EXECUTIVE SUMMARY In its most basic essence, third-party funding involves an exchange between the disputing party and the funder. The disputing party receives funds from the funder (often to cover the costs of the dispute) and the funder receives a return on its investment, either as an agreed sum or as a share of the proceeds of the dispute. The main advantage of using third-party funding is the ability to minimise the ongoing cost of funding the dispute, whilst still benefiting from any favourable award. If the case is lost, the funder covers the costs (most funding agreements will include After the Event (ATE) insurance to cover adverse costs orders). If the case is won, the disputing party will benefit from the proceeds, and the funder will receive the fee previously agreed in the funding agreement. If you are facing difficulties in funding your dispute, or if you would prefer to use your funds for ventures other than litigation or arbitration, third-party funding becomes a go-to option. Such arrangements provide a practical, commercial way of managing and/or deferring the cost of running a dispute, whilst ensuring the best chance of maximising any potential returns.OVERVIEW The market for financing international arbitration is rapidly evolving. Initially, TPF was introduced to resolve an inability to cover the costs of arbitration. Today it is being used in a number of ways. There are several misconceptions about arbitration funding, for instance that the funding is only for one-off claims, or that the funds must be used to cover the costs of the arbitration. The reality is that the current market is far more sophisticated and can now be likened more to “arbitration finance” or simply “finance”. As such, there are an increasing number of ways that parties facing disputes can manage uncertainty and risk, and ensure that good claims don’t go unheard. BENEFITS OF THIRD-PARTY FUNDING The classic example of a party using TPF is a claimant in an expropriation case – it cannot fund the claim, has no control over its assets, and has no access to loans on the market. TPF covers the costs so that the claimant can pursue the claim without risk. If the case is successful, the claimant receives damages and pays the TPF fee; if it is unsuccessful, the funder covers the costs (adverse costs can be covered by ATE insurance). At the other extreme, a well-capitalised company might use TPF as a financial tool to shift the risk of a claim to a funder whilst still reaping the benefits of an award. This might be the case with a general counsel seeking to turn the legal department into a profit making entity. Most TPF users come between these two: not insolvent but cash sensitive, and would rather invest their funds in their business, while still pursuing the claim and outsourcing the risk to the funder. Other benefits include where the claimant faces budgetary constraints (for instance, where there has been no money set aside for potential disputes) or potential accounting benefits (owing to an asymmetry in the accounting treatment of litigation costs and any award). WHO ARE THE FUNDERS? When considering using TPF, it is crucial to partner with the right funder. The major funders providing TPF in international arbitration are all specialised in funding high-value commercial litigation and arbitration disputes. The key attributes to look for in a funder are that they are capitalised – that is, “good for the money” – and have a strong track record. Other questions include whether the funder is (i) backed by institutions, (ii) publicly listed or private, (iii) a permanent capital vehicle, a private equity fund or a high net-worth individual. Funds also differ in their decision-making structure: some undertake an analysis of the merits using in-house lawyers or external legal experts, while others prefer to analyse the claim as they would any other type of investment. An interesting trend in the market is for funders to align with certain firms (or, less frequently, certain companies) in so-called “portfolio funding”. This relatively new practice (which is more developed in the US) provides an attractive mechanism for ensuring long-term reliability in funding disputes. SECURE FINDING TENDERING FOR FUNDING The process of tendering for and securing funding works in largely the same way with all funders: – First, the funder undertakes a high-level analysis of all aspects of the claim, and preliminary terms of agreement are drawn up between the claimant and the funder – Second, the funder spends a period of between three weeks to three months on a more thorough investigation of the claim (due diligence), after which the terms of agreement are accepted, modified or rejected The process is not formalised and funders may vary in their approach. For instance, some funders have lawyers in-house, and so may have a quicker turnaround time for an initial decision than those who have to outsource. The length of funders’ due diligence period also differs considerably. Another key difference is the nature of the initial agreement. Most funders will offer preliminary terms of agreement, to be confirmed and accepted at the end of the due diligence period. This is often coupled with the requirement of exclusivity during that period – meaning that the claimant is prevented from going elsewhere and it is the funder’s choice whether to go ahead with the deal. Other funders will offer more certainty and actually sign terms of agreement after the initial stage, leaving an opt-out clause in the event that the due diligence reveals a serious irregularity. Given these various issues, it is crucial to consider various funders as early as possible, in order to negotiate the most favourable terms of agreement and ensure that the claim can be reliably funded, keeping in mind any relevant deadlines in the arbitration and other time constraints. EVALUATION OF THE CLAIM The key factors funders consider when evaluating a claim are: i) any potential issues with enforcement of the award or recoverability; ii) the merits of the claim itself (jurisdiction, liability, facts); iii) a reasonable estimate of the quantum based on the damages claimed; and iv) issues relating to the arbitration process (including legal and other costs, duration of the case (potential bifurcation or document production), rights of appeal/annulment, the arbitrators involved). The funder’s investment committee will consider these factors and decide whether the claim as a whole is a worthy investment. The committee will then offer terms of agreement based on the expected return versus the expected risk, assessed on both a qualitative and quantitative basis. The due diligence period involves an evaluation of the same issues in greater detail. The claimant’s lawyers often assist the funder in this evaluation period, providing guidance on strategic issues and assisting with