The rise of Third-Party Funding (“TPF”) in international arbitration in the western world is now of interest to those in other jurisdictions. In this article, we put the spotlight on Brazil to explore the laws to determine whether TPF is permissible.

ARBITRATION IN BRAZIL

The statistics released by the main Brazilian Arbitration Centres show a consistent increase in the number of new arbitration proceedings. For the past five years, the numbers of new cases and the values in disputes have more than doubled. CAM-CCBC indicates an annual growth rate of 20%. The ICC has recently reported that Brazilian parties are the third largest users of arbitration, behind US and Canada; accounting for 41% of the Latin American proceedings. The ICC also ranks São Paulo as the eighth most frequent jurisdiction chosen as a seat, and Portuguese as the fifth most popular language used in arbitration proceedings.

In Brazil, arbitration is booming. It is the chosen method for dispute resolution in the majority of large contracts. It is more efficient considering the average duration of court proceedings; combined with the fact that arbitrators are specialists on the matters in disputes. Brazil is a signatory to the 1958 New York Convention and the Brazilian Superior Court of Justice (STJ) supports arbitration (as of today, the STJ has only set aside 14 awards). In addition, the New Brazilian Civil Procedure Code - which will be in force next March, includes arbitration among its core rules (article 3, paragraph 1). It provides that the Court will refrain from analysing the merits of the dispute when facing an arbitration agreement or when the arbitral tribunal recognised its jurisdiction (Article 485, VII).

THE ECONOMIC CRISIS AND “CAR WASH OPERATION” – AN INCREASE OF DISPUTES AND LACK OF LIQUIDITY

Brazil is facing its worst economic crisis in the past 20 years, aggravated by the ‘Car Wash Operation’, a Federal Police investigation into major Brazilian state-owned companies, Petrobras and Eletrobras, regarding construction projects and politicians. This is leading to renegotiation, breaches, defaults and termination of contracts, consequentially, increasing the number of disputes.

In addition, the economic crisis brings with it insolvent parties lacking funds to bear the costs of arbitration proceedings; i.e. the filling, management, legal and expert fees, among others. Similarly, some solvent companies choose to fund other activities or are simply not taking the risks and avoiding the impact of contingency and legal fees on their financial statements. Whether due to lack of liquidity or because of a commercial reason, these parties are not pursuing their claims.

As result, the rise on the number of parties failing to pay for costs or requesting (i) to negotiate the payment of the arbitration costs, and /or (ii) to suspend the proceedings has been observed.

ENTER THIRD-PARTY FUNDING

HOW IS IT WORKING IN THE LATIN AMERICAN MARKET?

Third-party funding is more common in the UK and the US however, it is fairly common in Latin American countries. In Brazil, third-party funding is still new and only few funds currently operate.

Lex Finance, a Peruvian fund currently operating in Brazil has reported a 50% increase in the number of requests from Brazilian parties and their legal counsels. It envisages having USD 400 million invested in Brazil within the next three years.

Similarly, other funds based in the UK have indicated a noticeable increase in requests from Brazil.

Lex Finance only finances arbitration proceedings and it has a three level procedure:

  • an internal due diligence
  • an external due diligence performed by independent law firms; and
  • the approval of the Funding Agreement by an Investment board.

As a general rule, the Funded Party is not required to provide any guarantees to the Funder.

The Funder does not interfere with the claim, as the independence of the parties and arbitrators shall not be comprised. The Funded Party may be required to provide updates on the status of the proceedings so the Funder may monitor its investment.

REGULATION / LIMITATION IN BRAZIL

In Brazil, court litigation proceedings are subsidised by the government, the court fees are capped and, if parties evidence they lack funds, they are exempted from bearing the costs of the proceedings and fees to the prevailing party (so called “sucumbência”).

It is also common practice in Brazil for attorneys to enter into success contracts with their clients in exchange for a percentage of the value awarded in the court judgment. Brazilian legislation also permits a party to assign credits and contractual positions. On this basis, it is possible to say that there is no prohibition for third-party funding practices under Brazilian law.

Funds currently operating in Brazil and those targeting Brazil have not reported any regulatory issues. The rise of third-party funding, however, may lead to the necessity to issue regulation in this matter; or to amend the existing rules.

A similar situation took place in the UK, where the lack of regulation caused the major funds to create the Association of Litigation Funders of England and Wales (the “ALF”). The ALF sets out a framework for the third-party funding activity, as well a Code of Conduct to its members.

POINTS FOR CAREFUL CONSIDERATION

There are a number of questions currently surrounding third-party funding, its workability, interference and compliance with the arbitration rules and principles, as the examples set out below:

  • Arbitrators’ duty to disclose

The New Brazilian Arbitration Act in force since July 2015, Article 14, paragraph 1, provides for the arbitrator’s duty to disclose, before accepting the appointment, any fact pertaining his/hers impartiality and independence. This raises the issue whether the Funded Party has the duty to disclose a Funding Agreement to the Tribunal and/or the other party.

A relationship between the arbitrator and the Funder may compromise the arbitrator’s independency and impartiality.

The main Brazilian arbitration centres have indicated concerns in relation to this point and there may soon be further Arbitration Rules issued regarding this point.

  • Autonomy of the parties

Scholars have shown concerns over the Funder’s interference in the proceedings, as it may limit the Funded Party in settling the proceedings, appointing arbitrators and legal counsels.

Conversely, these rights are discretionary and, therefore, one can say that there is no prohibition under Brazilian law.

  • Security for costs and recovery of arbitration costs

Some scholars believe that the Funder merely provides a tool allowing a party to pursue its rights and, therefore, the Tribunal cannot issue orders against it. Albeit, others have the view that if the Funder makes the dispute feasible, the Funder may also be liable for the recovery of costs in the event the Funded Party loses the claim. In this sense, some funds require the parties to have ATE insurance.

The lack of regulation also raises other questions, as a matter of principle, for instance, the economic balance between the parties; due legal process; the increase of frivolous claims and nature of the funding agreement and confidentiality.

Above all, the freedom of the parties to contract and agree over a [potential] credit is a fundamental principle; and third-party funding emerges as an additional solution and a tool to provide parties with the access of justice for those lacking in funds and an alternative to the parties that prefer to allocate their financial resources elsewhere and preferring to manage the risk of pursuing a claim.