A fine balance - the future of insolvency litigation

by James Delaney, TheJudge

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01 Jul 2011

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Balancing litigation costs for insolvency

THIS SPRING, the Ministry of Justice (MoJ) announced the planned implementation of Lord Justice Jackson’s proposals to reform civil litigation costs. These reforms are broad in scope but two principle proposals will have an impact on how litigation is run in England and Wales and will have serious implications for insolvency practitioners.

At present, litigants can engage lawyers on conditional fee agreements (CFAs), which see the lawyer taking on some or all of their own risk in respect of their fees. If a case loses then the lawyer is not paid a fee, or receives some form of discounted fee.

If the case succeeds then the lawyer receives their fee plus an uplift, which is currently a recoverable cost from the paying party. In addition, litigants can take out an after-the-event (ATE) insurance policy that indemnifies the litigant’s risk of having to pay adverse costs if the case is lost. This insurance will also typically cover the litigant’s own disbursement costs (for instance experts' and barristers' fees). The premium for this insurance is usually paid only if the case is successful. As with solicitors’ uplifts, the cost of this premium is recoverable and is met by the paying party.

The MoJ believes that allowing recoverability of uplifts and ATE premiums creates an unfair imbalance on the paying party and encourages a blackmail cost culture, with parties being forced to compromise because of the fear of inflated costs.

While significant debate continues over the ideology, with some arguing that the present system simply levels the playing field by allowing impecunious clients to bring a claim against a large corporate without fear of the corporate driving up costs to stifle the claim, the fact remains that the reform proposals look set to be adopted.

Insolvency implications

So what are the implications of these proposals for insolvency practitioners pursuing claims on behalf of creditors?

1. Economics

Currently, IPs evaluating a potential claim value do so on the basis that the majority of the lawyer’s success fee can be recovered in addition to a potential 100% recovery of insurance premium cost. Under the new regime, the client will have to pay any uplifts owed to their solicitors or ATE premium from the damages they recover. This means that the net recovery will be smaller in future. On this basis, IPs will have to consider seriously the economics of pursuing cases with a smaller cost versus damages ratio. Inevitably some cases may prove uneconomic under the new cost regime.

2. Pressure

Given tighter restrictions on economics, it is likely that lawyers and ATE insurers will face increased price-led competition, placing downward pressures on fees. This should help to redress some of the impact of the eradication of recoverable uplifts. Heavy discounts in ATE premiums for early settlement are already the norm with most providers but headline maximum trial rate premiums could also be squeezed as insurers grapple with the pressures of rating versus actually writing the business.

3. Innovation

In addition to price sensitivity, ATE insurers will likely try to add value to their offerings and seek to differentiate from competitors. Products are quickly evolving for the commercial litigation sector and insolvency market in particular. For example, once an ATE insurance policy covering adverse costs and own disbursements was the norm. However, these failed to address security for cost issues and thus deeds of indemnity (bonds) were born as an optional extension to cover.

Bonds are now readily available from multiple different insurers competing to be the preferred capacity provider for insolvency practitioners. The recent launch of Insolv3ncy, a new suite of options supported by a number of A-rated insurance companies, demonstrates that the next generation of product development has begun. Key innovations within Insolv3ncy include: optional cover for the IPs’ own costs; insurance for own-side lawyers’ fees i.e. in addition to traditional adverse and disbursement cover; defendant credit risk protection to deal with situations where the IP obtains an unenforceable judgment; split-outcome protection to deal with situations where success is achieved against one opponent but not against another.

4. Evolutions

Speculation has been rife among legal commentators and law firms over the past two years about what will happen to litigation funding, notably with law firms who prefer not to offer conditional fee agreements envisaging the alluring prospect of a third-party financing their monthly bill. Ultimately, reality has kicked in as the cost of such funding has proven too prohibitive for many litigants or IPs to bear.

Funding can assist IPs where there is a limited pool of capital available to pursue an action. While CFAs and insurance can go some way to managing costs if the case loses, there can still be a significant cash requirement to finance a case on a day-to-day basis.

Funding potentially provides a bridge but as many IPs and lawyers will have concluded that this does not mean an agreement will be accepted at any cost. Fortunately, the funding market is evolving with the introduction of more realistic pricing models. The more competitive the funding agreement, the greater the upside recovery left for creditors.

However, movements in price also pose dangers for lawyers. Any lawyer who has been quick to veer down a particular route with a given funder, charging say 30% of damages, could face answering difficult questions if ultimately it can be shown that terms could have been secured at far-reduced cost.

Summary

The MoJ’s proposals present an economic complication to managing litigation costs. The very smallest of cases will suffer most. However, the positive news is that the ATE insurance and funding sectors have already started their evolution to meet the demands of future litigants. The signs are positive for IPs, with the scope of the protection now offered by leading providers being more comprehensive than ever.

James Delaney is a director at specialist litigation risk transfer brokers TheJudge.

For more information, go to www.thejudge.co.uk.

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