Speculate and arbitrate to accumulate

Third-party funders have flooded the investment arbitration world in recent years, taking on claimants’ risk for a share of the award. Some suggest these funds assist access to justice, while others say they exploit flaws in a system already in serious need of reform.


Argentina is not having an easy time of late. Beleaguered by a tidal wave of investment treaty arbitration claims following a series of vast debt restructurings – after the country’s record $94bn default in 2001 – it has found itself facing potential pay-outs to investors of tens of billions of dollars. In one recent landmark decision, Abaclat and Others v Argentine Republic, 60,000 Italian bondholders were given the right to file a $1bn group claim against the country after it was ruled that their restructured sovereign bonds could qualify as expropriated ‘investments’. According to Argentina’s chief legal advisor to the Treasury, Eduardo Barcesat, the International Centre for Settlement of Investment Disputes (ICSID) is little more than ‘a tribunal of butchers’ that favours corporations over governments. Argentina wants out.

Argentina is not the first state to declare a lack of faith in ICSID, the World Bank body set up to arbitrate between foreign investors and states. Bolivia, Ecuador and Venezuela have already withdrawn from the institution, claiming it denies them autonomy over public policy and puts too much power in the hands of investors. For investors, the argument is far from convincing: if a state expropriates funds illegally, it cannot complain when asked to honour the covenant it signed. To default undermines future trade agreements, they point out, and destabilises the world economy.

Over the past three years, third-party litigation funders have vigorously entered the debate. With tens if not hundreds of millions of dollars at their disposal, they assist companies by agreeing to fund their claim for a share of the eventual award. Such a service assists access to justice, they say, by keeping costs down.

However, concerns have been raised that, as third-party funders spread their risk across an extensive portfolio of cases, frivolous lawsuits will become more common. With a conspicuous absence of international regulation, there are currently no rules determining the amount of control a funder can take over a case, or whether its presence should be disclosed. And with both lawyers and funders being repeat players in the industry, there is unease over potential conflicts of interest for counsel and arbitrators.

Yet there may be more serious ethical issues at stake. Are funders who take on claims against struggling states any different from the disgraced ‘vulture funds’ that grew up in the 1990s, which buy the debt of weak nations at a heavily discounted rate and then claim for a higher amount? Funders deny the analogy is fair: the huge sums they invest in claims are incomparable, they insist, and such cases wouldn’t prove profitable anyway. However, now sovereign bondholders have been given permission to recover debts through international arbitration, there could be new scope to enter potentially vulturous territory. While the majority of Abaclat creditors seeking redress from Argentina may have an arguable case for reimbursement, what about the cheap bonds on the secondary market, sometimes bought for as little as a fifth of their original value? And what about similar potential cases against euro-crisis countries or post-Arab Spring states desperately rebuilding entire nations? Where does the vulturous line lie, and how do third-party funders orientate themselves along it? With so little transparency in the system, few currently have the ability to judge.

You look at the rapid rise of investment cases and you think, wow, the world didn’t really expect this. And you wonder, is third-party funding going to put this on steroids?
Catherine Rogers
Professor of Law, Penn State University


Maya Steinitz, Associate Professor of Law at the University of Iowa and a leading scholar on third-party funders, is clear that investment arbitration funding should be subjected to rigorous scrutiny due to its public policy dimension. ‘Investment arbitration is waged against governments, which means it is ultimately the public who end up paying,’ she says. ‘Traditionally we have regarded states as having sovereignty over deciding how to deal with public policy issues such as a financial crisis. Now they have to deal with third-party funders who, unlike the original claimant, never had a direct stake in the country.’

Boom now, bust later?

Third-party funding may attract controversy, but one thing is undisputed: the industry is growing, and growing fast. Burford Capital, the world’s biggest litigation funder, was founded by former Time Warner General Counsel Chris Bogart and former Latham & Watkins partner Selvyn Seidel in 2009. Registered in Guernsey, it is one of a handful of firms with at least $100m in its coffers to fund litigation and arbitration. Other big players include Juridica Investments Ltd, Calunius Capital, Allianz ProzessFinanz and Harbour Litigation Funding.

