Third party funding of climate change arbitration

Arbitration offers an ideal forum to resolve these disputes and is often preferred to litigation because of features such as the appointment of arbitrators who are experts in a particular field, the control over confidentiality of the proceedings and award, the availability of expedited procedures, the ability to involve multiple interested parties through joinder and consolidation, the independence of a tribunal as compared to state courts, and the ability to resolve cross-border disputes.

Often valid claims are not pursued, or settle for less than their value, because of the claiming party’s financial investment priorities. That is rapidly changing with the availability of third-party funding (TPF) especially in the field of high-value climate change arbitrations.

Arbitral disputes connected to climate change

Climate change disputes cover a wide range of areas, but arbitration offers an ideal forum to resolve these claims and is often preferred to litigation. Cases can arise in a range of areas, including:

• commercial disputes in the energy, infrastructure, agricultural, insurance, manufacturing infrastructure and processing sectors, where governmental environmental policy change and/or private company policy change has given rise to claims in respect of a specific project or contract;
• disputes arising from specific transition, adaption or mitigation contracts entered into, to meet specific climate change goals or commitments;
• inter-state, investor-state, lender-state and citizen-state disputes;
• disputes and claims brought against a state by other states that are adversely affected by measures taken in response to climate change;
• claims brought against states by investors affected by measures taken in response to climate change;
• finance and investment disputes concerning breach of representations or commitments in respect of climate change

The rise of climate-change related arbitrations

Annual reports published by key arbitral institutions have, in recent years, recorded growing case numbers.

One category of cases on the rise is those related to energy and environmental related disputes. There is a correlation between the increase in these cases and the shift in global consensus on the need for action to reverse climate change, the energy transition, amendments to environmental protection laws and regulations, the demand for sustainable energy solutions, the introduction of new processes and technology and corporate policy changes around net zero emissions.

Like any global commercial transition, this has the potential to cause disputes. The full extent of the increase in climate change arbitrations is unclear because of the approach of institutions to categorising these disputes, and the confidential nature of arbitration.

However, the more detailed data available in respect of treaty-based arbitrations provide helpful indicators as to trends in climate change disputes.

Examples of treaty-based climate change arbitrations include claims related to roll-backs or changes to laws or policies originally intended to meet climate goals.

The solar tariff related disputes brought by investors against Spain in the last decade as a result of changes to the country’s renewable energy tariff regime are prime examples. Following Spain’s implementation of regulatory measures to incentivise investment in renewable energy in 2007, a tariff deficit caused it to retract certain features of the regulations. As a result, a number of foreign investors commenced claims under bilateral investment treaties or the Energy Charter Treaty for their losses. Several third-party funders have been involved in these cases.

There have also been claims for compensation following the introduction of policy measures deemed to be ‘climate-justified’. This includes claims brought by a German utility company against the Netherlands as a result of the Dutch government’s planned phase-out of coal-fired plants by 2030, or the various cases brought by investors against Canada as a result of its moratoria on hydrocarbon exploration in Alberta and Quebec.

Claims for compensation arising out of states’ environmental permitting decisions are also rising. Examples include a case brought under the North American Free Trade Agreement in respect of the Obama administration’s denial of a permit for the Keystone XL pipeline, and a case brought against the Italian government over its reintroduction of a moratorium on oil and gas projects along the Italian coast once the permitting process for a new oil field had already begun.

It is not hard to imagine the private contract-based arbitrations that could also result from the above scenarios, such as disputes arising from wrongful termination, disputed variations, material price escalation, omissions, or changes in law.

Disputes of this nature are projected to become more frequent as countries implement new policies and regimes to address the nationally-determined contributions they committed to under the Paris Agreement and introduce new ‘green’ projects with low emissions to attract foreign investment.

These disputes involve considerable volumes of evidence both in the form of documents and expert reports and tend to take place over a considerable length of time as a result. They are therefore expensive to run.

The cost of climate change arbitration

The cost of the arbitration varies depending on whether the arbitration is contract or treaty-based, and whether a party is claimant or respondent.

In treaty-based arbitrations, studies have found that investors incur higher costs than respondent states. International Centre for Settlement of Investment Disputes (ICSID) proceedings incur higher costs than cases brought under UNCITRAL rules.

