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Out of step with the market? The English court’s decision that third party funding can be awarded as “costs” to a successful claimant

As discussed in Robert Rothkopf’s recent blog post, the English court in Essar v Norscot has refused a challenge under section 68(2)(b) of the Arbitration Act 1996 (AA 1996) and held that a tribunal did not exceed its powers by including the costs of third party funding within a costs award.

Essar sought to challenge an award in which the tribunal awarded Norscot its costs, which included the sum of £1.94 million, being the sum owed to the litigation funder for advancing Norscot its legal costs to bring the claim. Essar’s challenge was brought under section 68(2)(b) on the grounds that, under section 59(1)(c), “other costs” do not include the costs of litigation funding and the tribunal had no power to include them in the costs award. Essar argued that, as a consequence, the tribunal had exceeded its powers such that it constituted a serious irregularity under section 68(2).

A challenge on the ground of serious irregularity under section 68(2)(b) can only be made out where the tribunal purports to exercise a power which it does not have, and not where a tribunal exercises one of its powers “erroneously”. In Essar, the court found that the tribunal had the power to award the costs of the arbitration under both the AA 1996 and the International Chamber of Commerce (ICC) Rules. Even if the arbitrator was wrong in his interpretation of “other costs” under section 59(1)(c), an award of costs outside the scope of “other costs” was an erroneous exercise of the power to award costs. It was not sufficient to make out a section 68(2)(b) challenge.

The court then went on to consider the meaning of “other costs” under section 59(1)(c). The court held that, “as a matter of language, context and logic… ‘other costs’ can include the costs of obtaining litigation funding”, and that awarding the costs of litigation funding falls within the arbitrator’s general discretion to determine the recoverable costs of the arbitration. The court also held that “whether and, if so, how the arbitrator exercises that discretion in any particular case is an entirely different matter”.

Exercise of power to award costs cannot be challenged

The drafters of the AA 1996 may not have envisaged that “other costs” would include third party funding costs (in particular because such funding was in its infancy in the UK at the time that the Arbitration Bill was being debated). However, the very lack of any specificity in the provision does allow for this broad reading of “other costs”. The court has certainly not said that funding costs must be included in “other costs”, but that, should the tribunal determine, in all the circumstances, that it is appropriate to include them, it has the discretion to do so. Arbitration practitioners are used to relying on the exercise of the tribunal’s discretion in respect of many aspects of arbitral procedure and decision-making. Further, given that the right to appeal for an error of law under section 69  is both unusual and non-mandatory (and often excluded, including by application of the London Court of International Arbitration (LCIA) and ICC Rules), we are also used to being unable to challenge an arbitral award on the basis that the tribunal has got the law wrong. Against this backdrop, one might have expected that this decision (in which the English court recognised and upheld the tribunal’s discretion in the exercise of its powers) to be well-received by the wider arbitration community. Yet the decision has not been universally welcomed. On the contrary, it has prompted a degree of spirited debate within the arbitration community.

Broader impact of the decision and the questions it raises

While much of the court’s reasoning focuses on access to justice considerations, the impact of the decision is broader than cases which replicate the fact pattern in Essar. In emphasising the tribunal’s discretionary power to determine “other costs” and confirming (albeit obiter) that it concurred with the way in which that discretion was exercised in a situation such as arose in this case, the decision also tells us that the erroneous exercise of that discretionary power cannot not, in itself, be challenged.

The decision does therefore leave open the question of when a tribunal should exercise its discretion. If there is a sense that a party should not recover costs of funding in these circumstances, does that mean the tribunal’s discretion should only be exercised in the event that the funding was a necessity to bring the claim? What if a tribunal were to make an award of funding costs to a party which had used third party funding simply to hedge its risk in pursuing a bona fide claim?

There is some guidance on the exercise of the tribunal’s discretion; its power to award costs is not unfettered. While referring to the tribunal’s discretion to award costs, the court mentioned briefly that there is a requirement that costs, including “other costs” should be reasonable. This is set out at section 63(5) of the AA 1996, which requires that the tribunal determine whether the costs claimed are “reasonably incurred” and “reasonable in amount”. A tribunal faced with a decision as to whether or not to exercise its discretion to award funding costs as part of “other costs” would therefore be required to ascertain whether such funding costs were reasonably incurred and reasonable in amount. It might be possible for a tribunal to award a proportion of funding costs for an impecunious claimant on the basis that they were reasonably incurred, but not reasonable in amount (for example, where the funding agreement was not entered into on standard market terms). It might also be possible for a tribunal to determine that it was not “reasonable” for a claimant with sufficient funds to incur funding costs, although it is as yet a controversial issue whether the business decision to hedge risk can be considered “reasonable” in an assessment of costs. However, this does beg the question whether, if the general scheme in the AA 1996 envisages making a successful party whole so far as reasonable costs are concerned, is it right that the cost of funding is recouped by a claimant purely on the basis of whether or not it had the money to pursue its valid claim in the first place?

