Third-Party funding for energy disputes

Introduction

This article examines how parties to energy disputes manage to fund these expensive and long-running disputes and whether third party funding is suitable to fill an emerging funding gap for small and mid-cap parties to future energy disputes.

The role of arbitration in energy disputes

A theme of this edition of IAR is international arbitration’s role as the leading means of resolving international energy disputes. The energy industry spawns large, complex international disputes, often involving state parties, partly as a result of the energy markets’ particular sensitivity to political and economic disruption. A leading survey by London’s Queen Mary University shows that industry participants expect energy disputes to increase in volume over the next five years as a result of short to medium term market issues such as price volatility of raw materials and energy, inflation in construction costs, procurement and supply chain issues and changes in regulatory frameworks and technology. In the longer term, issues such as the impact of the energy transition and the drive for energy security are also likely to be important. The energy transition is also likely to cause new players to emerge as technology is developed and deployed; will these new players have the resources to pursue disputes in international arbitration?

Arbitration has not emerged as the preferred choice of dispute resolution because it is cheap or swift. On the contrary, international arbitration is often expensive because the parties must incur legal, tribunal and expert costs, and have to bear these costs for a long time as proceedings can take years to be resolved and awards paid out. Arbitration has also largely adopted the common law practice of cost shifting, so that the loser can end up having to meet the reasonable legal and other costs of the victorious party. Arbitration is therefore costly and involves risk. These may be key considerations for parties in terms of whether claims can or should be pursued.

Advantages of third party funding

For these reasons, third-party litigation funders have long identified the energy industry as an attractive target. Funders assess the attractiveness of investing in claims based on a number of factors, including the amount in dispute, prospects of success and possibility of turning awards into cash at the end of the proceedings. The energy industry reliably produces claims that meet all of these criteria.

The central claim in funders’ sales pitch to energy industry players is that funders assume the cost risk associated with the proceedings. This means that the risk of material financial liability for legal and other costs, and of the other parties’ costs should the claim fail, are removed from the funded party’s balance sheet. This may not be a material consideration to states or the traditional energy majors, which have both the resources and expertise necessary to manage their own claims and can absorb costs as they arise. However, this is not the case for small- and mid-cap energy players. These smaller players find third party funders attractive because they are unable to raise capital, or have to conserve cash, precisely because of the same factors (e.g. economic and political volatility) in the industry that cause disputes to arise in the first place. Funders report that they are increasingly developing relationships with such players for all of these reasons.

The funders’ second claim is that they understand their market and provide a product tailored to suit that market. For example, claimant parties bringing claims under investment treaties for breach of treaty obligations owed to foreign investors face a range of challenges in funding such claims without recourse to specialist funders. In a 2021 study, the British Institute of International and Comparative Law found that the mean costs incurred by investors are US$6.4m (with states incurring US$4.7m) with proceedings taking on average just under five years. Claimants often lack the resources to pursue such claims. Indeed, claimants are often special purpose vehicles established for the purpose of pursuing the investment that is the subject of the investment claim, and that claim may be the investor’s major or only asset. Specialist funders, who understand and accept how investment arbitration functions in terms of cost and the time periods involved, have been active in some of the highest profile energy disputes of recent times, including claims brought by investors against Spain in connection with that state’s decision to withdraw its renewable energy feed-in tariff scheme.

According to funders, there are other advantages in using third party funding. Certain funders claim to bring a particular expertise in the energy industry, including in assessing whether the dispute is likely to succeed and the prospects of collecting on a successful claim. Such expertise can be of comfort to the funded party and may also impact on the cost of funding. Other funders have in-house asset-tracing capability in order to ensure that any award will be worth obtaining.

The fact that a claim is funded can also be a strategic asset in the arbitration. The existence of a funding agreement must often be disclosed to the other parties to the dispute, which can apply additional pressure given that they will then appreciate that the resources of the funder stand behind what might otherwise be an impecunious party.

Disadvantages of third party funding

The major downside of litigation funding is that it can be expensive in comparison with other forms of finance (assuming that any is available). A typical funding model for a single case dispute referred to international arbitration will involve the funder funding all of the legal and other costs of the proceedings in return for having recourse to recover all of the money put in, plus a multiple of that amount (e.g. three times) and a proportion of any damages recovered.

Funders are more attracted to, and offer more competitive pricing for, a portfolio of claims by which they can spread their risk over multiple different claims. Some funders argue that portfolio financing also unlocks value because the funder may be prepared to finance claims that would otherwise not be pursued by a self-paying client, which might be more disposed to focus financial and management resources on their strongest and most valuable claims only.

The other drawback in third party funding is that the process by which funding is obtained can be long and cumbersome, with the funder conducting extensive due diligence on the dispute in advance. Further, whilst there have been reported instances in which the additional cost associated with funding is recoverable as a cost in the arbitration but this is by no means an established practice.

Conclusion

Third party funding may be an expensive option but, for certain types of claimants, it can be a good option or even the only feasible option, and it looks likely to play an increasingly prominent role in the energy arbitration landscape.