An Introduction To Third Party Funding In Dispute Resolutions In India

Arbitration, when compared to adjudication of disputes through Court, though being an expedited process, is generally an expensive affair. More often than not, litigation costs for litigants are generally unwanted and therefore it makes commercial sense for a litigant to secure such costs by entering into an agreement with a third party, who is otherwise unconnected to the litigation and who agrees to bear the costs and expenses for the litigation in return for a share in damages or claim. If third party funding can be effectively and properly used in the context of transactions, it can benefit by increasing the access to justice for parties and have the effect of putting parties on a level playing field in the dispute resolution process. In this article, we intend to delve through the various factors which often fall for consideration from the perspective of the litigant, the third party, and the arbitral tribunal or courts.

The contractual arrangement between the litigant and third party is one where the third party agrees to bear the costs of a dispute resolution process in return for a share in the claim or damages.

Third Party Funding Transactions and how the Indian Courts view it

In common law countries, such third-party funding transactions would be tantamount to ‘champerty’ and would therefore be considered illegal and tortious. In India, law does not define ‘champerty’, and such transactions in the nature of ‘champerty’ are not barred by law. In fact Courts have, time and again, held that a third-party funding agreement where the returns are made contingent on the outcome of the case is not per se illegal unless such third party is an advocate. However, such transactions also ought to be reviewed from the perspective of them being ‘extortionate’, ‘unconscionable’ or ‘made for improper objects’, in which case, the same will be considered illegal and invalid. This view also resonates from a reading of Section 23 of the Indian Contract Act, 1872 (‘Act’).

From the Indian perspective, therefore, while third-party funding transactions are not per se illegal, there is a possibility that Courts would endeavor to scrutinize the agreement from the perspective of Section 23 of the Act and, therefore a conclusion as to whether a transaction is legal or not, will possibly depend on the terms and conditions, set-out in each such agreement. Recently, the Hon’ble Gujarat High Court, without concluding on a third-party funding transaction in relation to an immovable property litigation, opined that such transaction in typical facts of the case must require deeper scrutiny in view of the possibility that such transaction would be inequitable and unconscionable.

Disclosure before Court or Arbitral Tribunal

In India, as such, there is no mandatory requirement for disclosing the existence or otherwise of such third-party financing agreements. Such disclosure would be necessitated only when the third-party seeks to be impleaded or joined in the litigation by name. Despite such disclosure, it is not necessary for the Courts or the Tribunals to implead such third-party funder, more particularly when the latter is not a party to the contract which is under dispute and, therefore, as such, would not fall within the ambit of either a ‘necessary party’ or a ‘proper party’. The third-party funder would only step into the shoes of the litigant. Disclosure of a third-party funding agreement would be necessary if the Arbitral Institution under whose aegis the arbitration is being conducted mandates it. Decisions on impleadment, however, would depend on the facts and circumstances of each case and the terms and conditions set-out in the agreement entered into between the litigant and the third-party funder.

The Litigant and the Third Party

A litigant, irrespective of the fact whether he is a claimant or a respondent, who seeks to enter into a funding agreement with a third party, will necessarily have to provide to the third party all details in relation to the claim/dispute, irrespective of whether such information is confidential or privileged, so as to enable the third party funder to conduct a SWOT analysis of the claim or the defense, the likelihood of success on merits, the ability to recover such costs or damages or claims from the opposite party, etc. Implications of non-disclosure agreements or confidentiality agreements or risks of sharing data with third-parties, is a factor which needs consideration before a decision is made to enter into a third-party funding agreement for a dispute.

Where the third-party funder approves of the litigant’s case, the funder and the litigant would thereafter proceed to negotiate the agreement. The position, of equality or dominance, of the third-party funder will play a major role in how the agreement is negotiated, which in turn will have an impact on the determination of the legality or otherwise of such transaction from the perspective of it being ‘extortionate’, ‘unconscionable’ or ‘made for improper objects’ when the same is placed for consideration before an appropriate Court or Tribunal. It is necessary for the benefit of the parties that every aspect of the dispute and its contingencies and their implications ought to be discussed and agreed upon, including in relation to providing securities during the course of litigation or payment of adverse cost awards, if any. Upon having so agreed, the third-party funder will start to bear costs of the litigation, including but not limited to administrative fees, fees of arbitrators, attorney fees, etc.

