Security for costs in international commercial arbitration – a useful protection or tactical ploy?

Conversely, international arbitration has taken much longer to embrace the concept. This has been for 3 key reasons:

1. Arbitration is a creature of contract. If a party decides to contract with a shell company or SPV, then they should be taken to accept the fact that if they arbitrate there is a risk that that party will not be able to pay the costs (or even the award).
2. The Civil law influence over arbitration means that a large number of arbitration practitioners are unfamiliar with the concept.
3. The difficulty of an Arbitral Panel to enforce an order against a party, has led to reluctance of Tribunals to order Security for Costs.

In recent years there has been a change of approach and we are starting to see an increase in Security for Costs orders. A number of arbitral institutions have now incorporated rules for Security for Costs and this article looks at the rules around Security for Costs in a number of the leading arbitral institutions and how they are applying those rules.

What is Security for Costs?

An order for security for costs protects a respondent against the risk of being out of pocket, by ordering the claimant to provide a security (in the form of money, a bond, a guarantee, or after the event ("ATE") insurance) for the costs of the arbitration. Costs of the arbitration include the respondent’s legal costs, and the tribunal's fees / administrative costs. The Costs are often awarded in tranches to match milestones in the case.

Although this relief does not extend to a security for any damages award¹, it certainly provides a welcome protection for respondents brought into arbitral proceedings, which are inherently expensive prior to and in the initial stages of proceedings. However, the relief does open up the risk of respondents misusing it with the sole motivation of deterring an impecunious claimant from bringing perfectly reasonable and meritorious claims.

Power to order security for costs

As with all arbitrations, the rules and governing law are heavily dependent on the seat of the arbitration. However, many jurisdictions have rules allowing applications for security for costs.

International Chamber of Commerce ("ICC")

In arbitrations governed by the ICC Rules there is no specific reference to security for costs orders. However, the tribunal has a general power (under Article 28(1) of the 2021 Arbitration Rules) to order an 'interim or conservatory measure' that requires a security being provided. Security for costs orders are granted "rarely and restrictively" in ICC Arbitrations². It is of note that the ICC Secretariat has the power to order that one party will pay all the ICC's Global advance on Costs if one party refuses to pay their share, this can amount to Security for Costs through the back door.

London Court of International Arbitration ("LCIA")

The London Court of International Arbitration ("LCIA") Rules 2020 provide that the arbitral tribunal has the power to order a party to provide or procure security for legal costs by way of (i) a deposit or (ii) bank guarantee or (iii) in any other manner and upon such terms as the tribunal considers appropriate in the circumstances (Article 25.2 of the LCIA Arbitration Rules 2020).

UNCITRAL

Pursuant to the United Nations Commission on International Trade Law ("UNCITRAL") Arbitration Rules 2021, a tribunal has the power to "provide a means of preserving assets out of which a subsequent award may be satisfied" (Article 26(2)(c) of the UNCITRAL Arbitration Rules 2021 and Article 17(2)(c) of the UNCITRAL Model Law on International Commercial Arbitration 1985). The UNCITRAL Working Group noted that it is 'generally understood' that the rules grant the power to order security for costs.

Arbitration Act 1996

The Arbitration Act 1996 gives a specific power to tribunals seated in England and Wales to order a claimant to provide security for costs (section 38(3) of the Arbitration Act 1996), including both the administration fees of the arbitration and legal costs.

The Chartered Institute of Arbitrators’ 2015 guidelines

The Chartered Institute of Arbitrators’ 2015 guidelines on applications for security for costs state that tribunals should “consider the merits of the application having due regard to all of the relevant circumstances of the case and without any predisposition in favour of, or against, the application.” The guidelines set out three issues that the tribunal should consider in relation to security for costs applications: (1) the prospects of success for the claim(s) and defence(s); (2) the claimant’s ability to satisfy an adverse costs award; and (3) whether requiring security is fair in all the circumstances.

Test for an award of a security for costs order

Given that case law is not binding in international arbitrations (and that reference to the tribunal power for security for costs under several of the standard rules is itself vague), there are few places where an explicit test for grant of an order for security for costs is set out. Arbitration law provides persuasive principles but, lacking specific rules, tribunal members tend to be influenced by the experience of their own national legal systems.

Those arbitrations governed by the UNCITRAL Arbitration Rules 2021 do have to satisfy the requirements of Article 26 applicable to all interim measures, including a consideration of the likelihood of the substantive claim succeeding, satisfying the tribunal that the harm is not adequately reparable by an award of damages, and balancing the likely harm to the claimant against that to the respondent.

For arbitrations without explicit incorporated tests, the Chartered Institute of Arbitrators ("CIArb") has set out some guidance on applications for security for costs. As with all arbitration rules, this is not binding on parties unless specifically incorporated into the contract. Under these guidelines, the principles arbitrators should take into account are:

1. The prospects of success of the claim and defence;
2. The claimant’s ability to satisfy an adverse costs award and the availability of the claimant’s assets for enforcement of an adverse costs award; and
3. Whether it is fair in all of the circumstances to require one party to provide security for the other party’s costs.

Other factors that tribunals may take into account is any history of non-payment of costs by the respondent to the application, and where the balance of prejudice lies. These are broad considerations that should normally be evident in the reasoning to the grant or denial of all responses to applications for security for costs.

Prospects of success of the claim and defence

The guidance also provides some helpful commentary on the principles. For example, in relation to the first principle listed, the CIArb says that "Arbitrators should not consider the merits in detail, as it is unlikely that there will be adequate materials to do so and it would be a time-consuming and expensive exercise". They should provide a view only on whether there is a prima facie claim / defence. If both parties have arguable cases, this will be a neutral factor.

