The Court of Appeal has this morning handed down its judgment in the case of Excalibur Ventures LLC v Texas Keystone Inc and others, a decision that is of great importance to third party funders and their potential liability for adverse costs.

They say that hard cases make bad law. The third party funders in Excalibur had no or very little experience of funding any form of litigation and no experience in the UK. The underlying claim had failed in terms described by the trial judge as “a resounding, indeed catastrophic, defeat”. The “spurious” claims had been “speculative and opportunistic" and had “no sound foundation in fact or law”. Indemnity costs were awarded against the unsuccessful claimant but there was little prospect of the £4.8m shortfall in costs being recovered from the claimant despite £17.5m having been provided by way of security by one of the funders.

The issues for the Court of Appeal were whether the funder’s liability for costs should be on the same basis as that ordered against the claimant, namely indemnity, and whether the sums provided by way of security for costs should be taken into account for the purposes of the “Arkin Cap”.

The “Arkin Cap” is a term derived from the decision in Arkin v Borchard Lines Ltd [2005] 1 WLR 3055 which limits the liability of a commercial third party funder for adverse costs to an amount equivalent to the funding provided so that if, for example, a funder provided £1m to the claimant to fund the claim that funder would potentially be liable to the other side for up to £1m in costs.

The Court of Appeal decided that normally the fortunes of the funder should follow those of the funded party so that if that party is ordered to pay costs on the indemnity basis then the funder will have to pay them on that basis also. Whilst the conduct of the funder may not necessarily be subject to criticism the funder could not normally dissociate itself from the conduct of those that it had enabled to conduct the litigation and from whom it hoped to make a return on its investment.

The Arkin Cap itself was not the subject of challenge on the appeal. The Court of Appeal held that a funder that contributes to security for costs will face potential exposure of an equivalent amount under the Arkin Cap – so putting up £1m by way of security may result in that funder losing both the security provided and a further £1m. Where, as in Excalibur, the funder is only providing funding by way of security in return for a share of the proceeds that is not a surprising outcome but in the UK most responsible funders may find themselves funding the claimant and funding the security. The effect of Excalibur will be that the funder will be liable under the Arkin Cap for a total amount equivalent to the sum of the funding provided to the claimant and the amount provided by way of security.

The Association of Litigation Funders (“ALF”), the body charged by the Ministry of Justice through the Civil Justice Council with delivering self-regulation of third party funding in England & Wales, has welcomed the endorsement of third party funding by the Court of Appeal and the role played by ALF in regulating professional funders. The funders in Excalibur were not members of ALF and had minimal experience of litigation funding.

The judgment gives an important indication that responsible funders can and should undertake regular reviews of the cases that they are funding, including rigorous analysis of the law, fact and evidence, without such reviews being characterised as champertous.

What is clear from the judgment is that professional third party funding is now a fully accepted part of the legal landscape. The role of ALF is recognised. The duties and liabilities of funders are clarified. Whilst hard cases sometimes make bad law most responsible lenders will welcome the clarification given.