The funding model has so far proved highly lucrative. Typically, funders will claim around 20 to 50 per cent of the recovery proceeds, while spending an average of $8m on each investment claim. Burford, which commits up to a quarter of its funds to international investment cases, saw its profits grow nine-fold from 2010 to 2011, while Juridica’s grew by nearly 600 per cent. For Bogart, this is a clear sign that the legal sphere was gasping for help. ‘I’ve done this full-time now for three-and-a-half years and the response has been extraordinary,’ he tells IBA Global Insight. ‘It clearly suggests there was a dramatic need for incremental capital into the legal market to make it work properly. What is going on is really a correction of a longstanding under-serving of the legal market.’

Seidel, who left Burford to found Fulbrook Capital Management in 2011, describes the change in the industry over the past three years as ‘like night and day’. ‘I see it in front of me, growing and growing,’ he says. ‘It is no longer an emerging industry, it is maturing, and in my view it will inevitably reach maturity and be a good part of financial day-to-day life.’

A commercial claim is no different from any other asset, Seidel explains, and can be compared to a security or share. ‘They can be bought, sold, financed, pledged. I think they will eventually be part and parcel of derivatives. Some people say, isn’t that a bad thing? Well, they are good and bad. They can be good just like any other derivatives.’
For some, however, such ideas set off alarm bells. Mention of derivatives inevitably brings to mind root causes of the current financial crisis. While comparable problems don’t currently seem to exist in the investment arbitration market, there are concerns that this may change as claims continue to multiply: 19 ICSID cases were registered in 2002, which rose more than150 per cent to 50 cases in 2012. ‘One of the real dangers is a boom in the number of cases brought because there is funding available,’ says Eric Branbandere, Associate Professor of International Law at Leiden University’s Grotius Centre for International Legal Studies. ‘The procedure is very costly so many claimants are reluctant to engage funds. But if third-party funders invest, the threshold is lowered – especially if they want to spread risk to several cases and are perhaps a bit less rigorous in assessing the meritorious character of a claim.’

When funding goes wrong: Juridica Investment Ltd v S&T Oil Equipment and Machinery Ltd

In 2007, S&T Oil Equipment and Machinery Ltd, represented on a contingency fee basis by King & Spalding, brought an ICSID arbitration against Romania. However, within a year of filing the claim, the law firm allegedly informed their clients that unless they located an outside funding source, they would resign. In May 2008, S&T Oil entered into an agreement with Juridica Investment Ltd whereby the funder agreed to pay for part of the arbitration in exchange for a percentage of any proceeds.

In late 2009, King & Spalding informed S&T Oil that it wished to withdraw from the case, claiming that the company had not produced a ‘critical piece of evidence’. S&T Oil called the claims ‘false, untrue, inflammatory, and highly defamatory’. King & Spalding declined to comment.

King & Spalding and S&T Oil notified Juridica of their falling-out. In November 2009, Juridica asserted that S&T Oil made ‘material misrepresentations’ about the facts underlying the case and refused further funding. S&T Oil denied the charges, and has declined to comment further. The funder demanded ‘immediate reimbursement of all sums’ paid to S&T Oil under the investment agreement.

In July 2010, the ICSID panel dismissed S&T Oil's case against Romania after the company failed to find alternative funding. In December, Juridica filed an action against S&T Oil at the London Court of Arbitration (LCIA) to retrieve its $3.5m investment.

In February 2011, S&T Oil filed a complaint against Juridica alleging violation of the Racketeer Influenced by Corrupt Organisations (RICO) Act in the US District Court for the Southern District of Texas. S&T Oil alleged that when entering into the agreement, Juridica omitted material facts, including that the agreement violated attorney–client privilege (the company claimed that soon after entering the agreement, its lawyers began seeking legal advice from Juridica), and that Juridica intended to use S&T Oil’s attorney–client privilege information against the company. Juridica denied the charges, and has declined to comment further.

In March 2011, the District Court denied S&T Oil’s application for a temporary restraining order against the LCIA proceeding, and dismissed the case the following month. In January 2012 the US Court of Appeals for the Fifth Circuit affirmed the district court’s order dismissing S&T Oil’s case. The LCIA arbitration is still ongoing.‘It is certainly a concern,’ agrees Penn State University Professor of Law Catherine Rogers, who specialises in international arbitration. ‘You look at the rapid rise of investment cases and you think, wow, the world didn’t really expect this. And you wonder, is third-party funding going to put this on steroids?’

