Still Stuck in the Stone: Third Party Funding in the Excalibur CaseRobert Blackett
The last issue of The Arbiter featured an article which discussed Essar Oilfields Services Limited v Norscot Rig Management PVT Limited  EWHC 2361 (Comm), a Commercial Court decision from October 2016 regarding 3rd party funding. In that case a successful claimant had borrowed money from a third party funder in order to fund an arbitration claim. The arbitrator ordered the defendant to pay the premium which the claimant had to pay the third party funder. The court upheld the tribunal’s decision, confirming that arbitrators have a power to make such an order, even though the courts would have no power to do so had an analogous case been brought before the courts.
Subsequently, the Court of Appeal has given its judgment in another case about third party funding, namely Excalibur Ventures LLC v Texas Keystone Inc and Others  EWCA Civ 1144. Since the case has an interesting background, and deals with different issues to Essar, I thought it might be of interest to our readers, even if it has less practical importance.
Third party funding
The situation with which we are concerned is one where a funder provides a prospective claimant with a non-recourse loan, which the claimant uses to bring a claim in litigation or arbitration. If the claim succeeds then the claimant must repay the loan, together with a substantial uplift. If the claim fails, then the claimant pays nothing, and the funder loses its investment.
In England, 3rd party funding arises in what might be termed “David vs. Goliath” cases. A party believes it has a substantial claim, which it cannot afford to fund in any other way.
Third party funding is also used in cases where a more substantial claimant could afford to fund a claim but wants to preserve its cash-flow or de-risk the claim to some degree. The claimant in such a case therefore funds, or part funds, the claim by way of a third party funder.
Other possibilities also exist. These include so-called “portfolio funding.” Rather than the lender provide funding on a case-by-case basis, the funder enters an agreement with a law firm to fund any case which the law firm acts in and which meets certain pre-agreed criteria (usually including that the law firm be acting on a conditional fee basis). Other potential customers for “portfolio funding” are businesses with large books of litigation (particularly high volume, low value litigation).
Non-party costs orders
The Senior Courts Act 1981 provides:
“51 Costs in civil division of Court of Appeal, High Court and county courts.
(3) The court shall have full power to determine by whom and to what extent the costs are to be paid.”
This is the source of the courts’ jurisdiction to order a third party funder to pay the costs of litigation which they have funded.
CPR 44 provides:
“(4) In deciding what order (if any) to make about costs, the court will have regard to all the circumstances, including –
(a) the conduct of all the parties;
(b) whether a party has succeeded on part of its case, even if that party has not been wholly successful; and
(5) The conduct of the parties includes –
(a) conduct before, as well as during, the proceedings and in particular the extent to which the parties followed the Practice Direction – Pre-Action Conduct or any relevant pre-action protocol;
(b) whether it was reasonable for a party to raise, pursue or contest a particular allegation or issue;
(c) the manner in which a party has pursued or defended its case or a particular allegation or issue; and
(d) whether a claimant who has succeeded in the claim, in whole or in part, exaggerated its claim.”
The Arkin cap
Arkin v Borchard Lines  1 WLR 3055 was a claim by a shipping company which claimed to have been put out of business by the anticompetitive behaviour of its competitors. Arkin’s lawyers acted on a “no-win no-fee” basis. In order to pay its expert witnesses, Arkin borrowed around £1.3m of non-recourse funding from a funder called MPC. Arkin agreed to pay MPC 25% of any monies recovered up to £5m, and 23% thereafter. The claim failed. The court made a third party costs order, ordering the funder, MPC to pay towards the defendants costs. But the court capped the funder’s liability at £1.3m - the amount which the funder had loaned, and this practice has been followed in subsequent cases.
The result is that a funder’s maximum exposure is 2 times the amount loaned. If the claimant loses, then the money they have loaned the claimant is gone and the funder will have no recourse against the claimant. The funder can also be ordered to pay that same amount again to the successful defendant.
No third party costs orders in arbitration
Unlike the courts, arbitrators seated in England have no power like that in section 51(3) to order third party funders to pay costs. An arbitrator can only make awards against the parties to the arbitration agreement. There is no power on the part of the court to order a non-party to pay the costs of an arbitration. A defendant facing an arbitration claim from an impecunious claimant who is supported by a third party funder would be well advised to seek an order that the claimant provide security for costs.
