Asian Dispute Review | To Fund or not to Fund: The Costs and Benefits of Hong Kong's Third Party Funding and Outcome-Related Fee Structures
This article was originally published on Asian Dispute Review, issue 3, 2024.
Written by Adriun Luk
Introduction
In Hong Kong, it is an offence at common law and a tort for a third party to fund an unconnected party’s litigation, unless one of the narrow exceptions permitting such third party funding (TPF) applies.[1] The criminal offence and tort of maintenance had both prohibited TPF of litigation and arbitration and prevented lawyers from offering outcome related fee structures (ORFS) to clients engaged in those processes. Recent amendments to the Arbitration Ordinance (Cap 609) have relaxed the rules to permit TPF and ORFS in the arbitration context.
On 1 February 2019, the Arbitration Ordinance (Cap 609) was amended to permit TPF for arbitration expressly.[2] Nearly four years later, on 16 December 2022,[3] the Ordinance was amended further to allow lawyers expressly to offer their clients ORFS for matters relating to an arbitration. Subsidiary legislation under s 98ZM of the Ordinance, entitled the Arbitration (Outcome Related Fee Structures for Arbitration) Rules (Cap 609D) (the ORFS Rules), was enacted to make the necessary provision; these rules also took effect on 16 December 2022.[4]
Collectively, these amendments reflect Hong Kong’s desire to maintain its competitiveness as one of the world’s leading arbitral seats, as it recognized both that TPF for arbitration has become increasingly common[5] and that all major arbitral seats permit some form of ORFS.[6]
1. A general introduction to TPF and ORFS
1.1 TPF
Part 10A of the Arbitration Ordinance governs TPF for arbitration. Section 98G of the Ordinance defines TPF as “the provision of arbitration funding for an arbitration - (a) under a funding agreement; (b) to a funded party; (c) by a third party funder; and (d) in return for the third party funder receiving a financial benefit only if the arbitration is successful within the meaning of the funding agreement.”[7]
The nature of TPF is that a third party funder may receive a return “only if the arbitration is successful” (ibid, emphasis added). It is non-recourse financing made in the form of provision of cash.[8]
A funded party may find TPF attractive as there is no restriction on its use. It may therefore be used to finance legal costs, expert costs and other costs incurred in the arbitration.
A funder may also agree to be liable to meet any liability for adverse costs, to provide security for costs and to meet any other financial liability.[9] Some professional funders have after-the-event insurance, which may cover the funder’s liability for a funded party’s adverse costs.
However, a funded party may find obtaining TPF difficult, as a funder would likely conduct a detailed due diligence exercise prior to agreeing to the provision of TPF, costing the funded party time, energy and money. While a reasonable portion of this cost may be recoverable in the event that the funded party is successful in the arbitration, this cost will be borne by the funded party if it is not successful, or if the arbitrator finds that the cost has not been reasonably incurred. Further, if the funder considers the arbitration unsuitable for TPF after conducting due diligence, then the costs and time incurred by the funded party will likely be a ‘sunk’ cost.
1.2 ORFS
Part 10B of the Arbitration Ordinance governs ORFS for arbitration. Section 98ZB(1) defines ORFS as “any of the following agreements made between a client and a lawyer of the client - (a) a conditional fee agreement [(CFA)]; (b) a damages-based agreement [(DBA)]; (c) a hybrid damages-based agreement [(Hybrid DBA)].”[10]
ORFS is the provision of legal services at either no cost or a reduced cost.[11] Unlike TPF, which can be used to pay any costs of the arbitration, ORFS only affects the costs of the arbitration by reducing the legal fee of the lawyer who is a party to an ORFS agreement. However, legal fees in arbitration tend to be one of the most expensive cost items. ORFS can therefore be an important tool for cost and risk management in arbitration.
2. Success sharing mechanisms of TPF and ORFS
If a party has entered into both a TPF agreement and an ORFS agreement, it is contractually bound, in the event that it is successful in the arbitration, to provide the promised financial reward to the funder and the lawyer. That reward may come from both the successful party and the unsuccessful party.
