Introduction
There are a number of reasons potential claimants in Latin America would be wise to consider third-party funding in relation to international arbitrations they are contemplating. Most importantly, funding can be critical to parties with meritorious claims that otherwise would be unable to pay for the counsel of their choice.
While contingent fees can also assist impecunious parties seeking to hire counsel for an arbitration without the necessity of upfront payments of cash, such structures are not universally available – meaning not all law firms will agree to such arrangements; and not all legal systems permit local law firms to agree to contingency fee arrangements. As a result, third-party funding can operate to broaden the array of counsel options available to would-be claimants in Latin America.
More importantly, in addition to attorney’s fees, arbitration involves a number of significant costs, which include, among others, arbitrator, expert and institution fees. Few law firms would be willing to advance such costs in the context of contingent fee arrangements. As a result, without third-party funding, many meritorious arbitration claims simply could not be brought.
That being said, financial need is not the only reason to seek third-party funding. For one thing, some wealthy individuals and solvent corporations may lack the experience to manage complex international claims. Funders can provide significant assistance in this regard. Third-party funders can also assist claimants seeking to monetise existing awards that are likely to involve protracted enforcement efforts.
Furthermore, some claimants use third-party funding as a corporate finance tool. Securing funding allows the company to allocate resources for their core business objectives, rather than sinking more resources into a dispute. With the use of third-party funding, a positive litigation outcome can turn the in-house legal department from a cost centre into a profit centre.
In addition, third-party funding is also a driver for diversity in arbitration. It can help women and Latin American attorneys get new clients, cases and exposure in the highly competitive international arbitration arena. Such exposure to a wider group of arbitration practitioners in turn helps expand the small pool of arbitrators adjudicating Latin American cases. Also, the use of third-party funding can help diverse attorneys originate cases and reach partnership at faster rates.
This article provides parties in Latin America with an overview of what types of third-party funding are available, how it works, and the practical and legal issues likely to arise in the context of a third-party funding arrangement.
What is third-party funding?
Third-party funding, also known as legal financing, is a means of non-recourse financing whereby a third party provides capital to a claimant in a dispute in exchange for a portion of the claim recoveries. The third party, a funder, receives compensation only if the claim is successful. The capital provided by third-party funders is used to pay for the costs and legal fees of the dispute, such as attorney’s fees, administering institution’s fees, expert fees, investigators, translations, travel, hearing costs, annulment, and enforcement costs, among others. Funders can also provide working capital for claimants.
Single case and portfolio financing
Funders usually finance a single case or a portfolio of cases. Single case financing consists of providing non-recourse funding for a single dispute. The funder receives returns only if the case is won or settled. Portfolio financing consists of a capital facility extended to a law firm or a claimant to fund multiple cases with cross-collateralised returns for the funder. In other words, the funder’s return is obtained from the pool of cases.
Portfolio financing can be beneficial to funders, clients and counsel. It can be beneficial to law firms because it offloads some of the risk that law firms would have otherwise taken when entering into contingency agreements with clients. It can be beneficial to clients because, when a funder and counsel have a portfolio in place, funders still do due diligence, but the turnaround time for assessing the viability of new cases is often shorter. Portfolio financing is especially important for Latin American claimants with smaller damages claims that might not meet the threshold required by funders for single case funding.
This type of funding also helps firms have a clear expectation of their receivables for purposes of financial planning. Finally, portfolio financing is also beneficial for law firms and clients because the pricing offered by funders is usually lower compared to single case financing. This is possible because risks are hedged among the pool of cases.
Types of cases that are usually funded
Some funders have been hesitant to invest in local litigation in Latin America given the unpredictability of some of the legal systems in the region and the common place delays in adjudicating disputes. However, there is appetite for investments in investor-state and commercial arbitration cases originating from or related to the region. Funders finance cases from pre-notice of arbitration all the way to enforcement.
Investor-state arbitration allows an investor to present a claim arising out of a state’s breach of its international law obligations set out in bilateral or multilateral investment treaties. Claimants can then initiate arbitrations before the International Center for Settlement of investment Disputes (ICSID) or other dispute resolution institution, each with its own set of arbitration rules, or before an ad hoc tribunal.
Commercial arbitrations, unlike investor-state arbitrations, derive their jurisdiction from the consent of two or more parties expressed in a private agreement rather than a treaty, typically involving private entities from different jurisdictions, or a state entity acting in a commercial capacity. Commercial arbitration is used to avoid local courts that might in some cases be biased in favor of domestic parties, and to have disputes adjudicated more efficiently. Besides the usual jurisdiction and merits review, the underwriting of a commercial arbitration by a funder requires an analysis of the substantive law that applies to the arbitration and the procedural law which is determined by the arbitration ‘seat’ selected by the parties. Funders will also consider creditworthiness of the opposing party and the challenges for enforcing a potential award.
