The interim report in Lord Justice Jackson's year-long review of English civil litigation costs was published on 8 May. Our e-bulletin sent out the same day summarised key points from the consultation which could affect the conduct of major commercial litigation.

This e-bulletin considers in more detail Lord Justice Jackson's proposals relating to the methods of funding litigation and the rules governing recovery of costs. It summarises the various issues and arguments raised in the interim report before giving Herbert Smith's views, and those of clients whom we have consulted to date, on the following points

We will shortly be publishing further bulletins considering other aspects of the interim report including those relating to the management and assessment of costs, and procedural issues such as disclosure, witness statements and pre-action protocols.

1. Cost shifting

Lord Justice Jackson invites views as to whether there are any specific areas where cost shifting (or recovery of costs) should be abolished, though he expresses the "tentative conclusion" that it must remain in some form for the generality of litigation:

Lord Justice Jackson reports that there is unanimity among those who have contributed to Phase I of his costs review that the cost shifting rule must be retained. He describes this as the one matter upon which all the "warring parties" are agreed.

He states, however, that the pros and cons of retaining the cost shifting rule are more finely balanced than this consensus would suggest, and that each category of litigation needs to be critically examined to assess whether retention or abolition of cost shifting is beneficial for that particular category.

Comment: We oppose the abolition of the cost shifting rule in any major commercial litigation. Commercial clients' views echo our own: in the survey we conducted of clients' views in advance of our submission to Lord Justice Jackson in respect of Phase I of his review, all respondents were against the abolition of this rule. Lord Justice Jackson himself refers to the widespread agreement among contributors to Phase I that the cost shifting rule must be retained. This is not surprising. Cost shifting acts as an important safeguard for both claimants and defendants:

  • It allows claimants with meritorious claims to receive full compensation for their losses, in that they recover their reasonable legal spend in addition to the damages awarded. This is only just: subject to any unreasonable behaviour on the part of the claimant (which can of course be taken into account in the costs order made by the court) it is the defendant's wrongful act that has forced the claimant to incur the costs. It would therefore be wrong in principle for the successful claimant to have to bear its own costs out of the damages awarded.
  • It also protects defendants from unmeritorious claims. Without cost shifting there is a significant risk that defendants will feel forced to settle claims regardless of merit, due to the irrecoverable costs they would otherwise incur defending the litigation. The absence of cost shifting would therefore act as an incentive to claimants to bring unmeritorious claims with a view to extracting a settlement – so-called "blackmail suits".  

2. Collective actions

Lord Justice Jackson suggests that the abolition of costs shifting in the context of collective actions "merits serious consideration". He acknowledges, however, that proper incentives would have to be built into the rules to deter the commencement of unmeritorious collective actions.

He states that a "no costs" regime in collective actions would promote access to justice for claimants, in that they would not be exposed to the risk of adverse costs orders. He suggests that it may be better for defendants to collective actions as well, if in practice they are generally unable to enforce costs orders. Defendants would escape substantial costs liabilities in those cases which they lose.

Interestingly, he states in a footnote to his report that he has "certain reservations about the desirability of introducing opt out class actions", although he does not comment further as this issue lies outside his terms of reference.

Comment: As stated above, cost shifting plays an important role in protecting defendants from unmeritorious claims, and this applies with at least equal force in the context of collective actions. The absence of cost shifting and the associated incidence of "blackmail suits" is generally perceived as one of the worst elements of the US class action system.

The Civil Justice Council recognised this in putting forward its recommendations for the reform of collective actions (see our e-bulletin of 29 August). It specifically recommended that the cost shifting rule should remain "not least as disincentive to the issue of purely speculative, unmeritorious, vexatious or otherwise spurious claims".

We have conducted research on the views of large corporates and institutions on various issues relating to class action reform (see our report "Class action reform: A business perspective", May 2009). Respondents were unanimous in their view that the cost shifting rule must be retained as a protection against weak claims.

