The State of Dispute Funding in Latin America

Introduction

Dispute funding consists of the provision of funds by a commercial funder to a company or individual pursuing a claim in litigation or arbitration. Pursuant to a funding transaction, during the course of the proceedings, the funder pays some or all of the funded party’s legal fees and disbursements, including lawyer and expert fees, litigation or arbitration related costs, and can even provide working capital to the funded party. In addition, a funder may agree to bear adverse costs liability and provide, when ordered by the court or arbitral tribunal, security for costs. In exchange for providing financing, the funder may receive a portion of proceeds recovered in litigation or arbitration. Dispute funding arrangements generally work on a non-recourse basis, meaning the funder’s right to payment is limited to any proceeds recovered from the respondent if the claim is successful.

Although dispute finance is firmly established in many jurisdictions, such as the United Kingdom, continental Europe, Australia, Canada and the United States, it is still taking hold in others. In recent years, Latin America (LatAm) has become the new hotspot for dispute funding. This is not surprising as the region offers all of the key ingredients for dispute funding to emerge: well-respected legal professionals, high-stake disputes involving cash-constrained claimants, pro-arbitration legal systems and nonrestrictive regulatory regimes towards dispute funding.

In this chapter we explore the state of dispute funding in LatAm, including the legal framework governing dispute funding in LatAm, the LatAm dispute funding market, and the criteria claimants should consider when selecting a funder, as well as the criteria applied by funders considering investments into LatAm disputes.

Legal framework governing dispute funding in LatAm

Civil law legal systems in LatAm are based on the Roman law and did not inherit the common law prohibitions of champerty and maintenance. Broadly, there are no legislative prohibitions as to the use of dispute funding in LatAm. Under the basic principles of contractual freedom and parties’ autonomy recognised in civil law jurisdictions, litigation funding agreements (LFAs) are legal and enforceable provided they comply with the basic elements of contractual validity in the applicable jurisdiction, namely: consent, legal capacity, and an object that is not contrary to the law, the morality or the state’s public interest.^[2]

However, civil legal systems may contain regulations that can be tangentially relevant to LFAs, which may impose restrictions that would make dispute funding transactions financially inviable. In particular, special consideration should be given to the following.

Limitation to the transfer of litigious rights

Many civil law countries recognise a special prerogative for the respondent in the case of a transfer of litigious rights. Some civil codes in the region provide that if a litigious right is transferred after the claim is filed, the claimant must notify all parties in the proceeding of such transfer and, once notified, the respondent has the right to pay the transferee the price the transferee paid to acquire the claim. If the respondent does so, the transferred litigious right will be extinguished. This prerogative is recognised in the civil codes of Chile^[3] and Colombia,^[4] for example, and has its origin in Roman law.^[5] Although an LFA does not entail the transfer of a litigious right, special consideration should be paid in cases when a claim is sold to a funder after the claim has been launched but before the award or judgment is final, as this can be interpreted as a form of transfer of litigious rights. Careful consideration should be given to the structure of the LFA, as some LFAs provide for a ‘true sale’ of the future right to recover proceeds from the underlying litigation or arbitration. Those LFAs should make clear that such sale is not a transfer of the actual claim but rather the purchase of a future right to recover proceeds from such claim, which remains owned and controlled by the claimant.

Protection against usury interest rates

A second restriction that may apply in civil law countries refers to the rate of interest that can be legally charged for a loan. Many countries set a maximum interest rate to protect consumers from unreasonable and disproportionate interest rates. The consequences of applying an interest rate that surpasses the ceiling vary depending on the jurisdiction but mainly encompass a declaration that the contract is void^[6] or a reduction of interest owed to the lender.^[7] Although an LFA is not a loan, it is important that the conditions set forth in the LFA are mindful of the limitations on the use of interest applicable in the relevant jurisdiction. Funders should make clear in the terms of the LFA that the arrangement is not a loan, promissory note, secured obligation or other instrument of debt and that the LFA represents an investment in an asset (the litigation or arbitration).

