5 Nov 2014 11:52am

Litigation funding and the short-lived insolvency exception

On 1 April 2013, the world changed for litigators across England and Wales, with the introduction of the Jackson reforms. With the launch of costs budgets came the abolition of the recoverability of conditional (CFA) uplifts and after-the-event (ATE) premia; that is, unless you were an Insolvency Practitioner (IP) as, after fierce lobbying, the government permitted a 2-year hiatus on the introduction of the rule for insolvency litigation

But that hiatus is set to expire on 1 April 2015, meaning that a frequently large element of the costs will no longer be recoverable from the defendant to insolvency litigation.

There is plenty of commentary around to suggest that this is a bad idea, and it is very clear that a lot of insolvency professionals agree that the move will not pave the way for better access to justice in an insolvency situation. But what will the impact be in reality? Let's look to the non-insolvency world of litigation for an insight.

Throughout the relatively recent history of litigation funding, CFAs and ATE policies have traditionally formed an integral part of a claimant's ability to fund its claim, where it might otherwise not. Arguably, this gave rise to a glut of claims of questionable merits, mostly in the personal injury sector, which led Lord Justice Jackson to decide that the way to put a stop to these claims was to impose more of the cost of the litigation onto the claimant, without a chance of recovery from the defendant.

The changes appear to have resulted in many claims of modest value being simply too costly to bring. This may eradicate the spurious claims that Lord Justice Jackson considers should not be brought - such as personal injury - but the impact for those with reasonable but modest claims has also been considerable; for many claims under £1m, which would previously have been cost effective, the irrecoverable costs will outweigh the damages that can be recovered, meaning that potential claimants will be put off bringing claims that they would have won.

The abolition of the recoverability of CFA uplifts is likely to mean that third party funding is more frequently sought by claimants to bring proceedings, though it will not necessarily be available for lower value claims. The legalisation of damages-based agreements (DBAs) was intended to bridge this gap and law firms are increasingly offering alternative funding solutions to clients, but due to widespread concerns about problems with the regulations that govern DBAs, the take up has been very low to date. In addition, third party funders have traditionally required ATE insurance to be taken out in conjunction with their funding to protect against adverse costs orders, particularly where the value of the claim is low. If those ATE premia are not recoverable, it is unlikely to be cost effective to bring a low value claim with the aid of third party funding. While, the third party funding market is on the increase at the higher end of the market, funders are still likely to steer clear of lower value cases.

Insolvency litigation has some fundamentally different features to commercial litigation. It is brought not for the benefit of one party but for the benefit of all creditors, frequently including the government. An IP is often able to assign a cause of action for valuable consideration and obtain a benefit for the estate that way, but an IP's responsibility to pursue a rogue director under the Insolvency Act is more akin to statutory enforcement action than commercial litigation: the IP stands to gain nothing other than recovery from those who have acted contrary to their duties for the benefit of the creditors. As such, there is even more basis to argue that a rogue director should be liable for all of the costs of bringing this "enforcement" action against him/her.

The government has not carried out any impact assessments in respect of the change in law as they apply in specific cases, including insolvency litigation, which has already been criticised by the court in respect of mesothelioma cases, but this does not seem to have influenced the decision to continue with the lifting of the insolvency litigation exemption. We will have to wait and see whether there will be a reduction in funds available for distribution to creditors in insolvencies, as reported by R3 – the trade body for IPs – or a blossoming of the litigation funding market to ensure that all sensible claims can be pursued, no matter how small.

Jessica Walker, Senior Associate, Restructuring, Bankruptcy and Insolvency

Kate Wilson, Professional Support Lawyer, Commercial Dispute Resolution

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