Litigation for the benefit of others
Insolvency office-holders are responsible for the realisation of the bankrupt’s or insolvent corporate’s assets; one of the most important asset classes being causes of action.
Insolvency office-holders are responsible for the realisation of the bankrupt’s or insolvent corporate’s assets; one of the most important asset classes being causes of action.
In determining to litigate the office holder must act in the best interests of the creditors, ultimately seeking for them a better return. This does not mean that an office holder is bound to take action just because a claim exists; conversely recent rule changes mean that the office holder does not need to seek sanction from the creditors to take action. Office holders thus have a significant amount of discretion on whether to litigate. In making that determination however they will differ from a normal litigant. Firstly the office holder is to some extent a ‘disinterested’ litigant and will not having a personal stake in the proceeds of recovery. Secondly it is highly likely to be paucity of fund available to take the action forward. It is these twin factors that has driven the insolvency market to be pre-dominated by no win no fee agreements (conditional fee agreements) (CVAs) and after the event (ATE) insurance.
On 26 February 2015, the Government surprised many commentators by granting an eleven hour reprieve to the insolvency profession; announcing that insolvency litigation will continue to remain 'for the time being' outside of the scope of the reforms introduced in Part Two of the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (LASPO). As a result in insolvency proceedings CFA success fees and ATE premiums remain recoverable from an unsuccessful defendant.
CFA and ATE have played an important part in the shaping the practices of both insolvency practitioners and the lawyers acting for them. The risk to the insolvent estate in commencing litigation, which may prove unsuccessful, is significantly mitigated by the lawyers acting on a CFA and any adverse costs consequences potentially alleviated by ATE, especially where the premium is deferred and non-recoverable.
The shifting of risk to the legal team is balanced by the potential for better return in the event of success. Lawyers with a risk appetite for taking on this type of work are also more likely to seek to specialise and run a portfolio of cases, ensuring that any cash flow pressures on the practice are minimised and less successful cases are in effect 'subsidised' by the higher returns obtained where there is a success fee.
For an insolvency practitioner the CFA offers 'cost protection' (the insolvent estate will not be diminished) with the CFA success fee playing an important role in incentivising those involved in spending professional time and resource in seeking realisations for the insolvent estate. Furthermore the recovery of a success fee and insurance premium exponentially increases the risk to the defendant who is more likely to wish to settle early and on terms favourable to the office holder.
In support of its campaign to see the exemption extended, R3 the Association of Business Recovery Professionals, estimated that should the exemption to LASPO be lost there would be a consequent fall in insolvency litigation, with a cost to creditors estimated to be at £160m. The argument proffered being that litigation would be made unattractive in the many cases, which cannot bear the success fee and premium from the award. Despite the apparent success of the campaign, it is questionable whether the announcement marks a permanent change in Government attitude. As a result the insolvency sector remains alive to the possibility that the exemption will be removed and the need to find innovative funding solutions will once again move high upon the industry’s agenda.
Clearly seeking funding from the creditors (on whose behalf the insolvency practitioner is acting) is an option. In practice the collective nature of the insolvency process and the need to co-ordinate a potential disparate body of creditors provide fetters, with many creditors taking the not unreasonable view that they have already suffered the economic loss on the insolvency and would have no wish to speculate to accumulate.
Over the past decade the litigation funding market has been developing apace offering litigants an alternative to pure CFA arrangements. The announcement is however an indication that the Government did not feel that the insolvency industry had embraced the opportunities presented by the funding industry and/or that the funding industry has not developed sufficiently to ensure that the current volume of cases being commenced for the benefit of creditors would continue.
While in the months leading up to the potential loss of the exemption it was clear that funders had given thought as to how best to deal with lower value cases and some new product lines were developed, a significant take up was not necessary due to the LASPO exemption being extended.
It does however leave an intriguing question; what potential developments might we see to funding models that could meet the challenges should the LASPO exemption be lost and/or offer an alternative to CFA/ATE funding?
From the point of view of the specialist funds, the ability to take on a larger number of cases will mean potential economies of scale; the fund, possibly employing its own specialist in-house team of insolvency practitioners and lawyers to run its acquired actions, as opposed to relying on external advisors.
Alternatively one might see the emergence of joint ventures between funders and insolvency practitioners. The funder providing working capital to a ‘partner’ insolvency practitioner to investigate and take forward the claim assigned claims on their joint behalf. This would have attraction to practices that have grown on reliance of creditor services and/or are reliant on the legal team’s engagement on a CFA. The alignment of interests between the fund, the insolvency practitioner and legal teams could be met by the development of alternative business structures, providing a special purpose vehicle possibly created by a fund or in which a fund has a stake.
The Government has provided for the continuation of the insolvency exclusion to LASPO for ‘the time being’. As a result both the insolvency and litigation funding industries must continue to plan for a day when such innovative solutions are necessary to ensure that office holders can continue to litigate for the behalf of others.
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