The Excalibur case
Excalibur was a nameplate company with no money owned by a former US special forces soldier called Rex Wempen and his brother. Shortly before the fall of Saddam Hussein, Wempen visited Northern Iraq and befriended various local Kurdish leaders, who later became members of the new regional government. Wempen identified an opportunity to invest in a contract with the new regional government to explore for oil in a previously unexplored block called “Shaikan.” Wempen introduced this opportunity to an established Texas oil company called Keystone. Keystone entered a “collaboration agreement” with Excalibur, which provided for Excalibur and Keystone to bid for the Shaikan contract, with Excalibur to hold a 30% interest and Keystone to hold 70%. In the event, Excalibur consented not to be party to the Shaikan contract and withdrew, because Excalibur had no experience of oil exploration, no funds, no access to funds and so no way of funding its 30% share of the exploration costs, nor its share of the substantial up-front payment which any successful bidder would have to make to the regional government. A different consortium was awarded the PSC. One member of that consortium was “Gulf,” a company in which Keystone’s owners owned a minority share. That other consortium explored the field, and made a major oil discovery.
Excalibur instructed Clifford Chance, who brought a claim against Keystone and Gulf in the Commercial Court in London, claiming (on a whole host of grounds, including alleging several frauds) that Excalibur was somehow entitled to an interest in the field, said to be worth over $1.75 billion. Over about three years, five different funders provided Excalibur with £31.75 million of non-recourse funding with which to fight the case. Some was used to pay Clifford Chance. Some was used to fund a series of payments into court which Excalibur was ordered to make as security for Keystone and Gulf’s costs. The result was a vast piece of litigation with 5,000 pages of inter-solicitor correspondence, a 60 day trial and closing submissions 30,000 words longer than the Bible. Excalibur lost on every point. Excalibur’s case was “spurious”, “bad, artificial or misconceived,” “contrived … fallacious,” and “grossly exaggerated” and had been “pursued relentlessly to the bitter end.” Certain of Excalibur’s factual witnesses had lied. Certain of Excalibur’s experts had given evidence which was “wholly inaccurate and misleading.” Clifford Chance was criticised for the “belligerent tone, volume, content and repetition of the correspondence” which was “voluminous and interminable, in some circumstances highly aggressive and in others unacceptable in content.” Excalibur was ordered to pay Keystone’s and Gulf’s costs on the “indemnity” basis.
Keystone and Gulf’s claims against the funders
Keystone and Gulf sought costs orders against the funders. At least some of the funders were special purpose vehicles whose function had been to lend money to Excalibur. They were just conduits through which the real funders had transmitted money to Excalibur and had few or no assets themselves. So Keystone and Gulf also sought orders against the immediate funders’ owners.
Funders generally “follow the fortunes”
The funders argued that they should not have to pay towards Keystone’s and Gulf’s costs on the “indemnity” basis. They had no control over the way Excalibur had conducted the litigation. The funders had just provided finance, in good faith, based on legal advice and should not have to “follow the fortunes” of Excalibur.
None of this made any difference. The funders were liable to pay on the indemnity basis, subject to the Arkin cap. The Court of Appeal said:
“The argument for the funders boiled down in essence to the proposition that it is not appropriate to direct them to pay costs on the indemnity basis if they have themselves been guilty of no discreditable conduct or conduct which can be criticised.”
“. … a litigant may find himself liable to pay indemnity costs on account of the conduct of those whom he has chosen to engage – e.g. lawyers, or experts, which experts may themselves have been chosen by the lawyers, or the conduct of those whom he has chosen to enlist, e.g. witnesses, even though he is not personally responsible for it. The position of the funder is directly analogous. The funder is seeking to derive financial benefit from pursuit of the claim just as much as is the funded claimant litigant, and there can be no principled reason to draw a distinction between them in this regard.”
“the derivative nature of a commercial funder's involvement should ordinarily lead to his being required to contribute to the costs on the basis upon which they have been assessed against those whom he chose to fund. That is not to say that there is an irrebuttable presumption that that will be the outcome, but rather that that is the outcome which will ordinarily, in the nature of things, be just and equitable.”