Professional conduct laws

Although LatAm countries do not have ethical restrictions applicable to lawyers and law firms regarding the use of dispute funding, as a rule, civil law countries have codes of ethics that are applicable to lawyers. Common to all ethics codes is an obligation that lawyers act independently and in the best interests of clients and safeguard the principles of professional secrecy (attorney–client privilege). Consequently, lawyers are required to obtain express consent from their clients before sharing confidential information with funders and must avoid conflicts between funders’ expectations and clients’ interests.

Disclosure obligations

It is also important to note that in the arbitration space more specifically, international bodies and regional arbitral institutions have adopted guidelines^[8] and rules around the disclosure of funding. This is mainly to enable arbitrators to verify whether they have any conflicts of interest and make any disclosure as necessary in respect of any relationship they may have with the funder in question. Where arbitration rules or guidelines recommend or require disclosure, it is limited to the disclosure of the existence of funding and the identity of the funder, as opposed to the disclosure of the LFA or terms thereof.

The Center for Arbitration and Mediation of the Chamber of Commerce Brazil-Canada (CAM-CCBC), a leading arbitration centre in Brazil, was a forerunner in this respect with its adoption in 2016 of Administrative Resolution No. 18, which recommends the disclosure of the existence of funding and the funder’s identity at the first opportunity available.^[9] Other Brazilian arbitral institutions have since followed suit,^[10] and it is expected that more local arbitral institutions may adopt similar recommendations in the near future.

International arbitral institutions have taken the further step of expressly mandating a funded party to make such a disclosure. This includes the International Chamber of Commerce (ICC) in its revised 2021 Arbitration Rules^[11] and the International Centre for the Settlement of Investment Disputes (ICSID) in its revised Arbitration Rules, which entered into force on 1 July 2022. New Rule 14(1), under the title ‘Notice of Third-Party Funding’ of the amended ICSID Arbitration Rules, provides:

A party shall file a written notice disclosing the name and address of any non-party from which the party, directly or indirectly, has received funds for the pursuit or defense of the proceeding through a donation or grant, or in return for remuneration dependent on the outcome of the proceeding (‘third-party funding’). If the non-party providing funding is a juridical person, the notice shall include the names of the persons and entities that own and control that juridical person. ^[12]

Rule 14(1) presents several noteworthy features not seen in the guidelines or regulations of other arbitral institutions. First, it sets forth a broad definition of ‘third-party funding’, to capture the wide variety of dispute funding agreements that can be employed in practice. This aims to prevent possible issues of interpretation on what qualifies as ‘third-party funding’ and what does not.^[13]

Second, Rule 14(1) includes, in its definition of ‘third-party funding’, arrangements with party representatives, such as contingency fee agreements with legal counsel, thereby extending the scope of the duty to disclose beyond that imposed by other arbitral institutions.^[14]

Third, the last sentence of Rule 14(1) requires a party to reveal the names of the entity or individuals ultimately controlling the funder. This requirement, introduced in the sixth working paper, attempts to ensure additional ‘transparency regarding the identity of the funder’ and ‘allow the arbitrators to accurately identify any conflict of interest’ involving the ‘ultimate beneficial owner’ of the funding entity.^[15] This provision was initially rejected by the Secretariat (in the fifth working paper), because it creates a risk of confusion among interpreters and involves concerns that have not been encountered in practice. Commentors have also criticised that Rule 14(1) requires disclosure of more information from the funder than from the funded party itself, which is not required to reveal its shareholders. The response to this criticism has been that, where there is a risk that the funder is a shell company, not providing this information might defeat the purpose of disclosure.^[16]

Finally, a more extreme approach has been discussed by some states in the context of discussions on the disclosure of funding by UNCITRAL’s Working Group III. Some states have proposed a ban of dispute funding in investor-state dispute settlement altogether.^[17] Argentina has gone one step further and actually included such a ban in its 2018 BIT with the United Arab Emirates.^[18] This ban could be considered a limitation on an investor’s legitimate right to have access to justice, which is a constitutional right protected by the contracting states and international law.

As dispute funding continues to grow in LatAm, it will be interesting to monitor if and how legislatures, courts, professional associations, and arbitral institutions regulate its use and disclosure.