For third-party funders, what ought to actually matter the most is (i) the possibility of success on merits, and (ii) enforceability of the award passed by a Tribunal or a decree passed by a Court. As a word of caution, litigation outcomes generally, and more particularly in India, are unpredictable and therefore come with their share of uncertainty.  As far as India is concerned, the entire scenario needs to be viewed from the following perspective:-

• Arbitral Awards
  1. Arbitrations in India, by statute, are required to be concluded within a period of 1 year from the date of completion of pleadings or within a further extended period of 6 months. Therefore, arbitrations in India are a time-bound process. However, a challenge to an award under Section 34 of the Arbitration and Conciliation Act, 1996 (‘Arbitration Act’), either before a Commercial Court or before the High Court[1], as the case may be, takes time to get heard and decided upon. Generally, Courts in India, direct anywhere between 50-100% of the decretal amount to be deposited with the court, as a pre-condition for the grant of stay on the execution of the award.
  2.  A delay in the disposal of a challenge to the award by courts and the consequent stay on execution proceedings sometimes make the process cumbersome and time-consuming. Needless to mention that any order passed under Section 34 of the Arbitration Act can be a subject matter of appeal under Section 37 of the Arbitration Act. This delay is enforcement of the award results in the delayed realization of the consideration by the third-party funder, in addition to incurring additional costs for either defending or challenging such an award.
• Judgement and Decree of Court
  1. Commercial Disputes are adjudicated by specially designated Commercial Courts in India. While the Commercial Courts Act, 2015 prescribes a time-bound adjudication of disputes, the same is only directory and not mandatory. While Commercial Court do decide upon and dispose-off Commercial Suits faster than regular Suits, this time period is much more than the time taken in concluding arbitral proceedings.
  2. A Judgement and Decree of a Commercial Court can be a subject matter of a First Appeal in accordance with the provisions of the Code of Civil Procedure, 1908. It is pertinent to mention that the scope of judicial review of a Judgement and Decree in a First Appeal is far wider as compared to the limited scope of challenge under Section 34 of the Arbitration Act, thereby making the appellate process lengthy. Needless to mention, the availability of a remedy in the form of a Second Appeal.
  3. It is also necessary to note that during the entire process of appeal and challenge to a judgement and decree, the execution proceedings (which otherwise take substantial time) remain stayed. However, in cases of money decrees, depending on the facts and circumstances of the case, Courts do insist on a pre-deposit before granting any stay on execution proceedings.
  4.  While the process in India does take some-time, there are multiple strategies which can be adopted during proceedings and even thereafter, which are prescribed in law, in order to ensure a timely realization of amounts for the third-party funders. It will also be necessary to note that such contracts, which seek to reap the fruits of a future contingent event, may also be viewed partly as ‘contingent contracts’ as defined in Section 31 of the Act.

Funders and Funding Relationships

Internationally, third-party funders are either law firms, insurance companies or an outside institution such as a corporation or a financial institution. For example, in admiralty cases (whether in India or abroad), vessels are generally covered by a Protection and Indemnity insurance. Therefore, in such instances, where a vessel is arrested for a maritime claim and/or arbitral proceedings are initiated, the litigation is often handled or funded by the concerned institution which has rendered the Protection and Indemnity insurance. Similarly, in case where a litigant has an insurance policy that covers the situation at hand, then such insurance company will cover the litigation or arbitration expenses. Alternatively, a litigant can also seek to obtain a traditional loan or a non-recourse funding where the repayment in contingent upon the litigant succeeding in the litigation. Obviously, such loans will require to be repaid.

Internationally, insurance is the most common form of third-party funding and traditionally in such instances, the insurance companies would demand that the litigant ceded much or all control over the management of the litigation and any possible settlement negotiations or agreement that may arise. Before the Event (BTE) and After the Event (ATE) insurances are specifically intended to cover the insured’s own legal expenses, or the legal expenses of the winning party if the insured loses the case, or both. In BTE and ATE insurances, generally, the litigant is not required to cede control over the management of the litigation and in turn the litigant is not completely insulated from the risk of having to pay the amount awarded or the decretal amount, in case such litigant loses the case.

Another form of hedging on the litigations, is by way of assignment of a claim to an institution or an asset restructuring company. The third-party in whose favour the claim is assigned, steps into the shoes of the litigant and pursues the legally available remedies against the opponent. Generally, the litigant would assign the claim to a third-party at a value lesser than the actual claim and the difference in the amount actually paid to the litigant and the amount actual realized from the litigation, being the consideration for the assignee.