The funders’ due diligence
This aspect of the case is interesting, not so much for the result (which seems unsurprising) but because in the course of argument some details emerged as to the due diligence which the funders had done before investing nearly £32 million in the case. Of course, this was all ultimately irrelevant since (per the Court of Appeal):
“… the existence of encouraging legal advice from a reputable source is not a ground for declining to make an order under section 51(3) and by parity of reasoning it is no more a ground for declining to direct that costs be paid on an indemnity basis. Indeed it would be contrary to all principle that a party should be absolved of liability by reason of receiving legal advice which suggested that he did not attract it.”
Nonetheless, the picture which emerges from the judgments is of a lack of rigour and sophistication on the part of the funders, particularly given the sums involved. The Court of Appeal considered that the due diligence undertaken by the funders before agreeing to support the claim was “inadequate,” “superficial, feeble and rushed.” In his costs judgment  EWHC 4278 (Comm) the first instance judge made the point that: “This is not … a case where there have been understandable differences of recollection such as occur in every trial. Many of the issues in the case did not depend on whose recollection was right about a meeting attended by both sides.” The implication being that the problems with the claim could and should have been identified.
The first prospective funder had been approached by the Clifford Chance partner representing Excalibur. The funder claimed that the partner had told him it was “the best case he had ever seen in his career,” that he had “never lost a case” that “he put [Excalibur’s] chances at 90%” and that, by advancing money, the funder would not be exposing itself to any further liability (which would not have been true, given the Arkin case). Clifford Chance also explained that it was undertaking the case on a 40% conditional fee arrangement. The funder said it had asked if it would be possible to get a QC’s opinion, but to have been told by Clifford Chance that this would not be possible before the date by which funding was needed (there was no explanation as to “why there was any deadline, let alone one which should prevent him from obtaining the second opinion which he had sought”). The funder agreed to provide an initial tranche of funding, and continued to provide further funding investigating any further into the merits as the case developed.
Other funders did conduct some due diligence. One obtained an advice from Orrick, Herrington & Sutcliffe but this the first instance judge described as: “a very limited review … largely parasitic on the work of Clifford Chance.” Another funder “Blackrobe” (who also had the best name) apparently obtained some advice from Allen & Overy. The first instance judge described this advice as “curious” since it described Excalibur as having a “high likelihood” of recovery, despite considering that in relation to the critical issue whether Gulf was a party to the Collaboration Agreement, there was only a “medium likelihood” that Gulf would prevail on at least one of the three theories advanced by Excalibur; and Excalibur was then said to have only a “low to moderate likelihood of success” on the first two and a “low” one on the third.
An “acute conflict of interest”?
In the Court of Appeal Tomlinson LJ said (emphasis added):
“I am particularly unimpressed by [one of the funders’] plea that they relied not just upon the advice of one of the best known firms of solicitors in England, Messrs Clifford Chance, but also sought independent advice from Orrick. The advice of the latter was so heavily qualified and expressly dependent upon the analysis conducted by Clifford Chance as to be of very little value. … The approach of Orrick to proof of the claim asserted amounted … to an assertion that they did not know what the evidence was going to be, but assuming that it stood up, all would be fine. Clifford Chance themselves had from the outset an acute conflict of interest, the extent of which worsened as their own investment in the case increased over time. It should have been obvious to any astute businessman…”
What was the “acute conflict” referred to? First and foremost, a lawyer should be seeking to advance their clients’ interests. Excalibur was a nameplate company with no assets and so nothing to lose if it lost its case. If it could pursue the claim it might get an enormous pay off. If it couldn’t pursue the claim, it would get nothing. Excalibur’s interests were best served, then, by obtaining the funding it needed in order to pursue the claim, have its day in court and its chance to win big.
If a lawyer acted for such a client under a normal retainer then the lawyer would get paid win or lose. So it would also be in the lawyers’ interest to see that the claim get the funding it needs to proceed. This might be moderated to some degree by the lawyer’s concern for their reputation and future business. They would not want to become known for losing cases and, if they consistently overstate the merits of cases in order to obtain funding, it will become harder to obtain work, and funding for that work, in the future.
The funder unlike the claimant or the lawyer who acts under a normal ‘pay come what may’ retainer, gains nothing and loses everything if it funds the claim and the claimant loses. Its only interest is in picking winners. Of course, it’s impossible to know for certain if a claim will win, and so in practice, whether a funder provides funding depends on its assessment of the merits and its attitude to risk.