3. Alternatives to "loser pays"

The report proposes consideration of alternative forms of cost shifting, which are more directly based on encouraging early resolution of claims. The two examples identified in the report are as follows:

  • There might be no presumption that costs would be ordered, but the court would have jurisdiction to award costs based on the conduct of the parties, in particular whether they have made reasonable attempts to settle the proceedings.
  • As a variation on this theme, claimants might have no general liability for defendants' costs unless and until a defendant had made a Part 36 offer, but from that point the current entitlements and costs sanctions would apply.  

Comment: Under the current rules, costs are normally awarded to the "winner" but the court has a discretion to make a different order taking into account all the circumstances of the case. This allows the court to penalise in costs those parties whose conduct has been unreasonable, for example an unreasonable refusal to attempt ADR. The existing regime of Part 36 offers, which is widely seen as one of the success stories of the Civil Procedure Rules, also encourages a reasonable approach to settlement offers. We remain to be convinced that the current rules require modification.

4. Part 36 offers

Lord Justice Jackson suggests that serious consideration be given to a rule change to reverse the Court of Appeal's decision in BAA v Carver [2008] EWCA Civ 412 (which allowed a wider interpretation of whether a judgment in favour of a claimant is "more advantageous" than a defendant's Part 36 offer) as it introduces an unwelcome degree of uncertainty into the Part 36 process and puts unreasonable pressure on claimants to accept offers which are not quite high enough.

Comment: We agree that the decision in BAA v Carver is unhelpful and should be reversed by way of rule change. As a result of that decision, where a claimant rejects a Part 36 offer and then, at trial, beats it by only a small amount, the claimant may still be penalised in costs if the overall result is considered to be less advantageous than the rejected offer. The court may consider all the facts and circumstances, including more subjective factors, such as the emotional toll of the litigation. The clear line in the sand which previously existed under the Part 36 regime has therefore been removed. Whilst this may increase the court's ability to do justice in the particular case before it, it comes at the price of certainty.

5. Costs protection for individual litigants

Lord Justice Jackson invites views as to whether the rules should introduce some form of cost protection in favour of individual (as opposed to corporate) litigants. Costs orders against individual claimants (and perhaps also defendants) would be strictly regulated, for example according to the individual's means or the size and nature of the claim.

The reasoning would be that, if a main aim of costs orders against claimants is a deterrent against unmeritorious litigation, the level of costs sanction should be no higher than necessary to act as a real deterrent, rather than threatening financial ruin for the claimant.

Comment: Whilst cost protection orders may be appropriate in some circumstances, we are not convinced that they should be the rule for individual litigants across the board. Clearly, the defendant would be prejudiced in such circumstances and it would open the door again to the possibility of blackmail suits. If such a system were to be introduced, the rules would have to be carefully crafted so that the potential costs liability, even if limited, remained a real deterrent against spurious claims.

Under the current system, where a litigant is concerned about the risk of an adverse costs order, there is the option of taking out "after the event" (or ATE) insurance to cover this potential liability. Such cover is generally only available where the claim (or, in some cases, defence) has good prospects of success, which acts as a filter for weak claims.

6. Conditional fee agreements (CFAs)

Currently, a successful party can recover from its opponent the success fee, or uplift on the solicitor's basic costs (which cannot be more than 100%), payable under a CFA and also the premium taken out to cover potential liability for an opponent's costs (known as "after the event" or ATE insurance). The report invites views as to the appropriateness of the levels of success fees and ATE premiums currently set in different types of litigation, and whether these should continue to be recoverable.

Lord Justice Jackson expresses the provisional view that, following the retraction of legal aid, either CFAs or some other system of payment by results (for example, contingency fees or third party funding) must exist in order to facilitate access to justice. The real issue is therefore how CFAs or alternative "no win, no fee" arrangements should be structured, not whether they should exist.

