The risk problem
Mining is a high-risk business. Price fluctuations and high capex put pressure on margins and profits—and that’s to say nothing of legal and regulatory risk, particularly for companies with sizeable international operations. Many companies have already turned to technology to increase efficiency and improve forecasting to ease margin and pricing pressures, but what good are those improvements if a project is nationalized by a foreign government? What if new regulations are passed and a contract is voided, or operations are halted?
Investor-State Arbitration: A solution not without risks
The reality for mining companies operating internationally is that some number of projects and contracts will be subject to a forced renegotiation or prematurely ended by the host state. Companies are primarily protected in these scenarios through bilateral and multilateral investment treaties, which have exploded in recent years, numbering today over 3,000. Mining companies have demonstrated a tangible need for these protections, as evidenced by the frequency of mining disputes seen before ICSID and UNCITRAL tribunals.
The numbers confirm as much. As of June 2018, 166 of ICSID’s 676 total cases have been tied to disputes in the oil, gas and mining sectors between foreign investors and sovereigns. These investor-state disputes are generally lengthy (3.86 years on average), expensive (US$6.1 million claimant costs, on average) and victory is never assured. Meanwhile, for contracts with scores or hundreds of millions of dollars at stake, investor-state disputes can upend balance sheets and destroy cashflow models.
In the last five years, 17 mining disputes were registered by ICSID, the majority of which are still pending, not to mention those currently before UNCITRAL tribunals. Consistent with the size and scale of mining operations abroad, the damages claimed in many of those pending arbitrations are significant: Gabriel Resources v. Romania (US$4.4 billion), and Eco Oro Minerals v. Colombia (US$764 million). The mining arbitrations initiated before 2013 likewise had significant damages claims and resulted in some of the largest ICSID awards ever rendered: Crystallex International Corporation v. Bolivarian Republic of Venezuela (US$1.2 billion); and Rusoro Mining Ltd. v. Bolivarian Republic of Venezuela (US$967 million). What is more, in all of these mining cases—Gabriel Resources, Eco Oro, Crystallex, and Rusoro—the claimants relied on arbitration finance.
Like those claimants were once forced to consider, imagine the unhappy scenario of making a sizeable investment in a foreign jurisdiction after years of assessing the viability of a site, acquiring all of the proper permits and complying with the state’s various regulatory requests—only to have the state do an about-face and halt or seize operations. By not arbitrating or seeking legal redress, a company loses its investment. Given the amount of capital necessary to finance mining projects, abandoning an investment under siege generally is not an acceptable business outcome. Alternatively, if a company does choose to pursue arbitration, it will bear the additional burden of sustaining its claim through a lengthy, expensive legal battle—which may fail. Further, the company may lack the budget to pursue the necessary legal remedy effectively—on top of the initial capital raised to pursue the project in question.
A solution: Arbitration finance
Arbitration finance—also known as third-party funding—offers a solution to mining companies facing these challenges.
In essence, arbitration finance offers mining companies a means to shift the cost and risk of pursuing their meritorious claims to a third party specialist financier. Companies may use the financier’s capital to cover the cost and risk of pursuing and being made whole through arbitration—and, because financing is typically provided on a non-recourse basis, the financier assumes the downside risk in the case of a loss. If the matter is successful, the financier is entitled to recoup its investment plus a return from some portion of the award. If the matter is not successful, the company owes the financier nothing.
Mining companies may use arbitration finance in a variety of ways. They may finance single matters with extraordinary exposure and risk. They may also secure capital for multiple matters in a portfolio arrangement, in which the financier covers the fees and expenses of pursuing a group of claims and—because risk is diversified—may offer lower priced capital.
There are myriad benefits to using arbitration finance, which allows companies to:
- Manage corporate resources by shifting legal costs from balance sheets to a third party, thereby reserving cash for other corporate purposes
- Manage and mitigate risk, because a third party assumes that risk on the claimant’s behalf
- Improve accounting outcomes, because financing legal fees and expenses and moving risk off corporate balance sheets result in a friendlier accounting outcome
Although third-party financing clearly benefits companies that are unable to finance their own legal proceedings, even companies that have ample financial resources to pursue arbitration can benefit. Often, it is simply a more efficient way to address legal cost and risk. Companies that finance arbitration rather than paying out of pocket can model potential outcomes with greater certainty, given that downside risk is assumed by the financier. Additionally, financing provides a means of avoiding the often quite negative impact of legal fees and costs on accounting and reporting outcomes.
The most obvious factor in determining the suitability of a dispute for outside finance is its likelihood of success. Given that arbitration finance is typically provided on a non-recourse basis, and the financier will lose its investment if the underlying matter proves unsuccessful, third-party financiers will look hard at the merits of the claim first and foremost, and the experience and expertise of counsel handling the claim. This means that parties seeking financing should be realistic about the prospect of success and prepared to explain the strength of their factual and legal position.
Beyond this basic criterion, matters suited for financing are high-stakes commercial disputes with significant value to the business, in which damages or returns are sufficient to appropriately balance the interests of the client, lawyers and an outside financier.
What should parties look for in a finance partner?
Parties seeking financing should carefully perform their own due diligence in seeking out the right fit for their business and their needs. Two issues are paramount.
First, in transactions when some capital is to be paid in the future, claimants must be confident that capital will be available to them at the point when it is needed. Does the financier have its own capital? If the capital must be called, are the capital sources firmly bound to provide it?
Second, even when capital availability is not an issue—such as when all the capital is received up front—claimants need to focus on the size and structure of their finance providers to assess their stability and incentives, and the materiality of the investment to them. This is important, because if a transaction is material to the financier, there are inevitably contractual provisions in the arrangement that will, if it comes under pressure, permit the financier to act in a manner that may be inconsistent with the client’s interests.
As the largest player in the industry, Burford offers significant experience and expertise in international arbitrations, as well as capital, to parties seeking financing for investor-state disputes. We stand ready to help.