TAKEAWAYS FROM THE CASE FOR CORPORATE LAWYERS/CLIENTS

The Commercial Court has ruled that a successful claimant can recover the costs of a third party funding agreement from the defendant in English seat arbitration. This differs from the position in English court litigation. This may have consequences for dispute resolution clauses within English law share or asset sale and purchase agreements (“SPA”):

  • Litigation vs arbitration: When drafting an SPA, this may be an additional factor for clients and advisors to bear in mind when considering using litigation or arbitration in the dispute resolution clause. As a buyer, arguably arbitration will be preferable as there is potential to recover the costs of third party funding should a buyer need to obtain funding in order to bring a claim under the SPA (for breach of warranty or restrictive covenant, for example). As a seller, litigation may provide greater certainty as to the costs recovery position following this case, as third party funding costs would not be recoverable by a claimant buyer in English court litigation;
  • Carve out as to costs if arbitration used: Where arbitration is the chosen method of dispute resolution, clients and advisors may want to consider whether wording should be included in the arbitration clause in order to address the issue of cost recoverability under third party funding agreements (as parties are free under s.63(1) of the Arbitration Act 1996 to agree what costs of the arbitration are recoverable). This is likely to be driven more by a seller than a buyer (although, of course, a seller could also be a claimant and thus may need to consider its own potential need to seek third party funding in such a scenario).

HEALTH WARNING

Essar v Norscot had a very specific fact pattern and the unequal bargaining powers of the litigants, as well as the conduct of Essar throughout the course of the agreement and the dispute, undoubtedly influenced the ruling of the arbitrator, which was upheld by the Commercial Court. The wider impact of this decision has yet to be tested in the market. The extent to which this decision could impact on a particular dispute arising out of an SPA will need to be considered both at the time that the SPA is entered into, and during the operation of the transaction, taking into account the fact pattern and dynamics of the parties and the transaction.

BACKGROUND INFORMATION

Background to the case

Norscot sued Essar in arbitration for the repudiatory breach of an operations management agreement. In order to fund the litigation, Norscot had obtained third party litigation funding of circa £657,000 on the basis that the funder would receive an uplift equivalent to 300% of the funding or 35% of Norscot’s recovery, whichever was greater. Norscot succeeded in its claim and sought recovery of the sum of circa £1.94 million due to the funder.

The sole arbitrator awarded Norscot these costs. He found that Essar’s conduct both during the operation of the agreement and the proceedings was reprehensible. He felt that Essar was undoubtedly aware that Norscot’s costs could not be financed from its own resources and had deliberately sought to cripple Norscot financially by withholding payments due under the agreement. This forced Norscot to have no choice but to enter into third party litigation funding on the terms that it did.

The law

S.61(1) of the Arbitration Act 1996 gives an arbitrator the general power to allocate the “costs of the arbitration” between the parties. S.63(3) provides that the arbitrator has a discretionary power to determine “the recoverable costs of the arbitration on such basis as it thinks fit”. Lastly, s.59(1) defines “costs of the arbitration” as the fees and expenses of the arbitrator and any arbitral institution concerned as well as the “legal or other costs of the parties”. In this particular case, the arbitrator held that the costs of third party funding fell within the meaning of “other costs” in s.59(1).

The decision of the Court

Essar brought an application before the Commercial Court to set aside the award under s.68(1) of the Arbitration Act 1996, on the grounds of “serious irregularity affecting the tribunal, the proceedings or the award”. Essar claimed that the arbitrator had exceeded his powers in making the order allowing recovery of the third party funding costs (s. 68(2)(b)).

In this landmark decision, the Commercial Court dismissed Essar’s challenge under s.68(1), holding that there was no serious irregularity as the arbitrator had not exceeded his powers in making such an order. The Court found that the arbitrator had the power to make an order as to costs as he saw fit, and so Essar’s complaint was actually with how he exercised that power (which is not a valid ground for challenge under s.68). Of particular relevance here is that the Court went on to say that even if it had been required to consider the arbitrator’s exercise of his power, it would have found that he exercised it correctly, thus endorsing the arbitrator’s decision.

Further considerations

As a result of this case, there is potential for an increase in parties involved in arbitration proceedings, who are being funded by third party litigation funders, seeking to recover the uplift payable to the funder from the losing party.

That said, there is still some uncertainty as to when an arbitrator will exercise their discretionary power to allow a party to recover the costs of third party funding. It appears that it was not the court’s intention for arbitrators to award these costs as the usual rule in all arbitration cases going forward. The court noted, in particular, that it was Essar’s exceptionally suppressive conduct which justified the arbitrator’s conclusions, and that there was an overall requirement for “reasonableness” and this would act as “an important check and balance”.

This case represents a divergence between arbitration and litigation taking place in the UK, as third party funding costs are not recoverable in litigation (see CPR rule 44.1(2)(a)).