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The Singapore Law Gazette

Mitigating the Risks of Subrogated Claims by Insurers

International Arbitration and Third-Party Portfolio Financing

Picture this: you are a trade credit insurer with multiple claims from policy holders. What are some relevant factors that may help you reduce the risk of pursuing subrogated actions instead of passing on losses to your policy-holding clients? This article discusses the benefits of using international arbitration as a dispute resolution mechanism and third-party portfolio funding to cover costs of international arbitration.

Picture this scenario: You are a trade credit insurer. Your claims department recently received five claims from policy-holding clients arising from defaulting trade partners in five different Southeast Asian countries. The claims under each policy appear meritorious and these are long-term policy-holding clients. The claims have therefore been promptly paid out on a near-indemnity basis for a total loss to your business of US$10 million.

Your claims department must now consider its options to recover this loss. One option is to write off any subrogated claim and recoup the loss through future premiums. The other is to exercise your subrogated rights (ie, to step into the shoes of the policy-holder and sue the defaulting parties to recover the underlying debts).1 The doctrine of subrogation applies to insurance contracts which are contracts of indemnity as is the case between an insurer and its assured covering the default of the assured’s customer on an invoice. This entitles an insurer the right to step into the shoes of its assured to sue for any amount not paid by its assured’s customers which it has insured. The case of Castellian v Preston (1883) 11 QBD 380 describes the nature of this right as having the “advantage of every right of the assured, whether such right consists in contract, fulfilled or unfulfilled, or in remedy for tort capable of being insisted on or already insisted on, or in any other right, whether by way of condition or otherwise, legal or equitable, which can be, or has been exercised or has accrued, and whether such right could or could not be enforced by the insurer in the name of the assured by the exercise or acquiring of which right or condition the loss against which the assured is insured, can be, or has been diminished.”

Any decision on whether to pursue the defaulting counterparties will require a careful assessment of the strength of each claim, the prospects of recovery and the cost and resourcing required to pursue it. This evaluation alone requires extensive resources and potential cost.

Our discussions with sources in the industry indicate that many potential subrogated claims are, as a result, written off. Insurers prefer to recoup losses through future premiums as opposed to subrogated actions. The inherent value in those subrogated actions is therefore lost and the cost is passed on to the client.

The rationale for this approach is often motivated by the perceived risk and costs of obtaining, not only a successful judgment or award, but equally, a successful enforcement in the home jurisdiction of the defaulting party.

The arrangements between policy-holders and their defaulting parties may not be subject to well-planned dispute resolution clauses, and require that the insurer, stepping into the shoes of the policy-holder, must sue in the local courts of the defaulting party. In some jurisdictions, where local court systems are less transparent and predictable, this may be an unattractive proposition. The risk of an unsuccessful attempt at recovery may well militate against incurring the cost of doing so. The reputational risk of incurring cost and failing may equally dissuade those claims managers to embark on any such recovery efforts.

In this article we highlight two key considerations which may help to substantially reduce the risk of pursuing subrogated actions: insistence on international arbitration as a dispute resolution mechanism, and third-party portfolio financing. By adopting these measures, claims managers and insurers, like that in our hypothetical example, can more confidently leverage on their subrogated rights to increase profitability and avoid passing on losses to valued clients through increased premiums.

Insistence on International Arbitration for Dispute Resolution2 This section is primarily authored by Vera Koh, Associate, and Arvin Lee, Partner, at Wee Swee Teow LLP.

When exercising its subrogated rights, an insurer is effectively treated as if it were the policy-holder assured. This means that any dispute resolution mechanism agreed between the assured and its defaulting party will govern the subrogated action.

As noted above, the use of the local court systems in some jurisdictions can carry significant risks, such as local-party influence, delay, lack of transparency and unpredictability.

