The Court of Appeal has overturned a High Court decision granting a non-party costs order against an insolvent company’s director and majority shareholder. The court cited the claimant’s failure to warn the non-party of its intention to seek such an order as fatal to the application: Sony/ATV Music Publishing LLC v WPMC Ltd (in liquidation) [2018] EWCA Civ 2005.

This decision illustrates that a failure to warn will be a material factor in some cases when considering whether a non-party costs order is appropriate. The practical message is obvious: where a litigant may wish to pursue a non-party for costs, in the event that the losing opponent does not pay them, it would be well-advised to warn the non-party of that possibility as early as possible in the proceedings.

Each case will turn on its facts, however, and a failure to warn will not always be fatal. It is likely to be less significant, for example, where the court considers that a warning would have made no difference to the conduct of the proceedings (see this post) or where the non-party is a professional litigation funder (see this post).

The decision is also of interest in suggesting that the Arkin principle, which has been held to restrict a third party funder’s adverse costs liability to the amount of funding provided, has no application outside the realm of professional litigation funding.

Background

Section 51 of the Senior Courts Act 1981 gives the court a broad discretion to “determine by whom and to what extent” the costs of proceedings are to be paid. That includes making orders for costs against non-parties to the proceedings.

The claimant in the present case (SATV) brought a successful copyright claim against the defendant (WPMC) in relation to the exhibition of a documentary about a Beatles concert. WPMC was ordered to pay costs at a hearing in July 2015. WPMC was subsequently wound up and a liquidator appointed. SATV was therefore required to prove in WPMC’s winding up for their costs, although it was clear that this would not have been a surprise to SATV as it had been advised in an email in August 2014 that WPMC had “no assets to speak of” and SATV had later indicated that it was “not convinced that WPMC will be able to meet” an adverse costs order.

Mr David Bailey had been the director and majority shareholder of WPMC since January 2013, having been approached by the previous owner to acquire WPMC as a means of recouping some of the money that he (along with other investors) had lost in a separate investment (the “GLE Investment”). On 7 July 2016, SATV wrote to Mr Bailey, indicating that they intended to seek a non-party costs order against him under section 51(3) of the Senior Courts Act. This was followed up by an application for a non-party costs order. Mr Bailey opposed the application on the basis that requiring him to pay the costs would be unjust because (among other things) he had not been warned at any stage up to 7 July 2016 that SATV intended to take this step in the event they were successful at trial.

The High Court (Arnold J) made the non-party costs order (to apply from January 2013 onwards) on the basis that:

  • Mr Bailey, as director and shareholder of WPMC, was the “real party” to the litigation. He was in a position to control WPMC’s defence of the claim against it, and had funded the defence and otherwise supported it by providing his own time. The judge found that Mr Bailey had defended the claim with a view to his own benefit, because he hoped that succeeding in the litigation would lead to the generation of funds from the documentary.
  • Despite Mr Bailey’s evidence to the contrary, Mr Bailey would not have acted differently had SATV warned him of its intention to seek a non-party costs order against him.

Mr Bailey was granted permission to appeal.

Decision

The Court of Appeal (Kitchin and Floyd LJJ) allowed the appeal, finding that the failure to warn in particular was fatal to the application.The court referred to the guidance in Dymocks Franchise Systems (NSW) Pty Ltd v Todd [2004] UKPC 39, which summarised the “main principles” which apply to the award of non-party costs orders. These principles include the following:

  • While non-party costs orders are “exceptional”, this “means no more than outside the ordinary run of cases where parties pursue or defend claims for their own benefit and at their own expense.” The key question is “whether in all the circumstances it is just to make the order”.
  • As a general rule, the discretion will not be exercised against “pure funders”, ie “those with no personal interest in the litigation, who do not stand to benefit from it, are not funding it as a matter of business, and in no way seek to control its course”.
  • Where a non-party does not merely fund the proceedings, but “substantially also controls or at any rate is to benefit from them”, justice will usually require the making of a non-party costs order because the non-party is in fact “the real party” to the litigation.

Divergence of interests

Mr Bailey argued that, in order for a non-party costs order to be made, it was necessary to show a divergence of interests between Mr Bailey and WPMC.