LatAm dispute funding market

The non-restrictive regulatory framework for dispute funding in LatAm has enabled the development of an active funding market in the region, in particular involving arbitration. Funders are investing in arbitrations involving every industry sector in LatAm (much like other regions) in which there are substantial damages at stake, from construction and infrastructure, to mining, to oil and gas.

At the outset, the term ‘LatAm’ requires clarification. The LatAm dispute funding market could be perceived as being limited to domestic investment opportunities within the physical geographies of the region. However, it also encompasses cross-border and international opportunities arising from investments or commercial activities of LatAm clients abroad, and companies outside the region with LatAm operations.

Currently, the main area of opportunity for dispute funders in LatAm lies in the funding of arbitral disputes, rather than commercial litigation before the local courts. The slow penetration of dispute funding for local court litigation in LatAm is mainly attributed to a combination of lower demand for funding in this space and increased risks for funders.

Claimants may be less likely to turn to non-recourse funding options in local litigation because of the lower cost of litigating in civil law jurisdictions relative to common law jurisdictions and claimants’ lower exposure in the event of a loss, which is usually limited by statute to a percentage of the claimed amount.

Local court litigation in LatAm also represents higher risks for funders. These risks include political factors affecting court independence and impartiality, and potentially case outcome; and duration, with cases sometimes taking between 10 and 15 years to conclude, thus affecting a funder’s internal rate of return on its investment. These risks will vary depending on the jurisdiction, of course, but a funder will be particularly attuned to them when deciding whether to invest in a local LatAm litigation. These risks have also driven many disputing parties to resort to international arbitration instead of local courts. This is particularly true of foreign companies doing business in LatAm, for which arbitration is ‘the preferred dispute resolution method’.^[19]

The LatAm arbitration market has experienced sharp growth over the past few decades. On the commercial arbitration side, the ICC reports that during the 10-year period from 2005 to 2015, the number of LatAm parties in ICC arbitration increased 131 per cent from 170 in 2005 to 393 in 2015.^[20] In 2020, the ICC reported that 396 LatAm and Caribbean parties participated in ICC cases, which represented over 15 per cent of all ICC parties. Brazil remained the most represented nationality within the region (38 per cent) with 150 parties (compared with 133 in 2019), rising from third to second place in the worldwide nationality ranking for the first time. Within LatAm, Brazil was followed by Mexico with 78 parties (compared with 51 in 2019), which ranked 10th in the worldwide nationality ranking.^[21] Investment arbitration has grown at a similarly brisk pace, with approximately 30 per cent of ICSID matters in 2021 involving South and Central America and Caribbean sovereigns.^[22]

As arbitrations are often costly, expose claimants to significant adverse costs orders, and require enforcement against able but unwilling debtors, claimants are increasingly turning to dispute funders to mitigate their risks.

LatAm dispute funding criteria

Funder selection criteria

With the development of dispute funding in LatAm, it is not surprising that we have seen over the last five years the establishment of local funders and a growing interest of international funders in the region.^[23]

An interested party will generally contact a funder through its lawyer. An interested party may also contact a funder directly through its website or an internal contact without a lawyer, and a funder may suggest potential counsel for the interested party. Prior to any substantive discussion of the case, a non-disclosure agreement will be executed to ensure attorney work-product protection.^[24] Detailed information about the case will then be shared, including (1) the factual background and legal theories asserted; (2) estimated recoveries, including any preliminary damages analysis, (3) the jurisdiction of the litigation (to verify there are no funding restrictions); (4) the anticipated funding amount sought; and (5) the requested funding arrangement (i.e., whether the claimant is looking for working capital, litigation fees, costs, or a combination thereof).^[25] 

