Third Party Funding

TPF is also referred to as litigation financing and relates to funding from an independent third party for the purpose of covering litigation costs, upon agreement that in the event of success, the third party will receive a share of the monetary amount awarded in the form of damages. It is widely regarded as an essential tool to promote access to justice by levelling the playing field, at least in terms of financial capacities.

Relevance in the Indian Context

In India, where “we the people” have been given “access to justice” in the preamble of our constitution, the need for TPF cannot be understated. Independent third parties certainly stand to gain from such arrangements as they receive a return on their investments. TPF agreements may have any lawful structuring and can cover the legal counsel’s fees, court/tribunal fees, venue costs, and other costs for cases such as class action suits, commercial suits, commercial arbitrations, tortious claims, etc.  The third party in all such cases is usually a bank, hedge fund, insurance company or sometimes can even be an individual. This process enables the parties to realize their likely standing, in case they pursue litigation and can thus, lead to a higher number of out-of-court settlements[2].

TPF is not expressly prohibited in India. In fact, several judgments highlight its benefits and express that there is a need for its regulation. A perusal of existing statutes and precedents set by courts indicates that though several restrictions are in place for TPF, it is not altogether prohibited. One such noteworthy restriction is that advocates cannot fund the litigation on their client’s behalf[3]. This can also be gathered from the Standards of Professional Conduct and Etiquette as per the Bar Council of India (BCI) Rules[4], which impose several restrictions on the advocates, some of which are as follows: –

• Acting or pleading in matters in which he is pecuniarily interested[5];
• Bidding for or purchasing any property sold in the execution of a decree or order in any suit, appeal or other proceedings in which he was in any way professionally engaged[6];
• Being a party to fomenting of litigation[7];
• Stipulating for a fee contingent on the results of litigation or agreeing to share the proceeds thereof[8].
• Buying or trafficking in or stipulating for or agreeing to receive any share or interest in any actionable claim[9].

TPF is obtained by entering into an agreement and thus, is subject to the provisions of the Indian Contract Act, 1872. As per Section 23 of the said Act, the funding must not be considered by courts to be “opposed to public policy”. Further, it will be barred if it is not for a bona fide purpose, is extortionate, is an unconscionable & unfair agreement, is gambling in litigation, etc[10].

While TPF is still not statutorily recognised in the country, certain state amendments have been made to the Code of Civil Procedure, 1908, in Gujarat, Madhya Pradesh, Maharashtra and Uttar Pradesh. TPF is also widely used for arbitrations as it is a money-intensive dispute resolution mechanism and the claims staked are likely to give the investors large payouts. The Arbitration and Conciliation Act, 1996, however, remains silent on the matter.

Existing Issues and the Need for Regulation of TPF

Some of the issues faced in the country in opting for this mode of funding are as follows: –

• Confidentiality of Arbitration Proceeding

As per Section 42A[11], the parties to the arbitration, the arbitral institution, and the arbitrator must maintain the confidentiality of all proceedings except for awards which require to be disclosed for their enforcement. The application of this provision and its impact on TPF is unclear as of now. Ordinarily, the litigant should be able to update the third party on key developments of the proceedings as the third party invests on the basis of such knowledge.

• Third Party-Litigant Confidentiality

As per Section 126 of the Indian Evidence Act, 1872, Attorney-Client privilege is statutorily recognized to protect the rights of the client. As per this Section, communications made by a client to a barrister, attorney, pleader or vakil in the course and for the purpose of his employment cannot be disclosed by such professional. This applies to the advice provided by the professional to his client and the contents of any documents he becomes acquainted with, in the course and for the purpose of his employment. An important question then arises as to whether a similar standard applies to a Third Party Funder since the client puts such a party in a position of active confidence. As a part of general practice, confidentiality clauses may be added to the agreement between the litigant and the investor. However, such an agreement would not be as secure as the protection provided under said Section.

• Disclosures regarding Third Party Funding

Presently, there is no mandate for a party to disclose to the opposing party that it is engaging a third party for funding the litigation/dispute costs. Such disclosures may be relevant since the opposing party may have objections to such funding. This could be for a number of reasons such as apprehension that the third party will exert undue control over the funded party to the disadvantage of the adverse party, apprehension regarding the relationship between the third party and the arbitrator, further, there is often reasonable cause for the adverse party to believe that the investor is providing funding not for profit but due to their interest in the subject matter.

• Profit Sharing

In the case of a favourable outcome, the amount recovered from the opposition party is utilized for paying the investors as per the TPF Agreement. However, the courts have not yet clarified what proportion of this amount would be deemed to be so excessive that the arrangement is categorized as extortionate and unconscionable.