The Court of Appeal said that such a principle did not find a clear expression in any of the authorities. The effect of the test put forward in Dymocks was that, generally speaking, where a non-party funds a claim brought by an insolvent company solely or substantially for his own financial benefit, the non-party should be liable for costs if the claim or defence fails. That will not always be the case, however. Where the non-party is a director who can realistically be regarded as acting in the interests of the company (and its shareholders and creditors), rather than his own interests, the position may be different.

Mr Bailey argued that he had acted in the interests of WPMC, its creditors and shareholders in enabling the company to defend the proceedings, and so a non-party costs order should not be made against him. He submitted that if non-party costs orders were available where the interests of the shareholder and the company were aligned, this would have a number of unprincipled consequences, including that it would collapse the principle of separate corporate personality.

The Court of Appeal rejected this argument, finding that a requirement for a divergence of interests was not justified by authority or as a matter of principle. It was wrong to regard the imposition of a non-party costs order as piercing the corporate veil by treating the company’s rights and obligations as those of its directors or shareholders. In making a non-party costs order, the court exercises its discretion to impose a liability on a non-party who would not otherwise have had that obligation.

Failure to warn

As noted above, Mr Bailey gave evidence in the High Court that he would have acted differently had SATV warned him of its intention to seek a non-party costs order against him. The Court of Appeal found that Arnold J erred in concluding that no weight could be given to the failure to warn Mr Bailey in determining whether it was just to make a non-party costs order. Specifically, “he left out of account a feature which he should have considered, namely the prospect that Mr Bailey would have conducted the defence of the case differently if a warning had been given.” By way of summary, the reasons for this decision were:

  • Caution was necessary in making summary findings of fact relevant to the award of a non-party costs order. Mr Bailey had not given evidence at trial and therefore the judge had not had an opportunity to assess his credibility.
  • Mr Bailey’s honesty in giving evidence was not in doubt. In that regard, the Court of Appeal observed that “Mr Bailey had given evidence in the clearest possible terms as to how he would have behaved if he had known that he was running the risk of a [non-party costs order].”
  • The factors that Arnold J relied on in reaching his conclusion were “inferential ones”. These factors included that Mr Bailey had wished to recoup money for himself and other investors in the GLE Investment, that he had been motivated by advice he had received from his lawyers and the fact that they were prepared to act on a conditional fee arrangement. The Court of Appeal concluded that “[t]hose factors do not mandate a conclusion that Mr Bailey would have acted in the same way if he had known that he would face a costs bill for several hundreds of thousands of pounds”.
  • Mr Bailey did not take out ATE insurance. While he did not ask for, or receive, advice as to the potential remedies open to SATV if WPMC were to lose and no ATE insurance had been obtained, this was because “Mr Bailey and SATV were operating on the assumption that any costs order made against WPMC would not be met” and it was accordingly not clear what ought to have prompted Mr Bailey to obtain advice in relation to that point. The Court of Appeal concluded that “if [Mr Bailey] had been warned that a [non-party costs order] was being sought against him, there was every reason for him to ask for and obtain appropriate advice as to how he might protect himself against such an order.”

Having reached this conclusion, the Court of Appeal found that it was necessary to exercise the discretion to award a non-party costs order afresh. Leaving aside the failure to warn Mr Bailey, the court considered that matters were “fairly evenly balanced”, noting that Mr Bailey could be considered as “a real party” to the litigation given that he stood to benefit from the outcome, though the proceedings were also in the interests of the company and other stakeholders.

Ultimately, however, the failure to warn Mr Bailey until a year after final judgment was fatal to the application to grant a non-party costs order. It was “manifestly unfair” to Mr Bailey because it deprived him of the opportunity to settle or abandon the litigation, or to take steps to protect himself against a non-party costs order.

Arkin cap

Mr Bailey also argued that the funding he provided was de minimis compared to SATV’s overall costs. If a non-party costs order was made against him, therefore, the court should apply the Arkin cap to limit his costs liability to the amount of funding provided.

The Court of Appeal rejected this argument, saying that there was no basis for extending the Arkin approach to this sort of case. In Arkin v Borchard Lines Ltd [2005] EWCA Civ 655 the Court of Appeal limited a professional funder’s adverse costs liability to the amount of funding provided, in circumstances where the funding left the claimant as the party primarily interested in the result of the litigation and the party in control of it. That principle was based on policy considerations which did not apply where the funder was the “real party” to the litigation and “not so much facilitating access to justice by the party funded as himself gaining access to justice for his own purposes”.