Claimants in commercial arbitrations spend about 12% more than respondents, and a Chartered Institute of Arbitrators study of over 250 commercial arbitrations showed costs averaged $2.6m – substantially less than the cost of a treaty-based arbitration.

Legal and expert fees are similar in treaty-based and commercial arbitrations, accounting for just over 80% of costs.

Arbitrators’ fees account for around 17% of the cost of treaty-based arbitrations, and about 15% of total expenses in commercial cases. Institutional expenses make up 2% of both types of cases.

The arbitral institution chosen can also influence the cost of arbitration. Articles 37 and 38 of the ICC Arbitration Rules (2021) requires both parties to pay an advance to cover the costs of arbitration. This is a fixed amount, determined by the court, which will most likely cover the fees and expenses of the arbitrators and the ICC’s administrative expenses.

The rules make provision for any party to cover the other’s fee if one of the parties fails to make payment. If the parties fail to comply with a request for an advance on costs, the secretary general may, after consulting with the arbitral tribunal, order the arbitral tribunal to suspend its proceedings and establish a timeframe, after which the relevant claims will be regarded withdrawn.

The final award fixes the costs of the arbitration, and which party shall bear the costs or in what proportion.

Article 61(2) of the ICSID Convention stipulates that in arbitration proceedings, the tribunal will decide how and by whom expenses incurred by the parties, as well as the fees and expenses of tribunal members, and costs for the use of facilities, should be paid. The decision forms part of the award unless agreed otherwise by the parties.

Costs can, however, be allocated earlier on partial awards. The ICSID Convention and the attendant rules or regulations do not offer guidance on the allocation of costs between parties.

Article 40(1) and (2) and 42 of the UNCITRAL Arbitration Rules state that the tribunal will fix the costs of arbitration in the final award and, if it deems appropriate, in another decision.

Costs include tribunal fees, reasonable travel and other expenses incurred by the arbitrators, reasonable costs of expert advice, travel and other expenses of witnesses, legal and other costs incurred by the parties, and any fees and expenses of the appointing authority as well as the fees and expenses of the secretary-general of the Permanent Court of Arbitration.

Article 42 also stipulates that both legal and arbitral costs will be borne by the unsuccessful party, although may be split between the parties if the tribunal decides this is reasonable.

In the absence of guidance from the applicable institutional rules, or agreement between the parties, arbitrators have discretion to determine and allocate costs. As a result, the cost of treaty-based arbitrations in particular is on the rise.

Cost remains a significant determining factor for a party when considering whether to pursue a valid claim, especially claims relating to climate change which can be lengthy. TPF therefore has the potential to play a significant role.

One of the main determining factors in the cost of arbitration is the length of time the proceedings take. Arbitrations relating to climate change can be particularly time-consuming as a result of the volume of evidence and the desire to find a balance between efficiency, costs, and the ultimate end goal of rendering an enforceable award.

Treaty-based arbitrations tend to take longer than contract-based arbitrations, but in both cases, the proceedings can be longer than the average case as a result of the extent of the document disclosure stage and the availability of senior experienced arbitrators.

Recoverability of costs

The extent to which parties are able to recover the costs of the arbitration can be agreed contractually or in a procedural order, or according to the measures in the applicable institutional rules.

The extent to which a winning party is entitled to recover its costs is affected by factors such as the merit of the claim, conduct during the arbitration, abuse of process, or the extent to which parties have assisted the tribunal to resolve the dispute.

Generally, states are perceived as being likely to comply with arbitral awards without challenge, especially in respect of treaty-based awards, in order to maintain their reputation as an investor-friendly country, and to avoid any possible negative reputational repercussions as regards their relationship with the World Bank.

Enforcement

Enforceability is another important deciding factor for a party and a funder in pursuing a climate change claim in arbitration, as well as the likelihood of recovery of costs.

Arbitral awards are final and binding, and the creditor is immediately entitled to receive the awarded sum. If it does not, enforcement proceedings can be brought in the national court where the debtor’s assets are located, particularly where that court is in a jurisdiction that has acceded to the New York Convention on Enforcement of Arbitral Awards.

