In the recently released “Report on Third Party Funding for Arbitration” (“Report”) the Law Reform Commission (“LRC”) has recommended that the Arbitration Ordinance (Cap. 609) be amended to permit third party funding in arbitration, mediation and litigation proceedings under the Arbitration Ordinance.

Though the reform still awaits passage through Hong Kong’s Legislative Council, should it go ahead it is likely to herald a flurry of activity in the funding space, with several funders having already set up shop in Hong Kong over the past 18 months in anticipation of the reform.

The reform is also likely to have a significant impact on the construction industry which continues to rely on arbitration, mediation and litigation proceedings under the Arbitration Ordinance as its primary means of dispute resolution. We discuss below the background to and results of the Report and our reading of the tea leaves on some of the key takeaways for the construction industry in Hong Kong.

Background to the Report

As a common law jurisdiction, Hong Kong has inherited the now somewhat archaic English legal doctrines of maintenance and champerty which prohibit funding of legal proceedings by third parties. Whilst there has been a loosening of the scope of these doctrines, the Hong Kong courts have continued to resist their outright abrogation.

As a result, and subject to limited exceptions, third party funding of litigation remains impermissible in Hong Kong. With regard to third party funding of arbitrations taking place in Hong Kong, however, the position has been less clear. In Cannonway Consultants Ltd v Kenworth Engineering Limited [1995] 1 HKC 179, Kaplan J held that in light of the history of champerty, it was not appropriate to extend the doctrine from public justice to the private consensual system of arbitration. The Court of Final Appeal, however, muddied the waters in the case of Unruh v Seeberger (2007) 10 HKCFAR 31. In that case, Ribeiro PJ expressly left open the question of whether maintenance and champerty applied to arbitrations taking place in Hong Kong. It has remained an open question since whether the doctrines of maintenance and champerty apply to arbitrations in Hong Kong.

In an attempt to clarify the position, the Law Reform Commission’s Third Party Funding for Arbitration Sub-committee was formed in June 2013 with the task of reviewing the current position relating to third party funding for arbitration and considering whether reform was necessary. On 19 October 2015, the Sub-committee released a Consultation Paper which, amongst others things, proposed that third party funding for arbitration be allowed.

On 1 February 2016 the public consultation period ended and on 12 October 2016 the LRC released the Report.

Results of the Report

Apart from the Report’s key recommendation that third party funding of proceedings under the Arbitration Ordinance be allowed, some of the other LRC’s recommendations included:

1. Regulation

Following the trend towards light touch regulation in common law jurisdictions, the LRC has proposed an initial three year period in which a code containing clear standards (including ethical and financial standards) for third party funders providing funding to parties should be developed (“Code”). The LRC recommended that the Hong Kong Advisory Committee on the Promotion of Arbitration should oversee the adoption of the Code and assess its effectiveness after this initial three year period.

2. Disclosure of Funding

The LRC has recommended that if a funding agreement is entered into, the funded party must give written notice to the other party to an arbitration and any administering arbitral institution of the fact that a funding arrangement has been entered into and the identity of the third party funder. Disclosure of funding agreements will assist in minimising conflicts of interest and fostering a more open and transparent system of funding.

3. Adverse Costs Orders

Interestingly, the LRC did not recommend that any changes be made to the power of the arbitral tribunal to make an adverse costs award against third party funders. The Report found that the current powers of a tribunal under the Arbitration Ordinance to order a party to give security for costs was adequate protection. The LRC also recommended that the Hong Kong Advisory Committee should consider the adequacy of this arrangement further during the initial three year period of the Code's operation.

4. Mediation and Court Proceedings

The LRC has also recommended that consideration be given to whether to make consequential amendments at the same time to the Mediation Ordinance (Cap 620) to extend such non-application of the common law doctrines.

The Report considered the effect of changing the law with respect to the Arbitration Ordinance and not making consequential changes to the Mediation Ordinance and court proceedings. It considered that given the interaction between the Arbitration Ordinance and court proceedings, such as enforcement and supervision, that the changes to allow third party funding should equally apply to court proceedings.

