbitration was conducted under the ICC Rules. The seat of the arbitration was England. There was a sole arbitrator, the former Court of Appeal judge Sir Phillip Otton.

In 2011 Norscot made an agreement with Woodsford Litigation Funding ("Woodsford"). Woodsford agreed to advance to Norscot £647,000 for the purpose of funding an arbitration claim by Norscot against Essar. The judgment states:

From the judgment, it is not clear what was to determine whether Norscot had to pay 300% of the funding or 35% of the recovery.

The arbitrator made five partial awards. He awarded Norscot various sums which were due under the Agreement, and found that Essar was also liable to pay Norscot damages for repudiatory breach of the Agreement. In the fifth award (the "Award") the arbitrator found that Essar was liable to pay Norscot's costs on an indemnity basis. The judgment states:

This suggests Norscot was awarded: (i) around £8 million in respect of its substantive claims; (ii) around £1.94 million in respect of the sum owed to Woodford; and (iii) around £2.06 million in respect of Norscot's other costs.

Evidently the terms of Norscot's contract with Woodsford had only required Norscot to pay Woodsford 300% of the £647,000 funding (i.e. £1.941 million), not 35% of the £8 million recovery (which would have been £2.8 million).

The arbitrator had been very critical of Essar's conduct:

The challenge to the award

Essar brought a challenge to the award under section 68 of the Arbitration Act 1996, which provides that a party may apply to the court challenging an award on grounds of "serious irregularity":

The tribunal's power to award costs is to be found in sections 59 and 61 of the Arbitration Act 1996, which have already been set out above.

The parties had agreed that the arbitration should be subject to the ICC Rules. The Rules which were in force at the time were the 1998 Rules. Article 31 of those Rules (which is Article 37 in the current version of the Rules) states:

"Article 31: Decision as to the Costs of the Arbitration

1. The costs of the arbitration shall include ... the reasonable legal and other costs incurred by the parties for the arbitration.

3. At any time during the arbitral proceedings, the arbitral tribunal may make decisions on costs, other than those to be fixed by the Court, and order payment.
4. The final award shall fix the costs of the arbitration and decide which of the parties shall bear them or in what proportion they shall be borne by the parties."

Also pertinent was the ICC Commission Report of 2015 on "Decisions on Costs in International Arbitration". It provides:

Essar argued that the Tribunal had no power to make an award allocating the costs of the litigation funding. Essentially, Essar's argument was that the words "other costs" in section 59(1)(c) of the Arbitration Act 1996 and Article 31(1) of the ICC rules should be read down so as to exclude the costs of third party funding, by analogy with the position in court, because these were not properly "costs of the arbitration", but rather "costs of funding the arbitration".

The court dismissed Essar's challenge, finding that the words "other costs" in section 59(1)(a) of the Arbitration Act 1996 and Article 31 of the ICC Rules 1998 can include the costs of obtaining litigation funding. The judge said:

Implications of Essar

The case confirms that arbitrators can award the costs of litigation funding. This does not mean that, from now on, 100% of the cost of any litigation funding is always going to be recoverable in an arbitration. It is just that it is within the arbitrators' power to award such costs.

The arbitrator's decision to award such costs in Essar was influenced by Essar's conduct, of which the arbitrator was very critical, and also by the fact that Norscot "had no alternative" but to resort to Woodsford's litigation funding, which represented "standard market rates and terms for such a facility".

Litigation funding seems to be used most often in "David v Goliath" cases, where the prospective claimant is a small enterprise which has a relatively high value claim against a much larger business or a state, but which the "David" company cannot afford to pursue other than by way of third party funding. Sometimes (as in the Essar case) it will be "Goliath's" failure to pay which has placed "David" in this position, and the prospective claimant may even be technically insolvent.

When "David" wins such a case, it seems fair that "Goliath" should have to pay "David's" unavoidable third party funding costs. A useful parallel may be drawn with the law of contract damages. It will often be the case that, if the claimant had been more pecunious (i.e. had more money), the damage resulting from the respondent's breach could have been halted earlier, lessened or prevented.