Enforcement of treaty-based arbitration awards can be particularly complex as a result of challenges around asset tracing and sovereign immunity challenges brought by states. Political considerations, both locally and internationally, can also increase the likelihood of enforcement challenges against a state.

The ease of enforceability of an arbitral award is another key factor funders will investigate when assessing the viability of funding a climate change dispute. Apart from ensuring it understands the legal and financial risks, a funder will seek to understand the extent and location of the respondent’s assets against which enforcement could be sought. After the event (ATE) insurance is sometimes obtained to address the risk of non-compliance with the award.

Funding climate change cases

The past two years have seen a particularly sharp increase in the number of third-party funded arbitrations of climate change cases. One reason is the disruption caused by Covid-19 which galvanised companies to carefully consider how to make capital growth more resilient, and where to prioritise their investments, and the resulting wave of investment strategies that target climate change-combative projects.

These projects introduce considerable risk for companies. The introduction of new processes and technology, teams of staff and emissions related key performance indicators all have the potential to give rise to disputes.

Funders are rising to the demand by ringfencing specific funds for climate change related disputes. As the funding model becomes more widely adopted, ease of access to capital has become highly efficient. The steps involved in assessing a climate change case for funding do not differ considerably from an assessment of any other dispute.

Unique aspects which funders will consider when deciding whether to fund a climate change case include the higher risk profile of these cases, which consist of complex technical facts. However, higher risk can also mean higher return.

While funders will generally consider funding a case if there is a greater than 60% chance of success, in some situations they will choose to invest in climate change arbitrations where the success rate of the case is lower than 60% if there is a compelling enough narrative.

For any case involving TPF, due diligence is performed on the legal framework of the relevant jurisdiction to determine whether the governing law and jurisdiction will afford relative legal certainty. This is no different for climate change arbitration.

Certain funders are focusing on environmental, social justice and corruption issues in Africa, Latin America, India and other indigenous communities, which are priority investment areas. However, funded cases will also usually involve parties that have a foothold in jurisdictions with a more established judicial and legal system, such as the UK or US.

The political and legal infrastructure of these countries are desirable destinations for trying climate change disputes because awards are much less likely to be siphoned off due to corruptive practices and competing economic interests.

Disclosing TPF to an opponent at an early stage in the case can be a signal of strength and conviction in the merits, as claims are generally only funded when the prospects are good. Recently ICSID, a popular venue for climate change arbitration, proposed a rule change relating to disclosure which will require a party to file a written notice disclosing any TPF arrangement either on registration of the request for arbitration, or as soon as any TPF arrangement is concluded.

For parties seeking funding, and the funders themselves, this is not necessarily a disadvantage, and indeed disclosure of funding has been known to encourage early settlement.

Portfolio funding

One possible challenge for claimants considering funding of climate change disputes is the nature of the cases, which are often unique and not one of a series of disputes for a company.

While funders have traditionally financed single claims, unless a case has around a 60% chance of success, many funders will not take a risk on funding that claim alone. Without good prospects of recovery, the economics of the funding may not stack up on a single case basis.

In response, portfolio funding is now gathering momentum. A client’s portfolio of claims could fund the cost of several arbitrations, both strong and weak – for example where the client is a respondent without a counterclaim.

Portfolio funding is more attractive for the funder, as it cross-collateralises risk across multiple potential outcomes. The funder is more likely to receive a return, cover its outlay and make a profit, while the company takes the benefit of an injection of capital. Third-party funders offering portfolio funding will value the claims and decide how much they can put at risk against that portfolio ‘asset’.

If a climate change dispute is a ‘one off’ claim, then the 60% likelihood of success benchmark is one that they will be held to. Given the nature of these disputes, which can be ground-breaking, involving new technology and legal issues, this could cause a challenge for funders in some cases.

It is for this reason that it is incumbent upon funders to identify climate change projects and the disputes arising from them as a priority investment area.

Arbitration experts Clea Bigelow-Nuttall, Glen Rosen, Mohammed Talib, Chloe De Jager and Jennifer Wu of Pinsent Masons contributed to this article.