By ensuring that policy-holders bind their trade partners to effectively drafted international arbitration clauses, insurers can improve the predictability of the process of any subrogated recovery action. One desirable consideration is the adoption of a set of international arbitration rules.3 Examples include SIAC Rules, ICC Rules, LCIA Rules With the adoption of a set of institutional rules, the parties have chosen procedural rules which apply to, inter alia, the appointment of the tribunal and other procedural issues which may arise during the proceedings.4 Rolf A Schutze, 2013, Institutional Arbitration Article-by-Article Commentary, C.H. Beck∙Hart∙Nomos, p.2 to 21 Some institutional rules also provide for expedited procedure under certain circumstances which will save the insurer time5 For example, Rule 5 of SIAC Rules, (but of course should be employed judiciously in circumstances where witnesses and evidence can be assembled quickly enough for the insurer to discharge its burden of proof as the Claimant). Another example is the appointment of a sole arbitrator by default to minimise cost and time unless parties have agreed otherwise.6 For example, Rule 9 of SIAC Rules, Rule 12(2) of ICC Rules, Rule 5.8 of LCIA Rules In addition, some institutional rules also allow for parties to apply to the Tribunal for security for up to the entire amount in dispute7 For example, Rule 27(k) of SIAC Rules (and not just costs, as is more typical in litigation (or ad hoc arbitration). These are just a few examples applicable to our hypothetical case of a subrogated claims of a credit trade insurer. In general, the adoption of institutional rules minimises the possibility of unnecessary argument over procedural issues, and instead enables the proceeding to move more smoothly and with greater predictability.

An arbitral award also carries significant benefits for enforceability. The New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (New York Convention) has improved the attractiveness of arbitration as a dispute resolution mechanism. There are currently 159 contracting states of the New York Convention.8 http://www.uncitral.org/uncitral/en/uncitral_texts/arbitration/NYConvention_status.html Contracting states are required to recognise and enforce arbitral awards made in other contracting states subject to very limited exceptions under Article V of the New York Convention. It is common for national legislation of contracting states to adopt these exceptions, thus facilitating the enforcement of an award under domestic law. In Singapore, Section 31 of the International Arbitration Act (Cap 143A) (IAA) incorporates these exceptions.

Section 31 of the International Arbitration Act states that:

  1. In any proceedings in which the enforcement of a foreign award is sought by virtue of this Part, the party against whom the enforcement is sought may request that the enforcement be refused, and the enforcement in any of the cases mentioned in subsections (2) and (4) may be refused but not otherwise.
  2. A court so requested may refuse enforcement of a foreign award if the person against whom enforcement is sought proves to the satisfaction of the court that –
    1. A party to the arbitration agreement in pursuance of which the award was made was, under the law applicable to him, under some incapacity at the time when the agreement was made;
    2. The arbitration agreement is not valid under the law to which the parties have subjected it or, in the absence of any indication in that respect, under the law of the country where the award was made;
    3. He was not given proper notice of the appointment of the arbitrator or of the arbitration proceedings or was otherwise unable to present his case in the arbitration proceedings;
    4. Subject to subsection (3), the award deals with a difference not contemplated by, or not falling within the terms of, the submission to arbitration or contains a decision on the matter beyond the scope of submission to arbitration;
    5. the composition of the arbitral authority or the arbitral procedure was not in accordance with the agreement of the parties or, failing such agreement, was not in accordance with the law of the country where the arbitration took place; or
    6. the award has not yet become binding on the parties to the arbitral award or has been set aside or suspended by a competent authority of the country in which, or under the law of which, the award was made.
  3. When a foreign award referred to in subsection (2)(d) contains decisions on matters not submitted to arbitration but those decisions can be separated from decisions on matters submitted to arbitration, the award may be enforced to the extent that it contains decisions on matters so submitted.
  4. In proceedings in which the enforcement of a foreign award is sought by virtue of this Part, the court may refuse to enforce the award if it finds that –
    1. the subject-matter of the difference between the parties to the award is not capable of settlement by arbitration under the law of Singapore; or
    2. enforcement of the award would be contrary to the public policy of Singapore.
  5. Where, in any proceedings in which the enforcement of a foreign award is sought by virtue of this Part, the court is satisfied that an application for the settling aside or for the suspension of the award has been made to a competent authority of the country in which, or under the law of which, the award was made, the court may –
    1. if the court considers it proper to do so, adjourn the proceedings or, as the case may be, so much of the proceedings as relates to the award; and
    2. on the application of the party seeking to enforce the award, order the other party to give suitable security.