Enforcement
It is increasingly common for funders to get involved at the enforcement stage, after an arbitration award has been issued, and the losing party has not paid. Funders are experienced in the enforcement of awards and judgments and as such, their knowledge and connections with asset tracers, enforcement counsel and local counsel could be leveraged in favour of the award holder.
Claim monetisation is a structure that gives a claimant an option of obtaining money before the dispute is settled or award issued, in exchange for all or a portion of the recoveries. This is a way of de-risking litigation. However, this option should be considered with caution by claimants and funders under the forum’s applicable law, as there may be some restrictions to the trade of a claim to a third party.
Award monetisation allows a party to sell a portion or the totality of the award to a funder at a discount. For the award holder, this is a convenient way of receiving money faster, and in the case of partial monetisation to have a partner with enforcement experience and aligned incentives.
Process for securing third-party funding
Client considerations when presenting a case to a funder
A Latin American party, like any other party seeking funding for arbitration, will need to take certain steps to secure such funding. To break things down more specifically: the first step is for the party to identify the funders that might be interested in the case and enter into a non-disclosure agreement (NDA) and common interest agreement with potential funders. The second step is to provide the interested funders with information, ideally in the form of a confidential memorandum (with supporting, non-privileged documentation), laying out the fundamentals of the case, including the main facts, legal arguments and likely quantum of damages. It is also helpful to discuss enforcement, if that is likely to be an issue, and how much the arbitration is going to cost. The third step is to negotiate a term sheet.
Step one: entering into a non-disclosure and common interest agreement and engaging in preliminary communications about the case
A claimant can either contact funders directly, do it through counsel or engage a broker. It is important to start by identifying the funders that could be potentially interested in the case (funders have different damages thresholds, minimum funding amounts, types of cases and jurisdictions they are interested in). It is best practice to enter into an NDA and a common interest agreement with the funder before information is exchanged. Funders usually have a boilerplate NDA and common interest agreement that they use as a basis; however, an interested party’s counsel (whether deal counsel or, if not acting as a broker, the arbitration counsel) should carefully review it and advise their client about any potential issues.
Once an NDA is signed, counsel will relate to the funder what amounts to an elevator pitch in relation to the case: the subject matter, the forum, the likely adversary, the anticipated claim value, and the likely cost of the dispute. The funder will respond with information on potential conflicts and its level of interest in funding such a dispute.
Based on this exchange, the parties will decide whether a further exchange of information makes sense.
Step two: the information and materials
Counsel, together with the client, ideally, should prepare a funding memorandum to be shared with funders that have identified themselves as potentially interested in funding the dispute. The purpose of such a memorandum is to provide a third-party funder a robust account of facts that make it a compelling case. The memorandum should provide sufficient information that would allow the funder to later conduct its own due diligence on whether to fund the matter.
What should go into the funding memorandum?
The funding memorandum should discuss the relevant facts in detail – noting the facts that make the case compelling, and also, potentially difficult facts that may emerge and how they will be overcome.
The funding memorandum should also discuss the key legal issues likely to arise in the dispute and how the law generally handles cases similar to the one raised by the client. At the same time, the funding memorandum should identify the forum where a claim would be submitted, any jurisdictional or admissibility challenges, what merits claims are likely to be raised, and whether the other party may have any counterclaims. Doing so helps to avoid surprises during the diligence stage that could affect the chances of securing funding.
The funding memorandum should also provide a preliminary damages analysis and the estimated worth of the claim. Depending on the associated costs and a number of issues to be covered, it might be advisable to engage a damages expert already at the time of drafting a funding memorandum. A preliminary expert opinion would certainly be appreciated by a funder, especially when dealing with complex claims.
Award-enforcement and execution are also an important part of funders’ decision-making process. Therefore, a funding memorandum should provide information about the enforcement and execution prospects of a potential award. Such information should identify the relevant enforcement forum (or potential forums), the likelihood of the opposing party to abide by the award voluntarily, or any plans for executing the award.
A funding memorandum should set out a detailed budget accounting for legal, administrative, and other miscellaneous fees and costs at various stages and requested funding. The budget should also consider whether ATE (after the event) insurance may be needed to address a potential security for costs application.
Finally, the memorandum should also disclose the existance of any other sources of additional funding or parties to which a portion of a potential or existing award is already owed. Such information is meant to help funders assess their exposure and potential returns on the funding arrangement.