2.1 Success sharing mechanism of TPF
Section 74 of the Arbitration Ordinance provides, so far as material:
“(1) An arbitral tribunal may include in an award directions with respect to the costs of arbitral proceedings (including the fees and expenses of the tribunal).
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(3) The arbitral tribunal may also, in its discretion, order costs (including the fees and expenses of the tribunal) to be paid by a party in respect of a request made by any of the parties for an order or direction (including an interim measure).
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(7) The arbitral tribunal - (a) must only allow costs that are reasonable having regard to all the circumstances; and (b) unless otherwise agreed by the parties, may allow costs incurred in the preparation of the arbitral proceedings prior to the commencement of the arbitration.”
Section 74 of the Ordinance therefore provides that arbitrators may award any costs, so long as those costs are reasonable and are costs of the arbitral proceedings.
Article 34 of the HKIAC Administered Arbitration Rules 2024 expressly provides, so far as material:
“34.1 The arbitral tribunal shall determine the costs of the arbitration in one or more orders or awards. The term “costs of the arbitration” includes only: …(d) the reasonable costs of legal representation and other assistance...
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34.4 In determining (i) whether the costs of the arbitration referred to in Article 34.1 are reasonable and (ii) whether and how to apportion the costs of the arbitration in accordance with Article 34.3, the arbitral tribunal shall take into account the circumstances of the case. The arbitral tribunal may take into account any factors it considers relevant, including but not limited to … (d) any third party funding arrangement; (e) any outcome related fee structure agreement; ..."
The funded party was successful in the arbitration and was awarded HK$50 million. The funder would therefore receive HK$15 million (based on 30% of the financial benefits received). The successful party would be entitled to receive from the unsuccessful party the reasonably incurred portion of the HK$50,000 (the cost of arranging TPF) and of the HK$15 million (the funder’s reward). The funded party would have to pay from its own pocket the remaining amount due to the funder.
2.2 Success sharing mechanism of ORFS
Section 98ZU of the Arbitration Ordinance provides:
“(1) Despite section 74(3), an arbitral tribunal may not order costs specified in subsection (3) to be paid to a party to an arbitration if an ORFS agreement for arbitration has been entered into between the party and a lawyer of the party for the arbitration.
(2) However, the arbitral tribunal may still order those costs to be paid to a party to the arbitration if satisfied that there are exceptional circumstances justifying the ordering of those costs.
(3) The costs are those that fall within any of the following descriptions –
(a) if the ORFS agreement for the arbitration is a conditional fee agreement - the success fee as defined by section 98ZC(2);
(b) any legal expenses insurance premium;
(c) any part of the fee that is in excess of the fee that the lawyer would have been entitled to be paid by the party if there had been no ORFS agreement for the arbitration (normal fee).[12]
(4) To avoid doubt, this section does not prevent the arbitral tribunal from ordering a party to the arbitration to pay costs in an amount not exceeding the amount of the normal fee.”
There are two matters to note with regard to s 98ZU. Firstly, a successful party with an ORFS arrangement may generally not recover a legal expenses insurance premium from the unsuccessful party. However, if the successful party has also secured TPF, the funder may agree to be liable for the funded party’s adverse costs. The cost of TPF, as noted at section 1.1 above, may be recoverable as costs from the unsuccessful party in the event of success. Thus, TPF may be used to complement ORFS in this respect.
Secondly, the general prohibition against recovery of costs mentioned in s 98ZU(3) of the Ordinance (such as the success fee under an ORFS agreement and legal expenses insurance premium) may be lifted if there are “exceptional circumstances” (ibid, s 98ZU(2))). This exception, which carries a punitive effect toward the unsuccessful party, was included to deter parties from employing tactics that go beyond the usual tussles which feature in contentious proceedings, as seen in Essar Oilfields Services Ltd v Norscot Rig Management Pvt Ltd. [13]
In an HKIAC arbitration (supra, section 2.1), an arbitrator may, pursuant to art 34.4(e) of the Administered Arbitration Rules 2024, take into account an ORFS agreement in considering whether costs of the arbitration have been reasonably incurred, provided that such costs fall within the rubric of “exceptional circumstances”, pursuant to s 98ZU(3) of the Ordinance.
2.3 ORFS: CFA example
The following is an example of how an award of costs may be made where a CFA is involved.
