By: 19 August 2016
New approaches to financing insolvency litigation

Maurice Power, managing director at Ferguson Litigation Funding, examines how with the end of the Jackson carve-out, insolvency practitioners have more reason than ever before to explore alternative financing solutions

On 1 April 2016, the exemption for insolvency litigation from the changes brought about by the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (LASPO), was withdrawn.

Prior to this, an Insolvency Practitioner (IP) could pursue action against a rogue director or debtor, on behalf of the creditors of an insolvent business/individual, by instructing a solicitor on a Conditional Fee Agreement (CFA), and protect themselves against adverse costs by taking out After The Event insurance (ATE). This could be done safely in the knowledge that should they win the case, the defendant would then pick up the cost of the ATE and pay the solicitor’s success fee within the CFA – and were they to lose, the ATE insurance would pay all the defendants costs.

So with the claimant now having to bear their own full legal costs and the premium for any ATE, what does a post-reform world look like for insolvency litigation? And what are the options available to IPs to pursue action in their duty to maximise the returns for creditors?

The options

Where there is no, or insubstantial, capital in the insolvent estate to fund litigation, the IP is faced with a number of options. The first option would be to take no action, this would be the easy way out – but is certainly not in the best interests of the creditors. The IP may also leave themselves open to action from the creditors, at a later date, for failing to perform their duties.

The second option could be to raise funds from the creditors. Now, unless there is the guarantee of substantial returns for no risk, then most creditors will not support this. Another option would be that the IP funds the action themselves – this is the least likely option to be pursued as most IPs will not put their own money and company at risk.

A further option could be to instruct a solicitor on a CFA and arrange ATE, but this option has many obstacles to overcome before becoming viable. If the CFA is a full CFA (i.e. no payment unless the case is won), will the solicitors only cherry pick claims that they are 100% certain of winning?

Further, if the CFA is a partial CFA (i.e. a percentage of the legal fees are paid) this may present the IP with the same funding dilemma.

Whichever type of CFA is agreed, the solicitor’s fees and success fee will need to be paid from the proceeds of the claim, if successful. Although the fee for ATE is deferred until the conclusion of the case, when due it will now be paid from the proceeds of the claim.

With the majority of claims brought on behalf of insolvent estates being small in value, once the CFA and ATE costs are taken from the proceeds of the claim, will there be anything left for the creditors, and/or enough to satisfy the action?

One option to fund litigation would be to instruct a solicitor on a Damages Based Agreement (DBA). Although similar to a full CFA, a DBA means that the solicitor receives an agreed percentage of the proceeds of a successful claim rather than their fee plus an uplift. As this is a new and relatively untested arrangement, there is very little appetite from solicitors to enter into these agreements.

It would also be possible to sell or assign the claim to a third party. Although this will realise an immediate, albeit considerably lower, return for creditors, the question will remain as to whether the deal was in the best interests of the creditors.

Third party funding

Finally, there is the increasingly common route of sourcing a third party litigation funder. Although providing funds to pay the claimants legal costs, for a fee, traditionally this does not protect against adverse costs should the claim be lost.

The IP’s regulatory bodies have already begun to provide guidance to their members though the recent rewording of the Statement of Insolvency Practice 2 within their handbooks. Section 11 now states:

“An office holder should determine the extent of the investigations in the circumstances of each case, taking into account of the public interest, potential recoveries, the funds likely to be available, either from within the estate and/or from other sources to fund an investigation, and the costs involved.”

And Section 15 has also been updated to say: “There may be circumstances where there are clearly insufficient funds to carry out a detailed investigation or to take action for recovery of assets, and an office holder should consider whether it is appropriate to seek funding from creditors or others.”

So, it is clear that the regulatory bodies believe that third party funding is an option that needs to be embraced by the IPs.

Third party funding for insolvency litigation is nothing new but, with the availability of CFAs and ATE pre-April 2016, many IPs did not initially see the benefit of using a funder if the solicitor and ATE insurer were content with the likelihood of success of the claim.

Post-1 April 2016, with the cost of CFAs and ATE making many claims cost prohibited, and with the regulatory bodies encouraging the use of litigation funding, third party funders have the challenge of:

– changing the behaviour of IPs when confronted with a viable claim but with no funds to pursue it

– presenting a funding option that provides for the legal fees and eliminates the risks associated with losing an action

– providing a cost effective solution to pursuing lower value claims

With the on-going evolution of third party funding in insolvency cases an IP can now source a funder which will provide many, or all, of the following:

– Funding of legal fees, expert witnesses and solicitor’s success fees

– Indemnity against adverse costs

– Security for costs

– A panel of expert solicitors

– Options – to include full or partial funding, claim purchase, etc

– Independent opinion

Rather than having a limiting effect on insolvency litigation, the removal of the exemption from the LASPO changes has created a market where the litigation funders are adapting their service to provide IPs with the means to maximise returns to creditors.

The solution is out there and the onus is now on the IP to source the correct funding option for each case.