What not to put into the funding memorandum
The funding memorandum should not include privileged information and information that the client and counsel would not be comfortable producing to the other side. Usually, in civil law jurisdictions, including for example, such Latin American States as Argentina, Colombia, Mexico and Peru, communications between outside counsel and clients are confidential and protected by professional secrecy rules. Such protection may be waived by disclosing privileged information to third parties. The question as to whether privilege would be waived by disclosing privileged information to a third-party funder has so far divided scholars. Some have advised to limit the risk of potentially waiving privilege by: communicating through legal advisers; drafting the funding and NDAs in a way to attract the common interest privilege protection; or limiting sharing any privileged information with a third-party funder. As a rule of thumb, it is advisable to avoid sharing any privileged document with a third-party funder, because doing so carries a significant risk of waiving privilege. Most reputable third-party funders are cognisant of this risk and would agree with this approach.
In terms of the second category of information, few courts or tribunals have ordered the production of all documentation a client produced to a third-party funder. However, one cannot exclude the possibility of such an order. As a result, the memorandum should not disclose anything that the funded party would not be comfortable disclosing to a tribunal or in open court.
Step three: the term sheet
If the funder, having reviewed the information memorandum and met with the client, considers it likely that it would want to fund the dispute, it will provide the client with a term sheet detailing the key terms of any further litigation funding agreement (LFA). In other words, the funder will detail the amount of money it is willing to provide for the purposes of the dispute, the minimum return expected on the capital it is contributing to the dispute, and any other material elements of the transaction. Funders also include an exclusivity period of 30 to 60 days during which the client and its counsel cannot seek or discuss funding with other parties, while the funder conducts in-depth due diligence of the case and the parties negotiate the deal documents.
With the negotiation of a term sheet, the parties reach a common understanding of the economics of the funding arrangement. If the terms laid out in the term sheet are acceptable to the client, the parties will sign the term sheet and due diligence will follow while the parties negotiate the final LFA.
Getting to yes: key considerations for third-party funders
Once parties have a signed term sheet with respect to key terms of a potential funding agreement, the funder conducts ‘deep dive’ due diligence by reviewing additional information and having discussions with claimant and its counsel. Most funders will have either their in-house counsel conduct due diligence to assess the probability of success based on the facts and legal issues outlined in the funding memorandum and the information provided, or they will hire an outside counsel; in some cases, both in-house and external counsel are involved in such due diligence. At some point, counsel for the funder may contact counsel for the client to discuss additional information they require and other questions they might have about the dispute and litigation strategy.
During due diligence, besides assessing the merits and risks of the case, funders consider various factors.
Threshold of damages and funding budget
The minimum threshold of damages and funding commitment varies among funders. It is market practice to require a 10:1 ratio of recoverable damages to funded amount. This ratio is usually evaluated under a conservative damages estimation, rather than the best case scenario. While it is rare for claimants to have a comprehensive damages analysis at the outset of litigation, it is recommended to provide funders with sufficient and reliable information to assess damages of the case.
When it comes to the case budget, it is important to present funders with a detailed budget for all stages of the proceedings including all foreseeable contingencies (e.g., bifurcation of jurisdiction and merits, challenges to arbitrators, security for costs applications). Counsel having ‘skin in the game’ in the form of a discount on fees or a contingency agreement is a good signal for funders that counsel is confident in the strengths of the case. It also helps align incentives between the funder, counsel, and the client. Funders greatly value budget discipline and efficient use of resources by counsel.
Tenor
The duration of a case impacts funders’ internal rate of return, and as such, it is a key element in the pricing assessment and decision-making process. If arbitration proceedings take too long to be decided, or if enforcement will likely take long, the chances of securing funding will be reduced. The length of proceedings and difficulties enforcing an award are considered for pricing purposes. While at the outset of litigation it is difficult to predict how long a case will take, funders and counsel try to anticipate factors that can affect the duration of the arbitration proceedings such as bifurcation of jurisdiction and merits, bifurcation of damages, challenges, amicus briefs, annulment and issues related to enforcement. Funding can be structured in stages that are negotiated with clients and counsel, including the different scenarios that can impact the timeline.
Claimants
The collaboration of a claimant throughout the proceedings is pivotal to the success of the arbitration. Claimants’ responsibilities include the disclosure of information, collaboration to structure and pursue the case, involvement in the decision-making process, distribution of claim proceeds according to the funding documents, among others. Therefore, funders may also do background checks on the claimant and the key people connected to the case (for example, company principals or main witnesses).