Example: Lawyer X’s normal fee is based on an hourly rate of HK$10,000. Lawyer X agreed to an hourly rate of HK$7,000 (CFA discounted fee) in exchange for receiving a success fee based on an hourly rate of HK$12,000. Lawyer X’s client was successful in the arbitration and Lawyer X billed 200 hours for work he had done on the arbitration. His CFA discounted fee and normal fee would therefore be HK$1.4 million and HK$2 million respectively, and his success fee would be HK$1 million.
The successful party would be entitled to receive from the unsuccessful party the reasonably incurred portion of the normal fee of HK$2 million. If there were s 98ZU(2) exceptional circumstances, the successful party would also be entitled to receive from the unsuccessful party a reasonably incurred portion of the success fee of HK$1 million.
It is important to note that the success fee cannot exceed 100% of the normal fee.[14] Thus, Lawyer X could at most charge only an hourly rate of HK$20,000 in the event of success.
2.4 ORFS: DBA example
Example: Lawyer Y’s normal fee is based on an hourly rate of HK$10,000. Lawyer Y agrees only to be paid a DBA payment of 30% of the financial benefit obtained by his client in the event of success. Lawyer Y’s client was successful in the arbitration and was awarded HK$10 million. Lawyer Y’s DBA payment (per s 98ZD of the Arbitration Ordinance) would therefore be HK$3 million. Lawyer Y billed 200 hours for work he had done on the arbitration and his normal fee would be HK$2 million.
The successful party would be entitled to receive from the unsuccessful party the reasonably incurred portion of the normal fee of HK$2 million. If there were s 98ZU(2) exceptional circumstances, the successful party would also be entitled to receive from the unsuccessful party a reasonably incurred portion of HK$1 million, the DBA payment that was in excess of the normal fee.
It is important to note that the DBA payment cannot exceed 50% of the financial benefit received by the client.[15] Thus, if Lawyer Y’s client succeeded in the arbitration but was only awarded HK$5 million, Lawyer Y could only receive up to HK$2.5 million.
2.5 ORFS: Hybrid DBA examples
The following are three examples of how an award of costs may be made where a Hybrid DBA is involved.
Example 1: Lawyer Z’s normal fee is based on an hourly rate of HK$10,000. Lawyer Z agreed to an hourly rate of HK$7,000 (Hybrid DBA discounted fee) in exchange for a payment equal to 30% of the financial benefit obtained by his client in the event of success (Hybrid DBA payment). Lawyer Z’s client was successful in the arbitration and was awarded HK10 million. Lawyer Y’s Hybrid DBA payment would therefore be HK$3 million. Lawyer Z billed 200 hours for work he had done on the arbitration, so his Hybrid DBA discounted fee and normal fee would be HK$1.4 million and HK$2 million respectively.
The successful party would be entitled to receive from the unsuccessful party the reasonably incurred portion of the normal fee (HK$2 million). If there were s 98ZU(2) exceptional circumstances, the successful party would also be entitled to receive from the unsuccessful party a reasonably incurred portion of HK$1 million, the Hybrid DBA payment that was in excess of the normal fee.
Rule 6 of the ORFS Rules contains two rules aimed at ensuring that, under a Hybrid DBA, a lawyer will not receive a greater amount in fees when his client receives no financial benefit than when the client receives a small financial benefit.[16] Rule 6(1)(c) of the ORSA Rules, which concerns a situation in which the client does not obtain any financial benefit, is discussed in section 3, ‘Loss sharing mechanism of ORFS’. Rule 6(1)(d) of the Rules is discussed in this section at Example 2 below.
Example 2 (rule 6(1)(d) of the ORFS Rules): Lawyer Z and his client agreed to the same Hybrid DBA agreement as in Example 1. Lawyer Z’s client was successful in the arbitration and was awarded HK1 million. Lawyer Z may elect either to retain the capped amount of HK$1 million or receive the DBA payment of HK$300,000.
Lawyer Z would most likely elect to receive the capped amount. Thus, rule 6 of the ORFS Rules is intended to ensure that the Lawyer Z would not receive less in Example 2 (in which the client received some financial benefit) than in the Example at section 3.2 below (in which the client received no financial benefit).
