Imagine you are driving a car at 100 kmph and your friend sitting in the front seat with you yanks the emergency brakes. You know what happens next. SPOILER ALERT- the car crashes. This is the exact effect of the COVID-19 lockdowns on the global economy, including the construction industry. The damage caused by the crash depends upon your readiness. The current piece addresses how the parties can boost their readiness, particularly in the context of management of construction disputes. The article makes a case for going beyond third-party funding ("TPF") and contemplating monetization as an effective means for making construction disputes financially viable.
Brace for impact: construction disputes coming
Construction projects often revolve around a multi-level contractual structure, involving multiple parties, including the employer, the main contractor, subcontractors, etc. based in various jurisdictions. The halt on construction projects due to COVID-19 lockdowns has led to unprecedented delays, disruptions and uncertainty which could unleash a barrage of claims. One of the most efficient ways of handling the disputes is to anticipate the kind of claims the parties might face. Remedies to parties to a construction contract depend on the terms of the agreement. The terms for each contract are unique. In the current circumstances, the most likely claim which might come up is the extension of time for completion. Apart from that, one might also deal with additional payments claims by way of variation due to changes in the law.
On top of this, construction companies are likely to have many pending disputes. In these uncertain times, the restricted budgets, costs of defending new claims and general liquidity issues would encourage settlements at an undervalue. This is also because handling the new claims as well as pending claims could be a headache and might lead to hemorrhaging of the remaining cash while not generating any capital. This might also lead the parties to abandon the pending claim. A 2019 report from Burford Capital found that a 63% majority of polled finance professionals said their companies have opted to abandon claims valued in the millions rather than pay the legal expenses to pursue them.1 It is worth noting that the report dates back to the pre-COVID-19 time. With this crisis, the chances of abandoning claims have gone up. There needs to be a way where parties are able not only able to pursue their arbitrations smoothly but also turn the disputes into assets and liquidate them. Two ideas come to mind - third party funding and monetization of the claim.
Using Third-Party Funding
As mentioned at the outset, a wide range of disputes might arise due to the current situation. The cash flow problem triggered by the crisis would cripple the capability of parties to handle those disputes, which is why there is now a renewed interest in the use of TPF.
While the topic remains heavily spoken about for the past few years, a recent report suggests that in the context of construction arbitration, the use of TPF arrangements is in its early stages.2 So much so that 64% of the survey report respondents have not seen international construction arbitrations with third-party funding.3 In fact, a survey which was part of a blog post suggested that the construction sector seems to be an attractive sector for the funders.4 In the context of the current crisis, TPF would be particularly helpful by allowing parties to (i) pursue an arbitration while also maintaining enough cash flow to continue conducting business; and (ii) pursue an arbitration that may generate cash flow for their businesses or mitigate the risk of losing a "bet-the-company" dispute.5
In fact, in the 2008 financial crisis, claims like these saw a rise.6 With a substantially higher number of funding companies around, TPF can once again be used to provide the much-needed capital for pursuing meritorious claims if parties do not want to tie up leftover cash in disputes.
Monetization of claims
Pending construction claims often represent enormous latent value for the parties. In the wake of the current crisis, the parties would end up spending cash to manage the pending dispute, and at the same time, they are not generating any capital due to a halt in the industry. There is some respite with the possibility of opting for TPF. While TPF sounds like a good option for future claims as well as pending claims, it is only limited to legal costs of arbitration. Another issue in case of TPF is that the parties might still have to wait for the award to be rendered before they can unlock the value. While managing the dispute is a priority for a business, the bigger priority is generating capital. That is when one of the most noteworthy (and perhaps lesser discussed) siblings of TPF - "monetization" of claims comes in.
Monetization of claims essentially means that a funder in addition to funding the costs of arbitration would also provide funds to the party for general corporate purposes against party's arbitration case as collateral.7 Typically, monetization is supposed to be working capital. However, funding proceeds are often unrestricted in use.8 In essence, capital provided through the monetization can be used to fund the legal department or to keep paying the staff or just to maintain the cash-flow when the industry is at a halt.
Why is monetization more relevant now?
Monetization has been relatively prevalent now in the construction disputes industry. For example, in 2019, a Spanish infrastructure company sold its arbitration for 170 million euros to a US funder Fortress.9 More recently it came into limelight in India when a major construction company monetized a pool of arbitration awards and claims in exchange for an upfront cash payment, which sought to allow the company to repay debt and meet its working capital needs.10
Given the current circumstances, this model is worth emulating for the parties to the arbitration. Particularly in case of pending disputes, arbitration hearings have been delayed which has naturally delayed the award and consequently the foreseen recovery from the award. Monetization would result in upfront availability of cash, essentially resulting in achieving the same objective (at least short term) as expected from the award. This will also help manage the liquidity issue triggered by the crisis.11
Factors to keep in mind
In civil law jurisdictions, monetization of claims is easily achievable. However, in the common law jurisdictions, parties need to keep in mind that monetization of claims could be against maintenance and champerty. Under English law, the original party and not the funder must retain control of the arbitration. Hence, strategically, it would make sense to partially monetize the claim while dealing with common law seated arbitrations.
Few considerations an investor might have before investing in the dispute would be similar to that of TPF, i.e., chances of success on the merits of the case, Respondent's financial situation, experience of the counsel of the party seeking funding, size as well as the enforceability of a potential award among other things. These factors would also be significant for the valuation of the dispute. In other words, the better above factors, the more parties would be able to gain out of monetization.
The use of TPF and monetization could be the much-needed airbags and seat belts for the crashing car metaphor used earlier. Construction Arbitration generally takes up a lot of parties' resources, which are scarce in the current circumstances. A funder or an investor helping the parties to pursue their dispute or just taking it off their plate will have twofold benefits. Firstly, it would allow them to stay afloat during such times. Secondly, it will let them get ready to focus on their core business, i.e., construction.
2. QMUL International Arbitration Survey November 2019, p. 6
4. How to Fund Construction Disputes - Relying on Third-Party Funding? http://arbitrationblog.kluwerarbitration.com/2019/12/24/how-to-fund-construction-disputes-relying-on-third-party-funding/
5. L. Bench Nieuwveld and V. Shannon Sahani, Third-Party Funding in International Arbitration, 2nd edn. (Kluwer 2017), p. 11
7. The Third-Party Litigation Funding Law Review, 3rd ed, p. 28
8. Ibid, p. 219
9. Acciona vende al fondo Fortress su pleito con la Generalitat de Cataluña por ATLL, https://www.eleconomista.es/empresas-finanzas/noticias/9952882/06/19/Acciona-cede-su-litigio-con-la-Generalitat-de-Cataluna-por-ATLL-por-170-millones-de-euros.html
10. HCC raises Rs. 1,750 crore in litigation funding deal, https://www.livemint.com/companies/news/hcc-raises-rs-1-750-crore-in-litigation-funding-deal-1553651279600.html
11. Addressing the financial impact of COVID-19, https://www2.deloitte.com/ch/en/pages/financial-advisory/articles/addressing-the-financial-impact-of-covid-19.html
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.