He notes that the overall effect of CFAs and ATE insurance in any area where ATE insurance is the norm is that the total costs of all parties in all such cases, regardless of which side wins, are borne by the defendants:

  • in cases which they win, claimants recover their legal costs, disbursements and ATE premium from the unsuccessful defendant through the "loser pays" rule;
  • in cases which they lose
    • claimants' legal representatives recover their legal costs through the mechanism of recoverable success fees in other (successful) cases;  
    • the ATE premium is not payable and the policy pays out to cover the claimant's disbursements and the defendant's costs, but this is ultimately paid for by defendants' liability for ATE premiums in many other cases.

The report notes that that in other jurisdictions where conditional fee agreements or contingency fees are allowed, the additional costs of such arrangements are not transferred to other parties, and that the approach adopted in England and Wales is apparently the source of some surprise overseas. It also notes that a benefit of making success fees and ATE premiums irrecoverable would be that market forces would once more come into play in setting their level, as claimants would (unlike currently) have incentives to shop around for low success fees / premiums.

Comment: We can see merit in the proposal that success fees and ATE premiums should not be recoverable from an opponent. It is arguably unfair that a losing defendant must bear not only the successful claimant's costs, but also effectively subsidise the costs of other claims in which the claimant was not successful. However, we would be concerned if a move to non-recoverability of ATE premiums led to an increased number of claimants bringing proceedings without any means of meeting an adverse costs order in the event that the claim failed.

7. Non-recovery of costs by defendants

Lord Justice Jackson invites views as to whether there should be a presumption of "one way" cost shifting, whereby the claimant could recover its costs but not the defendant, in any particular types of claim. He expresses the view that this should be seriously considered in personal injuries litigation.

He says that his "working assumption" is that cost shifting in favour of claimants should continue (since it ensures effective access to justice and allows the claimant to recover 100% of their damages) but suggests that the arguments for cost shifting in favour of defendants are perhaps less strong than for claimants.

Comment: One way cost shifting has obvious advantages for claimants, but is inherently unfair to defendants who would be fully exposed to the risk of adverse costs orders yet unable to recover their own costs if successful in defending the action. In these circumstances, there would be every incentive for claimants to "have a go" regardless of whether a claim had merit.

8. Contingency fees

Lord Justice Jackson also invites views as to whether contingency fees (whereby a lawyer is remunerated by way of a share in the client's damages) should be permitted and, if so, whether the losing party should pay costs on a conventional basis or should also be liable for the contingent element of the fee.

The report refers to an overwhelming consensus among submissions received to date that we should not adopt the total US system, i.e. contingency fees combined with no cost shifting. It goes on to say, however, that if costs shifting is retained views are more evenly divided.

The report also refers to a general acceptance that, if contingency fees are permitted, they should be regulated. It invites views as to what form such regulation should take.

Comment: In line with the consensus identified in the report, we do not support the introduction of contingency fees combined with no cost shifting. This would merely exacerbate the problems associated with an absence of cost shifting, as identified above. If cost shifting were retained, we believe the arguments are more finely balanced.

In our client survey for the purposes of our submission in Phase I of the costs review, views were divided on the question of contingency fees. However, in the research we conducted on class action reform, respondents were unanimous in their opposition to the introduction of contingency fees.

9. Commercial Court

Lord Justice Jackson states that recommendations in his final report must encompass all civil courts, including the Commercial Court, but recognises that "one size does not fit all". For example, he states that his "distinct impression" from the submissions and discussions to date is that in major high value litigation (Commercial, Chancery, Mercantile, construction, etc) court users generally wish to maintain the present regime of recoverable costs being at large. He says that if this impression is confirmed during the consultation process, then it would be inappropriate to introduce any form of fixed costs or similar into the realm of high value business litigation.

Comment: We welcome Lord Justice Jackson's recognition that "one size does not fit all". As recognised in the report, different considerations must be taken into account when considering sophisticated commercial parties and high value claims.