Financing Disputes – The Third-Party Funding Option

Introduction

Many businesses with strong claims are hesitant to pursue their legal remedies because of the high costs and significant risks of litigation and arbitration. This problem is particularly acute where the potential defendant has robust financial assets at its disposal. An increasingly available option for such businesses is third-party funding through a litigation funding agreement.

What Is Third Party Funding?

Third-party funding is an arrangement where a commercial funder, or a number of funders, finance claimants engaged in litigation or arbitration, as an investment. Typically, the funder will only realize a return on its investment if the claim is successful or the parties work out a favourable settlement, in which case the funder receives a share of the proceeds. Generally, third-party funders are interested in funding claimants. However, funding for defendants is becoming increasingly available as well.

Over the past several years, third-party funding has grown rapidly, in the contexts of international arbitration (including investor-state and commercial disputes) and class actions. The trend is beginning to penetrate the Canadian market. Canadian resource sector companies investing abroad are particularly interested in this option.

Historically, the concept of third-party funding ran afoul of the common law doctrines of maintenance and champerty. Maintenance is when a non-party to a lawsuit funds or “maintains” it with an improper motive, such as meddling where it has no legal interest. Champerty, a sub-species of maintenance, is where the maintainer shares in the profits of the lawsuit. However, in modern times, third-party funding is not considered maintenance or champerty. But funders must still be careful not to take complete control of the proceedings on behalf of the claimant.

How Does Third Party Funding Work?

Potential claimants (and their counsel) and third-party funders are actively seeking each other out. Once they make contact, the first step, generally, is for the funder to conduct due diligence on the potential claim, i.e., does it look like a good investment? This requires the potential claimant to provide the third-party funder with access to relevant records (including potentially privileged information – discussed below) to assess the strength of the claimant’s legal position, the potential amount of a successful result and the prospects of enforcing a court judgment or arbitral award.

Similar to the venture capital process, if the third-party funder believes that the claim (and the claimant) are fundamentally sound, then it will provide the necessary capital to fund the proceedings (and sometimes even the claimant itself, to assist it with its operations throughout the duration of the proceedings). A typical agreement will describe the claimant’s relationship with its legal counsel, the treatment of legal advice received by the claimant, the manner in which the claimant will instruct legal counsel, and the availability and timing of resources to conduct the proceedings. It will also generally prohibit the claimant taking any actions which may impair the success of the claim. As mentioned above, third-party funders should not have control of the conduct of the claimant’s case. Rather, the claimant should instruct legal counsel in much the same way as if the dispute was internally funded. However, funders will often expect to be involved in assessing critical issues, which could include the choice of legal counsel, the choice of an arbitral tribunal in arbitral proceedings and any potential settlement. Funders may also request the right to provide input on key strategic decisions, but claimants and their counsel should always retain the final say and control.

A third-party funder’s return may range from 20% to 50% of a successful outcome. It is unlikely that the fee limitations on contingency agreements in legislation apply to third party funding agreements: a “contingent fee agreement”, as defined in, for example, the British Columbia Legal Profession Act, must be between a lawyer and a client. A litigation funding agreement is generally between a third-party funder and the client. However, until this has been confirmed by courts of the jurisdiction in which the agreement is to operate, funders and claimants should be aware that a court may exercise its inherent supervisory jurisdiction to assess whether a funding agreement is “fair and reasonable” in all of the circumstances. This is particularly relevant in the class action context (where unique public policy considerations are often at play), but less of a concern in an international arbitration context

Who Are Third-Party Funders?

Following the 2008 financial crisis, corporate legal budgets contracted, allowing the arbitration and litigation finance industry correspondingly to expand. In a recent Wall Street Journal article, the United States litigation market, taking into account the money spent by plaintiffs and defendants, was estimated to be around $200 billion. Although the Canadian market is considerably smaller, many arbitration and litigation funders are positioning themselves to gain access to a piece of it.

The bottom line is that arbitration and litigation funding, although still considered a niche market, is expanding globally. For example, in 2012 investment bank Credit Suisse Group AG created a legal finance group, which has since raised over $200 million in capital. Mick Smith, co-founder of Calunius Capital, one of the world’s most reputable funders, estimates that the six best-known third- party funders have raised over $1 billion since 2007, with over half of that used to fund arbitration rather than litigation.