Funders also assess the financial situation of the individual claimant or company. It is important to disclose financial obligations and creditors that could affect the funder’s share of recoveries. If there are preferential creditors of the claimant, the funder will likely request them to enter into a subordination agreement as a condition to funding the claim.
Claimants’ counsel
Funders analyse counsel’s experience and track record with the specific type of case. Funders also assess counsel’s familiarity with legal issues and the relevant industry or sector (e.g., infrastructure, telecommunications, oil and gas, mining), as well as linguistic capabilities.
Enforcement
Assessing enforcement is key part of the decision-making process of funders. Funders analyse the counterparty’s payment capacity, payment and settlement history, the existence of other creditors that can potentially affect the respondent’s payment capacity, and identified assets in jurisdictions where enforcement is feasible, among others.
In the case of investor-state arbitration, funders typically analyse if arbitration awards are voluntarily honored by the state, its credit ratings, investment climate, payment capacity, payment and settlement history, if the country is a member of ICSID, the country’s ownership of assets in foreign jurisdictions where enforcement is feasible, and whether it receives aid from multilateral organisations among others.
It is advisable for counsel and claimants to present funders with a plan for enforcement of claims and continue updating such a plan during the course of the proceedings.
Other case-specific factors
Funders take into account the specific attributes of each case, including the reputation of appointed arbitrators (if the case is advanced); appointed damages and industry experts; the arbitral institution administering the proceedings; the substantive law applicable to the arbitration; the procedural law tied to the seat of arbitration, among others.
Pricing
Pricing ultimately depends on how long the case will take and the risks associated with it. Funder’s returns are typically set as a multiple of financed capital, internal rate of return, a percentage of gross claim recoveries or a combination of the above. As explained before, third-party funding can be provided to a party in all stages of the proceedings: from pre-notice of arbitration through hearing and enforcement. The earlier the funder gets involved, the more options the claimant has.
Negotiating and entering into a litigation finance agreement
After due diligence is completed successfully, the parties negotiate and formally document the transaction, usually mirroring the economics of the term sheet, although renegotiation of some terms after diligence might be needed. Upon closing of the deal, the funder will procure the funds committed according to the agreement between the parties and passively monitor the claim.
Whether counsel for the arbitration acts as a broker or a third-party broker is retained, it is best for arbitration counsel not to advise the client in connection with the LFA negotiations. Having another counsel advise on the third-party funding deal would eliminate any potential claims of conflict of interest against the arbitration counsel. This approach is especially relevant when dealing with individuals or smaller corporate entities that do not have in-house counsel to advise them on such deals. Sophisticated corporate entities with in-house counsel are more likely to assess independently whether there is a need for additional deal advisers; nevertheless, it is best practice for counsel to bring this matter to their attention.
The regulatory framework in Latin America as it pertains to third-party funding
Latin American states do not generally have statutes or regulations dealing specifically with third-party funding. Even the states that have recently reformed their arbitration laws (such as Argentina, Brazil, Panama and Uruguay) did not use that opportunity to introduce any specific rules in this regard. Furthermore, being mostly civil law jurisdictions, Latin American states do not recognise the doctrines of champerty and maintenance. As a result, in the absence of any specific regulation barring third-party funding, it is deemed to be permitted – civil law jurisdictions follow the maxim that ‘everything which is not forbidden is allowed.’ This has been confirmed in practice. Third-party funding has already been successfully used in Latin America, including in Brazil, Mexico, Peru and Chile, without the legality of third-party funding agreements or arrangements being challenged. Despite third-party funding being in principle allowed in Latin American states, funders as well as clients should familiarise themselves with the applicable laws and regulations. Regulation related to interest rates and assignment of claims, among others, might end up being relevant depending on how a funding agreement is drafted.
Third-party funding has regularly been used in support of aggrieved investors in investor-state arbitrations against Latin American states. While Uruguay reportedly received financial support from Bloomberg Philanthropies and Tobacco Free Kids in a case filed by Phillip Morris, some Latin American states are not enthusiastic about disputes arising from funded claimants. Argentina has taken the most extreme measures. In its 2018 bilateral investment agreement with the United Arab Emirates (UAE), Argentina expressly excluded the possibility of claims funded by third parties. However, this trend does not appear to have taken hold yet. The bilateral investment treaties that Argentina and the UAE negotiated subsequently do not contain similar provisions. For its part, Colombia has taken a different approach in its 2022 bilateral investment treaty (BIT) with Spain. Instead of strictly prohibiting third party funding, Colombia and Spain agreed that a claimant that does not timely disclose the existence and the identity of a third-party funder assumes the costs and fees of the arbitration irrespective of the outcome of the arbitration. Notably, a subsequent BIT that Colombia concluded with Venezuela does not contain a similar provision. Therefore, users of third-party funding should carefully analyse the applicable investment agreements to ascertain that no special rules are in place with respect to third-party funding.
