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May 22, 2017 Articles

Litigation Funding: Are These Costs Recoverable in Arbitration?

By Jim Reiman

The use of third parties to fund plaintiffs' legal and litigation expenses ("litigation funding") is becoming an increasingly common practice in Europe and the United States, and has been used in Australia for many years. As the litigation funding industry has grown and evolved, it is becoming more common in arbitration. Indeed, there are some litigation funding companies that limit their investments to cases that are being arbitrated rather than tried in a country's court system. Thus, arbitrators are being increasingly asked to award litigation funding expenses as costs.

As a result, the question has arisen: may they? Corollary questions are: If permitted, what elements of litigation funding fees may be awarded? Only the money actually advanced for legal and other fees and litigation-related expenses? Interest? The "uplift" (the fee over and above normal interest)? All of the above? Additionally, if permitted, should litigation funding costs be awarded? What principles should guide the arbitrator or arbitration panel in reaching its decision?

These questions were the subject of a U.K. (England and Wales) case decided in December 2016—Essar Oilfields Services Ltd. v. Norscot Rig Management Pvt Ltd. [2016] EWHC (Comm) 2361 (Eng.). The case is reportedly the first U.K. decision to address the issue, and is notable not only for its initial statement on the issue for U.K. litigants but also for the reasoning of its decision, which this commentator believes is an appropriate guide for arbitrators around the world.

The Backstory
Essar Oilfields was an action to set aside an award issued by a sole arbitrator in a dispute between Essar Oilfields Services Limited and Norscot Rig Management Pvt Limited. In that dispute, Norscot claimed that Essar breached an operations management agreement, causing Norscot substantial damages. Pursuant to the parties' contract, the dispute was arbitrated in England before a single arbitrator under the International Chamber of Commerce Rules of Arbitration (effective January 1, 1998) (ICC 1998 Rules).

The arbitrator entered a preliminary award in favor of Norscot whereupon Norscot, pursuant to the ICC 1998 Rules, filed an application for its costs. Norscot had engaged a litigation funding company to pay its legal fees and expenses relating to its arbitration against Essar, and included in its claim of costs the fees of such company. The litigation funding company's fee was 300 percent of the sums it had advanced on Norscot's behalf, or 35 percent of the recovery, whichever was higher. A total of £647,000 had been advanced; hence Essar sought £1,941,000 (the litigation funding company's entire fee). The arbitrator awarded Norscot that entire sum as costs.

Essar challenged the costs award and asked the High Court of Justice to vacate the award, arguing (1) under the law of England and Wales, litigation funding fees are not allowed as "costs," and thus the arbitrator had no power to include them in his award; and (2) "there was a serious irregularity under [the English Arbitration Act] because the arbitrator exceeded his powers and, given the amount ordered, it would cause substantial injustice to Essar if it had to be paid." Both arguments were rejected by the English court, and the arbitrator's award was affirmed.

The Applicable Law
The Essar Oilfields court commenced its opinion by noting the limited scope of its review and when it may vacate an arbitral award. The applicable law is the Arbitration Act 1996, England's and Wales's version of the U.S. Federal Arbitration Act. More specifically, at issue was section 68(2)(b) of the Arbitration Act, which provides that the challenging party must establish a "serious irregularity," defined as "an irregularity of one or more of the following kinds which the court considers has caused or will cause substantial injustice to the applicant[:] . . . the tribunal exceeding its powers (otherwise than by exceeding its substantive jurisdiction . . .)."

English law, like the law in the United States and other countries, holds that for a tribunal to exceed its powers and a court to vacate an award, the conduct must be egregious. As the court in Essar Oilfields noted:

"Section 68 is really designed as a longstop, only available in extreme cases where the tribunal has gone so wrong in its conduct of the arbitration that justice calls out for it to be corrected."

. . . .

"Section 68(2)(b) does not permit a challenge on the ground that the tribunal arrived at a wrong conclusion as a matter of law or fact. It is not apt to cover a mere error of law. . . . A mere error of law will not amount to an excess of power under the section."