Historically, it was thought that a claimant could not recover losses which he would have avoided if he had been more pecunious (Owners of Dredger "Liesbosch" v Owners of SS Edison [1933] AC 449). The modern position, though, is that a claimant will recover its actual loss, provided it acted reasonably given the impecuniosity, and provided the impecuniosity was foreseeable (which will usually be the case) (Lagden v O'Connor [2003] UKHL 64).

Likewise, if it was reasonable to enter into a third party funding arrangement, it seems reasonable that the costs of doing so should be recoverable. A "David" who was considering pursuing a claim with third party funding would obviously be well advised to approach a few possible funding providers, so as to be able to demonstrate that it acted reasonably and obtained the best deal.

Solvent businesses, too, may resort to third party litigation funding. The rationale for doing so is summed up as follows by Calunius Capital, a litigation funder:

If that kind of claimant succeeds, should the cost of its litigation funding be met by the respondent? Such a claimant undoubtedly has a weaker claim to the costs of its litigation funding than a "David" which has had to use third party funding as a last resort.

It can be argued that: (i) the claimant would never have incurred the costs of the third party funding if the respondent had performed the contract / complied with its legal duties; (ii) it was reasonable for the claimant to have hedged against the risk of losing, and foreseeable that the claimant might do so; and so (iii) the respondent should be just as much liable for the third party funding costs as for any other reasonably foreseeable consequences of its breach.

The tribunal's concern in such a case is, as the ICC report noted, "protecting against unfair or unequal treatment of the parties in respect of costs, or improper windfalls to third-party funders". If successful claimants were always to be awarded all the costs of their third party funding, then claimants would have no incentive to seek out the most competitive deal and minimise the costs to be paid to the third party funder. The claimant must always have an incentive to minimise the cost of the funding, otherwise the result is a windfall for the third party funder.

So a party which is considering using third party funding as a "hedge" would also be well advised to seek out the most competitive deal, negotiate hard and ensure that it has detailed evidence of having done so. For obvious reasons, the third party should also be an unrelated party and the transaction should be at arms length.

The alternative argument is that a party which has used third party funding as a "hedge" should not recover the associated costs. The whole point of a hedge is that you pay to offset a risk. If I insure against my building burning down then I still pay the premium if the building does not burn down. If a power producer buys coal on the futures market at a premium to the spot price in order to hedge against a future rise in the price of coal, and the price of coal actually falls or stays the same, then they still have to pay the premium.

These are not perfect analogies, but the central idea is still that a hedge is about whether to accept a lower potential reward in exchange for a lower risk. In the case of third party funding, the "risk" which I am hedging against is actually the risk that I will lose, and so not recover my legal costs. The person who should bear the risk of my losing is me - because II am the person who is best placed to eliminate that risk, by making a proper assessment of my chances and not pursuing an unmeritorious claim. A respondent, on the other hand, has no control over whether an unmeritorious claim is pursued against it.

If the costs of "hedge" type funding were generally recoverable, the effect would be to impose upon unsuccessful respondents the costs which claimants incur in order to guard against the possibility that their claim might lack merit. It seems iniquitous to impose such a cost on the respondent.

Agreements about third party funding

Of course (as with most things in arbitration) any uncertainty around the recoverability of third party funding costs can be resolved by express agreement. Parties to an arbitration agreement are free to agree as to what costs the tribunal will have the power to award. The parties could agree that the tribunal will have no power to award the costs of third party funding (also ATE insurance premiums, and success fees charged under CFAs). Such agreements obviously favour "Goliaths" who are dealing with "Davids", and also parties who consider themselves more likely to be on the receiving end of a claim than to be bringing one. Clauses to that effect may well begin to appear in contracts with state entities, and in the standard forms which are used by "repeat players" who are more likely to be respondents than claimants.

In theory, parties could expressly provide in their arbitration agreement that the arbitrators should award the successful party the costs of any third party funding. It seems unlikely that we will see many such agreements. Asking for such a provision to be inserted invites the implication that one expects to bring a claim, and to be short of the funds for doing so. Neither is likely to be the impression which a prospective party to a contract will want to give during negotiations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.