Outcome related fee structures for arbitrations

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Outcome related fee structures for arbitrations: gearing Hong Kong up for a competitive uplift

Reporters: Felda Yeung and Kritika Sethia

Outcome related fee structures (“ORFS”) for arbitration and litigation are currently prohibited in Hong Kong. In order to enhance the competitive position of Hong Kong as an international commercial arbitration hub, a Sub-Committee of the Law Reform Commission of Hong Kong (“LRC”) published a Consultation Paper (December 2020) reviewing the current legal position and the need for reform in respect of arbitration seated in Hong Kong and related proceedings.

Understanding what ORFS means

An ORFS arrangement sets out the terms and conditions governing the agreement between a lawyer (solicitor, barrister, registered foreign lawyer) and a client under which the lawyer who advises on contentious proceedings is entitled to receive a financial benefit in the event the case is successful. The Sub-Committee has considered the inclusion of fee arrangements such as conditional fee agreements (“CFAs”), damages-based agreements (“DBAs”) and hybrid damages-based agreements (“Hybrid DBAs”) in the context of arbitrations seated in Hong Kong. Arbitration proceedings, in the context of the Consultation Paper, includes any arbitration, and related court proceedings, mediation, or emergency arbitration proceedings under the Arbitration Ordinance.

This is what the various arrangements mean:

CFAs: Under a CFA, the client pays a success fee to the lawyer only if the claim(s) is successful. The fee is not calculated as a proportion of the amount awarded or recovered; rather it is structured in the form of “No-Win, No-Fee” or “No-Win, Low-Fee” arrangement. In the former type, the lawyer is not paid any fee during the proceedings but receives a fee only upon the success of the case. In the latter type, the lawyer charges a lower fee or their usual fee which is supplemented with a success fee or “uplift” in the event of a win.

DBAs: A DBA is akin to a contingency fee arrangement where the lawyer receives a financial benefit calculated as a proportion of the amount awarded or recovered. No legal fees are paid if the proceedings are unsuccessful (‘No-Win, No-Fee’).

Hybrid DBAs: Under this arrangement, while the lawyer receives a lower than usual legal fees during the proceedings, the financial benefit is calculated as a proportion of the amount awarded or recovered.

Weighing the pros and cons of permitting ORFS in Hong Kong

The Consultation Paper provides an analysis of the arguments for and against ORFS. As will be discussed further below, we consider that arrangements can be made to address any potential loopholes or concerns that may arise with ORFS agreements.

Briefly, the Consultation Paper lists out the following arguments in favour of ORFS which promote contractual freedom and competition:

  • Preservation and promotion of Hong Kong's competitiveness as a leading arbitration centre
  • Enhancement of access to justice
  • Response to client demand and provision of pricing flexibility
  • Supporting freedom of contract between lawyers and clients
  • Weed out weak claims
  • Provide the lawyers in Hong Kong an opportunity to compete on a level playing field with international counterparts

Whereas, the arguments against ORFS are:

  • Risk of conflict of interest and unprofessional conduct
  • Increase in opportunistic and frivolous litigation
  • Excessive legal fees
  • Reliance on After the Event Insurance (often referred to as ‘ATE Insurance’) / litigation insurance
  • Increase in satellite litigation

A case for allowing ORFS

The applicable laws in a jurisdiction and the manner in which a jurisdiction innovates in response to needs of the hour largely determine the likelihood of parties’ preference of the arbitral seat at the time they enter into the arbitration agreement.

Hong Kong is a pro-arbitration and pro-enforcement jurisdiction with a sophisticated infrastructure, mutual arrangements with Mainland China for seeking interim measures and for enforcement of arbitral awards, and the availability of third-party funding for arbitration. Currently, the most contentious issue is the introduction of ORFS which is expected to preserve and promote a competitive edge for Hong Kong as an arbitral seat and bring it in line with other international commercial arbitration hubs. Although Hong Kong’s closest competition in the Asia Pacific region is Singapore which currently lacks a system akin to ORFS, public consultation regarding conditional fee arrangements is ongoing in Singapore as well.