[2016] EWHC (Comm) 2361 [8], [10] (quoting Lesotho Highlands Dev. Auth. v. Impregilo SpA [2006] 1 AC (HL) 221 [27], [31]–[32] (appeal taken from Eng.)). Thus, the Essar Oilfields court reviewed the award before it from roughly the same perspective as an American court—arbitration awards are to be given great deference and cannot be vacated for mere errors in law or fact.

Having established the parameters of its review, the Essar Oilfields court next turned to the assertion that the arbitral tribunal exceeded its power by awarding litigation funding expenses as costs. It framed this question by asking (1) does the law of England and Wales permit the awarding of costs, (2) did the parties' agreement or the rules that governed the arbitration permit the awarding of costs, and (3) if the answer to both (1) and (2) is yes, what elements of the litigation funding fee may be included in costs?

The court held that, under English law, costs may be awarded under the Arbitration Act. It also found that costs may be awarded under article 31(1) of the ICC 1998 Rules.

Next, the court asked: What comprises "costs" under English law and the ICC 1998 Rules? Two provisions of the Arbitration Act and a provision of the ICC 1998 Rules provide the answer.

Section 59 of the Arbitration Act states (emphasis added):

(1) References in this Part to the costs of the arbitration are to—

(a) the arbitrators' fees and expenses,
(b) the fees and expenses of any arbitral institution concerned, and
(c) the legal or other costs of the parties.

(2) Any such reference includes the costs of or incidental to any proceedings to determine the amount of the recoverable costs of the arbitration (see section 63).

Section 63 of the Arbitration Act states:

(1) The parties are free to agree what costs of the arbitration are recoverable.

(2) If or to the extent there is no such agreement, the following provisions apply.

(3) The tribunal may determine by award the recoverable costs of the arbitration on such basis as it thinks fit.

If it does so, it shall specify—

(a) the basis on which it has acted, and
(b) the items of recoverable costs and the amount referable to each.

The court also examined article 31(1) of the ICC 1998 Rules, which provides (emphasis added):

The costs of the arbitration shall include the fees and expenses of the arbitrators and the ICC administrative expenses fixed by the Court, in accordance with the scale in force at the time of the commencement of the arbitral proceedings, as well as the fees and expenses of any experts appointed by the Arbitral Tribunal and the reasonable legal and other costs incurred by the parties for the arbitration.

Lastly, and most importantly, the Essar Oilfields court addressed the question: What sums may be included in "costs"? Put another way, what is the definition of "costs"? The court focused on the amorphous language "other costs" in the Arbitration Act and the ICC 1998 Rules. In the arbitration, Norscot argued that "other costs" could include all litigation funding expenses, including the uplift. The arbitrator agreed, and expressly found that it was within his discretionary power to award all litigation funding expenses as "costs."

The Court's Holding and Analysis
The court, having noted that, under the law, only truly egregious awards could be vacated, concluded "that there was no serious irregularity within the meaning of [section] 68(2)(b), even if the arbitrator was wrong in his construction of 'other costs.'" [2016] EWHC (Comm) 2361 [47]. This conclusion was based in part on the court's finding that both English law and the applicable arbitral rules permitted the award of costs. Specifically, the court held: "In my judgment, the relevant power here is the undoubted power to award costs. If the arbitrator fell into error, it was an error as to the scope of such costs by reason of his allegedly erroneous interpretation of [section] 69(1)(c) and Rule 31(1)." Id. at [41].

The court further held that any such error does not and cannot be held to be a "serious irregularity," and thus it disposed of the case. Nonetheless, the court deemed it appropriate to address the other issues raised, specifically: whether the arbitrator was correct in its determination that applicable law permitted it to award all litigation funding expenses, including the uplift, and whether it should have done so.

To answer these questions, the court focused on the Arbitration Act's and ICC 1998 Rules' use of the term "other costs." Essar argued that the term should be defined narrowly, and limited to "costs of arbitration," thus precluding the award of litigation funding costs. The court disagreed:

Essar seeks to cut down on the scope of [Arbitration Act section 59(1)(c)—"the costs of the arbitration are . . . the legal or other costs of the parties"] by saying that the governing expression is really "costs of the arbitration" and that in itself would exclude the costs of third party funding, since the latter is not the cost of the arbitration, but the costs of funding it. However, that is the wrong way round. It is the collection of items in [section] 59(1) itself which defines what the costs of the arbitration are. "Costs of arbitration" is not some prior limiting definition.