The Future of Third Party Funding

There is no legislative regime in Canada that regulates the disputes funding industry. This is consistent with the remainder of the world, where the industry remains almost completely unregulated. Indeed, litigation funding agreements have received very little judicial consideration in Canada and elsewhere. However, a recent decision of the British Columbia Supreme Court confirmed the validity of such agreements under that Province’s class action legislation. The Court addressed, among other things, whether communications between the claimant and the funder, including the agreement itself or portions of it, were protected by privilege, and confirmed that they were, although some parts of the agreement, such as the amount of control the funder may have over the litigation, may be subject to disclosure to the opposing party in certain circumstances.

In Ontario, the Superior Court has taken a different approach on the issue of privilege in the class action context, holding that litigation funding agreements are not privileged at all because they should be completely transparent and not allowed to operate clandestinely, due to public policy concerns relating to the purpose of class proceedings. The Ontario Court, however, appears to support the validity of such agreements in general.

In light of the divergent authority on the issue of privilege, counsel should be cautious and take particular care to ensure that confidential information is provided only through highly structured and controlled processes, recognizing that the potential funder requires enough information to be able to evaluate of the risk and potential reward the case presents, and that the claimant may be unable to proceed with its case at all without the assistance of third-party funding.

Litigation funding agreements appear to be here to stay and the funding of disputes by third parties is likely to be big business for the future. Businesses assessing the viability of pursuing potential claims should not overlook this option.

Craig R. Chiasson
604.640.4221
cchiasson@blg.com

Hunter Parsons
614.640.4218
hparsons@blg.com

Shareholder Oppression in Action

Dispute Resolution doesn’t usually publish case comments. But the Supreme Court of British Columbia’s decision in Southpaw Credit Opportunity Master Fund LP et al v. Asian Coast Development (Canada) Ltd. et al, 2013 BCSC 187, is worth making an exception for because it contains several points of interest in the shareholder oppression field. It is a useful illustration of the fact-specific nature of the necessary shareholder’s objectively reasonable expectations. It is a useful reminder that, before oppression can result in a remedy, it must have actually caused the harm complained of. And it includes an interesting discussion of the concept of accessory liability in the oppression context.

Background

Asian Coast Development (Canada) is (now) a British Columbia Company, building a resort and casino complex in Vietnam, the first of its kind in that country, at a total estimated cost of US$4.2 billion. In early 2008 – just in time for the world financial crisis – it obtained from the Vietnamese government the crucial “investment certificate” necessary to proceed with the project. That required Asian Coast to raise a total of $795 million by specific deadlines, failing which the government had the right to withdraw the certificate – and put an end to the company’s raison d’être.

A group of investment of funds we’ll call “Harbinger” (and for which the authors acted) was the first institutional, and largest, shareholder in Asian Coast. By 2008 it had invested $42 million. Not surprisingly, it negotiated a host of protections for its investment, including comprehensive security, rights of consent to, and first refusal on, further issues of equity and debt, and remedies for the Asian Coast’s default on its commitments which would essentially give Harbinger control of the company. Harbinger did not have any representation on the Asian Coast board of directors at the material time.

Two other groups of investment funds, which we’ll call “Bessemer” and “Southpaw”, invested $20 million and $4.6 million in Asian Coast later, in full knowledge of Harbinger’s position. Bessemer negotiated price protection in its subscription agreement. Southpaw did not.

Needless to say, in the financial climate beginning in the fall of 2008 it proved extraordinarily difficult for Asian Coast to meet the deadlines in the investment certificate. It was unable to attract additional investment. It repeatedly missed those deadlines and defaulted under its arrangements with Harbinger. Harbinger repeatedly forbore from enforcing its rights, not surprisingly exacting a price for doing so.

By October 2009 the situation was dire. Asian Coast approached Harbinger for a $3 million bridge loan. They negotiated. A penny warrant proposed by Harbinger as part of the transaction brought into play Bessemer’s price protection. Asian Coast approached Bessemer, which said it would loan the company half the required money on the same terms as Harbinger proposed. Harbinger refused to allow Bessemer to participate in the transaction and revised it to delete the warrant. Asian Coast and Harbinger eventually agreed on terms, which Harbinger felt were commensurate with the risk it was undertaking, but which Bessemer and Southpaw later claimed were commercially unreasonable.