Access to justice and financial risk management are also determinative of parties’ decision to arbitrate. The Consultation Paper acknowledges that despite the availability of third-party funding, not all cases are eligible. ORFS may enhance access to justice which has been one of the primary reasons for relaxing the prohibitions against the common law torts that prohibit ORFS (maintenance and champerty) in both Australia and England and Wales.

Concerns have been raised that ORFS may create conflicts of interest for lawyers who will be interested in the financial benefits. However, it appears that contrary to doubts, given that the stakes for lawyers are higher in case of an ORFS, lawyers would be incentivized to narrow down the issues and seek to weed out weak claims. Concerns regarding maintenance and champerty have been alleviated in other jurisdictions with ORFS’ potential to increase access to justice. Moreover, with appropriate legislative and regulatory amendments, it is possible to introduce ORFS without compromising the professional integrity of lawyers.

Suggested Safeguards

Generally, international commercial arbitrations involve parties who are acquainted with business negotiations. Accordingly, when clients enter into ORFS agreements, unequal bargaining power vis-à-vis the lawyer may not be the greatest of concerns, nonetheless, it would be prudent to strike a balance between contractual freedom and other safeguards. This could be done through appropriate amendments to the Arbitration Ordinance, Legal Practitioners’ Ordinance (and rules thereunder), the Solicitors’ Guide to Professional Conduct and the Barristers’ Code of Conduct. Indeed, the Sub-Committee recommends professional conduct safeguards.  Similar to any other contractual arrangement, the parties should be able to freely negotiate the terms of the ORFS agreement. However, minimum statutory protections are desirable to mitigate against the risk of unscrupulous conduct, protection of lawyers’ fees and unwarranted satellite litigation.

Lawyers and clients should have a choice on whether or not to enter into ORFS and also at which stage of the arbitration proceedings should they enter into such agreements, if at all. In the event they choose to enter into ORFS agreements, the form of ORFS (whether CFA, DBA or Hybrid DBA) should be a matter of choice for the parties and lawyer, depending on the case.  Lawyers may be placed under an obligation to explain to their client, the nature and operation of ORFS and inform them of their right to seek independent legal advice prior to entering into the agreement. In order to minimise ambiguities and the risk of satellite litigation, the parties should clearly stipulate the scope of the agreement (such as claim(s) and the stage(s) of the proceedings to which it relates), include clear definitions of “successful outcome” (such as what amounts to a successful outcome, whether it includes negotiated settlement), “success fee” (in case of CFAs) and “financial benefit” (in case of DBAs). To avoid excessive legal fees, the CFAs and DBAs may be subject to capped rates and it will also be necessary to ensure that lawyers remain subject to the prohibition against taking gifts.

The agreement should provide the basis of calculation for the amount sought as an uplift or the success fee, the grounds of termination, and whether or not the lawyer is entitled to the whole or part of the success fee or percentage of the DBA in the event of premature termination of the arrangement or a change of lawyers during the proceedings. If an ORFS agreement seeks to provide for liquidated damages requiring the client to compensate the lawyer (or vice versa) in the event of early termination, care must be taken to ensure that the liquidated damages sought (if any) are a realistic pre-estimate of loss in order for such a clause to be enforceable. Moreover, it will also be useful to insert clauses to state that the client will remain liable for all cost orders made by court or arbitral tribunal, taxes, court fees, disbursements (with specific modifications made in respect of counsel fees depending on the ORFS if any with the barrister) and other miscellaneous expenses. The fact of the existence of ORFS must also be disclosed to other parties to the arbitration, the arbitrators, and the judges.

Going forward

Hong Kong is an established arbitration friendly jurisdiction with an advantageous position in the Asia Pacific region, not least because of its unique arrangements with Mainland China. With minimal legislative changes and careful drafting of ORFS agreements to incorporate sufficient safeguards, Hong Kong stands only to gain in parties’ choice of an arbitral seat when parties contemplate international commercial arbitration.

This article was first published on Kluwer Arbitration Blog.  Click here to see the original post.

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