Hong Kong has today passed long-awaited legislation1 that makes it clear that third party funding of arbitration is permitted under Hong Kong law. In broad terms, third party funding involves a third party covering the costs of a legal proceeding, in return for a share of the proceeds if the claim is successful. The new legislation is an important development, which opens up the available options for funding of arbitration claims in Hong Kong.
Third party funding. Third party funding involves the funding of one party’s costs by an unrelated third party, in expectation of a financial return if the funded party is successful in its claim.
The new legislation makes clear that third party funding will be permitted in arbitration cases, as well as in related proceedings including ancillary court proceedings, proceedings before an emergency arbitrator and mediations.
Outside of arbitration, the historical reservations with allowing third party funding of legal proceedings in Hong Kong remain.2
Third party funders. The third party funding industry comprises a range of different players. These range from large, established third party funders with hundreds of millions of dollars in investment funds at their disposal to much smaller players with more modest resources. Increasingly, there are also niche funders which specialise in particular segments of the market or which provide more creative funding options. The largest funders tend to invest in high-value cases, investing sums which potentially exceed US$10 million, in return for a share of the proceeds.
The sources of funds for third party funders are varied, ranging from private equity investors and financial institutions to high net-worth individuals and members of the public, depending on the funder’s specific structure and business model.
A number of significant third party funders have recently opened offices in Hong Kong and Singapore, with a view to capturing a share of the growing market in Asia.
Permitted funding under the new legislation. The new legislation permits third party funding of arbitration costs and expenses in Hong Kong-seated arbitrations, as well as in ancillary court proceedings and related mediation. This includes legal fees and other costs of the arbitration, such as the fees of the tribunal and expert witnesses, and the administration costs of arbitral institutions. Funding is also permitted for arbitrations seated overseas and those without a seat of arbitration, although in such cases, the legislation states that the funding is limited to the costs and expenses of services provided in Hong Kong.
Typical funded cases. Historically, third party funders have focused on cases where claimants have a substantial claim with good prospects of success, but do not have sufficient funds to pursue it. An example of this in the arbitration context is a special purpose vehicle or one-asset company holding a valuable asset that has been expropriated by a foreign state, and which as a result, does not have sufficient funds to pursue an arbitration claim against the state. In such a situation, a third party funder can assist the claimant by financing its legal costs.
With the growth of third party funding, a much wider range of cases are now being funded, including funding of substantial claimants who wish to have greater flexibility over the use of their capital or wish to share the financial risks (and benefits) of pursuing a claim. In other cases, funders have been prepared to provide funding for an entire portfolio of cases from a multinational or a law firm, or to acquire arbitral awards and court judgments at a discount, in return for the potential upside of recovering more at the enforcement stage.
Financial criteria for funded cases. The financial criteria vary among funders, but the more substantial funders tend to be interested in cases with good prospects of success, and where the claim value is 10 times (or more) than the expected investment costs.
Traditionally, third party funders have also structured their returns in arbitration cases either as a percentage of the sum awarded by the arbitral tribunal (e.g. from 10% to 40% or more of the sum awarded) and/or a multiple of the sums committed to the proceedings (typically, at least two or three times the invested amount and/or one or two times the committed but undrawn amount). It is also not uncommon for a time element to be built into the funding agreement, to take into account the increasing cost of committed capital with the passage of time.
Sharing information with a funder. A third party funder will almost invariably conduct due diligence to satisfy itself of the merits of the claim and its expected returns before making an investment. Such due diligence will often include reviewing the pleadings and key documents in the dispute. In practice, the majority of cases proposed to funders will fail to meet the investment criteria.
After making an investment, funders will also commonly require periodic updates, particularly if the prospects of success have changed.
To facilitate information sharing with funders, the new Hong Kong legislation allows for the disclosure of confidential information relating to an arbitration for purposes of having, or seeking, third party funding. Recipients of the information are required to maintain confidentiality over such information.
Extent of funder’s control over the funded arbitration. A concern is sometimes expressed that a third party funder may have undue control over the funded proceedings. This is a particular issue where the funder and the funded party have different views on settlement or strategy.
In practice, the level of control exercised by funders varies. Some funders are content to take a largely passive role, while others expect to play a more active role. The Hong Kong legislation provides for the drawing up of a Code of Practice governing the conduct of third party funders.3 The current draft of the Code expressly provides that a third party funder is required to undertake in the funding agreement that it will not control or direct the funded party as to the conduct of the arbitration, or to influence the funded party’s lawyers to cede control or conduct of the arbitration to the third party funder.
Funding of defendants. It is rare for third party funders to fund defendants, and many funders are not prepared to do so. However, there are funders who are prepared to consider providing such funding, for example, as part of a portfolio of claims or in the form of an insurance-type arrangement.
Disclosure of third party funding. The disclosure of third party funding has become a significant issue, due to concerns over potential conflicts of interest, such as those between funders and arbitrators.
To help address this issue, under the new legislation, a funded party is required to disclose the fact that it is receiving third party funding and the identity of the funder to the arbitral tribunal and the opposing party. However, there is no requirement that the funding agreement itself has to be disclosed.
Strategic issues in defending third party funded cases. There are a number of strategic issues that arise in defending third party funded cases. First, the very use of third party funding may suggest that the counterparty is impecunious, and potentially unable to satisfy an adverse costs order. Accordingly, it may be prudent to consider seeking security for costs – a potentially controversial issue, as it raises the question of whether the third party funder itself should provide such security.
Second, as alluded to above, third party funding potentially raises various conflict of interest issues, which need to be carefully taken into account in any arbitration.
Third, the motivations of a third party funder may be different from those of the funded party, and their views on strategy and/or settlement could also differ. It is therefore important to also take into account the funder’s perspective, as part of an overall case strategy.
Effective date of the new legislation. The new legislation was passed earlier today, and it is expected that the main provisions permitting third party funding in arbitration will come into effect later this year. In the meantime, the Code of Practice, which will apply to all third party funders, will need to be finalised and issued by an authorised body appointed under the legislation.