Implications of Third Party Funding on the integrity of arbitral proceedings - Is there need for action in Switzerland?*

The general admissibility of Third Party Funding ("TPF") in Switzerland has been affirmed by the Federal Tribunal in its landmark decision DFT 131 I 223, dated 10 December 2004. However, in spite of its legality, TPF still raises a number of issues, in particular in the context of arbitration proceedings. Two of the most controversial issues will be briefly addressed in the following paragraphs.

The impact of TPF on an arbitrator's independence and impartiality

The dual function of arbitration practitioners, acting both as counsel and arbitrators, and a third party funder's entitlement to a share of the funded claimant's proceeds from the arbitration may create a potential for conflicts of interest. This can be the case if an arbitration practitioner, in the function of counsel, has cooperated with a third party funder in the past and has, thereby, established a close relationship with that funder. If the same funder provides financial support to a party in which the same practitioner sits as arbitrator, the funder's direct financial interest in the outcome of the arbitration may raise doubts as to the concerned arbitrator's independence and impartiality.

Various views have been expressed on how such conflicts of interest should be dealt with. Some authors argue that corresponding problems arise only if TPF is being brought to the arbitral tribunal's and the other party's attention in the first place. They opine that TPF should, therefore, generally not be disclosed at all. Others maintain that, for the sake of transparency and in line with the newly enacted laws in Hong Kong and Singapore, the funded party should be required to disclose the existence of TPF and the identity of the third party funder at the beginning of arbitration proceedings.

If such obligation is not being imposed on the parties, it cannot be excluded that a third party funder's involvement is discovered at a later stage of the arbitration process. This may trigger the late replacement of an arbitrator and even jeopardize the enforceability of the arbitral award. Such scenarios can only be avoided if the existence of a TPF arrangement does not temporarily stay under the radar of the arbitral tribunal. The parties should, therefore, be required to disclose sua sponte the existence of a TPF and the identity of the funder.

The risk of unenforceable adverse cost awards

The losing party in an arbitration is most frequently ordered to bear the cost of the proceedings as well as the legal costs of the opposing party. However, prevailing respondents are often unable to successfully enforce adverse cost awards against impecunious claimants. It is, therefore, feared that TPF may increase the risk for successful respondents to ultimately bear their own legal costs.

Some authors, therefore, take the stance that such danger, also referred to as "hit-and-run arbitrations", should be addressed by empowering arbitral tribunals to order security for a party's legal costs more readily as soon as TPF is involved. In this context, it has also been argued that arbitral tribunals should be informed to what extent a third party funder can be held liable for the legal costs of the victorious respondent. It is further held that arbitrating parties should, therefore, be required to disclose the individual terms of a TPF agreement.

It appears that TPF is increasingly used by perfectly solvent claimants as a tool to manage financial risks. In such cases, there is no risk of "hit-and-run arbitrations". The mere existence of TPF should thus not be considered a sufficient ground to uphold the other party's request for security of costs. To the contrary, if the TPF agreement concluded by an impecunious claimant provides for the direct entitlement of a successful respondent to be covered for the legal costs incurred, this may even give additional comfort to such party. In these situations, it is in the funded parties' very own interest to disclose the relevant provisions of the TPF agreement. No disclosure obligations regarding the terms of the TPF agreement should, therefore, be imposed on them.

Conclusion

It is undisputable that a third party funder's direct financial interest in the outcome of an arbitration may affect an arbitrator's independence and impartiality, as well as the integrity of the arbitration process as such. Such negative implications can be avoided only if arbitrating parties are required to disclose sua sponte the existence of a TPF relationship and the identity of the respective funder. A corresponding obligation of the parties should, therefore, be included into the parties' agreement to arbitrate or corresponding institutional arbitration rules.

By contrast, in relation to security for costs orders, no change of paradigm seems to be necessary due to the existence of TPF. Rather, arbitral tribunals should continue to base their decisions on security for costs applications only on the concerned party's ability and willingness to pay for the prevailing party's legal costs. The existence of a TPF agreement is no indication that such prerequisite is lacking. Rather, it may even give additional comfort to the opposing party. As a consequence, the funded party may, but should not be required to disclose the individual terms of the TPF agreement.

***

* The author's full article on the topic can be found in the newly published commemorative compilation in honour of Prof. Andreas Furrer "Von A wie Arbitration über T wie Transport bis Z wie Zivilprozess – Liber discipulorum für Professor Dr. Andreas Furrer zum 55. Geburtstag". The views expressed in said article and in this contribution are those of the author and do not necessarily reflect the position of CMS.