After this high-level review, if the case satisfies the funder’s investment para­meters, the funder will issue a term sheet outlining the proposed commercial terms of the investment on a non-binding basis, including the level of investment, the funder’s return usually expressed as a multiple of the investment or percentage of the recoveries or a combination thereof, the distribution priorities upon recovery, and any other relevant terms and conditions. In most circumstances, the only binding clause is an exclusivity period, usually between 30 and 45 days, during which the claimant agrees not to enter into funding discussions with other players to allow the funder to conduct an in-depth due diligence into the case. The elements a funder will carefully analyse during this phase are expanded upon below. This due diligence process can have significant advantages for the party and lawyers seeking funding as it provides an increased level of planning, analysis, and discipline prior to the filing of a dispute, thereby anticipating issues that could have been missed in the initial assessment of the case.^[26]

Once the investment is approved by the funder’s investment committee, often composed of former judges and arbitrators, the claimant and the funder enter into an LFA. This contract is the main protection a funder has over its investment because apart from a security interest in the claim or the proceeds of the claim, funders generally do not take any other security interest or collateral. The LFA also typically provides the funder with a limited set of termination rights, which are used only in very extraordinary circumstances as termination may be tantamount to a loss of the investment and any prospect of a return.

The careful selection of a funder who understands the claimant’s needs and concerns is as important as having the right legal representation and experts in a case. Navigating a highly complex case involves an element of risk, and there is always the possibility of unforeseen events that might alter the initial budget and timing calculations. Selecting a funder with the financial strength to adapt to these unexpected developments and expenses is vital to ensuring the appropriate course of action is taken.^[27] The party seeking funding should also ensure that the funder is prepared to tackle the jurisdiction where the claim is made. In LatAm cases, language barriers, economic, political, and cultural realities can have an impact on the course of the dispute. An experienced funder who understands these realities and the nature of the market in which it is investing would be better prepared to approach these issues in the most efficient manner. Other criteria to consider when selecting a funder include its track record,^[28] expertise^[29] and expectations around the working relationship.^[30]

LatAm dispute selection criteria

In light of the non-recourse nature of a dispute funding transaction, funders typically undertake rigorous diligence in assessing potential investment opportunities whether in LatAm or elsewhere. This may require them to understand:

• the capital needs in the case;
• the strengths and risks associated with the case and the legal strategy contemplated;
• realistic recoveries and settlement expectations;
• the time required to achieve those recoveries;
• the respondent’s payment capacity and any collection risk; and
• the parties responsible who will be involved in the funded case, including the claimant, counsel and the arbitrator or arbitrators.

The weight assigned by a funder to these considerations can depend on the type of dispute. Investor-state arbitrations, for example, are usually more costly, last an average of four to six years, and may require enforcement proceedings that add two to four years to the life of the investment. Likewise, damages in investor-state arbitrations may be less certain, as they often involve a valuation of the profits an investor would have realised, but for the government’s interference. In this context, a funder may assign less weight to the use of a discounted cash flow model to quantify lost profits for a project that was not a going concern, and more weight to the investor’s sunk costs.^[31] Commercial cases, on the other hand, are often less costly and resolve more quickly, which may weigh favourably in a funder’s consideration of a potential investment.^[32]

Although the substantial majority of requests do not result in a funding proposal, becoming familiar with the criteria applied by funders can meaningfully improve the likelihood that a funding proposal will be made and a funding transaction successfully closed.

Capital needs of case

The first step in exploring a funding transaction is defining the amount of the funding request. If counsel has been engaged already, it should prepare a detailed case budget that describes legal fees and out of pocket costs (such as arbitrator fees, expert fees and hearing transcripts), ideally broken into stages, through final resolution and payment.^[33] The funder may probe the assumptions underlying the budget to ensure it is neither excessive nor inadequate, to avoid the need for additional funding to be negotiated midway through the case or at the enforcement stage. The process of budgeting itself encourages counsel to consider important issues such as early challenges that might be raised, required witness statements and whether experts will be retained. If there is a meaningful risk of setting-aside or enforcement proceedings, the budget should make provision accordingly. In arbitrations where adverse costs may be awarded, the parties must plan around how such an award will be paid. Some funders may be able to extend the benefit of their own after-the-event insurance at favourable premiums and without the need for independent underwriting.

