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). Successful claimants will 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 shows that the exemption helps 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?

On the face of it, there must be a risk that fewer directors are pursued and even where they are, the net return to creditors is diminished.  Not everyone agrees:  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 consider 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:

  • He argues 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. 
  • 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.
  • 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 should IPs do?

  • In the short term, IPs should assess their portfolios and get as many good cases as possible on to a CFA and with ATE before 1 April 2016 to maximise costs recovery.
  • Post 1 April 2016, Solicitors will 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:
    1. 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.
    2. Closely monitor costs on an ongoing basis.
    3. Think even more carefully about the benefits of earlier settlement (whilst being careful not to under settle) and the right strategy to achieve that.
  • Consider whether a Damages Based Agreement (DBA) (ie a pure contingency fee) is appropriate.  The Government will not currently permit the use of hybrid DBAs and this seems to be limiting their use.  In the meantime, it is likely that DBAs will only be suitable for very large claims.
  • Pro-actively explore the pros and cons of the third party funding with brokers or funders.  R3 say that according to Walton's latest research, 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).  Will we now see a rapid growth in third party funding?  Will this be sufficient to bridge the gap?
  • Consider the assignment of claims.  Currently, claims belonging to an insolvent company can be assigned.  In due course, the rules will also permit the assignment of office holder 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.