• Conflict of Interest

Since the number of institutions providing such funding is minimal but the number of parties requiring TPF, especially for arbitration is very large, there is a likelihood of overlap in the appointments of the same investors and arbitrators.

• Recovery of costs against funders

A question which has arisen with the rise in the trend of third party funding is whether a third party funder can be held liable to pay the amount granted under the arbitral award to the adverse party. This question was discussed recently and answered in detail in the case of Tomorrow Sales Agency Private Limited v. SBS Holdings, Inc. and Ors[12]. In the said case, the Claimants were promoters of the company, Transpole Logistics Private Limited. Along with Transpole itself, they had instituted an arbitral proceeding against SBS Holdings. These proceedings resulted in an amount being awarded to SBS as per the arbitral award dated December 22, 2022, under the rules of the Singapore International Arbitration Centre. Tomorrow Sales Agency Private Limited (“TSA”) was the third party funder for the Claimants and had entered into a Bespoke Funding Agreement with them. However, TSA was not a party to the arbitration agreement, arbitration proceedings or even the arbitral award. The Claimants defaulted in making the payment awarded to SBS as per the arbitral award. Thus, SBS called upon TSA to cover the awarded amount. TSA refused to do so on the ground that the funding agreement stood terminated when Transpole lost its claim. Further, the agreement was only for the litigation costs of the proceedings. Thus, SBS filed a petition under Section 9 of the Arbitration and Conciliation Act, 1996 before a Single Judge Bench of the Hon’ble Delhi High Court praying that the Claimant and TSA be directed to disclose details of their assets. SBS also prayed for interim measures to secure the amount awarded to SBS as per the arbitral award by way of an order restraining them from creating any third-party interest/right/title regarding unencumbered moveable/immovable assets. The Single Judge Bench ruled in favour of SBS Holdings considering their argument that the proceedings were instituted with the funding provided by TSA. SBS had also claimed that TSA had full control over the arbitral action. Thereafter, TSA filed an appeal under Section 37 of the 1996 Act, against the impugned order of the Single Judge Bench. Before the Hon’ble Division Bench, the issue was whether a person who was not a party to the arbitral proceedings or the award, rendered in respect of disputes inter-se the parties to the arbitration, could be forced to pay the amount awarded against a party to the arbitration. The Hon’ble Division Bench set aside the impugned order to the extent that it directed TSA to disclose its assets, furnish security for the amount of the arbitral award and restrained TSA from alienating or encumbering its assets. The Hon’ble Court held that third parties are only bound by awards if they were a party to the proceedings for which they would have to first consent. Both SBS and the Claimants were bound by the SIAC Rules pursuant to the arbitration proceedings, however, TSA was not. Thus, as per SIAC rules, it could allocate costs only to the parties and could not pin such costs against a third party funder. The Court also highlighted that in the award, the duty to pay the costs in favour of SBS was imposed on the Claimants, not TSA. Lastly, Section 9 of the Act provides for aid in the enforcement of an arbitral award, however, as per the arbitral award there is nothing to enforce against TSA. The Court while concluding opined that, “Whilst, there is no cavil that certain rules are required to be formulated for transparency and disclosure in respect of funding arrangements in arbitration proceedings, it would be counterproductive to introduce an element of uncertainty by mulcting third party funders with a liability which they have not agreed to bear”.

Clarity on Third Party Funding is the need of the hour

While the permissibility, in fact, the encouragement, of TPF by the Judiciary is a positive sign for smaller businesses and other organizations/individuals that are finding themselves in a tight corner financially, it has become clear that unregularised TPF will be helpful only so far. Till the time clarity is not provided regarding the several possible issues and situations that arise on account of TPF, it will be difficult for the parties to the dispute, the third party funder as well as the arbitral tribunals and Courts to anticipate the consequences of their decisions and actions. This is why judgements such as that of Tomorrow Sales Agency Private Limited v. SBS Holdings, Inc. and Ors, are seen as knights in shining armour as they set the footprint of regularisation and standardisation of the TPF mechanism. Such orders by the Court don’t only clarify important points of dispute but also draw the government’s attention to the need for legislation, rules and regulations regarding TPF. Till that point attempts must be made by all parties involved to keep, at the very least the arbitral tribunal and Courts updated with all relevant disclosures, and where required even the adverse party should be kept in the loop. Further, agreements for third party funding should be drafted very carefully to ensure that all possible situations are specifically catered to so that future liabilities are not shifted or shirked.