Disclosure of funding arrangements: ascertaining the extent of a respondent’s exposure

Awarding funding costs in a costs award also raises questions about the ability of a respondent party to ascertain its potential liability in the event of losing. Unlike damage which is pleaded and proven during the arbitration itself, the sum claimed in costs is usually left until the end of the proceedings once liability and quantum have been determined. A defendant could find itself facing a substantial additional “claim” at the costs stage, perhaps with no visibility beforehand that the claimant’s case has been funded. Standard funding terms can require payment of a significant percentage of ultimate damages awarded. Paying this additional percentage on top of the damages could be a substantial additional exposure for a respondent. There are already calls for mandatory disclosure of funding arrangements and their terms across the arbitral community; the Hong Kong Law Commission has recommended such disclosure in its latest report on third party funding. This decision may provide further support for disclosure in order that a respondent can factor in the potential risk of being found liable to meet funding costs into its decision to proceed with defending a claim.

Costs or damages?

This decision by the English court that funding costs fall within the costs of an arbitration is out of step with the current thinking of some stakeholders in the arbitration process. (Note that in the ICC’s report on decisions in costs in international arbitration published in December 2015, the ICC did consider that there may be circumstances where it would be considered reasonable for a successful funded party to recover the costs of funding from the other side.) Some contend that these costs should more accurately be viewed as a damage that should be pleaded and proven in the arbitration itself. Indeed, the ICCA/QMUL draft report on third party funding (with the final report anticipated shortly) states that:

“[i]t is not appropriate for tribunals to award funding costs (such as a conditional fee, ATE premium, or litigation funder’s return), as they are not procedural costs incurred for the purpose of an arbitration. The success portion payable to a third-party funder results from a trade-off between the funded party and the funder, where the funder assumes the cost and risk of financing the proceedings and receives a reward if the case is won. This agreement is not linked to the arbitration proceedings as such. The reasonable legal fees incurred by a funded party should remain recoverable. Funding costs may be claimed as damages where permitted by the applicable substantive law. It is unclear whether such funding costs would meet the relevant tests for causation and foreseeability.”

A question mark rests over whether allowing the scope of a costs award to encompass third party funding costs is the right way to have achieved the result in Essar. It appears very likely that the same result would have been achieved if Norscot had pleaded out its funding costs as damage. Based on the facts as described by the court, both causation and foreseeability would likely have been made out. Dealing with funding costs as damage also removes the concerns about the potential for different treatment of parties based purely on the tribunal’s assessment of how badly treated or impecunious they may be. It also eliminates the risk of a defendant becoming aware of a potentially substantial additional liability only at the end of the proceedings.

Tactical decisions

Based on the decision in Essar, it seems likely that funded claimants with English-seated arbitrations will now seek to recover their funding costs under section 59(1)(c) of the AA 1996. The tribunal will have the discretion to award those costs, depending on its assessment of whether the costs are reasonably incurred and reasonable in amount.

A claimant taking a business decision to hedge its risk would appear to be unable to meet the requirement of causation or remoteness in a damages claim. Essar therefore offers it a chance to claim costs which previously it might not have claimed, with a chance that the tribunal may be minded to exercise its discretion. For a claimant with a fact pattern similar to that of Norscot, the decision is less clear cut. A costs claim comes at the end of proceedings, and leaving it until after liability and quantum have been assessed means that there is no second bite at the cherry to recoup funding costs if the tribunal considers such costs should have been claimed as damages. Should a claimant first plead out their third party funding costs as damage, hoping to fulfil the requirements of causation and remoteness? If it failed in this aspect of its damages claim, the claimant could potentially claim those costs as “costs”. However, would disclosure of the funding arrangement weaken the claimant’s case and open it up to an application for security for costs? Would failing to make out the requirements for a damages claim ultimately lessen the chances that a tribunal would exercise its discretion with regard to other costs and conclude that funding was reasonable?

What is clear is that if the paying party disagrees with the tribunal’s decision on this question, this judgment suggests there may be little it can do about it.

 

Herbert Smith Freehills Vanessa Naish Hannah Ambrose

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