Disclosure obligations arising in relation to third-party funding
In the absence of statutory regulations requiring disclosure of funding agreements, some arbitral institutions have enacted recommendations or rules in this respect. Two leading international arbitral institutions dealing with arbitrations involving Latin American parties have introduced rules regarding disclosure of a third-party funder’s involvement and identity. Under the 2021 Arbitration Rules of the International Court of Arbitration of the International Chamber of Commerce (ICC), parties ‘must promptly inform the Secretariat, the arbitral tribunal and the other parties, of the existence and identity of any non-party which has entered into an arrangement for the funding of claims or defences and under which it has an economic interest in the outcome of the arbitration.’
Similarly, under the 2021 Arbitration Rules of the International Center for Dispute Resolution (ICDR), at a party’s request or proprio motu, arbitrators may require parties to disclose the existence and the identity of a third party that ‘has undertaken to pay or to contribute to the cost of a party’s participation in the arbitration’ and to ‘describe the nature of the undertaking,’ as well as ‘the nature of [such third-party’s economic] interest’.
A local Latin American arbitral institution, Brazil’s CAM-CBCC, was one of the institutions at the forefront of the trend requiring disclosures of third-party funders’ involvement. In 2016, CAM-CBCC recommended that funded parties disclose the existence and identity of a funder at the first opportunity. In CAM-CBCC’s view, such disclosures were warranted by the fact that third-party funding arrangements could ‘raise reasonable doubts as to the impartiality or independence of the arbitrators’. In 2022, CAM-CCBC adopted a new set of arbitration rules, which provide that in their first submissions – the request for arbitration and answer to the request for arbitration – parties have to disclose information about related parties or third-party funding. The disclosure obligation does not end there. Parties have a continuous obligation to ‘promptly disclose the existence of third-party funding in order to allow the arbitrators to verify and disclose any conflict of interest’.
Other Brazilian arbitral institutions also appear to favor disclosures. For example, CAM-CIESP/FIESP recommends making disclosures related to third-party funding. The Market Arbitration Chamber (CAM) has not yet promulgated any rules on third party funding. However, it has reportedly handled the most Brazilian cases involving third party funding. Furthermore, at least on two occasions, arbitral tribunals have ordered a party to disclose the identity of the funder, although they have denied requests to produce the underlying funding agreement and even removed a contract produced by the opposing party from the record.
Other Latin American arbitral institutions have also adopted rules regarding third party funding in recent revisions. For example, the 2021 AMCHAM Peru Arbitration Rules established that a funded party should disclose in a timely fashion a funder’s identity for the purposes of checking conflict of interests. The 2022 Arbitration Rules for the Mexican Arbitration Center, CAMEX, likewise require the funded party to reveal ‘as soon as possible’ the existence of any financing agreement and the identity of any third-party funder.
Generally, there appears to be a trend of requiring disclosures of the existence of a third-party funding arrangement in arbitration proceedings. For example, the 2021 International Centre for the Settlement of Investment Disputes Arbitration Rules also require a party relying on third party funding to disclose the name and address of the funder ‘immediately upon concluding a third-party funding arrangement after registration’ for the purposes of conflict of interest. The arbitral tribunal may then order the party relying on third-party funding to disclose further information if it finds appropriate. In practice, investment tribunals seem to be satisfied with the disclosure of the third party funder identity, and do not grant requests for the disclosure of the funding arrangements. The IBA is also currently discussing a revision of its guidelines on conflicts of interest, which are intended to also reflect a revision of their provisions related to third party funding. In its 2014 revision, the IBA added an explanation clarifying that the parties should disclose information related to the relation between arbitrators and third-party litigation funds, stating: ‘A party shall inform an arbitrator, the Arbitral Tribunal, the other parties and the arbitration institution . . . of any relationship, direct or indirect, between the arbitrator and . . . any person or entity with a direct economic interest in, or a duty to indemnify a party for, the award to be rendered in the arbitration.’
Conclusion
The use of third-party funding has boomed over the past decade, granting access to justice to claimants that could not otherwise afford the high costs of arbitration proceedings.
The covid-19 pandemic further increased the need for litigation finance given the cash crunch that some claimants faced.
Litigation finance is growing worldwide, and while it is still a relatively unknown option for many attorneys and clients in Latin America, there is an increase in funding requests from the region for investor-state and commercial arbitration cases. This trend is likely to grow dramatically in the coming decade.
