Reshaping the Landscape for Third Party Funding in China – New CIETAC arbitration rules on TPF came into effect on 1 January 2024

Introduction

On 5 September 2023, a key milestone was reached when the China International Economic and Trade Arbitration Commission (CIETAC) issued an updated version of its arbitration rules that took effect on 1 January 2024. Out of the many welcomed changes, one of the important changes is that the new CIETAC Arbitration Rules introduced new rules for the third party funding (TPF).

TPF has attracted increasing attention in the regime of international commercial arbitration. In recent years, many arbitration institutions have introduced regulations regarding TPF: CIETAC Investment Arbitration Rules (2017) introduced the disclosure obligations for TPF, catering for the rapid growth of TPF in investment arbitrations. Article 39 of the Beijing International Arbitration Center Rules for International Investment Arbitration (2019) explicitly defines TPF, requires disclosure of information by the funded party, and empowers arbitral tribunals to decide on arbitration costs. Article 34(8) of the Shanghai Arbitration Commission Rules also imposes disclosure obligations on the funded party. Furthermore, CIETAC Hong Kong issued the Guidelines for Third Party Funding, aiming to provide certain standards for the application of TPF in arbitral proceedings and the conduct of participants.

While TPF in arbitration has been acknowledged by CIETAC and the broader arbitration community, Chinese law remains silent on the issue. Although generally inferred to be legitimate, recent case law highlights differing approaches between arbitration and litigation in China. This article will analyze the two cases, Sunan Ruili Airlines Limited et al v. Silver Aircraft Leasing (Tianjin) Co. Ltd (2022) and Company A v Company B (2021) Hu 02 Min Zhong No. 10, 224 to understand the possible reasons for the divergence, before turning to Hong Kong’s rules on TPF as an effective international regulatory exemplar. It is important to bear in mind that Chinese courts are not required to follow any previous decisions except those published by the PRC Supreme People’s Court as Guiding Cases, therefore the cases discussed below do not have any binding effect. The purpose of this article is to highlight the differences in the treatment of TPF in arbitration and litigation, and to provide guidance to relevant regulators and parties through a comparative analysis of relevant cases.

 

TPF acknowledged in arbitration: Sunan Ruili Airlines Limited

Sunan Ruili Airlines Limited et al v. Silver Aircraft Leasing (Tianjin) Co. Ltd (2022) is a case where one of the claimants, CLC Aircraft Leasing, was funded by a third-party funder, IMF Bentham Limited. The respondents Ruili Airlines Co. Ltd, Yunnan Jingcheng Group Co., Ltd. and Dong Lecheng opposed the enforcement of the arbitral award before the Wuxi Intermediate People’s Court. In the meantime, the respondents also applied to the Beijing No. 4 Intermediate People’s Court to set aside the arbitral award.

The Wuxi Intermediate People’s Court dismissed the respondents’ challenge and the Beijing No. 4 Intermediate People’s Court also dismissed the set-aside application. One of the grounds for challenging the award was that the claimant and tribunal had allegedly breached confidentiality by disclosing information to the third-party funder.

In reviewing the challenge under the relevant articles of the PRC Civil Procedure Law, the court first noted that current Chinese law does not explicitly prohibit third-party funding in arbitration. It confirmed that the civil party has a legitimate right to accept such funding. Secondly, the court observed that the claimant had voluntarily disclosed the existence of third-party financing to the arbitral tribunal. The parties had also exchanged views and evidence on the legality of the arrangement during the arbitration proceedings.

Regarding confidentiality, while arbitration rules prohibit disclosure of case details to “outsiders”, it ruled that information could be shared with people concerned, such as funders with a significant interest in the outcome of a case. Hence, sharing information to the funders for funding procurement purposes did not necessarily breach the confidentiality obligations. Overall, both courts were satisfied that the procedural fairness of the case remained uncompromised, and thus dismissed the challenge/application. This case emboldened the legitimacy of TPF as permissible in arbitration, allowing for funded parties to level the playing field to pursue viable claims and defenses that they otherwise could not afford to.

 

Diverging approach in litigation: Company A v Company B

While establishing an affirmative stance in arbitration, as of now, Chinese courts have adopted a comparatively cautious view of TPF in civil litigation. The 2021 Company A v. Company B decision invalidated a litigation funding agreement on several basis.

Company A (A) had agreed to bear the lawsuit fees and expenses of Company B (B), in exchange for a 27% return on any sums recovered via judgment. The agreement stipulated that A would bear the loss if B lost the case or failed to recover the awarded amount, with no right of refund from B. When B won the case yet did not remit the investment returns to A as contracted, A commenced proceedings seeking payment as well as liquidated damages.

The Shanghai No. 2 Intermediate People’s Court dismissed A’s claim and invalidated the funding agreement, whereby several policy concerns rendered the arrangement impermissible. Specifically, the court found: (i) the close connection between the funder and the law firm representing the funded party risked actual or perceived conflicts; (ii) the funder appeared to be able to exert inappropriate control over the litigation; and (iii) confidentiality clauses risked concealing facts impacting the court’s independence and impartiality.

In this case, the court emphasized that the key determinant for validity is whether the third-party funding agreement seriously impacts the integrity of litigation proceedings. The court opined that the fact that the funder and the law firm representing the funded party were related parties hindered the effective legal representation of the funded party, as the law firm would not be independent, especially when conflicts arose between the funded party and the funder. Further, the court suspected that the agreement was an attempt to circumvent applicable PRC regulations limiting the contingency fees that can be charged by law firms. In addition, the existence of the confidentiality clause providing for non-disclosure of the litigation funding agreement was detrimental to the good order of litigation. Finally, the court was concerned that the use of TPF in litigation is contrary to public policy because it would encourage parties to litigate at low costs instead of choosing other dispute resolution mechanisms.