The successful party would be entitled to receive from the unsuccessful party the reasonably incurred portion of the capped amount of HK$1 million, the arbitrator having considered the entire portion of the capped amount to have been reasonably incurred, in view of the fact that Lawyer Z would have received the normal fee of HK$2 million without the ORFS agreement.
3.Loss sharing mechanisms of TPF and ORFS
If a party has entered into a TPF agreement and an ORFS agreement, it may, in the event that it is unsuccessful in the arbitration, be able to share the loss with the funder and its lawyer.
3.1 Loss sharing mechanism of TPF
As TPF is a form of non-recourse financing, the funder will bear the loss of its investment. The funded party merely bears the cost it incurred in obtaining the TPF. If, however, the funder has agreed to meet any liability for adverse costs, the funded party may look to the funder to bear the costs awarded to the successful party.
3.2 Loss sharing mechanism of ORFS
The client would only need to pay to the lawyer the CFA discounted fee (as in the Example in section 2.3), or the Hybrid DBA discounted fee (as in Example 1 in section 2.5), under a CFA or a Hybrid DBA respectively. The lawyer would bear the loss arising from the difference between his or her normal fee and the applicable discounted fees.
The funded party would not be required to pay Lawyer Z more than half of the irrecoverable costs (defined as the “capped amount” in rule 6(2) of the ORFS Rules), namely HK$1 million.
The successful party would be entitled to receive from the unsuccessful party the reasonably incurred portion of the capped amount of HK$1 million, the arbitrator having considered the entire capped amount to have been reasonably incurred, in view of the fact that Lawyer Z would have received the normal fee of HK$2 million without the ORFS agreement.
Conclusion
TPF and ORFS were introduced in Hong Kong to provide parties to arbitrations with additional tools for managing the costs and risks arising in them. As these tools are still in the early stages of their application in the HKSAR, however, it may take some time and effort on the part of all arbitration stakeholders to structure an appropriately integrated system of TPF and ORFS. Parties involved in arbitrations with significant claims may, however, find it worthwhile to explore utilising TPF and ORFS, given their potential to reduce costs and risks.
[1] Unruh v Seeberger [2007] 2 HKLRD 414 (Court of Final Appeal). Editorial note: The Court left open the question of whether maintenance applied to Hong Kong-seated arbitrations, however, as the issue did not arise in this case: at [123], per Ribeiro PJ.
[2] Government of the Hong Kong Special Administrative Region press release, Relevant Provisions of Third Party Funding of Arbitration Come into Operation (1 February 2019), available at https://www.info.gov.hk/gia/general/201902/01/P2019020100676.htm. Editorial note: The amending legislation was the Arbitration and Mediation Legislation (Third Party Funding) (Amendment) Ordinance (6 of 2017), which had originally been enacted on 14 June 2017 and which added Part 10A (ss 98E-98X) (Third Party Funding of Arbitration) to the principal Ordinance. See Kim M Rooney, Recent Legal Developments in Third Party Funding of Arbitration and Mediation in Hong Kong [2017] Asian DR 172-177.
[3] Editorial note: Arbitration and Legal Practitioners Legislation (Outcome Related Fee Structures for Arbitration) (Amendment) Ordinance (6 of 2022), which had originally been enacted on 30 June 2022 and which added Part 10B (ss 98Y-98ZU) (Outcome Related Fee Structure Agreement for Arbitration) to the principal Ordinance. See New and emerging dispute resolution legislation [2023] Asian DR 105.
[4] Editorial note: For explanatory notes on the Rules, see Introduction: Arbitration (Outcome Related Fee Structures for Arbitration) Rules,Hong Kong Civil Procedure 2025 (the Hong Kong White Book), Vol 3, Part U9 (forthcoming).
[5] Law Reform Commission of Hong Kong (LRCHK), Report: Third Party Funding for Arbitration (October 2016), para 1.2, available at https:// www.hkreform.gov.hk/en/docs/rtpf_e.pdf.
[6] LRCHK, Report: Outcome Related Fee Structures for Arbitration (December 2021), para 1.11, available at https://www.hkreform.gov. hk/en/docs/rorfsa_e.pdf.