One exception under Article V is where the recognition or enforcement of the award would be contrary to public policy. Singapore Courts have held that it must “shock the conscience, or is clearly injurious to the public good or wholly offensive to the ordinary reasonable and fully informed member of the public”.9PT Asuransi Jasa Indonesia (Persero) v Dexia Bank SA (2007) 1 SLR(R) 597 at (59). Although this case, strictly speaking, was on setting aside, the same principles can be applied in Singapore to refusing enforcement of an award due to public policy reasons. Clearly, this is a high threshold which a party must meet in order to resist enforcement.

Apart from enforceability, an arbitral award is also attractive because of its degree of finality. If parties adopt institutional rules such as Singapore International Arbitration Centre (SIAC) Rules, International Commercial Court (ICC) Rules or the London Court of International Arbitration (LCIA) Rules in their arbitration clause, the Rules expressly provide for a waiver of right to appeal the award.10 For example, Rule 32.11 of SIAC Rules, Rule 35(6) of ICC Rules, Rule 29.2 LCIA Rules. While this prevents the losing party which takes the view that it has a legitimate ground of appeal from seeking any recourse, it protects the bona fide party from unpleasant surprises in national courts during enforcement proceedings where the standard of enforcement may vary,11 Rolf A Schutze, 2013, Institutional Arbitration Article-by-Article Commentary, C.H. Beck∙Hart∙Nomos, p 258. and also enhances certainty, which anecdotally is a key virtue — and value — for commercial parties. Moreover, the only recourse against an international arbitration award in Singapore is by setting it aside. The grounds for setting aside an arbitral award are substantively the same as the grounds for non-enforcement of an arbitral award — although some domestic legislation may provide for additional grounds of setting aside, such as those found in Section 24 of the IAA of Singapore.

Introduction to Third-party Funding, Portfolio Financing Structures and the Potential Application to Our Scenario12 This section is primarily authored by Tom Glasgow, Chief Investment Officer (Asia), IMF Bentham

The modern concept of third-party funding or dispute resolution finance was pioneered in Australia during the 1990s by companies like IMF Bentham Limited. It has since migrated to the United Kingdom, Europe, North America and, in recent years, to Asia, the Middle East and Latin America.13Report of the ICCA-Queen Mary Task Force on Third-Party Funding in International Arbitration, April 2018 (International Council for Commercial Arbitration) (ICCA TPF Report) pg 18. The global market for dispute resolution finance was recently estimated as exceeding US$10 billion.14Ibid, pg 17.

The third-party funding of international arbitration has become particularly prevalent in recent years. This has most likely been driven by the growth in prominence, cost and complexity of international arbitration together with increasing demands on users of arbitration to manage the associated costs and risks.15Ibid. See also, the 2015 International Arbitration Survey: Improvements and Innovations in International Arbitration, conducted by Queen Mary University of London and White Case LLP, in which 68% of participants cited ‘cost’ as the ‘worst characteristic of arbitration’. The cost of international arbitration is often compounded by the international nature of the dispute, requiring multi-jurisdictional and often specialist legal teams, as well as institutional fees, arbitrator costs and hearing venue hire. In early 2017, Singapore passed legislation expressly endorsing third-party funding of international arbitration seated in Singapore.16 Civil Law Act (Cap 43), Sections 5A and 5B and associated regulations. Hong Kong shortly followed suit by enacting similar legislation.17 Arbitration Ordinance (Cap 609), Part 10A and Mediation Ordinance (Cap 620) Part 7A.

In its simplest form, dispute resolution finance involves a third-party funder assuming the cost of arbitration or litigation in exchange for a share in the proceeds or commercial benefit if the case is successful.18 ICCA TPF Report, pg 18. Some funders will also assume the risk of any adverse costs ordered against the funded party if the case is unsuccessful.19 IMF Bentham will typically agree to meet any adverse costs or security for costs ordered against its funded parties; however, some funders will require the funded party to purchase an “after-the-event” insurance policy to cover this exposure. The approach varies considerably among funders and if insurance is required, that additional cost should be considered in evaluating the commercial benefit of the funding arrangement to the funded party. Even if the funder absorbs the cost of the ‘ATE’ policy premium, that cost is likely to be recovered from any resolution sum and possibly multiplied to calculate the funder’s return on investment.

The funder typically derives a return on its investment only from the proceeds of the case. It has no other right of recourse against the funded party. As a result, if the case is lost or if there is no recovery, the funder bears the cost.20 ICCA TPF Report, pg 18.