Along with a case budget, counsel should be prepared to discuss both the current fee arrangement and any changes contemplated to that arrangement, which are not uncommon as part of a funding transaction. Funders seek alignment among the parties involved and may prefer, but not necessarily require, some form of risk-sharing. Alternative fee arrangements are widely embraced across LatAm already, and counsel may share risk by agreeing to reduce its fees by some percentage in exchange for a contingency interest, or offer discounted fees with an ‘uplift’, or a capped budget. The goal is for any fee arrangement proposed by counsel, coupled with the funder’s proposed return, to result in claimant receiving a majority of recoveries. The claimant may share risk through its prior investment in the case or its willingness to cover some or all costs, or any overages in funded costs. Unless it has purchased the claim or judgment outright, a reputable funder should not interfere with the professional independence of counsel or the claimant’s autonomy around settlement or other important decisions, and risk-sharing is one way to ensure the parties are similarly motivated around settlement.

In addition to legal fees and costs, claimants may seek working capital as part of a funding transaction, and a funder considering such a request will seek to understand the amount and intended purpose of such working capital.

Case strengths and risks, legal strategy

One useful way to acquaint a funder with the strengths and risks associated with a case is through the preparation of a memorandum describing the key facts, legal claims and support for those claims, likely risks and challenges, including any counterclaims, the proposed legal strategy, expected damages and any collections risk. The funder may request further documentary support for the claims, decisions rendered in the case or related cases, and supporting case law or decisions.

While some funders have the expertise needed to analyse the case in-house, others may rely on external counsel to assist them in that analysis. Candour is encouraged in discussions with the funder concerning the risks associated with a case, as the funder expects there to be risks, and it is preferable to raise them early, rather than leave them to be discovered by the funder or its external counsel during the diligence period. Indeed, that diligence period is often an opportunity to address and plan around the challenges ahead, and it may be possible to structure around those risks as part of the transaction itself, for example, through the unlocking of capital in stages, such as after the claim survives a jurisdictional challenge.

The funder will seek to understand the risk of any set-aside proceedings, as such proceedings might cause a delay or allow the award to be challenged in domestic courts that may be less reliable or in a jurisdiction where the respondent has a home turf advantage. Accordingly, the law and practice governing how the courts of the seat handle set-aside proceedings is critical. As countries throughout LatAm have recently modernised their legal frameworks to accommodate arbitration, and parties are increasingly seating disputes involving LatAm within LatAm itself, seat risk has been decreasing in certain jurisdictions.

Realistic recoveries and settlement expectations

A critical part of the funder’s analysis of an investment opportunity is the anticipated recoveries. Counsel should be prepared to share its views on realistic damages, which quantum theories will be pursued, what portion of damages are based on sunk costs, as opposed to further lost or future profits, the evidence available to establish damages, and whether a damages expert will be required. To the extent a damages expert has been engaged already, a funder may ask to discuss the expert’s initial analysis or report. The currency of the anticipated recoveries will also be an important factor when assessing realistic recoveries as currency fluctuation may impact the value of the overall investment.

Equally important, the funder will want to understand the claimant’s expectations around settlement, whether any settlement discussions have occurred, whether the respondent has a history of settling similar cases, and when settlement is most likely. If there is a possibility that recoveries will be non-monetary in nature, such as a licence or right to future royalties, the funder will want to understand how it will be paid its return and may prefer to pre-agree on a fixed payment in those circumstances.

To determine whether a funding transaction is feasible and propose the terms of that transaction, the funder will weigh the capital needs of the case against likely recoveries. Reputable funders seek a healthy ratio between the funding amount and expected recoveries so that, after the funder is paid its return, and the law firm its success fee, if applicable, the claimant will stand to receive a majority of recoveries. Funders with a long-term view recognise that the sustainability of the dispute funding industry requires claimants to have positive experiences with funding. Even cases that are strong on the merits may be inappropriate for funding if there is insufficient ‘room’ in the case for the claimant to receive meaningful recoveries, and one of the most common reasons a funder may decline to propose a funding transaction is its concern around damages.