Claimant’s ability to satisfy an adverse costs award

In relation to the second principle, the guidance says that arbitrators should be satisfied that there is a 'serious risk' of the claimant being unable to pay the respondent's costs, which appears to mean more than a mere suspicion of impecuniosity. It also notes situations where it was known to the respondent that the claimant party had questionable solvency or access to assets at the outset of the commercial relationship, suggesting that arbitrators may come to the conclusion that "such a risk was a consequential effect of doing business with that party". It proposes that arbitrators should consider whether the lack of available assets was an 'accepted business risk'.

Additionally, it is relevant who the beneficiary of the claim is. If the claimant is pursuing a claim on behalf of another party with assets, this should weigh in the balance. It should not, however, be relevant whether the party is based in a foreign jurisdiction. The guidance notes that where this consideration is not already explicitly prohibited by national laws or international treaties, it would still be contrary to the principles of international arbitration. There is a distinction between this and if that party's assets are located foreign jurisdiction, in which case this can be factor to consider, subject to the same test of whether this was an 'accepted business risk'.

Whether it is fair in all of the circumstances

'Fairness in all the circumstances' is the broad, catch-all discretion retained by the tribunal. Suggested considerations include where the claimant's potential inability to pay an award has been caused or contributed to by the respondent, whether the application for the order has been made promptly, whether the applicant has already paid its share of the arbitration fees, and whether the purpose of the application is to stifle a genuine claim.

Form of security

Another key question is the form of security. Security for a respondent's costs can most simply be provided in cash, by payment into an escrow account held by the tribunal, a third party, or in some circumstances a law firm. Other common forms of security include bonds, guarantees, or ATE insurance. In each case the tribunal must be satisfied that the form of security is sufficient to cover the respondent's costs.

Bonds and guarantees

Bonds are the most common asset class that a claimant will offer as a form of security for costs. Alternatively, the claimant can obtain a guarantee from, for example, a parent company or bank. The guarantor must be demonstrably 'good for the money' and the guarantee easily enforceable. Some respondents will insist that the guarantor bank is a reputable one, or that a particular bank or category of bank provides the guarantee.

ATE insurance

ATE insurance is a relatively new form of security. For arbitrations seated in England and Wales, parties can refer to civil case law that accepts ATE insurance as an adequate form of security, as long as the scope of the cover is sufficient. The UK Court of Appeal stated (in Nasser v United Bank of Kuwait [2001] EWCA Civ 556):

"defendants would, at the least, be entitled to some assurance as to the scope of the cover, that it was not liable to be avoided for misrepresentation or non−disclosure (it may be that such policies have anti−avoidance provisions) and that its proceeds could not be diverted elsewhere."

Additionally, the English and Welsh High Court stated (in Michael Phillips Architects Limited v Riklin [2010] EWHC 834 (TCC)) that whether the insurance policy is an adequate security "will depend upon whether the insurance in question actually does provide some secure and effective means of protecting the defendant in circumstances where security for costs should be provided by the claimant".

The court concluded that ATE insurance will rarely provide as good security as a payment into court or a bank bond or guarantee, because policies can be voided by the insurer for reasons outside the control of the respondent (or 'defendant' in English and Welsh civil cases). It also said that there must not be policy terms "pursuant to which or circumstances in which the insurers can readily but legitimately and contractually avoid liability to pay out for the defendant's costs".

To mitigate the risk of a policy being voided, claimants can purchase an 'anti-avoidance endorsement', which entitles the respondent to the value of the policy even where the claimant has breached the policy terms. The claimant can also obtain a 'deed of indemnity' from the insurer, whereby the insurer agrees to pay the respondent directly following a trigger event, including an adverse costs order.
It is likely that a claimant who obtains these agreements from an insurer will persuade tribunals seated in other jurisdictions that the policy is an adequate security.

Conclusion

In international arbitration costs normally follow the event, meaning that the unsuccessful party pays the costs of the successful party. International arbitrations are expensive and can incur significant costs for parties even in the initial stages of proceedings. The ability to apply for a security for costs order is a useful tool for respondents to limit their exposure to unrecoverable expenses.

This relief therefore provides useful protection in arbitration proceedings to a respondent defending against an impecunious claimant and is a welcomed deterrent to them against claimants bringing non-meritorious proceedings.

That being said, careful consideration must be given by arbitrators when weighing whether to grant a security for costs order, to avoid respondents using this remedy with the sole motivation of deterring impecunious claimants from bringing meritorious claims, especially where a claimant’s impecuniosity is a result of the respondent's conduct.

While there is often no specific test that needs to be applied, there are guidelines available and persuasive case law from equivalent civil orders that tribunals can turn to. Generally, tribunals will need to carry out a balance of harm exercise and look at the prospects of the substantive claim succeeding before ordering security for costs.

Tribunals must also consider the form of security and whether it is adequate to cover the respondent's costs. Where this security is an ATE insurance policy, there are additional agreements a claimant can obtain from the insurer to persuade a tribunal that the insurer will pay out.

References

¹That is a procedure known as Security for Award and it is much harder to obtain than Security for Costs.
²'Security for Costs and Claim Under the ICC Rules of Arbitration: Rare, but Possible – A Survey of 23 ICC Procedural Orders and Final Awards' by Samaa A. F. Haridi in the ICC's 2020 Bulletin.