From the funded party’s perspective, the cost and risk associated with the dispute is therefore shifted from the funded party to the funder. In addition to financial support and risk mitigation, some funders also provide project management and strategic expertise to help improve the prospects of recovery and alleviate resource constraints on the funded party.21 For example, IMF Bentham has a team of over 30 expert investment managers (former commercial litigators and arbitration counsel with at least ten years’ experience) spread across 14 offices world-wide who provide project management services and strategic input on the matters which they fund.

Historically, third-party funding was directed towards impecunious or insolvent claimants as a means of providing access to justice. In recent years, however, there has been a notable shift. Much of the modern-day litigation finance market is aimed at meeting the increasing demands of financially stable corporations, small and large, seeking to manage risk, reduce legal spending and allocate resources to core business needs while ensuring the company’s interests in dispute are diligently pursued.22 ICCA TPF Report, pg 20. The industry’s focus on these demands has led to an increase in the sophistication and flexibility of financing models, including the rise of portfolio financing.

A funder’s return or share in the proceeds of a case is typically reflective of the risk which the funder takes on.23Ibid, pg 26. Much like other investment classes, the higher the risk, the higher the expected return to the investor. Where a group of cases are funded together, as a package, the funder tends to diversify its risk. The funder’s return and its costs of funding each of the cases in the portfolio can be recovered from those cases that are successful, mitigating the otherwise binary impact to a funder of an unsuccessful case. Indeed, in some situations, a funder may fund cases with no immediate monetary value (including defences) if its costs and a return may be recovered from other matters of potential value within the portfolio.24Ibid, pg 38.

The impact of this diversification of risk is often to reduce the overall cost of funding to the funded party. It may also allow the funded party to pool together claims in a portfolio that may not provide sufficient monetary value to secure funding on a stand-alone basis — although a single claim for recovery of USD1m may be insufficient to secure funding, the combined value in our hypothetical scenario above may well be. In some cases, the combined value of a portfolio may be used to secure funds, not only for legal expenditure, but also for general business purposes or simply to declare as profit.25Ibid.

Accordingly, portfolio dispute finance can provide several attractive benefits to organisations with multiple commercial disputes at play. It can allow the pursuit of numerous claims (and potentially defences) at zero or reduced cost to the business. The company effectively reduces its risk while it pursues its commercial interests and realises the value of its litigation/arbitration assets. Where the funder also provides project management and strategic support, the impact upon an organisation’s resources is also reduced. In many cases this allows the organisation to pursue claims that might otherwise have been written-off or settled on less favourable terms.

Our hypothetical scenario envisages an organisation with a clearly suitable profile for portfolio dispute finance. The insurer has multiple potential subrogated claims against the defaulting counterparties of its policy holding clients.

As noted above, any decision on whether to pursue those defaulting counterparties will require a careful assessment of the strength of each claim, the prospects of recovery and the cost and resourcing required to pursue it. This evaluation alone requires resources and potential cost and often results in insurers preferring to write off the value of the subrogated claims.

By sharing its portfolio of potential subrogated claims with a funder, our hypothetical insurer can outsource the cost and resources required to identify those subrogated claims with good prospects for recovery. Funders with extensive hands-on international expertise, like IMF Bentham, carry out this economic assessment every day and are well placed to assess the proportionality of cost, likelihood of success and potential difficulties for recovery and enforcement.

This sifting process, alone, assists the insurer in ascribing value or otherwise to its contingent claims. Those that lack prospects can be written-off, while those worth pursing are retained and pursued with the benefit of non-recourse funding, without risk or cost to the insurer. The bulk of any proceeds are returned to the insurer as they occur — value that otherwise would not have been realised — while the funder recoups its costs and a modest return reflecting its diversified risk. If the value of the portfolio of claims is sufficient, the insurer might also leverage its subrogated claims to fund other legal costs, such as defending unmeritorious claims by policy holders, or even to fund other operational needs of the business.

Conclusion

Each day, claims mangers of insurers, like our hypothetical trade credit insurer, face the difficult question of whether or not to pursue complex subrogated claims. Too often the perceived risks and costs lead to avoidance and considerable value is written off the books. In this article we have drawn on the expertise of experienced arbitration counsel and a leading international funder to demonstrate how insures may substantially reduce the risk of pursuing subrogated actions in the Asia region. By adopting these measures insurers can more confidently leverage their valuable rights of subrogation and increase profitability without taking undue risks.