The funders are emphatic in their response: profitable investments require strong claims, and there is nothing wrong with a ‘boom’ if the cases involve claimants with genuine grievances. ‘The meritorious litigation it encourages is litigation that should have a voice, but for unfair reasons can’t make its voice heard,’ comments Seidel. ‘And usually that means that the claimant doesn’t have the money, and often doesn’t have the money because of what the defendant has done to it.’

Yet what about borderline cases, where the claimants may try to overwhelm the defence with evidence? For those who believe the investment arbitration system is already overly investor-friendly, such concerns are very real. Andrea Dahlberg, Arbitration Practice Manager at Allen & Overy, concedes that ‘there is an imbalance’ stemming from the lack of effective lawyers in developing nations with a good understanding of treaties. Yet the top London law firms do their bit to ‘level the playing field’, she stresses, by providing regular pro bono training for African and Latin American lawyers. ‘There is something of a gap here,’ she explains. ‘But there are a lot of lawyers involved in this. We tackle everything, from how to negotiate these treaties to how to get the best advantages for the state.’

While funders can hardly be blamed for pre-existent flaws in the system, they are clearly far from the levelling force that many believe ICSID and its fellow institutions so desperately need. Despite being approached by a number of state defendants, Seidel, Bogart and Mike Smith, CEO of Calunius, all admit they are yet to take one on. While funding products for defendants have been developed – such as taking a fixed multiple of the amount invested or a percentage of the difference between the claim and final award – such arrangements are generally likely to prove less lucrative than claimant awards.

Bogart, however, claims the reason he hasn’t financed a defendant state has nothing to do with unwillingness. ‘We are completely agnostic,’ he says. ‘Frankly, it has more to do with the fact that governments have access to capital at a lower cost than I do. So it is cheaper for a government to fund its own litigation than it is for me.’

US Chamber of Commerce: a vehement critic

Whatever the merits of a case, questions remain over the amount of control a funder should be permitted to take. While most funders claim they do not want full control, and would almost certainly fall foul of champerty and maintenance laws around the world should they attempt to take too much, there are currently no international regulations outlining what level is acceptable [see Champerty and maintenance – a brief history box, page 48]. Most funders admit they expect a degree of input over the choice of arbitrator and counsel, as well as any potential settlement. They may also expect access to privileged documents.

‘Some funders say, I am financing, I want an influence,’ says Benoit Le Bars, co-founder and Managing Partner of Lazareff Le Bars, which specialises in international arbitration. ‘I think this is problematic. It is not a good thing for the arbitration world to have financial institutions intervening and influencing lawyers in their work.’

It is concern over potential conflicts, along with fears about funding for non-meritorious cases, that has prompted the US Chamber of Commerce to become one of third-party funding’s most vehement critics. ‘Third-party investments in litigation represent a clear and present danger to the impartial and efficient administration of civil justice in the United States,’ says the US Chamber Institute for Legal Reform. Indeed, with many funders enjoying strong connections to the legal profession, it is inevitable that lawyers may find themselves conflicted. Seidel’s former firm Latham & Watkins is one of the leading investment arbitration specialists, while Smith’s former firm Freshfields is now representing Rusoro Mining in its claim against Venezuela – a claim being funded by Calunius.

The funder will have an influence over the case, but lawyers have to be very careful in saying my duty is to the client, not to the funder. There are very serious ethical issues that have to be looked at here
Andrea Dahlberg
Allen & Overy Arbitration Practice Manager

Even lawyers who support arbitration funding in principle concede that such issues need urgently to be resolved. ‘The funder will have an influence over the case, but lawyers have to be very careful in saying my duty is to the client, not to the funder,’ warns Dahlberg. ‘There are very serious ethical issues that have to be looked at here.’

While a sprinkling of laws exist in Australia and the US, no jurisdiction has seriously addressed the pressing issues of control and conflicts of interest. The best attempt has come in the form of voluntary regulations in the UK – a Code of Conduct produced by the Association of Litigation Funders of England and Wales in 2011 – which outlines a series of important commitments for funders, including avoiding ‘unduly influencing’ the lawyers and observing confidentiality of material. However, the Code has been criticised for its lack of detail and non-binding character, and leaves many issues unresolved – including rules on disclosure. And for many, disclosure is key.

‘I’m definitely not among those who say funding doesn’t have to be disclosed,’ says Shearman & Sterling partner Emmanuel Gaillard, one of the world’s top international arbitrators. ‘I strongly believe that to assess conflicts of interest, some degree of transparency is required.’

