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The Structural Challenge of Investment Arbitration Viewed through the Lens of Third-Party Funding

The Structural Challenge of Investment Arbitration Viewed through the Lens of Third-Party Funding

Stack of money

Fig: By FBI Buffalo Field Office (http://buffalo.fbi.gov/images/c3.jpg) [Public domain], via Wikimedia Commons

Third-party funding has been relatively well-received by the international commercial arbitration system, with the caveat that there are justifiable concerns about disclosure requirements, evidentiary privileges, and conflicts of interest that must be addressed through international rules, guidelines, and norms.  Many discussions about third-party funding address international commercial and investment arbitration together.  However, third-party funding may affect the investment arbitration differently than commercial arbitration due to structural differences in the investment arbitration system.

Most funding happens on the claim side in any dispute system – litigation, commercial arbitration, or investment arbitration – because claim-side funding is more financially attractive to most funders than respondent-side funding.  Respondent-side funding is only financially attractive if the funding arrangement is structured in a certain way, such as legal expenses insurance or after-the-event insurance.  This is because the bulk (if not all) of any third-party funder's eventual payout will come from the respondent in the case.  For example, if a funded claimant wins, then the funder is paid from the awarded amount collected from the respondent.  If a funded respondent wins (or, depending on the financing structure, even if the respondent loses), the respondent must pay the funder its "insurance" premium or a success fee.  In commercial arbitration, having the respondent always serve as the source of funds for the funder is tolerable, because corporations could just as easily be respondents as claimants.  Furthermore, respondents in commercial cases have the ability to bring counterclaims under the contract that funders may choose to fund. 

By contrast, in investment arbitration, the rigidity of the parties’ roles may create lopsided funding incentives.  When the investor and host state sign a separate contract, such as a concession agreement, they each have an equal opportunity to bring claims against each other according to their contractual dispute resolution method, which may be arbitration.  When there is no pre-dispute arbitration clause or contract between the investor and the host state, however, the consent to arbitrate must be found in the bilateral investment treaty between the host state and the investor’s home state.  The investor is not a party to the treaty, so the investor’s “written” consent is evidenced by the investor filing a claim under Articles 25 and 28 of the ICISD Convention or under provisions of the bilateral investment treaty.  The state is always the respondent, and it is extremely rare for investment treaties to provide express consent for host states to bring counterclaims.

Investment arbitration tribunals hearing cases under the ICSID Rules are largely hesitant to uphold state counterclaims due to the difficulty in reconciling two provisions of the ICSID Convention.  Article 36 of the ICSID Convention states that the request for arbitration shall contain “information concerning…[the parties’] consent to arbitration.”  Article 46 of the ICSID Convention requires a tribunal to determine, “if requested by a party … any incidental or additional claims or counterclaims arising directly out of the subject-matter of the dispute provided that they are within the scope of the consent of the parties and are otherwise within the jurisdiction of the Centre.”  Since nearly all BITs expressly protect investor rights, but not necessarily host state rights, it is unclear whether claims involving the host state’s rights “are within the scope of the consent of the parties” or whether counterclaims brought by the state are “within the jurisdiction of the Centre.”  Several recent cases have dealt with this issue on a case-by-case basis but none of them have definitively resolved it.   Thus, third-party funders typically fund only investor-claimants in investment arbitrations brought exclusively under a treaty; respondent-side funding in investment treaty-based arbitrations is nearly nonexistent. 

Since the funder is always paid from the funds of the respondent any type of dispute resolution, then the funder is always paid with funds from the respondent state in investment arbitration.  In essence, states are the sole payers in a system of third-party funding for investment treaty arbitration in which they are unable to enjoy a benefit equivalent to investors’ benefits. 

If host states could become claimants against investor-respondents, or if arbitral tribunals determine that they have jurisdiction over host state counterclaims, then this would help even the playing field for third-party funding.  Under this new regime, if the funded state-claimant or state-counterclaimant wins, then the funder would be paid from the private investor’s funds.  Similarly, a funded investor-respondent would pay its "insurance" premiums from its own funds.  In essence, if treaties allowed host state claims and counterclaims, then third-party funding of investment arbitration would look a lot more like third-party funding of commercial arbitration.

Taking a broader view, third-party funding is just one lens through which to view the consequences of an overarching structural issue in the investment treaty arbitration system.  Investors and states in investment arbitration are stuck in their roles as claimant and respondent, respectively, due to the wording of the treaties.  The question is whether such immutability is good or bad for the integrity of the investment arbitration system.  The potential issues that may arise with respect to third-party funding are merely evidence of this real structural problem in investment arbitration.  If we fix the overarching problem, then not only third-party funding, but also the system of investment arbitration as a whole would likely be viewed in a more positive light.
 

By Victoria Shannon, Assistant Professor of Law, Washington & Lee University School of Law

Browse cases relating to third party funding on Investment Claims here.