06 Jul 2018

On 17 December 2015, the Ministry of Justice made a final decision to end the Insolvency Litigation exemption from the 2012 Legal Aid, Sentencing and Punishment of Offenders Act (LAPSO) (see Written Statement here). This meant that successful claimants would no longer be able to recover the success fee on a Conditional Fee Agreement (CFA) or After the Event insurance (ATE) premium from the opposing party for those CFAs entered into or ATE obtained from 1 April 2016.

Does this matter? 

The April 2014 Walton Report (the First Walton Report) commissioned by R3 found that CFAs and ATE are used by a majority of the insolvency profession to pursue insolvency claims. Insolvency claims are typically brought by failed companies (or an insolvency practitioner (IP) such as a liquidator) against errant directors to hold them to account. In December 2015, Professor Walton's updated research reportedly showed that the exemption helped to retrieve approximately £480m owed to creditors each year and enabled the profession to pursue over £1bn for creditors in 2014 (which includes £240m owed to HMRC being pursued of which £115m was recovered). 

What are the arguments?

There was concern within the profession that the removal of the exemption would mean that fewer directors are pursued and even where they are, the net return to creditors is diminished. Not everyone agreed: Manolete is an insolvency litigation financing company. In their response to the MoJ's announcement, they point out that in the First Walton Report, only 14 of 96 cases over a 3 year period showed any positive recovery and fewer still resulted in a distribution to creditors. They considered it unlikely that the removal of the exemption would deprive the Government of significant sums. 

Lord Jackson was the architect of the reforms that lead to LAPSO. In his 2015 Mustill lecture, he advanced various arguments why the exemption should be abolished, eg:

  1. He argued that solicitors are business people and cherry pick the best winning cases, so they recover more from success fees in winning cases than they lose from the failed cases. He believes that this increases the costs of litigation and creates an unequal playing field whereby the defendant is at risk of paying significantly more costs if he loses – and that, in his view, is unacceptable. IPs' response is that they face a double hurdle of being unable to pay for legal advice and potentially of having to overcome a security for costs challenge. Recoverability helps to level the playing field – an aid to accessing justice. 
  2. Success fee and ATE premium recovery may have a "chilling effect" ie some defendants are so overwhelmed by the significant adverse costs consequences of losing that they settle – even the ones that have a legitimate defence.
  3. The effect of recoverability is to drive up the costs of litigation - the claimant has insufficient incentive to control costs because he would not be paying them. R3 point out that IPs are Officers of the Court, not acting on their own behalf, but on behalf of creditors and that as such they do not seek to pursue unmeritorious cases and have a duty to minimise costs.

What do IPs do now?

  • Post 1 April 2016, Solicitors are still be able to sign up to a solicitor own client CFA. It just means that the net return to the insolvent estate from litigation could diminish as the success fee and ATE premium erodes that. IPs in this situation should therefore:
    • Continue to really focus on the cost vs benefit analysis at the outset. Be selective about what you pursue. Small cases are likely to be even less attractive than they are now
    • Closely monitor costs on an ongoing basis
    • Think even more carefully about the benefits of earlier settlement (whilst being  careful not to under settle) and the right strategy to achieve that.
  • Pro-actively explore the pros and cons of the third party funding with brokers or funders. In 2015, Walton reported that third party funding is a relatively small part of the insolvency litigation market: 160 cases use third party funding realising £45m compared to a total of 2,300 CFA backed cases per year (and about £480m of realisations). However, that has almost certainly now changed since the research was first published. Anecdotally, we now see much more use of specialist third party funding
  • Consider the assignment of claims. As with any assignment, the IP's duty is to maximise the value obtained on the assignment. They must test the market. That will entail an approach to the proposed defendants, shareholders, directors and creditors to see if a better offer can be obtained.

We do not see many instances of parties considering a Damages Based Agreement (DBA) (ie a pure contingency fee). The Government will not currently permit the use of hybrid DBAs and this seems to be limiting their use. 

What is happening now?

On 28 June 2018, the Government published its initial assessment of the reforms. It reports that MoJ officials have held initial discussions with key stakeholders about the impact of the reforms and that stakeholders have adapted "and that they are generally working well." However, they concede that they have access to reasonable data on PI claims, but less so in other areas. The Government is seeking views of stakeholders on the impact of its reforms to the LASPO. They particularly want to know whether stakeholders are aware of categories of cases where the number of meritorious cases has increased or decreased as a result of the non-recoverability of the success fee and ATE premiums. They say that it would be helpful if comments could be supported by data and evidence. Responses are requested by 24 August 2018 and a link to the consultation is here. It will be interesting to see whether the insolvency profession considers that the abolition of the insolvency exemption from LAPSO is still an issue or whether the growth in third party funding has bridged the gap.