Key takeaways for the Construction Industry

With most construction contracts in Hong Kong containing arbitration or mediation clauses, the Report and recommendations are likely to significantly affect the construction industry and disputes concerning it. We think some the key takeaways from the reform are:

  1. Access to arbitration and mediation;
  2. Claim risk and administration;
  3. Funding arrangements; and
  4. Conflicts.

1. Access to arbitration and mediation

Hong Kong construction contracts typically contain multi-tiered dispute resolution clauses. This usually leads to the dispute being finally resolved by mediation or arbitration. Frequently, funding such disputes lies with claimant sub-contractors who do not have the financial means or flexibility of resources to pursue potential claims against their larger and more resourceful contractor employers.

Accessibility to third party funding is likely to free up otherwise encumbered cash flow for these industry participants and has the potential to increase the number of claims brought in arbitration allowing meritorious claims to be brought that might not have been able to without the support of such funding.

Third party funders can also assist impecunious contractors or sub-contractors in managing resources during a project. Bringing or defending a claim has the potential to severely strain already tight budgets and tie up cash flow. With the assistance of a third party funder, the contractor or sub-contractor can avoid having to allocate or find funds to deal with the claim.

Should they go ahead, consequential amendments to the Mediation Ordinance will also likely affect the construction industry. Given that many standard form government construction contracts include dispute resolution clauses which mandate that the parties go to mediation this will equally open the door to many more mediation claims being brought.

2. Claim risk and administration

Third party funding will also allow construction industry claimants to spread their risk by not bearing the whole cost of bringing or defending a claim. Third party funders can assist in mitigating the financial exposure in exchange for a percentage of the successful award.

Another advantage of third party funding to the construction industry will be in the presence that the funder has on the administration of the claim. The presence of a funder may assist in discouraging vexatious or oppressive interlocutory applications or discovery processes which are often used by defendants to stifle a claimant’s claim in arbitration. Where a claimant is funded, its deeper pockets can allow it to expend the necessary legal costs to deal with these applications and may therefore discourage such applications being taken out in the first place.

A further corollary benefit is in the settlement of claims: knowledge of a funding arrangement (if disclosed) may promote settlement by increasing the defendant’s perception of the claim’s strength.

3. Funding Arrangements

Although there are now established players in the Hong Kong funding market, the reform, should it pass, is likely to encourage other funders to enter the market.

Construction claimants should therefore take care in choosing any funder and should ensure that they are financially able to see a claim through. A funder’s internal financing can vary significantly: some are publicly listed, some are backed by high net worth individuals whilst others have lines of credit available to them. The nature of a funder’s financing structure can affect not only its ability to maintain necessary funds but may influence its approach to management of claims. Different funders will focus on cases of different claim sizes, types and in differing jurisdictions.

Parties to a funding agreement should also be aware of potential risks that may arise from the agreement. Key amongst these, the effect on legal professional privilege of the funding agreement and documents provided to the funder in order to assess the claim should be considered. Construction industry claimants should do their due diligence on any funder and independent legal advice should be sought on the funder and the terms of the funding arrangement.

4. Conflicts

Potential conflicts of interest should be a key area of concern to construction parties seeking to use a third party to fund an arbitration. Although the LRC has recommended the adoption of the Code and the disclosure of funding agreements, funded parties should ensure that conflicts arising from the funding agreement are carefully managed.

One area of concern arises where a funder pays the legal costs of proceedings directly. This arrangement may result in a claimant’s lawyer being unduly influenced by the funder and therefore favour the funder's interests and views over those of the claimant beyond the terms set out in the agreement.

This should militate that those construction industry claimants accepting funding carefully consider the nature and extent of a funder’s control over proceedings. Any funding arrangement should clearly set out the relationships between the parties and necessary disclosures.

Conclusion

With the recent release of the Law Reform Commission’s Report and recommendations, it is now for the Legislative Council to decide on the proposed law amendments. In the meantime and in anticipation of likely reform, the construction industry should familiarize itself with the benefits of funding arrangements. In doing so, particular care should be taken to examine both the structure of third party funders and the details of any funding arrangement which will ultimately prove the most determinative elements in the success of any such arrangement.