Vernon Dennis looks at the innovations that may lie ahead in funding insolvency litigation.
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.
Third Party Funding
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?
- Standard Litigation FundingThe most significant problem in funding insolvency litigation is that the costs of proceedings can often be high; particularly in cases concerning lower value claims where complex issues of law and fact often arise. For the office holder an issue maybe that after deduction the costs and the funder’s fee, recovery for creditors is often limited. For the funders for both reputational and commercial reasons they will wish to see a high ratio of potential damages as against costs; ensuring that funding is show to be of value. This means in practice both parties will consider funding only for higher value claims. As a result standard litigation funding fails to provide a solution in many insolvency cases.
- Portfolio FundingDue to the above difficulties, an alternative solution is to fund a portfolio of cases. The portfolio may consist of cases linked by the same the insolvency practitioner and lawyer, or consist of claims of a similar type. For the funder this provides a different type risk assessment; requiring a close analysis of the team working on the cases, their competence in the type of litigation being pursued and overall success rates, as opposed to detailed consideration of the merits of an individual case.
- Work in progress FundingA short leap from portfolio funding is work in progress funding. Here the funder would simply provide an advance against the lawyers’ work in progress, secured against recoveries. For the law firm this overcomes the significant cash flow problems that arise in taking on CFA work and provides working capital.
- Hybrid CFA/DBASince LASPO damages based agreements (DBAs) have been available, but appear little used. The concept of a DBA does not sit comfortably within the UK legal system, which sees the recoverability of the legal costs from the losing party, underpinned by the indemnity principal. In contrast a CFA retains a link to the value of the work actually being carried out, with the uplift/success fee compensating for the risk being taken.If a funders success fee was to be payable from the potential damages one might see a move to tie the legal team into a similar percentage recovery. A hybrid CFA and DBA could arise with minimum and maximum recovery levels being calculated based on the eventual award.
- Assignment of ClaimsWhile the assignment of claims to parties potentially interested/involved in the litigation has been an option often utilised by an office holder, the presences of specialist funds seeking to obtain a profit on investment provides for a different dynamic. For the insolvency practitioner and the creditors the prospect of some return is better than leaving the action fallow. However significant development of this form of asset realisation is currently hindered as claims deriving from the office holders appointment and brought by the office holder (e.g. Insolvency Act 1986 Sections 213,214,238 and 239) are not capable of assignment (see Oasis Merchandising Services Limited  2 WLR 764).The Government is however proposing to allow the assignment of such office holder claims, a move that is currently due to be introduced with a raft of Insolvency Rule changes in April 2016. This move could well be the key to opening up new opportunities for funders and providing an alternative to the CFA/ATE model.
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.