Financing litigation - the changes

May 14, 2013

April Fool's Day 2013 was no joke when it comes to litigation.
 
The 'Jackson Reforms' (named after Lord Justice Jackson) saw a variety of changes to litigation. The most significant of these changes impact the ways litigation can be financed.
 
Prior to 1 April 2013, it was unlawful for lawyers in the UK to enter into contingency fee arrangements with their clients. This has now changed with the introduction of 'damages based agreements' (DBAs).  
 
Lawyers can now enter into agreements under which, in return for charging either no fees, or reduced fees, they are entitled to receive up to 50% of the damages recovered by the client. This provides claimants who either cannot afford to litigate, or who would prefer to give up part of their winnings rather than incur any fees, with an alternative method of financing their claims. DBAs achieve a similar result for claimants as obtaining financing from a third party litigation funder who will pay the claimant''s legal costs in exchange for a percentage of the winnings.  
 
Under a DBA, the law firm is effectively acting as the funder. The intention behind the introduction of DBAs is to increase the number and range of litigation funders. However, it remains to be seen how many law firms will be willing to offer DBAs. Most commercial litigation lawyers are likely to be concerned about the impact on their cashflow of financing a claim for months or years under a DBA. There are also issues over the new regulations governing the terms of DBAs. These are generally regarded as very poorly drafted. Lawyers will therefore be cautious about entering into DBAs which could subsequently be found to be unenforceable because they do not comply with the regulations. Also, even if a lawyer is willing to agree to a DBA, the claimant may well decide that it is better off persuading the lawyer to enter into a conditional fee agreement. This is because having to pay a 'success fee' (see below) could cost the claimant substantially less than the significant percentage of its winnings payable under a DBA, particularly if the claim settles at a relatively early stage in the proceedings.
 
Conditional fee agreements (CFAs) have been available for several years. Under these agreements, the law firm either charges no fees, or reduced fees, in exchange for receiving its normal fees plus a 'success fee' of up to 100% of the normal fees if the outcome of the case represents a success for the client. Prior to 1 April 2013, there was no downside for a client in entering into a CFA, as the success fee was recoverable from the losing party as part of the winning party's costs. However, that has now changed, with the result that the client will have to fund the success fee, which may eat up a significant proportion of the damages it recovers. The client will therefore have to balance the benefits of no / reduced fees if it loses its claim against the disadvantage of having to sacrifice part of its winnings to finance a success fee if it wins.
 
The same principle now applies to premiums for 'after the event' (ATE) insurance. ATE insurance covers the client against the risk of having to pay the other party's costs if it is unsuccessful. If the client is unsuccessful, then the premium is not payable as it is covered under the terms of the policy. If the client is successful, then the premium becomes payable. Prior to 1 April 2013, the premium was recoverable from the losing party as part of the winning party's costs. There was therefore no downside to taking out ATE insurance. However, now, if the client is successful, the premium is no longer recoverable from the other side and has to be paid by the client. Currently, ATE premiums are typically 50% or more of the sum insured, so can be substantial amounts. Premium rates are expected to come down significantly as ATE insurers recognise that their products have much more limited attraction as premiums will now have to be financed out of the client's winnings. However, this means that only cases with very good merits will be insurable as ATE insurers seek to balance their outgoings (on unsuccessful cases) against reduced premium income.
 
Overall  -  claimants will now have to undertake much more of a cost / benefit analysis when deciding how to finance litigation and how to protect themselves against the costs consequences of losing.


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