[7] A funding agreement is a written agreement made between a funded party and a funder (s 98H of the Arbitration Ordinance), and a funded party may be any party to an arbitration (ibid, s 98I). A funder may be anyone who does not have an interest recognised by law in the arbitration other than under the funding agreement (ibid, s 98J), and is not a lawyer acting for a party to an arbitration (ibid, s 98O). Thus, a lawyer acting for a party to an arbitration may only offer ORFS (discussed below), and not TPF. The term ‘financial benefit’ in s 98G(d) of the Ordinance is not defined in Part 10A. However, this concept is unlikely to be controversial, as funders will most likely look for money in return for their investment, which would certainly be considered a financial benefit. Whether the arbitration is ‘successful’ is to be defined in the TPF agreement (ibid).
[8] Crucially, TPF is neither a loan that may charge interest prior to repayment, nor a policy of insurance that may charge a premium at the time of disbursement.
[9] Code of Practice for Third Party Funding of Arbitration, para 2.12. Editorial notes: (1) The Code was published by the Secretary for Justice on 7 December 2018, in accordance with s 98P of the Ordinance. (2) As to the text of the Code, see Hong Kong Civil Procedure 2025 (the Hong Kong White Book), Vol 3, Part U8 (forthcoming).
[10] A conditional fee agreement (CFA) is “an agreement, made for a matter between a client and a lawyer of the client, under which the lawyer agrees with the client to be paid a success fee for the matter only in the event of a successful outcome for the client in the matter. ” (Section 98ZC(1) of the Ordinance) The term ‘successful outcome’ is to be defined in an ORFS agreement (ibid, s 98ZC(2)(a)).
A damages-based agreement (DBA) is one “made between a client and a lawyer of the client for a matter, under which - (a) the lawyer agrees with the client to be paid for the matter only in the event the client obtains a financial benefit in the matter (DBA payment); and (b) the DBA payment is calculated by reference to the financial benefit that is obtained by the client in the matter. ” (Ibid, s 98ZD) The term ‘financial benefit’ means any money or money’s worth (as defined in s 98ZA), but does not include legal costs and expenses awarded (ibid). It may be defined further in an ORFS agreement. It is noteworthy that, similar to TPF, a lawyer may, under a DBA, be paid only if the client obtains a financial benefit in the matter.
A hybrid damages-based agreement (Hybrid DBA) is one “made for a matter between a client and a lawyer of the client, under which the lawyer agrees with the client to be paid for the matter - (a) in the event the client obtains a financial benefit in the matter [as defined in s 98ZA) - a payment calculated by reference to the financial benefit; and (b) in any event - a fee, which may or may not be calculated at a discount, for the legal services rendered by the lawyer for the client during the course of the matter. ” (Ibid, s 98ZE)
[11] ORFS does not require the lawyer to offer the client a reduced hourly rate, but in practice a client will only enter into an ORFS agreement if the lawyer offers such a rate.
[12] The terms ‘normal fee’ in s 74 of the Arbitration Ordinance and ‘benchmark fee’ in rule 2(1) of the ORFS Rules appear to refer to the same fee.
[13] [2016] EWHC 2361 (Comm). This case involved an ICC arbitration in which the arbitrator had held Essar liable to pay Norscot the TPF cost (the reward the funder would receive in the event of a successful outcome). The LRCHK, in its report on ORFS (supra, note 6, at para 3.19) noted that “the arbitrator considered that Essar had set out to cripple Norscot financially and that, as a consequence of Essar’s treatment, Norscot had no alternative, but was forced to enter into the litigation funding … The funding costs reflect standard market rates and terms for such facility, …” The LRCHK noted further, citing HH Judge Waksman QC at [22]-[23], that the arbitrator also found that “[i]t was blindingly obvious to [Essar] that the claimant … would find it difficult[,] if not impossible[,] to pursue its claims by relying on its own resources. The respondent probably hoped that this financial imbalance would force the claimant to abandon its claims.” (Ibid)
[14] Rule 4(1)(b) of the ORFS Rules
[15] Ibid, rule 5(a)(ii).
[16] LRCHK, op cit (note 6), para 11.31.
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