On Thursday 19 January, Herbert Smith hosted a seminar to discuss how anticipated changes to the costs and funding regime are likely to change the litigation landscape for those who bring and defend claims.
Following introductory remarks by litigation partner Ted Greeno, there was an address by Lord Justice Jackson, the architect of the reforms that will (amongst other things) allow lawyers to conduct litigation on the basis of contingency fees, also known as “damages based agreements” (DBAs).
Presentations were also given by: Leslie Perrin, chairman of litigation funder Calunius Capital and of the newly formed Association of Litigation Funders of England and Wales; Matthew Amey, a director of The Judge, a broker specialising in after-the-event (ATE) insurance and litigation funding; John Kunzler, a senior product manager at Travelers Insurance; Charles Plant, chair of the Solicitors Regulation Authority (SRA) Board, and a consultant to and former partner of Herbert Smith; and Michael Napier, who was until very recently chairman of Irwin Mitchell and also chaired the Civil Justice Council working party that developed the new code of conduct for litigation funders. These were followed by a panel discussion chaired by Ted Greeno.
Some key points emerging from the presentations and discussion included:
- Removal of the current restrictions on contingency fees, combined with the liberalisation of the legal services market allowing outside investment in law firms, means that there will be the opportunity for outside capital providers to invest not only in litigation, via third party litigation funding arrangements, but also in law firms which pursue litigation on a contingency fee basis.
- There are many details still to be worked out as to how contingency fees will operate in practice, including: whether there should be a cap on the level of contingency fee in commercial cases; what controls should be placed on the lawyer’s ability to terminate the arrangement; and whether the lawyer should be potentially liable for adverse costs.
- If third party funders are liable for adverse costs but solicitors acting under contingency fees have no such liability, this might encourage funders to buy or set up law firms to conduct cases under such arrangements, rather than putting in funding as a third party, so as to benefit from that protection.
- The environment in which contingency fees are to be introduced will be very different from the present also because of the abolition of recoverable success fees and ATE premiums, which will change the balance substantially as these arrangements will no longer have significant advantages over third party litigation funding.
- There is some uncertainty as to the continued viability of the ATE insurance market once recoverable premiums are removed. Parties may become less willing to take out ATE insurance for good cases. The basket of cases covered by ATE could therefore downgrade, meaning a lack of premiums in successful cases to cover the cost of paying out in unsuccessful cases.
- The ATE market is likely to diversify its business model, including by assisting litigation funders, and/or solicitors acting under contingency fees, to cover their risks. We may even see insurers guaranteeing firms a minimum level of income.
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Introduction by Ted Greeno
In his opening remarks, Ted Greeno commented that we are entering a period of very significant change for how litigation is conducted in this jurisdiction. In particular, in the commercial context, the introduction of contingency fees, combined with the increasing use of third party litigation funding and the liberalisation of the legal market to permit alternative business structures (ABSs), has the potential to bring about a dramatic shift in how litigation is approached and funded.
The 1979 Royal Commission on Legal Services, led by Lord Benson, roundly rejected the concept of contingency fees on the basis that, if lawyers had a direct interest in the case, it could cause all sorts of mischief, including the construction of evidence, the improper coaching of witnesses, the use of professionally partisan expert witnesses, and groundless legal arguments.
In 1995, however, conditional fee agreements (or CFAs) were introduced, allowing lawyers to obtain an uplift on fees in the event of success. At that time the success fee was not recoverable from the opponent – that change was brought about in April 2000 – but whether the success fee was recoverable or not, the introduction of CFAs meant that the lawyer would have a direct personal interest in the outcome of the case.
Once that Rubicon was crossed, it was only a matter of time before contingency fees (or “damages based agreements”, DBAs, as they have more recently been called) would be permitted. That was indeed the recommendation made by Lord Justice Jackson in January 2010 following his year-long civil litigation costs review, and which is being implemented through legislation currently before Parliament. Lord Justice Jackson suggested that fears of conflicts of interest were perhaps overblown, and he could not see why contingency fees should give rise to any greater scope for conflicts of interest than CFAs.
Although the introduction of contingency fees may have been inevitable once CFAs were introduced, the change is no less significant for that. In the context of complex commercial claims, where it is likely that the true merits of a case will not be known until well after instructions are accepted, many may feel that a contingency fee is better able to reflect the risk a lawyer is taking on than the current restriction to a 100% uplift on basic fees under a CFA.
It is also significant that the arrival of contingency fees comes at a time when there is:
- First, a developing market for third party litigation funding, now regulated by a newly introduced code of conduct. The rise of this market demonstrates the interest of outside capital providers in investing in litigation risk.
