Arbitration Award Default Insurance (AADI): Transforming enforcement risk

Readers may recall that in the inaugural edition of our newsletter in April 2018 our feature article looked at third party funding. In that article we noted that there other products available to fund proceedings. In particular, we referred to there being a number of insurance products both before and after the event, as well in relation to the enforcement of judgments and awards.

In this article, we consider Arbitration Award Default Insurance (AADI).  We are pleased that Alex Southby, Associate Director and Head of Litigation Insurance at Howden Litigation Solutions in London has agreed to contribute to this article.

Despite the protection provided by international treaties, holders of awards against states remain exposed to the risk of non-compliance by respondents.  Whether due to illiquidity or evasiveness, respondents can flout rulings, forcing claimants that have already suffered substantial loss and endured a lengthy and expensive arbitration process into the difficult, costly and time consuming process of award enforcement.

Political risk insurers have responded to this by developing AADI.  By matching the insurance market’s appetite for political risk with the desire of claimants or investors for certainty and returns, AADI provides protection against complex political and economic risks.

The availability of AADI may provide a claimant or investor (including a third party funder of claims) with the necessary comfort to commence proceedings and realise value that would otherwise be left dormant because of uncertainty as to enforcement risk.

1. What is AADI?

AADI comprises bespoke insurance solutions provided by A rated insurers, designed to mitigate enforcement risk in proceedings against states or state owned entities.  In exchange for a premium, the insurer will guarantee payment of an award up to a pre-agreed limit of indemnity.

2. How much cover will the insurer give?

The limit of indemnity provided under the policy is negotiable with the insurer.  The insurer will want to set it at a reasonable settlement value, such that the claimant/investor is content to recover the limit of indemnity under the policy in the event that their enforcement strategy fails, and that the insurer has a degree of comfort that, over time, it will be able to recover the amount of the limit of indemnity from the respondent.

3. What kind of claims can be covered by AADI?

Insurers will consider claims against states or state owned entities under investment treaties or in international commercial arbitration.

4. When is it appropriate to use AADI?

AADI provides claimants/investors with certainty in respect of enforcement risk.  This is a multi-faceted risk that can be difficult to measure, which includes:

• Political and economic risks that can change drastically over the course of proceedings
• The risk of a total loss of the substantial costs of the arbitration/enforcement process
• Uncertainty as to when (if ever) recoveries will be made, and thus as to the cost-benefit analysis of committing to spending the costs of the arbitration/enforcement process

AADI transforms this into a quantifiable and significantly less volatile risk:

• There is no risk of a total loss and the worst-case outcome is the recovery of the limit of indemnity from the insurer net of the cost of the arbitration/enforcement process and the premium
• The claimant/investor has certainty that, if their own enforcement strategy fails, defined recoveries will be made within a defined time period, facilitating an accurate cost-benefit analysis

5. Can AADI cover awards that have already been made?

AADI can be used to transform enforcement risk both pre and post award.  In either case, the policy will give the claimant the option to call on the policy for payment of the limit of indemnity at any point after a defined waiting period during which the claimant pursues its own enforcement strategy.

6. What is the cost?

Pricing varies depending on the insurer’s view of the underlying risk.  As a rough guide, premiums range from 7-20% of the limit of indemnity.

The policy can be structured so that the premium is paid in stages, mitigating the cash-flow impact of the insurance and ensuring that the claimant is not paying for nothing in the event the claim is abandoned or resolved early.  Equally, the premium payments can be weighted to fall after an early procedural hurdle, such as the hearing of a jurisdiction issue.

In some cases, insurers may be open to a deferred and contingent premium structure, such that some or all of the premium is only payable in the event of (and out of) recoveries following a successful result.

7. Who controls the proceedings?

The claimant/investor remains in control of the proceedings until they decide to call for a payment from the insurer under the policy.  From that point, the insurer is subrogated to the claimant/investor’s enforcement rights.

8. What factors do insurers take into account in considering a risk?

The underwriting process will depend on the particular risk, but in essence an insurer will require the same information that a claimant/investor would want to understand before making a decision as to whether to proceed with a claim.  This will include:

• Identity of the parties
• Arbitral institute / rules
• Circumstances giving rise to the claim
• Claim value
• Advice on the merits
• Any analysis of enforcement prospects
• Current status of proceedings
• Any settlement discussions to date
• Identity of third party funder if any

9. What is the process to obtain AADI?

Generally, the first step is for the legal team to prepare a proposal setting out the background to the case, the merits of the claim (including jurisdiction, liability and quantum) and any view on the prospects of enforcement.

Next, a specialist insurance broker will be approached, who will enter into a non-disclosure agreement.  Following this, the broker will undertake an initial review of the information available and provide guidance on any further information required and on pricing.

The broker will then market the risk to select insurers, subject to the same or equivalent confidentiality provisions.  Those insurers will, subject to initial underwriting queries and their appetite for the risk, provide a non-binding indication of terms (NBI).

If the NBI is acceptable to the client, the insurer will then conduct a detailed underwriting process, including obtaining any third party advice.  Assuming nothing in the underwriting process changes the insurer’s view of the risk, the policy wording will then be negotiated between the broker, the client and its advisers (on the one hand) and the insurer (on the other).