Funding for litigation needn’t be so tough for IPs

LITIGATION FUNDING is a familiar concept to insolvency practitioners in their quest to obtain the best possible return to creditors. But despite recent developments and expansion in the litigation funding market, obtaining funding for insolvency cases is not without its challenges.

Insolvency practitioners faced with a potentially valuable claim, but insufficient resources to pursue it, currently have a number of options to obtain funding which include creditors or a third party litigation funder, engaging lawyers on a conditional fee arrangement (CFA) basis and obtaining after the event (ATE) insurance. The usefulness of the latter options will be restricted due to the upcoming abolition of CFA success fees and ATE insurance premiums. However, the government recently announced the abolition will not take effect in claims by liquidators, administrators and trustees in bankruptcy until April 2015.

Not all types of funding will be appropriate for all types of claims. For example, some claims unique to insolvency practitioners under the Insolvency Act (such as clawback and wrongful trading claims) can only be pursued by the practitioner and cannot be sold or assigned to a third party. In addition, sums recovered under such claims are not secured and so it is unlikely a secured creditor would wish to fund the litigation as it will not increase recovery.

Usually, the first major hurdle faced by practitioners is that funding parties will typically require a legal opinion on the prospects of success before deciding whether to fund a claim. In order to obtain such an opinion, a significant amount of costly work may need to be undertaken, such as gathering and reviewing relevant documents and evidence.

These costs are unlikely to be covered by a subsequent third-party funding agreement and, in any event, the practitioner’s own remuneration is not typically covered by funding agreements. If the estate is completely under water, and creditors are not willing to fund the insolvency practitioner’s investigations, what may have been a strong case may simply not get off the ground. Not much, as yet, in the recent expansion of the litigation funding market seems likely to change this.

Once the opinion has been obtained, the likelihood of funding being obtained and the case being pursued very much rests on the numbers. Most external funders (and lawyers entering into a CFA) currently require the prospects of success to be at least 70% and take an average cut of between 15% and 50%. The funders’ cut is usually inversely proportional to the prospects of success, although as competition between funders increases with a maturing market, we may well begin to see practitioners taking the upper hand in price negotiations.

For the time being, however, we can expect to continue to find that only stronger cases are being funded. For cases which are strong but have some weaker elements, the cost/benefit analysis for insolvency practitioners (and for creditors from whom sanction is sought) may well weigh in favour of the creditors simply cutting their losses at an early stage.

Losing control

Apart from the high cost of funding, insolvency practitioners’ traditional concerns with litigation funding include a loss of control over the litigation (particularly under an assignment model where the claim will be pursued by the funder in its own name), the cost of ongoing obligations often imposed upon the insolvency practitioner to provide access to information, the potential for the insolvent company to be at risk of being held liable for costs (if the insolvent company retains an interest in the proceeds, a third party costs order is made against it and the funder is not good for the money) and the risk that the funder might walk away after proceedings have begun.

To some extent, the latter two concerns should be eased by the voluntary code of conduct for litigation funders introduced last year (so long as insolvency practitioners have ensured the funder they have chosen has signed up to the code). The code is not, however, a panacea for all of the issues that face practitioners when deciding to pursue litigation with funding.

Kristy Zander is a restructuring and insolvency partner at Mayer Brown International