I accept, of course, that "other costs" has to be seen as other costs which relate to the arbitration proceedings. But, in my judgment, that does not help Essar very much, because the question then is what such costs are or might be. Certainly, where a party to an arbitration is funding it by obtaining specific litigation funding . . . , it is very hard to see how that is excluded for all purposes from the expression "other costs." Indeed, [Essar's counsel] in his submissions came close to accepting that when he said that other costs connoted "something necessary to get the arbitration off the ground or on the road." Here, at least, that could be said to include the costs of third party funding.

. . . . The better view, as noted above, is to look at the expression functionally.

. . . .

. . . . The expression ["other costs"] should not be confined by some legal straightjacket imposed by reason of what a court might or might not be permitted to order. . . .

. . . .

In my judgment, therefore, I unhesitatingly conclude that the arbitrator's interpretation of "other costs" was correct, in that it extended in principle to the costs of obtaining third party legal funding.

[2016] EWHC (Comm) 2361 [53]–[55], [68], [70]. Next, the court addressed, indirectly, what to this commentator is the most important question: Should the arbitrator award litigation funding expenses as costs, and if so, what elements of the litigation funding fee? The court posed the question in the context of arbitral discretion, and whether the arbitrator properly exercised that discretion. Without expressly so stating, the court held that he did.

The facts of the Essar Oilfields case are particularly poignant, and are detailed in some length both in the arbitral award and the court's opinion. Briefly, Essar engaged in a deliberate and premeditated course of conduct specifically intended to "cripple Norscot financially" and then to exploit Norscot's financial weakness. Payments to Norscot, its crew, and its suppliers were withheld. "Essar made and persisted in unjustifiable personal attacks and allegations of fraud and dishonesty against" Norscot employees. Id. at [21].

In short, the court concluded that (1) Norscot had no alternative and likely would have been precluded from pursuing its claim absent the litigation funding, and (2) Essar knew that Norscot had entered into a litigation funding agreement in order to finance the pursuit of its claims. These conclusions persuaded the court that the arbitrator's discretion had been properly exercised. Additionally, and very significantly, the arbitral tribunal and the court found that the litigation funding fee charged was reasonable and consistent with "standard market rates."

Essar Oilfields makes the clear statement that under English and Welsh law, where either the parties' agreement or the rules of the arbitral proceeding permit the award of costs, the tribunal has the power to award litigation funding expenses, including the uplift, as an element of costs. While not expressly stated, it also implicitly stands for the proposition that although a tribunal has the power to award litigation funding expenses, it should use its discretion in determining whether and when to do so, and that the fee assessed must be commercially reasonable and consistent with market rates.

For American lawyers, this commentator notes that many commercial agreements permit the award of legal fees and costs to the prevailing party, and that the ICC's cost rule is not unique. For example, UNCITRAL Arbitration Rule 40(2) (2013) provides (emphasis added): "The term 'costs' includes only: . . . The legal and other costs incurred by the parties in relation to the arbitration to the extent that the arbitral tribunal determines that the amount of such costs is reasonable."

Additionally, most arbitral institution rules similarly permit the award of costs. However, the definition of "costs" varies among the arbitral organizations' rules. For example, the American Arbitration Association's Commercial Arbitration Rules (effective October 1, 2013) do not use the term "costs," but rather encompass such in several rules, including R-53 (administrative fees), R-54 (expenses), and R-55 (neutral arbitrator's compensation). Additionally, R-47 (scope of award) states (emphasis added):

(a) The arbitrator may grant any remedy or relief that the arbitrator deems just and equitable and within the scope of the agreement of the parties . . . .

. . . .

(d) The award of the arbitrator(s) may include:

i. interest at such rate and from such date as the arbitrator(s) may deem appropriate; and
ii. an award of attorneys' fees if all parties have requested such an award or it is authorized by law or their arbitration agreement.

One or more of these rules may permit the award of litigation funding costs, including the uplift. Thus, the issue is applicable to American arbitrations, and the Essar Oilfields decision's analysis and implicit recommendation that discretion should be used should serve as a guide to American arbitrators.

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