Where a lawyer is working on a CFA (i.e. their fee, or part of it, will only be paid if they win) then they have an interest in winning / picking winners, and their interests and the funder’s interests become more closely aligned the bigger the CFA. This is, no doubt, why (judging from their websites) litigation funders prefer to work with lawyers who are acting on CFAs.
With a CFA, does any conflict worsen over time?
Tomlinson LJ suggests that, because Clifford Chance was acting on a conditional fee basis, rather than a traditional retainer, this will have made the conflict of interest between them and the funders worse “as [Clifford Chance’s] investment in the case increased over time”.
Do the lawyers and the funders interests diverge as the CFA lawyers do more work? Consider a lawyer acting on a 50% CFA in a case which is going to cost £1 million to take to judgment. As time goes on, the amount which the lawyers still need to “invest” in order to finish the case (i.e. 50% of the remaining costs) gets smaller, whereas the pay-off for winning stays the same. The effect is illustrated in the table below.
It can be seen that the reason why the lawyer’s incentive to see the case through increases is not the sunk cost (per Tomlinson LJ the lawyers’ “investment in the case”) but the relationship between the further investment which is required (which shrinks) and the pay-off for winning (which stays the same). At the beginning, you have to decide whether to “invest” £500,000 to have a chance of winning £1,000,000. A lawyer who was completely risk neutral would be happy to proceed provided he thought the chance of winning was at least 50%. But suppose you get to the point where all you need to pay to get your chance of winning £1,000,000 is £25,000. At that point a completely risk neutral lawyer would proceed so long as he thought the chance of winning was more than (25,000/1,000,000)=2.5%.
The funders’ position is very similar. Assume that, in the above example, the lawyers’ discounted fees are met by the funder, and the client has agreed to repay 5 times the sum advanced by the funder.
As the case progresses, and the amount of further investment that is required from the funder shrinks, the rewards for winning stay the same, and the chance of winning which is required in order to justify the further investment shrinks. Hence the interests of the CFA lawyer and the funder do not diverge as the lawyer’s “investment” increases - they remain aligned.
The position is slightly different if a new funder comes to the party late, when only a small further investment is required to finish the case. At that point, the client, the CFA lawyers and the existing funder all have a strong interest in seeing that the case gets the further funding it needs, and so have an incentive to overstate the prospects of success. The new funder which is considering advancing a small sum will have less to gain from a win, and so should require a higher chance of winning in order to proceed.
It remains true, however, that Tomlinson LJ’s suggestion that there was necessarily a conflict of interest between funder and the lawyers who act under a CFA, and that this worsens as the lawyers’ “investment” in the case increases is not correct. Of course, this makes no difference to the outcome - it is just a point of interest. Our understanding is that the modern practice among funders is to get an independent opinion as to the merits of every case and not to rely upon the claimant’s lawyers (with the possible exception of portfolio funders where the lawyers are acting under a CFA).
What the Excalibur funders stood to gain
Another area which might be of interest is that the Excalibur judgment reveals just how much the funders stood to have gained if Excalibur had been successful.
In Arkin, for comparison, the funder agreed to fund the cost of experts, which it expected would be £600,000. In the event, the cost was more like £1.3 million. In exchange the funder was to receive 25% of any recovery up to £5 million and 23% thereafter, plus anything which was recovered in respect of the costs of experts. The expected recovery was apparently $5 to $10 million. Assuming 100% of expert costs were recovered, the funder stood to recover a further $1.25 million (about £700k) to $2.4 million (about £1.4 million). That equates to about a 53% to 100% profit.
It will be recalled that in the Essar case which was discussed in the previous article, the funder provided £647,000 of funding. The claimant (if successful) had to repay three times the funding or 35% of the recovery, whichever was higher. In the event, the claimant had to pay the funder £1.94 million. So the funder made about a 200% profit.
In Excalibur each funder had provided funding on different terms:
It can be seen that the returns which the Excalibur funders stood to make were of a different order of magnitude to those in Arkin and Essar. Psari stood to make a profit of around 1,350%. The other funders stood to make a 600% profit, plus 25% annual interest on the sums they’d loaned (up to a further 35% profit since the first of these investors to advance any money was Hamilton in April 2012 and judgment was in September 2013, so Hamilton would have earned 17 months interest on that tranche of funding).
All the funders claimed to have had advice to the effect that Excalibur had a good claim. The fact that the funders required such a high return relative to the previous cases seems to suggest that the funders may actually have been rather more sceptical about Excalibur’s chances.
