All About External Funding in Indian Arbitration

Adv. Vandana Tiwari

Entry

The growing importance of international trade transactions has highlighted arbitration as a key method of alternative dispute resolution. This growth has brought into focus ‘third party funding in arbitration’, where an entity funds a party in arbitration in exchange for a share in the award. Third party funders, unlike traditional investors or banks, play a key role by investing in litigation and arbitration for profit. Given this, it is imperative to regulate third party funding in Indian arbitration to maintain competitiveness and prevent other countries from gaining an advantage.

A Brief History of External Financing in India

In India, there is currently no statutory framework regulating third party funding (TPF) in arbitration or funding itself. This issue, often overlooked, has recently started attracting attention. The Hon’ble Committee on the Review of the Institutionalisation of Arbitration Mechanism in India reviewed various policies on third party funding from different jurisdictions and suggested that adoption of similar measures with suitable adaptations for India could improve arbitration practices in the country. They observed that regulation of third party funding could go a long way in establishing India as a premier arbitration centre, comparable to the status of Singapore. The Code of Civil Procedure (CPC), through Order XXV(1), recognises third party funding of disputes in civil cases. The decision of the Supreme Court in Re: Mr. ‘G’, A Senior Advocate Of … v Unknown(2) clarified that there is no moral or public policy objection to third party funding, provided the funders are not lawyers and the funding does not violate public policy. Since such funding is permissible in disputes, it should be regulated in arbitration as well. The court has previously invalidated third-party financing agreements where they involved receiving a large portion of the final rate, ruling that such cases violated public policy. Although it is difficult to list all possible violations, they must be assessed individually.

Analysis of India’s future course

The author argues that third-party funding should be introduced to Indian arbitration, albeit with restrictions to ensure that it does not violate public policy. India has consistently supported arbitration and regulating third-party funding could increase its availability and popularity, especially given the current backlog of litigation that has highlighted the importance of arbitration. This funding could address the inequality in access to arbitration, making it a tool for more equitable dispute resolution rather than a privilege for the wealthy(3).

The Arbitration and Mediation Act, 1996 does not deal with third party funding, which means that it remains unregulated. Since arbitration is essentially a form of litigation, the provisions on third party funding under the CPC should also apply to arbitration. However, the definition of a ‘party’ in Section 2(h) of the Arbitration Act, which is limited to those involved in the arbitration agreement, may pose challenges. Therefore, introducing third party funding would require a joint effort by the legislature, the executive and the judiciary.

Based on the Hong Kong Law Commission Report (4), which proposes a phased approach to the regulation of third-party funding. This approach involves initial non-binding regulations tested for five years, followed by a comprehensive review. The establishment of ethical standards for third-party funded arbitration could be achieved through a dedicated Code of Conduct or an amendment to the Arbitration Act.

India also needs to balance regulation with the benefits of third-party financing. It should decide whether to allow narrow (super sensu) or broad (lato sensu) scope of financing. The author recommends starting with a stricto sensu approach, similar to the approach in Singapore, and gradually expanding to a lato sensu approach, as in Hong Kong.

In addition, the rules must address cross-border transactions involving international entities or funders. The Foreign Exchange Management Act (FEMA) of 1999 does not clearly classify third-party funding, which creates conflicts with the Arbitration Act.

The non-admission of third party funding may put India at a disadvantage in international arbitration, complicating the enforcement of foreign awards. International tribunals, such as in Giovanni Alemanni v. The Argentine Republic, have considered third party funding to be well-established and unobjectionable. This discrepancy may create difficulties in enforcing foreign awards in India, a point underscored by the pro-enforceability view of the Supreme Court in Government of India v. Vedanta Ltd. & Ors(5).

Finally, the Indian court has been taking a “minimum intervention” approach to arbitration, advocating that third-party funding should be privately managed by the parties involved but regulated. Denying access to third-party funding would be a denial of justice and a violation of fundamental rights.

Application

Even though TPF is currently relatively unpopular in India, it is becoming an increasingly important part of international arbitration processes due to its widespread acceptance in other parts of the world. The costs associated with arbitration have increased with the growing demand for it. Therefore, India needs to approve third party funding and facilitate it by framing clear rules. Small businesses would particularly benefit from such provisions as they lack the resources to set aside money specifically for legal fees. Moreover, arbitration has become increasingly popular across the world over the years, especially in cross-border conflicts where it is the preferred mode of dispute resolution through international arbitration. Like other countries, India has embraced and promoted the trend towards institutional arbitration. Moreover, Indian courts have delivered significant judgments on issues relating to the scope of public policy and the theory of severability in enforcement of arbitral awards, including awards from other countries. This provides India with a set of well-established legal concepts that it can use to provide safeguards against misuse of financial arrangements from other parties. Moreover, the expenses associated with arbitration are increasing with the demand for it. In particular, international arbitration procedures can be extremely expensive, often costing millions of dollars. Parties explore funding options before examining the substance, legality and strength of their claim due to the financial burden. TPF has become an indispensable tool in this regard.
Finally, it is necessary to address and close the current gaps in identifying and closing the current shortfalls in third party funding. Due to the lack of requirement to disclose the existence of TPF or any details, if any, TPF may be held liable for a certain information asymmetry that arises between the parties in the proceedings. Moreover, there is a risk of arbitration hit and run, where exaggerated and unsubstantiated allegations make the arbitration costs unrecoverable. As a result, India needs to take the initiative and implement the TPF legislation. Apart from improving India’s reputation as a hub for international arbitration, this exercise will promote transparent and fair development of the TPF sector in India.

Comments:-

(1) Code of Civil Procedure of 1908

(2) In the case of: Mr. “G”, learned Senior Advocate … v. Unknown (1955) 1 SCR 490 (SC.)

(3) Prakash Pillai and Umer Chaudhary, “Law Commission Report Strengthens Pro-Arbitration Trends in India” (Kluwer Arbitration, 9 October 2014), accessed 7 August 2024.

(4) Hong Kong Law Reform Commission, Third Party Funding of Arbitration – A Report (Law Reform Com 2016), accessed 7 August 2024.

(5) Government of India v. Vedanta Ltd. And Ors (2020) SCC Online SC 749 (SC).