In India, however, as discussed earlier, lawyers or law firms cannot enter into such transactions. As regards financial institutions or banks, the regulatory guidelines do not clearly permit such high-risk funding transactions and to that extent there exists a grey area. However, Protection and Indemnity insurance in relation to maritime claims, Director & Officer Insurances to secure the company from claims and prosecutions against its directors and key personnel, are available and largely prevalent in India. Further, assignment of claims or debt to institutions or asset restructuring companies is also legally and statutorily permissible. Assignment of debts and claims is a practice generally adopted in debt recovery or insolvency proceedings, and is not yet typically gain prominence in arbitrations. Traditionally, third-party funding in India is typically done through individuals who have the means and mode to support a litigation in lieu for a substantial consideration out of the results of such litigation. Recently, however, there has been an increase in institutionalized third-party funders who seek to finance international arbitrations, high-stake commercial litigations, or insolvency litigations.

Third Party Funding – World Over

1. USA – At present, the US legal and regulatory framework relevant to third party funding exists at the individual state level – in state statutes, state common law and state professional codes. The state law framework includes both historical laws and rules that pre-date the rapid rise of the current litigation finance industry in the United States but have potential application to legal financing arrangements, as well as a handful of recently enacted laws and rules in response to the recent growth in use of third party funding in the United States. Additionally, while there have been attempts to regulate issues surrounding third party funding at the federal level, no such attempts have been successful to date.
2. United Kingdom – third-party funding transactions are not yet statutorily legalized in England and Wales. However, such transactions have received approval from the English Court of Appeal in the year 2005. Further, in 2009, Justice Jackson submitted a report to promote justice at a proportionate rate and in the said report, Justice Jackson endorsed third party funding as providing an additional and sometimes only means of funding litigation and promoting access to justice. Apropos the same, Association of Litigation Funders of England and Wales (‘ALF’) was established on 23.11.2011. As the name suggests, ALF is an association of individuals engaged in third party funding and is being managed and administered by a voluntary Code of Conduct and the membership is open to third party funders. Apart from the procedure and terms and conditions for third party funding, the code also provides a mechanism to resolve the inter-se disputes between third party funder and the member.
3. Singapore and Hong Kong – Third-party funding in Singapore has, historically been, illegal whereas the position in Hong Kong was not clear. Both the countries legalized third-party funding in the year 2017.
4. Australia – While there is no separate legislation governing the third party funding in Australia, such transactions have received the approval of Courts in Australia as early as in the year 2006. Further, the Treasurer of the Commonwealth of Australia on 22.05.2020 declared that litigation funders are included under the Corporations Act and are subject to greater regulatory oversight by requiring them to hold an Australian Financial Services Licence (AFSL) and comply with the managed investment scheme regime.
5. China – there are currently no regulations or legislations legalizing or recognizing third-party funding. However, the need for third party funding has also made a significant place in International Arbitration in China, and therefore the Beijing Fourth Intermediate People’s Court upheld the legality and validity of third party funding in Arbitration.

To Conclude

While there can be no straight-jacket principle for the approval or rejection of a third-party funding transaction, its validity will largely depend on how balanced and conscionable such transactions are. In cases where the Courts will view such transaction as being ‘extortionate’, ‘unconscionable’ or ‘made for improper objects’, the same will be considered illegal and invalid. In India, the Delhi High Court has recently approved third-party funding transactions as being vital. We will only conclude by extracting the relevant paragraph of the judgement, which essentially summarizes the entire third-party funding scenario in India:-

“ Third-party funding is essential to ensure access to justice. In the absence of third-party funding, a person having a valid claim would be unable to pursue the same for recovery of amounts that may be legitimately due.  In many cases, the claimants become impecunious on account of the very cause for which they seek redressal. The cost for pursuing claims in arbitration are significant; the same not only include fees paid to arbitrators and institution but also professional fees for legal counsels and experts and other attendant expenses. A person without the necessary means would have no recourse, in the absence of third party funders. Third party funders play a vital role in ensuring access to justice.

It is essential for the third-party funders to be fully aware of their exposure. They cannot be mulcted with liability, which they have neither undertaken nor are aware of. Any uncertainty in this regard would dissuade third-party funders to fund litigation.”

The present Article has been co-authored by Parth Contractor and Nikita Barot of the Chambers of Parth Contractor in India. They can be reached at parth@pcchambers.com

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