While Seidel throws his support behind disclosure – mainly as he believes the presence of a funder could add credibility to the case and encourage opponents to settle – other funders are more reticent. It could encourage defendants to sidetrack a case with satellite legislation, they argue, and arbitrators may use it as an excuse to award adverse costs against the claimant. In international arbitration there is currently no standard system of how costs are allocated – though funders, lying beyond the arbitrators’ jurisdiction, cannot be forced to pay.

One common refrain among funders when demands for disclosure are made is that they are no different from any other lender, such as a bank or hedge fund, or a private equity fund that owns part of the business. ‘I promise, if you are a portfolio company of a multibillion dollar private equity fund and engaged in a significant piece of arbitration, that fund is exercising a heck of a lot more control than Burford ever would,’ says Bogart. ‘And law firms won’t want that disclosed because they probably have a client relationship with that fund. That is the elephant in the room that nobody wants to talk about.’

Bogart stresses that he would be happy with new disclosure rules as long as they apply to everyone. Smith, whose company Calunius had to disclose its funding of Rusoro Mining against Venezuela and Oxus Gold against Uzbekistan due to stock exchange rules, thinks similarly. ‘A lot of people see third-party funders as a different animal to other funders, but they are not really. So I say, let’s get some common guidelines in place that apply to all stakeholders behind the scenes on both sides.’

Carving out a threshold for disclosure should not prove too challenging: any financer with over ten per cent ownership, or with a direct stake in the award, or with rights over confidential material, could potentially be eligible. Deciding who should put such guidelines in place may prove more difficult. Calunius Capital CEO Leslie Perrin, who was involved in the drafting of the UK Code of Conduct, has voiced his support for international guidelines for litigation and arbitration. Yet such rules would have no enforcement powers, and Walter Remmerswaal, Managing Director of third-party funder Omni Bridgeway, confessed at a recent funding roundtable that they may have limited effect in practice. ‘If I want to make a deal with the general counsel of BP and he is willing to do business on extremely favourable commercial terms, who’s going to tell us we cannot do the deal because it falls outside the code?’

Champerty and maintenance – a brief history

Third-party litigation funding was forbidden at common law under the ancient doctrines of maintenance and champerty. Maintenance refers to the funding of a claim when the funder holds no valid interest in the claim itself. Champerty takes it one step further by adding that the funder has a direct financial interest in the outcome of the claim.

In 1843, British philosopher and social reformer Jeremy Bentham explained the origins of maintenance and champerty – to avoid unfairly influencing a case through money and power – and why the concepts eventually fell out of favour: ‘A mischief, in those times it seems but too common, though a mischief not to be cured by such laws, was, that a man would buy a weak claim, in hopes that power might convert it into a strong one, and that the sword of a baron, stalking into court with a rabble of retainers at his feet, might strike terror into the eyes of a judge upon the bench. At present, what cares an English judge for the swords of a hundred barons? Neither fearing nor hoping, hating nor loving, the judge of our days is ready with equal phlegm to administer, upon all occasions, that system, whatever it be, of justice or injustice, which the law has put into his hands.’

England and Wales abolished maintenance and champerty as crimes and torts in the Criminal Law Act of 1967, though the common law principles continue to apply to funding agreements. In more recent years, several US states have abolished the doctrines or limited their application. Over the same period, the US has developed contingency fee arrangements, which allow lawyers to gain a share of the profits of litigation in lieu of their fee. In the UK, lawyers are permitted to enter into conditional fee agreements, whereby the client agrees to pay lower (or no) fees if the case loses, and the full amount plus a ‘success fee’ if the case is successful. 

Only the arbitral institutions – ICSID, the UN Commission on International Trade Law (UNCITRAL) and the International Chamber of Commerce (ICC) – have the power to enforce compliance. However, Victoria Shannon, former Deputy Director of the North American Office of the ICC International Court of Arbitration, believes they may prove reluctant. ‘Arbitral institutions want to ensure their rules are applicable in all jurisdictions so they are very careful about what they put in them. I doubt they will want to touch this issue with a ten-foot pole.’

Vulturous prospects

What is clear is that, without transparency, speculation about potentially ‘vulturous’ activity can only grow. While stressing that her research is in the early stages, Steinitz believes the vulture fund analogy merits attention. ‘There are certainly hedge funds and other entities that are paying close attention to see if there’ll be the kinds of opportunities that the sovereign debt crisis in the 90s presented,’ she says. ‘The vulture funds that bought the arbitration awards against states are in a way what started this. Other investors thought, why wait until there is an award? Why not get involved earlier?’