In December 2009, Asian Coast approached both Bessemer and Southpaw about participating in its ongoing efforts to raise the money required by the investment certificate, through an equity raise. Bessemer’s response was that it was not prepared to participate and, indeed, questioned why it had made its investment in the first place. Southpaw also declined.

By January 2010 Asian Coast was in dire straits again. It approached Harbinger for an additional $12.5 million to meet its urgent obligations. It also canvassed other possible sources, but not Bessemer or Southpaw. Eventually, Harbinger again agreed to provide the necessary financing, again on terms which Bessemer and Southpaw later claimed were commercially unreasonable.

Throughout early 2010 Asian Coast continued to try to raise equity financing, without success. In July 2010, Harbinger agreed to restructure its position to make the company more attractive to new investors, and to loan it a further $125 million. One side effect of those transactions was the substantial dilution of the other shareholders, including Bessemer and Southpaw.

In 2011 Asian Coast was able to secure another substantial institutional investor. The first phase of the complex opened in July 2013.

The Litigation

Bessemer and Southpaw sued Asian Coast and Harbinger for shareholder oppression under s.241 of the Canada Business Corporations Act (under which Asian Coast had been incorporated at the material time). As required by the BC Supreme Court Civil Rules, the claim was made by petition supported by affidavit evidence. Essentially, Bessemer and Southpaw claimed that Asian Coast had oppressed them by entering into the October 2009 and January 2010 transactions with Harbinger without canvassing whether they, and the company’s other shareholders, were prepared to offer better terms. They claimed that the terms of those transactions interfered with Asian Coast’s ability to raise equity from new investors and eventually resulted in their shareholdings being diluted. They claimed Harbinger was an accessory to Asian Coast’s oppression. They sought an order requiring Harbinger to buy their shares in Asian Coast for their original purchase price of
$24.6 million.

After much preliminary skirmishing (including about sealing orders, disclosure of documents and conversion to an action to be tried on viva voce evidence), cross examinations on affidavits and the commencement of a separate action against Harbinger for intentionally interfering with Bessemer and Southpaw’s economic relations with Asian Coast, the oppression claim was heard on affidavit evidence in September 2012 by Justice Carol Ross of the Supreme Court of British Columbia. On February 6, 2013 Justice Ross dismissed the claim with costs, in written reasons for judgment.

Reasonable Expectations

The first step in Justice Ross’s analysis was to consider Bessemer and Southpaw’s claim they had objectively reasonable expectations that Asian Coast would canvass them about providing the necessary interim financing before concluding deals with Harbinger. She seems to have accepted that the company should have canvassed sources of financing other than Harbinger, but that the degree of canvassing required depended on the circumstances.

In the circumstances of the October 2009 transaction, Justice Ross’s view was that Asian Coast should have canvassed at least Bessemer to see if it would make the necessary loan on better terms than Harbinger. As she put it, “There was no down side.” If nothing else, Asian Coast should have given itself as much leverage for its negotiations with Harbinger as possible. It was not reasonable to decide to negotiate with Harbinger without canvassing Bessemer. Asian Coast’s failure to do so was unfairly prejudicial to Bessemer
and Southpaw.

However, Justice Ross viewed the January 2010 situation differently, because of Bessemer and Southpaw’s December 2009 refusals to participate in Asian Coast’s attempted equity raise. In those circumstances, Justice Ross concluded it was reasonable for Asian Coast to conclude that neither was prepared to invest any further funds in the company, including through the interim financing required in January 2010. Therefore it was not a breach of Bessemer or Southpaw’s objectively reasonable expectations for Asian Coast not to approach them about that financing.

Causation

The next issue Justice Ross considered was whether Asian Coast’s breach of Bessemer and Southpaw’s reasonable expectations had caused the share dilution of which they complained. Their claim was that, had Asian Coast canvassed them for interim financing in October 2009, Bessemer would have loaned the company the money on more favourable terms than Harbinger actually did, and that it would have done the same in January 2010. They also claimed that, without Harbinger’s terms in place, Asian Coast would have been able to find new investors and the dilutive July 2010 transactions would not have taken place.