- Second, a liberalised market for legal services, with the SRA having been designated as a licensing authority for ABSs just before Christmas, which means that for the first time there will be the possibility of non-lawyers owning and investing in law firms.
With these changes, there is the opportunity for outside capital providers to invest not only in litigation, via third party litigation funding arrangements, but also in law firms which pursue litigation. We may therefore see litigation being pursued by dramatically different firms in very different ways.
At the same time, the current regime governing CFAs and ATE insurance will also change dramatically, so that the costs of such arrangements are no longer recoverable from defendants, reverting to the pre-April 2000 position.
Against that background, the idea for the seminar was to try to look into the future and see how the various changes are likely to play out and how the litigation landscape will look in five years’ time, including: whether commercial litigation in this jurisdiction will commonly be pursued under DBAs by law firms owned and controlled by outside capital providers with a direct stake in the outcome of the cases pursued; if so, what impact that will have on the ethical standards of the profession, whether actual or perceived; and what impact there will be on the status of London as an international litigation centre.
Lord Justice Jackson
Lord Justice Jackson commented that it was an opportune time to host such a seminar as the legislation relating to changes in litigation funding is currently progressing through Parliament.
The civil litigation costs review required Lord Justice Jackson to look at the entire set of cost rules, funding rules and also the general procedures currently in place. This approach ensured that the review was conducted in a holistic way, looking at the issues and how they interrelate. The broad terms of reference for the review meant, however, that the report and recommendations were pitched at a certain level of generality. Lord Justice Jackson noted that there is much work still to be done on the detail of the reforms, including in relation to contingency fees, but first of all it is important to wait and see what Parliament will decide.
Following Lord Justice Jackson’s recommendation that contingency fees should be allowed, the government went to consultation on this issue, amongst other matters. In its response to the consultation it stated that contingency fees, or DBAs, would be permitted for civil litigation and would “provide a useful additional form of funding for claimants, for example in commercial claims”. Under the proposals, successful claimants would recover their costs on a conventional basis (i.e. the lawyer’s hourly rate and disbursements) but any shortfall will be payable by the claimant out of its damages.
The government adopted Lord Justice Jackson’s recommendation that the amount lawyers could take from the damages in personal injury cases should be capped (at 25% of damages excluding for future care and loss). However, the government said it was not persuaded by the recommendation that there should be a requirement for a claimant to obtain independent legal advice in respect of a DBA.
Lord Justice Jackson noted that the environment in which contingency fees are to be introduced will be very different from the present, including as a result of: the advent of ABSs; the abolition of recoverable success fees and ATE premiums, which will change the balance substantially as these arrangements will no longer have significant advantages over third party litigation funding; and the expansion of the litigation funding market, with its excellent new code of conduct.
For contingency fees, as for all of the other reforms, there are many details still to be worked out. Some issues that arise for consideration include:
- Does the public interest require that contingency fee agreements be regulated? (The Bill currently before Parliament permits the regulation of contingency fees but does not require it.) Or can the SRA Code of Conduct for Solicitors and the Bar’s Code of Conduct suffice, and if so what amendments might be required?
- Outside personal injury litigation, what cap (if any) should be placed on the percentage of damages payable to solicitors and counsel under a contingency fee agreement? Should this be expressed as the total sum payable to the lawyers or as the sum which the lawyers are entitled to take out of damages in addition to costs recovered on the conventional basis?
- Should there be a model form of contingency fee agreement or a set of such model agreements? If so, what should be their content? What should they say about termination? What should they say about liability for adverse costs?
Many similar issues have arisen in relation to third party funding, including in relation to termination rights and adverse costs liability. Lord Justice Jackson suggested that a working party similar to the group that produced the litigation funders’ code of conduct might usefully be set up to consider the detailed issues relating to contingency fees.
Leslie Perrin remarked that, to a litigation funder, litigation is a contingent asset or a contingent liability, the value of which depends on assessing both the likelihood of a positive outcome and the true quantum of the claim. In-house legal teams do not always see litigation in these terms. To them, the only certainty in litigation is that costs will be high and difficult both to predict and to manage.
In most similar situations, for example if a business is exposed to fluctuating exchange rates or other risks, it will manage its risk through hedging or insurance. Businesses do not generally approach litigation in the same way. If they did, they would see litigation funding as a risk management exercise.