Robert Volterra, co-founding partner of Volterra Fietta and one of the world’s top public international law specialists, dismisses the vulture fund argument. ‘In terms of third-party funders, I do not see the overlap with “vulture funds”,’ he says. ‘Apart from the fact that some NGOs do not like the fact that they are part of a process that makes governments keep their promises and punishes them for stealing from foreign investors.’

For Volterra, the term ‘vulture fund’ is ‘inflammatory rhetoric’ created by NGOs and the media (though it is also a term used by judges in London’s High Court). Countries such as Argentina, Indonesia and Zambia portray themselves as too poor to repay the debt, but, says Volterra, the reality is that they were not bankrupt, but they simply ‘wished to allocate their resources elsewhere’. The result? Nobody trusts the country and its recovery will be stalled.

Over recent years, following a spate of bad publicity for ‘vultures’ targeting poor African nations, policymakers have demonstrated a more liberal approach to the issue. The UK passed a law to limit vulturous activity against developing countries, while some jurisdictions have adopted ‘collective action clauses’ (CACs) in their bond agreements to prevent small numbers of creditors demanding full repayment of debts if a supermajority of stakeholders agree to restructured terms.

I think commercial claims will eventually be part and parcel of derivatives. Some people say, isn’t that a bad thing? Well, they are good and bad
Selvyn Seldel
Co-founder of Burford Capital and founder of
Fulbrook Capital Management

Yet with Abaclat looming ominously on the horizon, the floodgates have been opened for sovereign bondholders across the world to recoup their debts through international arbitration. In this murky legal no-man’s land, CAC laws have no enforceability, and several struggling states may find themselves vulnerable. According to a 2009 study by the International Monetary Fund, the 25 nations with the highest likelihood of default are signatories to an average of 48 BITs. ‘ICSID arbitration could blow a hole in the international community’s collective action policy,’ says Michael Waibel, Deputy Director of the LLM programme at Cambridge University, in an article for the American Journal of International Law. ‘The importance of this potential loophole for sovereign debt markets cannot be over emphasised.’

While Bogart et al concede that some less credible operators may pursue vulnerable states, they vehemently deny that it is part of their own business plan. Ethics aside, it simply isn’t profitable, they say; while vulture funds can snap up debt at hugely discounted prices, the hefty sums involved in investment arbitration force a more careful selection of cases. ‘Small defendants are obviously less appealing from a recovery prospect or from a vulturous prospect,’ says Smith. ‘So you wouldn’t want to be investing in claims against impoverished sovereign states. It doesn’t make economic sense.’

When asked what the definition of vulturous is, however, Smith takes a long time to respond. His first answer – ‘something we would avoid’ – seems unsatisfactorily circular. He qualifies it with something more concrete: ‘You wouldn’t go after a state where people are living on a dollar a day.’ What about Egypt, where a quarter of the population lives below the poverty rate, and which is currently facing more investment claims than any African nation? ‘In GDP terms, Egypt is not a weak country,’ he replies, before conceding: ‘There is no science to this, it is purely art. But at some point you say “no”.’

Profiting from justice

While there was a time that any third-party investment in a dispute was deemed champertous and immoral in many jurisdictions, now there seems a growing consensus that the principle is sound. As Lord Justice Rupert Jackson notes in his 2010 UK review on civil litigation costs, such funding promotes access to justice and can help filter out less credible claims by allowing impartial experts to gauge their merits before they reach court.

How far third-party funders can be blamed for flaws inherent in the system – flaws they amplify, but did not create – is open to debate. Yet while the industry remains less than transparent and unregulated, speculation over excessive control, conflicts of interest and potentially vulturous activity will persist. It is now, at this nascent stage in the industry’s development, that funders have the chance to prove their ‘meritorious’ credentials and put their critics’ minds at rest.

The alternative – doing nothing – is not an option when such important public policy concerns are at stake, stresses Rogers. ‘There is a general reticence about regulations, and I think that’s a healthy scepticism. But with a phenomenon like third-party funding, with the potential to affect investment arbitration so dramatically, I think the idea that we shouldn’t do anything is naive and risky.’  

Rebecca Lowe is Senior Reporter at the IBA and can be contacted at rebecca.lowe@int-bar.org