Justice Ross essentially rejected this claim on the facts. As she said, “Every link in the alleged chain of causation is problematic.” She was not persuaded that Bessemer would have provided the necessary interim funding in October 2009 or January 2010 on more favourable terms than Harbinger actually did. She noted Bessemer never actually offered better terms, only to participate in the October 2009 transaction on the same terms as Harbinger. She also noted that, while the expert evidence conflicted about whether Harbinger’s terms impaired Asian Coast’s ability to find new investors, Bessemer and Southpaw did not identify any potential investors who had declined to invest because of them. It was “pure speculation” that, without those terms, some investor would have invested on better terms. So, although it was unfairly prejudicial for Asian Coast not to canvass Bessemer and Southpaw about the October 2009 transaction, that did not cause the July 2010 share dilution of which they complained, and they were therefore not entitled to a remedy for it.

Accessory Liability

Bessemer and Southpaw’s claim against Harbinger was one of accessory liability. Because Justice Ross dismissed their primary oppression claim against Asian Coast, their accessory claim against Harbinger also failed. Nonetheless, Justice Ross made some interesting comments about this type of claim.

The claim was based on the venerable authority of Lumley v. Gye (1853), 118 ER 749, as interpreted by the House of Lords in OBG v. Allan [2007] UKHL 21. While one might be forgiven for thinking that line of authority concerned the specific tort of inducing breach of contract, Bessemer and Southpaw presented it as authority for a general concept of accessory liability. Justice Ross assumed, without deciding, that such a concept was applicable in an oppression claim.

Justice Ross accepted that accessory liability required “inducement, incitement or persuasion” of the person primarily liable, as set out in CBS Songs Ltd. v. Amstrad Consumer Electronics Plc[1988] AC 1013, in a patent infringement context. However, she concluded that the evidence did not support a finding that Harbinger participated sufficiently in Asian Coast’s unfairly prejudicial conduct to satisfy that test. Despite cross examination of Harbinger’s deponent, there was no evidence Harbinger had induced, incited or persuaded Asian Coast not to canvass Bessemer and Southpaw about the October 2009 or January 2010 transactions, nor that it had intended the company to oppress its other shareholders.

Conclusion

So, the question of accessory liability in a shareholder oppression context will have to wait for another day. Meanwhile, this decision reinforces a fundamental practical point about oppression claims – they are extremely fact dependent.

What is oppressive in one case – or in one of a series of closely related transactions – may not be in another.

Barry H. Bresner
416.367.6167
bbresner@blg.com

Stephen Antle
604.640.4101
santle@blg.com

Kara L. Beitel

Canada Ratifies ICSID Convention

At long last, the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (generally known as the ICSID Convention, but also referred to as the Washington Convention) has entered into force for Canada, as of 01 December 2013. An important tool for the resolution of international investor-state disputes is now available to Canadians who invest abroad, and to foreigners who invest in Canada.

What Is The ICSID Convention?

Unique challenges arise in the resolution of international investor-state disputes. Chief among them is finding an effective dispute resolution mechanism. Should investors rely on diplomatic channels, despite the delay and uncertainty that entails? Should they sue in the local courts of the host state, despite fears of discriminatory adjudication on foreign soil?

Realizing that such non-commercial concerns could discourage the free international flow of private investment, the World Bank sponsored negotiations in the 1960s to remove them, by establishing a specialized international dispute resolution framework. Those negotiations resulted in the ICSID Convention, a multilateral treaty that came into force in 1966.

The ICSID Convention offered a major step forward, by establishing neutral arbitration tribunals to resolve international investor-state disputes. Their neutrality would avoid the risk of discriminatory adjudication in the national courts. As well, ICSID awards would be enforceable with the same ease as other international arbitral awards. The sole mechanism for challenging a final ICSID award was the self-contained review regime established by the Convention itself.

As a result, and unlike many other forms of investor-state arbitration, awards under the ICSID Convention are not amenable to challenge in national courts. National courts cannot decline to recognize and enforce ICSID awards on the grounds in the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention) or the UNCITRAL Model Law on International Commercial Arbitration.

Over the intervening four decades, the ICSID Convention has become the leading mechanism for the resolution of international investor-state disputes. After a slow start, the Convention became a cornerstone of international investor protection in the 1990s, with a proliferation of bilateral investment treaties that required disputes to be resolved under its auspices. More than 2,000 such treaties are now in place and, as of November 2013, 158 states have ratified the Convention and become members of the International Centre for Settlement of Investment Disputes, the impartial international institution established under the Convention.