Leslie commented on three areas which affect both third party funders and, in future, solicitors offering damages based agreements:
- Capital adequacy: Under the new code of conduct, litigation funders are required to maintain adequate financial resources to cover their funding liabilities for a minimum period of three years. Solicitors have no similar requirements. This means an unequal playing field between solicitors offering DBAs and litigation funders.
- Termination of arrangements: The code governs the circumstances in which a funder can withdraw from a case. It is not clear how this issue will be dealt with for solicitors offering DBAs.
- Public policy regarding control over the litigation: The surviving influence of maintenance and champerty exerts limits over the extent to which litigation funders can have control over a piece of litigation.
Leslie noted that alternative models may develop where the litigation funder is funding the law firm rather than the claimant, which would produce quite a different dynamic.
Matthew Amey commented that the ATE market is almost unique in England and Wales. Having started out covering a party’s adverse costs risk, it has evolved to cover a party’s disbursements and, in some cases, even a party’s own solicitor’s fees. However, there is some uncertainty over whether the ATE market will continue to be viable once the Jackson reforms are implemented.
At the moment, ATE insurance has three very attractive features:
- Premiums that are deferred, so that they do not have to be paid until the conclusion of the case;
- Premiums that are contingent, so that they do not have to be paid at all if the case fails; and
- Premiums that are recoverable, so that they are payable by the opponent if the case succeeds.
ATE needs to be attractive, because parties are less inclined to think they need ATE cover for good cases. If the third advantage referred to above, recoverability, is removed, the basket of cases for which ATE insurance is sought could downgrade as parties become less willing to pay for ATE cover. This would be a problem for the ATE market, as the premiums payable in successful cases are needed to cover the cost of paying out in unsuccessful cases. On the other hand, it may be that parties will still be willing to pay for insurance, as it remains the cheapest way to transfer risk.
Some believe that premiums will go down following the end to recoverability, as to date they have been kept artificially high by the fact that the party taking out the policy is not the one paying the premium. However, Matthew believes premiums for commercial cases will stay the same, as sophisticated commercial clients currently do shop round for a number of reasons, including that they know the premium will come out of any settlement amount and that they do not want to be left with a shortfall on detailed assessment.
Matthew believes the ATE market will survive, but will look different from at present. In particular, the market is likely to move into assisting litigation funders, and/or solicitors on damages based agreements, to cover their risks. It may be that we will even see insurers guaranteeing firms a minimum level of income. There may also be an increased move to develop “one stop shops” with a combined funder and insurer.
John Kunzler commented that when businesses pursue or defend litigation they want certainty, in particular that they will not be making matters worse by doing so. When the Woolf reforms were introduced in the late 1990s they had some positive impact, but there are certain areas in which the battle was not won, in particular: disclosure, which remains hugely expensive and undercuts certainty; and the costs assessment process, in which the court seems reluctant to cut down recoverable costs sufficiently. Accordingly, the moves to control these aspects are welcome.
With regard to DBAs, whilst these could have merit, it is generally the case that as a case approaches settlement the question of how much the claimant will actually take home becomes the key issue. If the claimant is liable for the shortfall under its DBA, this could be an impediment to settlement, just as the additional costs of a CFA / ATE policy are now.
When you add ABSs to the mix, the uncertainty becomes even greater, and unless there are capital adequacy requirements introduced for ABSs (or other firms taking on DBAs) there will be an uneven playing field. There is also the question of whether DBA firms will be liable for adverse costs where a case is unsuccessful, and what impact this will have on a firm’s risk profile and its insurance position.
In John’s view, the one certainty is that businesses will continue to require expert advice to guide them through this changed landscape.
Charles Plant explained that the SRA sets the standards expected of the profession through its code of conduct. When the government introduces new legislation affecting the profession, such as removing the restrictions on contingency fees and permitting solicitors to operate through ABSs, it is the role of the SRA to ensure that the public is protected by the means of implementation.
From 6 October 2011, the SRA’s regulatory approach has been principles-based, risk-based and outcomes focused. Before that date, there was a huge code of conduct for solicitors, which tended to lead to a “tick-box” exercise and reactive regulation. The code is now just 50 pages and the approach to regulation is proactive. The code contains various mandatory principles which are highly relevant, such as the need to maintain integrity, act in the best interests of the client, and run your business in a sound manner. There are also mandatory outcomes, such as ensuring that clients are treated fairly. There is however flexibility on how those outcomes can be achieved, as what is required might be quite different depending on what sort of client the solicitor is dealing with.
