Epic Energy Dispute Gushes New Law: Court finds funders must bear the same adverse costs of unsuccessful litigants they backed

Thursday, December 29, 2016 - 10:46
Roy Powell
Stephen Pearson

Roy Powell

Stephen Pearson

For Jones Day partners Stephen Pearson and Roy Powell, it was a surreal litigation experience lasting some six years. The most recent turns in energy company Keystone’s epic, multifront battle against Excalibur and its infamous founder, Rex Wempen, over an estimated $1.6 billion stake in a Kurdistan oil bonanza concern the litigation funders who backed the losers and now find themselves on the hook for the winner’s costs. Below, Pearson and Powell discuss the case in remarks that have been edited for length and style.

MCC:  Please tell us about your backgrounds, particularly as they relate to the Keystone litigation?

Powell:  I started with Jones Day when we opened an office in Pittsburgh and have been with the firm 28 years. My practice is complex commercial and construction litigation. Even before Marcellus and Utica Shale became what they have now become in the Appalachian basin, we were representing a number of energy companies in commercial and construction disputes. One of those companies, Texas Keystone, was run by an entrepreneurial family, the Kozels. One of the brothers, Todd Kozel, was interested in international opportunities and was tasked with developing what eventually became Gulf Keystone, which became a standalone public company after an IPO.

Pearson: I'm a dual-qualified lawyer in English and New York law. I split my time between Jones Day offices in New York and London. I came to New York in 2007 during the financial crisis. The firm thought it would be sensible to have an English-qualified lawyer on board to handle the proliferating cross-border financial cases. In New York, I handle a lot of the cross-border cases coming out of Europe and other offshore jurisdictions, and in London, I handle the cross-border cases coming out of the U.S. I thought I would be staying three years, but I’ve stayed in New York for 10 years.

MCC: Please explain to readers who have not followed it closely the nature of the dispute in Texas Keystone. 

Powell:  Over the years leading up to what became the Excalibur case, we did significant litigation and transactional work with a number of the Kozel family-related companies in everything from land acquisition to exploration and development. They also had a drilling company and were significant players in the Appalachian basin. When Gulf Keystone and Texas Keystone were sued shortly before Christmas in 2010, in both London and a separate ICC action in New York, we were asked to ramp up quickly and respond on multiple fronts to claims by the Excalibur team of an alleged $1.6 billion interest in the Kurdistan oil fields. Excalibur had tried to obtain a worldwide freezing injunction in London while simultaneously pursuing the same claims in the ICC

Powell:  In 2006, after the second Gulf War, Gulf Keystone started looking at the possibility of exploration in the Kurdistan region of northern Iraq, which had opened up for oil and gas exploration. Gulf Keystone, in a joint effort with Texas Keystone, secured a concession for a region within Kurdistan and Iraq for oil and gas exploration and production. Early on, they met the now infamous Rex Wempen, who indicated that he had significant contacts and was interested in doing something with Gulf Keystone and Texas Keystone in Iraq. That was the beginning of the relationship, and several agreements were prepared to pursue those efforts.

The concession in Kurdistan was obtained and required significant upfront payment to the government, as well as agreements as to how the exploration and production will be pursued and how the profits will be shared. Mr. Wempen, it turns out, did not have the relationships he claimed he had and, in fact, was not in favor in the Kurdistan government. Most importantly, when it came time for him and Excalibur, a company he founded, to put up their share of the initial payments, he was unable to do so. As a result, Gulf Keystone pursued the concession and began exploring in Kurdistan without Mr. Wempen or Excalibur. With the discovery of significant oil and gas reserves, Gulf Keystone was becoming more and more valuable and the Wempens and Excalibur returned and in 2010 began the litigation

Pearson: Essentially, they went away and bided their time. After significant amounts had been spent on exploration, which could have been entirely wasted if oil had not been found, it became clear there was a biblical amount of oil, and Wempen and Excalibur suddenly re-emerged to claim a 30 percent interest in the oil fields and revenues. They sued for recognition of an interest they claimed was theirs from the beginning.

They had a strategy. They had an arbitration clause in the contract, so they wanted this to be an ICC arbitration on the merits in New York. But they also knew that in England you can get injunctions in aid of foreign arbitrations and you can sometimes go to the English courts and attempt to freeze assets pending the outcome of the foreign proceeding. They tried the twin strike. They filed an arbitration request in New York just before Christmas, and they also went to the English court to freeze the defendants’ assets. Gulf Keystone had been the subject of rumors about takeover bid that received a lot of publicity. I'm sure the strategy was that if the injunction was granted and froze the assets, there would be a quick settlement to avoid the negative impacts. The problem was that the English court was not impressed with the application and turned down their injunction request even though it was made without the defendants’ knowledge or participation.