The Arkin cap draws no distinction between costs and security
The funders in Excalibur argued that a distinction should be drawn between funding which had been provided for the purpose of paying Clifford Chance, and funding which had been provided for the express purpose of paying into court as security for Keystone’s and Gulf’s costs. The latter, said the funders, should not count towards the Arkin cap. The court was not impressed with this argument. Tomlinson LJ cited with approval the following passages from the first instance judgment:
“135. The provision of money to Excalibur in order that it may provide security for costs is not the equivalent of a payment of costs ordered at the end of the case. It was a form of funding of the claim in exchange for a return attributable to the monies provided for that purpose – in effect an investment. If the action was to continue it was, of course, beneficial for the Defendants to have security rather than not. But continuance of the action was the last thing they desired. The provision of money for security was the only means by which that could happen and it resulted in the Defendants continuing to incur the costs and suffer the detriment which the action cast upon them.”
“137. If the position were otherwise a funder whose sole contribution was to provide money for security for costs, without which the action would not have continued, would be in the happy position of facing no possible exposure under section 51; whereas those who funded the costs would bear that burden (alone). This would be the position even though, had the claim succeeded, the security for costs provider would have a right to share in the proceeds increased by a percentage reflecting what he had contributed in respect of security. In effect such a provider would have, so far as exposure to an order under section 51 was concerned, a “free ride”, on the back of those financing the costs. This could not be just and cannot be right.”
Using an SPV does not insulate a funder from liability
A final point which arose in the Excalibur case concerns parent company liability. Some of the companies against whom Keystone and Gulf sought orders had no contractual relationship with Excalibur. They had advanced money to their subsidiaries, and those subsidiaries had advanced the money to Excalibur.
The parents argued that it was not legitimate to make costs orders against them, as to do so would amount to “piercing the corporate veil,” in circumstances where they had done nothing dishonest or reprehensible. The court at first instance, and the court of appeal, rejected this argument. Tomlinson LJ said:
“… if an order under section 51(3) is available only against a funder who has entered into a contractual relationship with the funded litigant, then by use of a special purpose vehicle funders would be able to insulate themselves from exposure to the section 51(3) jurisdiction and thus escape their responsibilities.”
“… in making an order under section 51(3) the court is not fettered by the legal realities but can look to the economic realities. The exercise of the discretion to make a non-party costs order does not amount to an enforcement of legal rights and obligations to which the doctrine of corporate personality is relevant. The non-party has no substantive liability in respect of costs. The single question is whether in the circumstances it is just to make a discretionary order requiring the non-party to pay costs because of the nature of its involvement in the litigation.”
“The judge's approach gave effect to the proposition that it is just and appropriate to make an order for costs against a person who has provided funding and who in reality will obtain the benefit of the litigation.”
Whereas the Essar case is arguably of relevance to anyone who is choosing a dispute resolution clause, the Excalibur case only really has a practical significance for litigation funders. It confirms that funders will usually have to “follow the fortunes” of the party they fund, and pay indemnity costs if that party is ordered to pay indemnity costs. It confirms that the Arkin cap applies both to funding which is provided for legal costs and funding which is provided for security. It confirms that funders cannot escape third party costs orders by channeling funding through an SPV.
The case is interesting insofar as it provides an insight into how an enormous case was conducted and funded, and the approach which the funders took. But it is important to note that the practice of litigation funding has become more established and the practice of funders has been refined such that the same circumstances are unlikely to arise today. The Court of Appeal in Excalibur heard submissions from the Association of Litigation Funders of England & Wales (the “ALF”) of which most litigation funders operating in England appear to be members. The Court of Appeal stressed that “the present appeals are concerned with commercial funding, but the funding here was not typical of that which is routinely undertaken by [ALF members] There were here four groups of funders, none of them members of the ALF. Only one of the funders had any experience of funding litigation and this was its first foray into litigation in the UK.” The ALF had been critical of the Excalibur funders approach and, elsewhere in the judgment, the Court of Appeal said: “Making due allowance for schadenfreude, [the ALF’s] public comments on the judge’s judgment in this case reflect a recognition that the funders here were inexperienced and did not adopt what the ALF membership would regard as a professional approach to the task of assessing the merits of the case.” The Excalibur case may therefore prove to have been something of an anomaly.