Tribunal overturns own order for security because the cost of funding the security was “prohibitive”
An ICSID tribunal has overturned its own order that the claimant provides security for costs in order to allow a German administrator to proceed with their claim because the cost of funding that security previously ordered was considered as too expensive in the eyes of the tribunal.
It was a majority decision and one that controversially tilts the scales towards access to justice in a way that some commentators argue is unfair and could degrade the integrity of the arbitral system.
The tribunal found itself opining on a proposed litigation funding solution to fund the security ordered, which is described as “exorbitant and prohibitive” and which said the insurance terms were “patently unreasonable for both Parties”.
What the decision highlights is if the claimant can evidence there were diligent efforts made to source affordable options then, if none are available, arbitrators may demonstrate flexibility over security for costs, even to point of disregarding an earlier order. By extension, this presumably means that if a claimant fails to show that they have searched sufficiently for an affordable solution, it will surely follow that they will not receive such flexibility.
It is worth understanding the context and the nature of the funding solutions put before the tribunal.
The case in question is Dirk Herzig as Insolvency Administrator over the Assets of Unionmatex Industrieanlagen GmbH v Turkmenistan (ICSID Case No. ARB/18/35). The claimant is a German insolvency administrator of the assets of a construction company Unionmatex bringing a claim against Turkmenistan. As it is not uncommon for a claim being brought by an administrator, the arbitration was being funded by a litigation funder.
The tribunal had ordered the claimant to post security for costs in the amount of $3m. The order for security was made in January 2020 and at that point, the tribunal would have been forgiven for expecting the claimant would simply comply with the order after the all the case is third party funded. However, the funder would not provide a bank guarantee to enable the claimant to satisfy the order. The Tribunal had agreed to allow more time for the claimant to seek a solution by way of adverse costs insurance instead. Why was this?
- Using litigation funder’s money to post security is not a cost-effective way to satisfy security. Litigation funders who are willing to tie up large amounts of capital in escrow to ensure their counter-parties meet their security for costs obligations will typically want the same return on those funds as they would expect from deploying cash to pay for arbitration counsel or tribunal fees etc. In short, funders funding security for costs through cash or bank guarantee can double the cost of a funding arrangement.
This was presumably a factor in why the existing funder couldn’t or wouldn’t simply fund the full $3m order itself.
- The truth is claimants who engage external funding for their legal costs probably never expect to need their funder to post-security. Indeed, funders rarely enter funding transactions expecting to post security with their own funds either. Sophisticated litigation funders will have contemplated insurance solutions either for themselves, so they can provide a contractual indemnity for adverse costs (albeit insured in the background) or they expect their counterparty to source an insurance solution for themselves.
In this instance, it is not clear whether ATE insurance was always contemplated or was only considered after the order manifested.
- Insurance to cover security for costs usually requires an augmentation in the form of a Deed of Indemnity or an Anti-Avoidance Endorsement to overcome the Respondent’s inevitable objections about the inadequacy insurance in the absence of the aforementioned extras. Such enhancements generally require an upfront premium to pay the insurer. The rub is that if you are an administrator who has already had to engage with litigation funding in the first place, you probably won’t have any funds to pay that premium. This means, naturally, you’ll have to seek more funding from the litigation funder and those commercial terms will probably be no less expensive than the rest of the funding arrangement.
In the present case, there was a draft proposal from an insurance company (albeit for the half the level of the order at $1.5m) which included a deposit premium of circa $500k and contingent additional premium of a similar amount. The difficulty is that the administrator needed the funder to finance the deposit premium, which in turn increases the cost of funding.
This escalation in cost to meet the order prompted the Claimant to submit a Request for Reconsideration of the Arbitral Tribunal’s Decision to Grant Respondent’s Request for Security for Cost.
The majority on the arbitration panel concluded that the cost of the insurance and the associated cost of the premium funding was too high and that the administrator would never be able to finance the cost of the security ordered. They decided by majority decision to discard the need for security at all.
Having considered the option of suspending rather than continuing or terminating the proceedings, the majority parts ways with the minority in concluding that there is no practical prospect of Dr Herzig procuring security from [the funder] or elsewhere at any reasonable cost in the future. A suspension, therefore, would have the same effect as a termination, while leaving the Parties in limbo indefinitely.
Sometimes a willingness to accept an imperfect solution for security for costs is exactly what an arbitration panel must show in order to ensure that good claims are not (deliberately or otherwise) stifled. However, a tribunal strays into difficult waters deciding that an order should be disregarded if in their view the price of the funding arrangement to meet that order is too expensive. How does an arbitrator judge what is reasonable to allow a security for costs order to stand? In this case, they could at least fall back onto evidence from the Claimant that these combined offers of funding and insurance were the best they could get from the market.
One thing is clear from this, the efforts of the claimant to search the market for reasonable insurance terms are critical so that the claimant can show that efforts were made to seek affordable security.
The Tribunal unanimously considers that Dr Herzig and his counsel have seriously and diligently tried, but failed, to procure adequate security for costs.
Perhaps instead of reversing the need for security, it may help if tribunals were to be more flexible about the amount of security ordered or the nature of the security they would accept at the point an order is made in the first instance. This is because it would allow the pricing the solution to be lower such that it may be considered reasonable by the tribunal. For example, an adverse costs insurance policy without an AAE would have cost less and most importantly would have required less (or nil) upfront premium, which in turn removes the need for premium funding.
Perhaps in turn Respondents might start to accept a bare adverse costs policy as good, albeit not perfect, security rather than press for the ‘Rolls Royce’ of security.
Before this outcome, a Respondent would no doubt protest that a bare adverse costs policy is not a solution, but if they think they are going to win, and there is a risk of tribunals adopting a similar approach to Unionmatex, then perhaps accepting a basic adverse costs policy rather than pushing for a complete “guarantee” might be tactically more prudent.