Security for Costs – What is it and how do you get it?

Introduction

Under many arbitral laws and rules, tribunals have the power to order that a party that loses an arbitration reimburse some or all of the legal costs and expenses incurred by the successful party. However, that order may be pyrrhic should the losing party have no funds to pay those costs.

To avoid this scenario an arbitral tribunal may, as an interim measure in appropriate circumstances, require a party to provide security for the costs of the other party so that in the event a costs order is made there will be no question of funds or other assets being available to satisfy it. However, this may bar the progress of an otherwise good claim should the opposing party be unable to provide the security for costs

This article will discuss the particular circumstances in which an order for security for costs can be granted, as well as some of the common arguments adopted by parties to resist such applications.

Security for costs application - When is it appropriate?

Typically a party is not under an obligation to disclose documents as to its finances. However, signs which may indicate that a party is in a precarious financial position may include where a party is in some form of insolvency procedure or has entered into a voluntary arrangement with creditors, or where its audited accounts over a number of years show that it has limited financial means or assets.

In such circumstances the opposing party – usually the respondent -  is likely to want to ensure that the claim cannot proceed unless security for its costs is provided.

The source of an arbitral tribunal’s power to award security for costs is typically drawn from the law of the seat (i.e. the national arbitration law of the jurisdiction in which the arbitration is taking place). For example, section 38 of the English Arbitration Act 1996 expressly provides for such a power. The parties’ arbitration agreement may also grant the power, as it will likely incorporate the rules of an arbitral institution which in turn will state that the tribunal has such a power).

Principles applied by tribunals when deciding whether to order a party to provide security for costs

Generally, an order for security for costs can only be made against a party bringing a claim or counterclaim. Respondents to claims are generally immune from such applications because they are not the ones who have initiated the arbitration, chosen to force the opposing party to incur costs, and taken the risk as to recoverability.

Although there is no strict set of principles in place providing guidance to an arbitral tribunal on when to require a party to provide security for costs, guidance can be sought from national laws and judicial decisions. For example, whilst section 38 of the English Arbitration Act 1996 does not specify the grounds upon which an order for security for costs may be made, it makes it clear that it cannot be granted solely on the grounds that the claimant is an individual ordinarily resident outside the United Kingdom or a foreign company.

In addition, some international arbitration rules have sought to provide guidance to arbitral tribunals on factors to consider, for example:

a. The UNCITRAL Rules have since 2010 provided that a party applying for security for costs must demonstrate that it has a reasonable possibility of succeeding on the merits of the claim and that, without security, it will suffer irreparable harm which “substantially outweighs the harm that is likely to result to the party against whom the measure is directed”.

b. The Chartered Institute of Arbitrators has issued guidelines on what arbitrators should take into account when deciding applications for security for costs, including:

• The prospects of success of the claims and defences – taking great care not to prejudge or predetermine the merits of the case itself.
• The claimant’s ability to satisfy an adverse costs award and whether there are reasonable grounds for concluding that there is a serious risk that the applicant will not be able to enforce a costs award in its favour because:
  • The claimant will not have the funds to pay the costs awarded; and/or
  • The claimant’s assets will not be readily available for an effective enforcement against them.
• If the arbitrators conclude that, for either or both of these reasons, there is a real risk that the applicant will have difficulty enforcing a costs award, then these factors favour an order for security, unless these factors were considered and accepted as part of the business risk at the inception of the parties’ relationship.
• Arbitrators should consider and be satisfied that, in light of all of the surrounding circumstances, it would be fair to make an order requiring one party to provide security for the costs of the other party and should consider whether awarding security would unjustly stifle a legitimate and material claim.

Common arguments used to resist security for costs

Being forced to pay security for costs is usually a heavy burden, as the party subject to the order will have to deposit a significant amount of money in a bank account for the duration of the arbitration (which may be years) or pay for a guarantee (or other security) to be issued on its behalf, else it will be prevented from progressing its claim.

Such applications are therefore usually robustly resisted, often with the following arguments:

1. An order for security for costs will stifle a genuine claim, leading to a denial of justice.

This consideration will certainly weigh heavily on the tribunal’s mind, particularly in the quantum and/or kind of security that should be provided.

2. The claimant is financially weak because of the respondent’s breach of contract.

The claimant will argue that the only reason it is in financial distress is because the respondent failed to perform the contract. It would therefore be unfair for the respondent to now benefit from the consequences of its breach and prevent the claimant from claiming to recover the loss.  

3. There was a substantial delay by a party in bringing their application for security for costs.

Although tardiness in bringing an application for security for costs is typically not fatal, an arbitral tribunal may be justified in refusing that application particularly where the application was made at a late stage in the proceedings, for example, in close proximity to a final hearing or trial on the issues. The tribunal may feel that if recovery of costs was a real concern the respondent would have raised it sooner.

4. The claimant has obtained an adequate and appropriately worded ATE insurance policy cover, i.e., one that contains anti-avoidance provisions, has been obtained against the eventuality of having to satisfy an adverse cost order. This means that any costs award will be satisfied by the ATE insurance rather than the claimant itself.

5. The respondent brought the risk of costs in the dispute on itself and an order for security would not therefore be just. A possible scenario would be where a large entity is contracting with suppliers who are small companies such that the large entity will know (and have accepted) that in the event of a dispute the small company will probably not have the means to pay significant legal costs.

Consequences for failing to comply and considerations for the Respondent

The order of the tribunal will inevitably contain consequences for non-compliance, which will usually be that the party is prevented from progressing its claim, leading to its dismissal. Since the dismissal will not be on the merits it may be possible for the claimant to bring the claim again at a future date, which is a risk that the respondent should keep in mind. The respondent may take the view that it would be better to incur the costs and get the claim dismissed on the merits so that it cannot arise again.

The respondent should also consider other risks of making such an application:

a. The application will involve some consideration by the tribunal of the merits of the case, and may lead to unhelpful comments by the tribunal about the apparent merits of the claimant’s claim, giving confidence to the claimant and/or assistance in terms of third-party funding.

b. Due to the serious consequences of ordering security for costs (i.e. a genuine claim may be stifled), it can be difficult to succeed on them. If the application is refused the respondent may be ordered to pay the claimant’s costs relating to the application.

Conclusion

The ability to order security for costs is a powerful tool that tribunals have to protect a respondent from the risk of having to incur significant costs defending spurious claims with little prospect of recovering them from an impecunious claimant. However such orders can also lead to a denial of justice if a legitimate claim is not heard due to the financial distress of the claimant, distress which may have been caused by the respondent. Applications for security for costs are therefore rarely straightforward and parties should think carefully before making them.

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