case documents (often using secure-access websites to ensure confidentiality). Funders usually issue a questionnaire regarding key contracts, documents, accounts and financial information, reports on damages, expert reports, witness statements and legal opinions. Funders then follow up with supplementary requests and may seek external legal advice. How quickly the due diligence hurdle is overcome depends on the availability and quality of the documentation.TERMS OF AGREEMENT CLASSIC FUNDING ARRANGEMENT Terms of agreement usually follow a simple formula: 1. ESTIMATED COST OF THE CASE IS X 2. ESTIMATED QUANTUM IS Y 3. FUNDER WILL COVER THE COSTS AND a. If the case is won, the funder receives a multiple of X or a percentage share of Y, or some combination of the two b. If the case is lost, the funder covers the costs; most funding arrangements include ATE insurance to cover any adverse costs orders These terms can vary greatly, depending on the characteristics of the claim and the funder. As a rough guide, funders will ask for two or three times the costs, or anywhere between 10 to 40% of the quantum. These terms can also be varied in other ways, for example: FLEXIBLE ARRANGEMENTS Beyond the classic arrangement, funding can take many forms. This can range from the funder buying equity or putting debt into the claimant’s company, to monetising the award (that is, purchasing part of the award up front), to accepting payment from sources other than the award. When funders invest in the claimant’s company, this can be as simple as buying shares, or can go further to include placing members of the funder on the company’s board and taking part in running the claim or even the business. This more invasive approach is rare, however, with most funders looking simply to fund the claim for a return. Accepting payment through sources other than the award allows the funded party to reap the benefit of any award, with the funding agreement to becoming integrated in the company’s broader financial arrangements. These options see what is traditionally referred to as funding take on characteristics more akin to finance, whereby simple sourcing of funds is replaced by more sophisticated financial arrangements. While there is no bright line between these two terms, claimants facing financing issues are increasingly benefiting from tailored funding products. As Mick Smith from Calunius points out, the market is “open to invention”. TRADITIONALLY, T PF IS USED TO RESOLVE AN INABILIT Y TO COVER THE COSTS OF ARBITRATION. TIME: terms can include a time variable, whereby the percentage of damages the funder receives increases as time passes and more money is invested in the claim; for example, increasing from 10-25% over a two-year period. This allows for lower recovery by the funder where less is invested or in the event of settlement. VALUE OF QUANTUM: this variable provides for a different percentage recovery for the funder on separate portions of damages; for example, 25% on the first 20 million, reducing to 15% on the second 20 million, and 10% on the third. This allows the funder to achieve a return, while the claimant benefits from a large award. FINANCING INTERNATIONAL ARBITRATION: A PRACTICAL GUIDE 21THE FUTURE OF ARBITRATION FINANCE The financing of disputes is not a modern invention. But as disputing parties become more aware of the options available to them, this increased demand naturally causes the market to develop and expand. As funders grow in size and experience, they are able to offer more varied and tailored products. One of the main developments in this regard is for funders to enter in to multi-claim deals with certain clients or law firms: the funder covers the cost of several claims on the basis that it will gain a greater return in the long run, while disputing parties gain security in outsourcing risk and ensuring that they will not be prevented from defending and enforcing their legal rights owing to uncertainty or cost. So-called “portfolio funding” can also involve funding claims for defendants, contrary to the common misconception that funding is only for claimants. By spreading the risk across a portfolio of claims, a funding arrangement allows a company both to protect itself from adverse claims and pursue its own claims. At the other end of the spectrum, funding can be sought not only for individual claims, but for individual parts of claims – for instance, for security for costs or in the case of post-decision enforcement. Parties can avoid their claims failing at these hurdles by bringing in a third party and gaining immediate access to funds. There are also arrangements that can be developed to tailor legal fees to the specific needs of the case, for instance with hybrid funding products incorporating Conditional Fee Arrangements (CFAs) or Damages Based Agreements (DBAs). Funding can go further to cover a law firm’s work in progress (WIP), for example in a pre-dispute phase or during settlement negotiations. Perhaps the most common misconception about TPF is that the funds must be used to cover the costs of the dispute. This is entirely false. TPF agreements can be simply described as an exchange of funds for “disputes assets” – for example, a future or existing Award. There is no requirement that such funds be directed to a specific purpose. The market for arbitration finance is coming to reflect an increased awareness amongst parties of the broader potential for funding to become part of parties’ wider finance arrangements. There are certainly regulatory issues to be aware of, which will vary from jurisdiction to jurisdiction. But the trend towards the use of these arrangements is clear, and disputing parties should be aware of these options when considering or engaged in international arbitration. CONCLUSION To summarise, the key points to keep in mind when considering third-party funding are: 1. KNOW YOUR FUNDERS – use capitalised funders with a strong track-record 2 . NAVIGATE THE TENDERING PROCESS EFFICIENTLY – contact funders at an early stage and ensure the claim is well presented during initial evaluation and due diligence 3 . NEGOTIATE APPROPRIATE TERMS OF AGREEMENT – agree funding terms and a form of financing that suits the specific circumstances of the claim These basic rules all have in common the goal of providing practical financial solutions to address disputing parties’ funding needs. Flexible terms of agreement and the various forms the investment can take allow for funding to be adapted to suit each claim. These options provide invaluable access to justice for claimants lacking funds in the face of a dispute, and go further to provide a useful financial tool for parties seeking a commercial approach to managing risk and maximising returns in international arbitration. AS FUNDERS GROW IN SIZE AND EXPERIENCE, THEY ARE ABLE TO OFFER MORE VARIED AND TAILORED PRODUCTS.