Then they made a misstep in England. They took too many steps aside from just seeking the injunction. They essentially had started two sets of proceedings, both of which were substantive. That allowed us to argue that they should be stuck with England as a forum, whereas they had always wanted the U.S. to be their primary forum. There was a battle over which of the proceedings should go forward and which should be stopped. Our first success in the English courts was to persuade the English court to grant an anti-suit injunction and stop the U.S. arbitration on the basis that most of the defendants were not parties to the arbitration clause. Our injunction application was successful. We'd seized the forum we preferred, and they lost the forum they preferred. That was their first foot fault in the game. 

MCC: Tell us what this case means for coordinated global litigation that GCs and CLOs should take note of.

Pearson: When you have proceedings in more than one jurisdiction, large corporations will have preferred law firms in different locations. They sometimes retain multiple law firms to handle different pieces of a problem even though the proceedings are related and even though they need to be carefully coordinated to get the best result. That can be inefficient because law firms in competition with one another typically don't work together very well. There's often some rivalry and a bit of tension or even a turf war that goes on when there's a genuine choice between forums. They don't think about the interest of the client. They think about whether they're going to keep the case. With a firm like Jones Day, which can handle a case on the ground in all the relevant places, there isn't that turf war. We can put the client’s interest first. We ended up needing a team that included our offices in London, Pennsylvania, New York, Texas and elsewhere. It was all coordinated centrally by a small team led by Roy and myself. Our ability to be field marshals for the worldwide venture in multiple jurisdictions was instrumental in achieving the outcome we did.

Powell: The challenge of this case was clear early on. The strategy that was being implemented by Excalibur was essentially to do a Pearl Harbor-like attack on Christmas Eve and see if they could get a worldwide freezing injunction, which would have had a devastating effect on a publicly traded company. It was a difficult time of year when we became aware of the filings in multiple jurisdictions. It took about eight hours to put a team of more than 20 lawyers on the case around the world to respond through Christmas Day and New Year’s. By the beginning of January, we had developed an effective strategy with a well-coordinated group working toward the same end. It's in some ways unique for a firm to be able to do that worldwide. 

MCC:  Please describe the English commercial court trial, which we understand was epic.

Pearson:  It lasted 57 days, which I think is the third longest trial in the history of the Commercial Court. The English system is more forensic than the American system. American judges and courts don't have the time to spend weeks and weeks picking apart every detail of a case. In England, there tends to be more of an autopsy-like forensic analysis of almost every point presented. That means cases can go on far longer than they would in other jurisdictions.

It was fairly clear from the beginning that the Excalibur case was unraveling, and that the evidence put forward by Rex Wempen and his brother, Eric, was false. We managed to expose their lies. I'll give you an example. One of Rex's big themes was that he was a former U.S. special forces officer with a sterling service record, and he'd been unfairly cut out of this deal and it was a disgrace. He was playing the hero cheated out of the deal by greedy corporate types. By getting some discovery out of the U.S. courts, we got records from his brothers email account at UBS in Connecticut, where he worked, and other sources, including public military sources, and found a number of things the exposed the truth about the Wempens. For example, Rex had been dishonorably discharged from the military for, among other reasons, falsifying records. His brother, while at UBS, had been trying to do a deal with his own employer to raise money for Excalibur while using UBS facilities to negotiate that deal. That led to an internal investigation at UBS, and he was dismissed. The judge found them both to have lied under oath about many things. Their primary expert, a lawyer from Canada who Excalibur put forth as the leading light in the oil and gas world, was found by the judge to have been a completely unacceptable expert. I could go on and on. The case they tried to put on unraveled during the course of 57 trial days. They had nothing left to cling to by the end of the trial.

The judgment came in a few months later. It was over 300 pages of misery for Excalibur and the Wempens as all of their claims were dismissed on all grounds and the court awarded indemnity costs for bringing claims that should not have been brought as they were so deeply flawed legally and based on untruths.