Duration

As discussed above, another important factor considered by funders is case duration, as long duration will impact the funder’s internal rate of return. Factors impacting duration include whether the arbitration is expected to be broken down into stages, the anticipated length of the arbitration, and any time added by jurisdictional challenges, bifurcation, setting aside and enforcement proceedings. To manage duration risk, the funder may propose staged deployment of funds and a time-based return that increases the longer its capital is outstanding.

Payment capacity and enforcement

Without a clear path from award to collection, a funder’s investment into the merits stage of an arbitration is pyrrhic. Where enforcement is likely to be required, it is ideal to plan around and make provision for funding towards enforcement as early as possible. Thus, even if funding is sought to support only the merits stage of a proceeding, an experienced funder will study the respondent’s payment capacity and history, including ownership of assets in the United States or other jurisdictions in which enforcement may be viable. This includes understanding any risk that the respondent may be rendered insolvent, including by virtue of the award itself, the respondent’s exposure to other creditors, and those creditors’ efforts to enforce against the respondent.

A funder may be engaged for the first time after the merits stage of the case is over and an award has been issued but the respondent is either unwilling or unable to pay. In that instance, the funder may be asked to fund enforcement proceedings. Depending on the funder’s assessment of the time and cost required to enforce and the amount likely to be recovered, the funder may, in addition to funding enforcement, be willing to monetise the award, which enables the claimant to mitigate the risk of non-payment and realise an earlier recovery than it might otherwise.

Claimant, counsel and the arbitrator

Given the collaborative nature of the funding relationship and the fact that many factors impacting the outcome of a funder’s investment are not within its control, a funder typically devotes a lot of attention to selecting competent, trustworthy and reliable partners.

As for the claimant itself, the funding transaction obliges it to undertake certain responsibilities toward the funder – for example, the obligation to distribute recoveries according to the terms of the transaction. Thus, the funder will want to get comfortable with the claimant’s financial position in the event of a breach. The funder should be informed if the claimant has existing financing from a bank or other lender, and the funder may seek a subordination agreement. Any judgments or liens, or credibility issues, should be disclosed early, rather than waiting for the funder to learn about them on its own.^[34]

As for counsel, the funder will want to understand counsel’s track record, relevant experience, and capacity to manage the case effectively, including language competence, cultural knowledge and geographical presence.

Finally, the funder will assess the experience and reputation of the arbitrators, the arbitral institution, the legal framework for arbitration in the jurisdiction that will be the seat of arbitration, the track record and caseload of the institution, and any arbitrator requirements.

Conclusion

With arbitration having become more established in LatAm in recent years, dispute funding is poised to take off. As foreign investors grapple with recurring themes of expropriation and nationalisation of private industries, and commercial agreements increasingly call for arbitration of disputes, the legal markets have adapted their frameworks to better accommodate arbitration, including of cross-border disputes. With that shift comes increased legal costs, risks and enforcement needs, and increased reliance on dispute funding naturally follows. Funders who have been reluctant to invest in local court litigation due to perceived risks around reliability and duration are finding that arbitration funding presents an attractive alternative. Commercially minded claimants with meritorious disputes are interested in identifying capital partners to share in the cost and risk of resolving those disputes; top-notch counsel is seeking ways to serve clients who lack the financial means or risk appetite to cover legal fees and costs; skilled arbitrators are resolving disputes reliably and on a reasonable timeline; the amounts at stake are significant; and enforcement prospects are promising.

As more dispute funders have begun servicing LatAm, there has been an increasing shift in the users of funding away from distressed companies and towards well-capitalised companies who utilise funding as a financial tool that allows them to transfer costs and risks, realise an early monetisation on claims that may otherwise take years to convert into recoveries, and free up their own capital for core business operations. As those companies are beginning to engage with funders directly, often before they have even selected counsel, the hesitation to explore funding has been shed. Forward-thinking lawyers have responded by becoming proficient in funding, getting to know both local funders and funders with a larger deployment reach, and introducing funding into conversations with clients as one of the available options to explore.

Just as the next few years promise to be a time of significant growth for arbitration of disputes in LatAm, dispute funding will grow, enabling claimants with meritorious claims in need of a partner to share the risk and costs required to pursue those claims.

Notes