Until now, Canada had remained on the sidelines – the only G8 country to do so. This delay was generally attributed to Canada’s federal system of government: Canadian ratification of the ICSID Convention would require its implementation not only by the federal Parliament, but also by a least a critical mass of the provincial and territorial Legislatures. During that period, the only aspect of ICSID’s operations in which Canada has been able to participate is the ICSID Additional Facility, which was established by the World Bank in 1978 to extend the availability of ICSID arbitration to certain types of international disputes between investors and states that are not ICSID members. For example, so long as Canada and Mexico were not ICSID members, disputes under the North American Free Trade Agreement were ineligible for resolution under the Convention, but have been eligible for resolution under the Additional Facility. Although many of the principles that guide arbitration under the Additional Facility are similar to those under the Convention, one key distinction remains: the Convention’s self-contained provisions on recognition and enforcement of ICSID awards do not apply to Additional Facility awards. Additional Facility awards are as vulnerable to challenge in the national courts as any other international commercial arbitration award.

Ratification and its Implications for Canada

Over the past 20 years, the government of Canada has been actively promoting Canadian ratification of the ICSID Convention. These efforts have now paid off. Since the subject matter of the Convention falls within provincial jurisdiction over property and civil rights, the Uniform Law Conference of Canada sought to facilitate implementation by drafting model legislation for adoption by the federal Parliament and each of the provincial and territorial Legislatures. The ULCC’s model Settlement of International Investment Disputes Act is short (just 15 clauses) and aims to implement the Convention provisions concerning the jurisdiction and powers of the provincial superior courts to recognize and enforce ICSID awards (Clause 3). Under Clause 6 ICSID awards may be registered in the provincial superior court and thereafter are enforceable as a judgment of that court. Under Clause 8 an ICSID award is final and binding “and is not subject to appeal, review, setting aside or any other remedy except as provided in the ICSID Convention”. If a provincial, federal or territorial government in Canada consents to resolve disputes with foreign investors under the Convention, Clause 5 allows for variation as to whether the resulting ICSID award will bind crown corporations, crown agents and other similar entities.

To date, several Canadian jurisdictions have enacted legislation implementing the ICSID Convention based on the ULCC’s model statute. Although some jurisdictions have yet to legislate, it appears that there are firm understandings in place and that the appropriate steps will be taken in the near term, i.e., less than a year. Although some have suggested that Canada could or should have ratified the Convention without all provinces being onside, political reality has required a more subtle approach. The statutes enacted so far have followed the ULCC model statute template with only minor variations.

As a result of these developments, for the first time international investor-state disputes involving Canadians or their federal, provincial, and territorial governments will have direct access to the many advantages of dispute resolution under the ICSID Convention. Ratification provides important additional protections for the many Canadian companies of all sizes, and in a wide range of industries, that increasingly are investing in all parts of the world. Canada’s ratification also serves as a strong vote of confidence in ICSID, which recently has been the target of strong criticism, including denunciation of it by Bolivia and Ecuador.

As with any major policy initiative, Canada’s ratification of the ICSID Convention has attracted criticism from some quarters, including:

  • “We ratified only to placate the European Union!”
  • “Ratification compromises Canadian judicial sovereignty and puts our democracy into the hands of arbitrators rather than independent and accountable judges!”
  • “We have tilted the playing field to favour the interests of investors over those of states!”

Time will tell if this alarmism is well-founded, but early indicators suggest not. Around 75% of the world’s countries have ratified the ICSID Convention, and only a small handful have subsequently withdrawn from it – namely, the states that are repeatedly hammered for treating foreign investors unfairly. Canada is not in that camp. Even if its ratification of the Convention did prove to be a disaster, Canada would be able to withdraw at any time. As for the suggestion that ratification reflects idiosyncratic policy values of the current government, Canada’s Trade Law Bureau and members of the Canadian trade and arbitration community have been actively promoting Canadian ratification of the Convention for two decades, under governments of all political stripes.

Angus M. Gunn
604.640.4084
agunn@blg.com

Authors

Craig R. Chiasson 
CChiasson@blg.com
604.640.4221

Hunter Parsons 
HParsons@blg.com
604.640.4218

Barry H. Bresner 
BBresner@blg.com
416.367.6167

Other Authors

Angus M. Gunn
Stephen Antle

Expertise

Corporate Commercial Litigation and Arbitration