Costs of third-party funding awarded in arbitration

Arbitrator includes third party funder’s success fee when awarding costs to successful claimant

Norscot Rig Management Pvt Ltd (Norscot) brought arbitral proceedings in England against Essar Oilfields Services Ltd (Essar) for breach of an operations management agreement, under the ICC Rules. 

Norscot secured third-party funding of GBP 647,000 in order to bring the arbitration, which entitled the third-party funder to a fee in the event of Norscot’s success (the Success Fee).  The Success Fee was 300% of the funds advanced by the funder or 35% of the damages recovered.  

The sole arbitrator found Essar liable in damages to Norscot.  It is relevant to the arbitrator’s decision on costs that he found that Essar had sought to cripple Norscot financially; that Norscot could not have pursued its claim without third-party funding; and that the funding obtained by Norscot was on standard commercial terms for litigation finance.

The arbitrator also made an award of costs in Norscot’s favour.  One part of the costs order was a sum of GBP 1.94 million which Norscot owed to its funder.  This included the Success Fee.

Section 59 of the Arbitration Act 1996 (the Act) defines the categories of costs that an arbitral tribunal seated in England may award.  They are: (a) the arbitrators’ fees and expenses; (b) the fees and expenses of any arbitral institution; and (c) “the legal and other costs of the parties”.  The ICC Rules refer similarly to “the reasonable legal and other costs incurred by the parties for the arbitration”.

The arbitrator determined that s59 and the ICC Rules gave him a wide discretion as to the “other costs” he could award, and that the cost of litigation funding fell within the ambit of such “other costs”. In deciding his exercise of his discretion, the arbitrator took into account his criticisms of Essar’s conduct. 

Costs award challenged in Commercial Court

Essar challenged the costs award under s68 of the Act.  s68 allows a party to challenge an award on the basis that a serious irregularity (of one of the types specified in s68(2)) has occurred which has caused substantial injustice to that party.  Essar asserted that the arbitrator had allegedly exceeded his powers by awarding costs which he had no jurisdiction to award (s68(2)(b)).

HHJ Waksman QC rejected the challenge, finding that the arbitrator did not exceed his powers.  Consequently, there could be no serious irregularity to justify annulling the award under s68.  The judge seems to have held that, since the arbitrator had a power under the Act and the ICC Rules to award costs, it followed that the arbitrator did not exceed his powers because an award of costs is what he made.  This is consistent with previous authorities (especially the decision of the House of Lords in Lesotho v Impregilo [2006] 1 AC 221): even if an arbitral tribunal’s award is erroneous, this does not mean that it has exceeded its powers.  Essar’s challenge therefore failed for this reason alone.

What type of costs can be claimed?

The real interest in the judgment is found in the judge’s subsequent comments (which are obiter) on the meaning of “legal and other costs”.  The judge effectively endorsed the arbitrator’s broad reading of this phrase: “the real limiting factor … is the functional one.  Do the costs relate to the arbitration and are they for the purposes of it?”.  The judge seemed to have reasoned that, since Norscot had incurred borrowing costs in order to pursue the arbitration (including, contingently, the Success Fee), they fell within the category of “other costs”.  The judge noted that no arbitral tribunal would be required automatically to make an award of such costs.  Instead, it would fall within the tribunal’s broad discretion under the Act.

Two matters fortified the judge’s conclusion.  The first was statements in a 2015 report by the ICC Commission on Decisions on Costs in International Arbitration which suggested that success fees payable to a third party funder ought in principle to be recoverable in costs awards (It appears that the court was not made aware of a draft report by a committee of academics at Queen Mary University of London, practitioners and litigation funders earlier this year which reached the opposite view.)  The second was the particular circumstances of this case.  The judge felt that it would be unjust for Norscot to have to bear the Success Fee when Essar’s conduct had compelled it to obtain third party funding.

The judge went on to consider other aspects of the challenge which are not covered here.

Comment

Potentially, the consequences of this decision could be quite far-reaching.  If the recoverable costs in an arbitration include any costs that have been incurred by reason of participating in the arbitration, other categories of costs are arguably recoverable too.  These could include a success fee under a damages-based agreement (DBA) payable by a claimant to its law firm, an after-the-event (ATE) insurance premium or an uplift in a conditional fee arrangement (CFA).  As a result, the costs liability of an unsuccessful party could vary substantially, depending on whether the successful party self-funded its claim or assigned some of the risk to a litigation funder or to its counsel by way of a DBA.  The unsuccessful party may not be aware that the successful party has any of these arrangements in place until a statement of costs is submitted.

Even in an ordinary case without any of these features, on the reasoning of this case it would be within an arbitral tribunal’s discretion to award a successful party its cost of funding the proceedings, by reference to its cost of capital.  That would introduce a good deal of complexity into costs claims.  It seems unlikely that most arbitral tribunals are ready or willing to deal with that.

The decision does not mean that an arbitral tribunal will always make an award of costs covering any of the broad categories referred to above.  For the arbitral tribunal, the allocation of costs is a matter of discretion.  It was evidently relevant to both the arbitrator and the judge that Norscot was compelled by Essar’s conduct to fund its claim by borrowing from a litigation funder.  Arbitral tribunals in future might well regard this case as a decision based on its particular facts, and decide to exercise their discretion differently. Nevertheless, as a matter of principle there would be nothing to stop an arbitral tribunal from awarding to a party, as “other costs”, the success fee that it owes to a third-party funder, even when that funding was not necessary to pursue the claim.  There is scope for debate as to whether it is right that this risk should fall on the unsuccessful party.

This decision goes against the prevailing trend in the English courts: ATE insurance premiums and CFA uplifts have not been recoverable since the Jackson reforms were implemented in 2013 (subject to certain limited exceptions). In the same way, in English civil litigation the cost of funding a claim (ie in this case, the Success Fee) is generally not recoverable. This decision suggests, therefore, that the categories of recoverable costs are potentially broader in arbitration than litigation.  There is no obvious policy reason why this should be the case, but it seems to make third-party funding more attractive in arbitration than English civil litigation.

As a practical matter, it is worth considering whether to seek disclosure of the other party’s funding arrangements if it is suspected to be in receipt of third-party funding, through an order from the tribunal if necessary.  Conversely, there may be some tactical advantage to a party disclosing that it is in receipt of third-party funding, since the threat to the other party of an adverse costs order including the cost of that funding may provide some leverage in settlement discussions.

Further information

This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication.  For more information please contact Amy Edwards amy.edwards@allenovery.com, or tel +44 20 3088 3710.​