 

Analysis of the different approach

One explanation for the inconsistent treatment of TPF is the differing nature between arbitration and litigation. Arbitration is fundamentally a commercial and private process, with its foundations built upon principles of party autonomy and flexibility, rather than strict legal standards. In contrast, litigation occurs within official state legal institutions and engages matters of public interest. Furthermore, as cross border commercial relationships become more and more prominent, arbitration serves such business parties through neutral forums and internationally accepted norms. Meanwhile, litigation directly affects domestic policymaking and jurisprudence. Courts thereby are inclined to impose higher barriers when scrutinizing novel legal issues to safeguard national imperatives.

Another reason lies upon the international trends that shape perspectives on TPF, where places such as Hong Kong and Singapore have been influential leaders in shaping such norms. Singapore’s TPF regulations establish clear rules around qualifying funders and requisite funding agreements, after setting out that TPF contracts will not be deemed illegal due to principles of maintenance or champerty. Similarly, Hong Kong’s Arbitration Ordinance contains detailed provisions governing TPF disclosure obligations – it was amended in 2018 to definitively permit TPF activities, providing much-needed legal certainty for parties. There are mandatory duties under Sections 98T through 98W ensure arbitral tribunals and opposing parties are informed of any funding arrangements from the outset. This protects against potential bias or confidentiality issues by allowing consideration of interests and mitigating strategies upfront.

Furthermore, the Code of Practice for Third Party Funding of Arbitration (the Code) was issued on 7 December 2018 to supplement statutory change and came into operation on 1 February 2019 in the Hong Kong International Arbitration Center (HKIAC) rules. The Code adopts a ‘self-regulating’ approach aimed at managing the potential risks of TPF by establishing clear professional standards for third-party funders. Notably, the Code requires parties to maintain written protocols and controls, formulated in a manner permitting timely identification of conflict of interest. Third party funders are allowed to be communicated with the information of the arbitration insofar as it is for the purpose of seeking TPF or enforcing or challenging an award. Funded parties and counsels must notify counterparties and arbitrators in writing about the funding arrangement, including important details such as (i) the existence of the funding agreement and (ii) the name of the funder. The Code further clarifies that tribunals may take TPF into account when determining the costs of the arbitration.

Through a principle-based approach, Hong Kong has established itself as a leader in facilitating TPF in arbitration in a controlled manner, whereby the Code demonstrates how maintaining integrity, fairness and risk governance can normalize this practice. This framework offers an instructive model for China as its own arbitration system continues to mature.

Thirdly, the diverging judicial perspectives on oversight also contributed to the divergent results between arbitration and litigation. On the one hand, the Shanghai No. 2 Intermediate People’s Court expressed caution that unfettered TPF could incentivize non-meritorious litigation and compromise solicitor-client relationships. However, other courts like the Beijing No. 4 Intermediate People’s Court have taken a more flexible approach in arbitration cases, respecting party autonomy without direct interference. This subtly illustrates China’s strategic aim of advancing itself internationally as a preferred neutral seat for complex commercial arbitrations in Asia. Over time, it is likely that there will be standardizing TPF practices across the arbitration and litigation spheres.

 

New CIETAC Rules

The new CIETAC Arbitration Rules, which came into force on 1 January 2024, aim to enhance the transparency and impartiality of arbitration proceedings. Requiring parties to timely disclose information about TPF to the arbitral tribunal is a significant step in addressing concerns about the impact of TPF on the impartiality and independence of arbitrators.

Article 48 of the New CIETAC Arbitration Rules introduces a framework for TPF, which mandates that once a TPF agreement has been concluded, the funded party must promptly inform CIETAC about the existence of the TPF Agreement, the financial interest involved, and the identity of the third-party funder. This information is then forwarded to the other parties and the arbitral tribunal, whereby the latter has the authority to order the disclosure of additional relevant information if deemed necessary. This provision enhances the transparency of the arbitration process and helps to address potential conflicts of interest.

When determining the costs of arbitration and other fees in the award, the arbitral tribunal may consider the existence of the TPF arrangement and whether the funded party has complied with the disclosure requirements set forth. This provision ensures that the use of TPF does not unfairly influence the arbitration process and outcome, and also underscores the importance of compliance with the disclosure requirements, thereby promoting fairness and integrity in arbitration proceedings.

Overall, these changes reflect an institutional innovation that enhances the flexibility, fairness, efficiency, and transparency of arbitration procedures. They provide a high level of institutional safeguards for the development of CIETAC arbitration and offer a more internationalised dispute resolution service for all parties.

 

Conclusion

The updated CIETAC Arbitration Rules herald China’s maturation towards a practical framework governing TPF. Along with the affirming decision in Sunan Ruili, the foundation which enables funded parties fair access to arbitration has been strengthened.

Although challenges remain in uncovering TPF’s optimal role within the local courts, it appears that maintaining an open dialogue to rationalise standards is a prudent strategy. As CIETAC adopts new principles, it may serve as a successful regulatory template that can inspire norms in the local jurisdiction.

Overall, by acknowledging TPF, the new arbitration rules of the CIETAC indicate progress towards establishing greater transparency in the increasingly utilized practice of TPF in arbitration proceedings. For all arbitration participants, this development is a sign of a more standardized procedural playing field, in which parties can expect a more consistent and predictable process in the future.