Powell:  There's one other significant point. It was a given that Excalibur and Rex Wempen could not fund their buy-in. They did not have the money. Their theory of the case was that they were precluded from raising the funds because of bad conduct on the part of the defendants. That forced them to identify entities and individuals they believed would have provided them with the funding had Gulf Keystone been more forthcoming with information. Through U.S. discovery, which is very different than what's available in the UK, we were able to disprove that. The groups that they were trying to raise funds from simply would not have invested the money based upon what Excalibur was bringing to the table. It became a central issue in the case. It’s one of the main reasons they had such a difficult time, beyond their own lack of truthful testimony, in front of the judge. It turned the tide against them.

MCC: Tell us about the litigation funding aspects of the matter and the disputes regarding the funders’ liabilities?

Pearson: Excalibur couldn't have brought this litigation without outside funding. It didn't have the resources to finance the proceedings or pay security for the costs of the defendants, which is required in the UK. We knew there must have been someone in the background funding them. We managed to out the identity of the funders because it was relevant to certain issues in the case.            

After Excalibur lost and didn't have the money to fund the shortfall between the costs that we'd incurred and the security they had put up, we went after the funders. These people facilitated the litigation, we convinced the court, and if not for them we wouldn't have incurred these costs. Excalibur is bankrupt, so the court issued a cost order that said that all the syndicate lenders that backed Excalibur should be joint and severally liable with Excalibur for the costs. 

There was a fight over that principle, we won, the funders appealed, and the Court of Appeals, grappling with some of these funding issues for the first time, upheld all of the cost orders against the funders. A number of the funders are now in some form of bankruptcy or liquidation process. One is subject to U.S. criminal indictments. There are not many of them left standing.

Powell:  The cost-shifting approach under the English system is very different than the U.S. system. However, the concept of third-party funding for litigation is gaining traction everywhere. Sophisticated investors are taking investment positions in litigation every day. Stephen and our London team were able to make some new law clarifying that if you're going to take a risk with a big upside, you have to assume the downside risk. I think that ruling will have implications worldwide as people recognize this is not a free-pass investment.

MCC: Where does that leave the practice of litigation funding in the UK?

Pearson:  Litigation funding is part of the fabric of the English legal system. This won't make it disappear. At least now there is some clear guidance about certain principles that will apply to litigation funding and how responsible funders are expected to behave. If that means that they get hit with costs for reasons that had nothing to do with their personal conduct, that's tough. If you back a funder, you back the witnesses, you back the experts, you back the legal team that's running the case. If they fall down on the job and a large cost order comes the way of the litigant, you’re stuck with the bill as the funder. That's the new general principle. The court also made it clear that it will expect funders to conduct rigorous due diligence not only before the claim is funded but during the case. It isn't just a one-time analysis at the start. 

MCC:  What, if any, impact will this have on third-party funding in the U.S. or in other jurisdictions?

Powell: The analysis done by the court was much more rigorous than is done in the U.S. system, where the backstop for these activities is Rule 11 of the Federal Rules of Civil Procedure, which requires parties to have a good-faith basis for their claims. Many state courts have similar rules. The implications are that courts are beginning to look at the puppeteers, if you will, funding the litigation as being equally responsible for taking good-faith positions supported by the law and the facts. The pendulum is moving in the direction of making the funders as responsible as the named parties.

Pearson:  The key takeaway is that funders need to understand the local markets in which they're funding. A lot of American funders thought they could simply apply the same methodology they use in the States to a case that ends up being tried in the UK. That's overly simplistic. If you're a funder, you have to understand the nuances, the risks involved in any market in which you fund. It may well be very different from your home jurisdiction.

MCC: Is there anything that either of you would like to add?

Powell: The case went on for six years. Millions of documents were produced. Sitting in the courtroom was a surreal experience because of the number of lawyers and barristers, and often 50 to 100 observers interested in the case. The courtroom experience was unusual in the extreme for me.

Pearson:  Surreal is a good word. Some people were making cartoons of the proceedings and putting them on YouTube as a weekly update of the trial. Some were doing amateur sleuthing to figure out who these mysterious funders were. It was like a mystery novel in which they felt they could play some part.



Roy Powell, co-chair of Jones Day’s worldwide construction practice, devotes his practice to complex commercial disputes and counseling, with an emphasis on the construction and energy sectors. Based in Pittsburgh, he can be reached at rapowell@jonesday.com.

Stephen Pearson’s practice focuses on complex international litigation and arbitration. He is dual qualified (England/Wales and New York) and actively practices in the courts in both jurisdictions. He can be reached at sjpearson@jonesday.com.