The Commercial Court rejected an application to set aside an arbitral award entitling the respondent to its costs of third party litigation funding on the ground of serious irregularity. It also held that the Arbitration Act 1996 power to award "legal and other costs" included the costs of litigation funding.

Background

In Essar v Norscot, Essar brought an application to set aside an award on the question of interest and costs made by Sir Philip Otton as sole arbitrator in an arbitration subject to International Chamber of Commerce (ICC) rules. This followed earlier awards in which Essar had been found liable to pay damages to the respondent, Norscot, for the repudiatory breach of an operations management agreement.

Norscot had obtained third party litigation funding of £647,000 in exchange for which the funder was entitled, in the event Norscot succeeded, to an uplift equivalent to 300% of the funding or 35% of Norscot's recovery, whichever was greater. Norscot had sought recovery of the sum due to the funder of c. £1.94 million.

The arbitrator was highly critical of Essar's conduct, both during the operation of the agreement and for most of the arbitration proceedings. He found that Essar had deliberately sought to cripple Norscot financially by withholding payments due under the agreement and then persisted in unjustified personal attacks and allegations of fraud and dishonesty against Norscot's principals. The arbitrator concluded that Norscot had no option but to enter into third party litigation funding on the terms it did and that it would have been "blindingly obvious" to Essar that Norscot "would find it difficult if not impossible to pursue its claims by relying on its own resources". Norscot adduced expert evidence that the terms of its funding were market-standard, which the arbitrator accepted.

S.61(1) of the Arbitration Act 1996 (the Act) gives an arbitrator the general power to allocate between the parties "the costs of the arbitration". S.63(3) provides that the arbitrator "may determine by award the recoverable costs of the arbitration on such basis as it thinks fit". Finally, s.59(1) provides that "the costs of the arbitration" comprises, in addition to the fees and expenses of the arbitrator and arbitral institution, "the legal or other costs of the parties".

The arbitrator held that Norscot was entitled to its costs on the indemnity basis. He also held that he was entitled to award (and did award, subject to final quantification) Norscot the costs of third party funding (including the uplift payable) on the basis that they fell within the meaning of "other costs" in s. 59(1).

Essar applied to the Court to have the award set aside under s. 68(1) of the Act on the ground of serious irregularity. (It was not open to Essar to appeal on a point of law under s.69 of the Act, that provision having been excluded by the applicable ICC rules.) The Court first addressed the issue of whether, if "other costs" did not include the costs of third party funding, there was a serious irregularity in the award. The Court noted that for there to have been a serious irregularity the arbitrator would have to have exceeded his powers. It held, however, that awarding the costs of third party funding in circumstances where "other costs" did not include such costs should be characterised as the exercise of the arbitrator's "undoubted power to award costs" coupled with "an error as to the scope of such costs", rather than the arbitrator exceeding his powers. Accordingly, there was no serious irregularity. That was sufficient to dispose of the application.

Does "other costs" include the costs of third party funding?

Given the obvious importance of the issue, the Court went on to consider the meaning of "the legal or other costs of the parties" in s.59(1) of the Act. As a starting point, the Court rejected Essar's submission that s.59(1) should be construed by reference to what a Court could order in litigation under the CPR and related common law rules, noting that the Act was a complete code as to the conduct of arbitration.

The Court then went on to consider the language of the sub-section. It noted first that "Sections 63(3) and 61(1) allow the arbitrator to determine the recoverable costs of the arbitration as he sees fit" and that "Section 59(1)(c) then deliberately includes a head of costs, other than legal costs." The Court dismissed as arbitrary Essar's submission that "other costs" (which must have been intended to capture something other than pure legal costs) could include, for example, internal expert fees or management time but not litigation funding and also rejected Essar's submission that "other costs" should be construed eiusdem generis with "legal costs" so as to cover only costs which were truly analogous to legal costs. The Court concluded that "The real limiting factor […] is the functional one. Do the costs relate to the arbitration and are they for the purposes of it?"

Accordingly, the Court concluded that "as a matter of language, context and logic […] 'other costs' can include the costs of obtaining litigation funding". The awarding of such costs had therefore been within the arbitrator's general costs discretion.

A brave new world?

This result has already prompted a significant response amongst commentators and has been hailed by many as a landmark decision. It has been met with understandable delight within the third party litigation funding industry. In the short term, assuming it is not overturned on appeal, it will almost certainly prompt third-party funded parties to arbitration to seek to recover the uplift payable to the funder, if not routinely, then at least more frequently. Whether many of them are likely to succeed is a different matter.

The impression given by the judgment is that it was not the Court's expectation that arbitrators would award the costs of third party funding as a matter of course. Having reached its conclusion, the Court noted that "the overall requirement of reasonableness can act as an important check and balance" and re-emphasised the arbitrator's findings in relation to Essar's exceptionally repressive conduct which justified the award in this case.

In relation to the issue of reasonableness, s.63(5) of the Act provides that "Unless the tribunal or court determines otherwise […] the recoverable costs of the arbitration shall be determined on the basis that there shall be allowed a reasonable amount in respect of all costs reasonably incurred". This is similar (albeit expressed the opposite way round) to the indemnity basis for assessment under the CPR set out in 44PD.6, which requires the court to disallow any costs that have been unreasonably incurred or are unreasonable in amount.

However, it is not clear that the default test in s.63(5) would act as a bar to recovery in many cases at all. If a prospective claimant enters into third party funding on market-standard terms, then it generally will be the case that any uplift ultimately payable will be both reasonably incurred and in a reasonable amount, especially where a claimant had no other means of funding its dispute. That may also be the case where a claimant could have funded from its own resources, but chose to manage its downside risk by obtaining third party funding for the whole or part of the cost. Accordingly, if the cost of third party funding is to be allowed as a category of recoverable cost, it follows that, on the basis of the default test in s.63(5), they could be recovered in most cases.

However, what may in fact have been envisaged by the Court is an examination of the reasonableness of requiring the paying party to pay the costs of third party funding in all the circumstances, which may not straightforwardly follow from the fact that those costs were reasonably incurred and reasonable in amount. The Court clearly did consider it reasonable for such costs to be awarded in a case such as this, where those costs were "so directly and immediately caused by the losing party". The difficulty is that an assessment of what is reasonable in this broader sense is a less familiar exercise, which arbitrators and the Courts will now be expected to carry out without much guidance. Accordingly, although the absence of an absolute bar on the recoverability of the costs of third party funding is to be welcomed in order to do justice in cases such as this, the uncertainty parties to arbitration will now face (particularly given the absence of an obligation to disclose the terms of funding) pending further Court authority (or amendment of the Act) is not.

As for litigation under the CPR, rule 44.1(2)(a) limits the recoverable costs of court proceedings to "costs payable by a client to their legal representative". Accordingly, there is not currently scope for a corresponding development without a change in rules, and it seems unlikely that anything will change soon, given that it is still less than four years since a significant move in the opposite direction with the abolition of recoverability of success fees for most new CFAs (although that was prompted in large part by policy considerations which do not apply to third party funding to the same extent). That said, this decision potentially paves the way for the development of principles governing the recoverability of the costs of third party funding which we may one day see adopted in the CPR.