When a business is on the receiving end of a claim, it is faced with the prospect of having to incur significant costs to defend the action.

A defendant in that situation will usually be protected by the general rule that 'the loser pays the winner's costs'.

This means that if the defendant successfully defends the claim, the defendant can expect to recover a percentage of its costs from the claimant as ordered by the court if not agreed.

But what if happens if the claimant is unable to pay the defendant's costs?

In those circumstances, the defendant would be left in the unjust position of having to bear its own costs, even if successful.

For this reason, a defendant can apply for an order that the claimant provides security for costs. This means that the claimant must pay money into court or provide a bond or guarantee as security for the defendant's costs, as a condition of being permitted to continue the action.

When can a defendant get security for costs?

A court may order a claimant to give security for costs if one of several specified conditions apply, including:

  • the claimant is resident outside the European Economic Area and Switzerland
  • the claimant is a limited company or other body (i.e. not an individual) and there is reason to believe that it will be unable to pay the defendant's costs if ordered to do so
  • the claimant has taken steps in relation to his assets that would make it difficult to enforce an order for costs against him

If one of the specified conditions is met, the court may make an order for security for costs, if it considers that in the circumstances it is just to do so.

When is there reason to believe a company will be unable to pay the defendant's costs?

Reason to believe that a claimant, which is a company, will be unable to pay a defendant's costs if ordered to do so (i.e. the claimant is insolvent) is one of the most common grounds for seeking security for costs. But what does it mean?

In the recent case of Eagle Ltd v Falcon Ltd [2012] EWHC 2261 (TCC), the Technology and Construction Court considered the basis on which it should determine whether the claimant was insolvent. In doing so, it made comparison to the test under the Insolvency Act.

The defendant, F, sought substantial security for costs from the claimant, E. There was no dispute that E was insolvent on the balance-sheet basis, i.e. its total liabilities exceeded its total assets.

However, E denied that it was insolvent on the cash-flow basis, i.e. being unable to pay its debts as they fell due, as defined at section 123(1) of the Insolvency Act 1986.

E suggested that it was trading profitably and could, if necessary to satisfy a costs order, call on money owed by other group companies.

Mr Justice Coulson decided that insolvency on the balance sheet basis alone was enough to demonstrate a reason to believe that E would not be able to pay F's costs. In doing so, he found that the test of a company's insolvency for the purpose of an application for security for costs was less than the test under the Insolvency Act.

What does this mean?

The decision in Eagle v Falcon clarifies what a defendant needs to show when seeking security for costs on the grounds of the claimant being an insolvent company.

The case is helpful for defendants in that they will only need to demonstrate that the claimant is balance-sheet insolvent, and not that the claimant cannot pay its debts.

However, it must be remembered that this is only the first part of the test. The court must also consider that it is just in all the circumstances to order the claimant to give security for costs.

What should I do?

If you are faced with defending a claim and you have doubts about the solvency of the claimant, you should discuss this with your solicitor.

A well-timed application for security for costs may protect you if the claimant is ordered to pay your costs. It may also give you a tactical advantage, as the claimant will have to decide whether to continue with the action if they have to pay a significant sum into court.

On the other side, if you are a company intending to bring a claim and know or believe that you have more liabilities than assets, even if you can pay your debts, this is something you should consider with your solicitor before commencing a claim.