Footnotes   [ + ]

1. The doctrine of subrogation applies to insurance contracts which are contracts of indemnity as is the case between an insurer and its assured covering the default of the assured’s customer on an invoice. This entitles an insurer the right to step into the shoes of its assured to sue for any amount not paid by its assured’s customers which it has insured. The case of Castellian v Preston (1883) 11 QBD 380 describes the nature of this right as having the “advantage of every right of the assured, whether such right consists in contract, fulfilled or unfulfilled, or in remedy for tort capable of being insisted on or already insisted on, or in any other right, whether by way of condition or otherwise, legal or equitable, which can be, or has been exercised or has accrued, and whether such right could or could not be enforced by the insurer in the name of the assured by the exercise or acquiring of which right or condition the loss against which the assured is insured, can be, or has been diminished.”
2. This section is primarily authored by Vera Koh, Associate, and Arvin Lee, Partner, at Wee Swee Teow LLP.
3. Examples include SIAC Rules, ICC Rules, LCIA Rules
4. Rolf A Schutze, 2013, Institutional Arbitration Article-by-Article Commentary, C.H. Beck∙Hart∙Nomos, p.2 to 21
5. For example, Rule 5 of SIAC Rules,
6. For example, Rule 9 of SIAC Rules, Rule 12(2) of ICC Rules, Rule 5.8 of LCIA Rules
7. For example, Rule 27(k) of SIAC Rules
8. http://www.uncitral.org/uncitral/en/uncitral_texts/arbitration/NYConvention_status.html
9.PT Asuransi Jasa Indonesia (Persero) v Dexia Bank SA (2007) 1 SLR(R) 597 at (59). Although this case, strictly speaking, was on setting aside, the same principles can be applied in Singapore to refusing enforcement of an award due to public policy reasons.
10. For example, Rule 32.11 of SIAC Rules, Rule 35(6) of ICC Rules, Rule 29.2 LCIA Rules.
11. Rolf A Schutze, 2013, Institutional Arbitration Article-by-Article Commentary, C.H. Beck∙Hart∙Nomos, p 258.
12. This section is primarily authored by Tom Glasgow, Chief Investment Officer (Asia), IMF Bentham
13.Report of the ICCA-Queen Mary Task Force on Third-Party Funding in International Arbitration, April 2018 (International Council for Commercial Arbitration) (ICCA TPF Report) pg 18.
14.Ibid, pg 17.
15.Ibid. See also, the 2015 International Arbitration Survey: Improvements and Innovations in International Arbitration, conducted by Queen Mary University of London and White Case LLP, in which 68% of participants cited ‘cost’ as the ‘worst characteristic of arbitration’. The cost of international arbitration is often compounded by the international nature of the dispute, requiring multi-jurisdictional and often specialist legal teams, as well as institutional fees, arbitrator costs and hearing venue hire.
16. Civil Law Act (Cap 43), Sections 5A and 5B and associated regulations.
17. Arbitration Ordinance (Cap 609), Part 10A and Mediation Ordinance (Cap 620) Part 7A.
18. ICCA TPF Report, pg 18.
19. IMF Bentham will typically agree to meet any adverse costs or security for costs ordered against its funded parties; however, some funders will require the funded party to purchase an “after-the-event” insurance policy to cover this exposure. The approach varies considerably among funders and if insurance is required, that additional cost should be considered in evaluating the commercial benefit of the funding arrangement to the funded party. Even if the funder absorbs the cost of the ‘ATE’ policy premium, that cost is likely to be recovered from any resolution sum and possibly multiplied to calculate the funder’s return on investment.
20. ICCA TPF Report, pg 18.
21. For example, IMF Bentham has a team of over 30 expert investment managers (former commercial litigators and arbitration counsel with at least ten years’ experience) spread across 14 offices world-wide who provide project management services and strategic input on the matters which they fund.
22. ICCA TPF Report, pg 20.
23.Ibid, pg 26.
24.Ibid, pg 38.
25.Ibid.

Partner
Wee Swee Teow LLP

Chief Investment Officer (Asia)
IMF Bentham

Associate
Wee Swee Teow LLP
E-mail: vera.koh@wst.com.sg