DBAs are not currently permitted for civil litigation, but they are in employment tribunals where, under the applicable regulations, they are subject to a 35% cap. The SRA Board has not yet addressed the question of how DBAs should be regulated, as first we need to see the final position adopted by Parliament. However, in Charles’s view, the starting point is that DBAs are unlikely to require specific additional regulatory controls by the SRA. If, for instance, the government does not seek to impose a percentage cap on the amount that can be paid to a solicitor under a DBA, in line with its position in the response to consultation, the SRA is highly unlikely to seek to impose such a cap. Similarly, he agrees with the government’s approach that there is no need for independent advice where a client enters into a DBA with its solicitor.
The SRA may however ask DBA firms, in particular, to satisfy it that they are meeting the requirement to run their business in a sound way, and not running a significant risk on their DBA book of business.
The SRA will also have to address the question of whether a litigation funder or claims management company could be the owner of an ABS, if it receives applications to license such structures. The SRA will have to apply the suitability test, as to who should be entitled to own a law firm, and this test will be applied stringently. There is an additional control in that every firm, including an ABS, must have a compliance offer, and part of that role will be to ensure that the owner of the ABS does not have improper control over the conduct of litigation.
Referring back to the title of the seminar, Michael Napier said it is certain that contingency fees will change commercial litigation because they will be better for the client, and so clients are likely to demand these arrangements from their lawyers. Firms will have to meet this demand.
As Michael pointed out, history teaches us that costs reforms result in unintended consequences:
- When “type 1” CFAs were introduced in 1995 in only three areas (personal injury, human rights and insolvency), no one anticipated that five years later they would be extended to all civil cases and that “type 2” CFAs would permit recovery of success fees and ATE premiums.
- In 2000, no one anticipated that the introduction of recoverability via “type 2” CFAs and the legitimisation of referral fees would lead to the proliferation of claims management companies, and the cost wars.
- In 2005, when we were in the middle of the costs wars, no one anticipated that five years later they would lead to Jackson LJ being asked to conduct his fundamental review of civil costs.
- In 2012, when the legislation to implement the Jackson reforms is before Parliament, no one can foresee what the consequences will be in 2017. But, if history is anything to go by, some of them will be unintended.
As for what the litigation landscape will look like five years from now, Michael made a number of predictions:
- Clients will have more options to choose when it comes to funding, and this increased choice means that contingency fees are a good thing.
- Because there are more options, there will be more difficult decisions, including for those regulating solicitors.
- Because there will be more difficult decisions, there will be confusion, and solicitors will have a duty to ensure that clients are not confused.
- Confusion leads to more satellite litigation, which is likely to be an unintended consequence of the reforms.
Overall, however, the introduction of contingency fees means that sophisticated clients will sit down with their solicitors and discuss the issues and how their litigation can be funded. A recent article regarding how one US firm is using blended contingency fee / fixed fee arrangements shows that these structures can be very imaginative.
Some points of interest emerging from the discussion included:
- Lord Justice Jackson has an open mind as to whether there ought to be a cap on contingency fees in commercial cases, similar to the 35% limit that exists for DBAs in employment tribunals. He sees considerable force in the argument that, in the commercial context, there is no reason why sophisticated clients and solicitors should not reach whatever agreement they wish. If litigation is very high risk, solicitors may only be prepared to act on under a DBA if the fee is greater than 35%. Contingency fees have the benefit of widening the range of funding options available, and caution should be exercised before those options are cut down unnecessarily.
- Leslie Perrin commented that litigation funders are likely to feel uncomfortable if a case is of a nature to require a contingency fee of more than 40% or 45%, as it begins to look like the funder is taking control of the litigation if it is to receive a majority of the spoils. The vestiges of maintenance and champerty are helpful to the extent that they impose a curb on what might turn into greed and improper control of the litigation.
- One participant commented that the best approach is to remain flexible and allow market forces to operate. The UK reforms tend to view funding as a series of choices, rather than flexible solutions that can be combined. In the US there is an active market in managing litigation risk through a number of mechanisms, including floating bond issues based on litigation risk.
- There was some discussion of how contingency fees would affect the Bar. There was speculation that the Bar might be slower to embrace contingency fees, as barristers are independent practitioners and therefore less able to take the sort of risk associated with these arrangements, but that the Bar would come to accept them in time. Changes to the Bar as a result of ABSs may make barristers better able to take these risks. Lord Justice Jackson commented that we are likely to see a range of responses, with some barristers insisting on payment on a traditional basis, but others willing to act on a “no win, low fee” arrangement if not a pure contingency fee.
- There was discussion of the potential for regulatory arbitrage if third party funders are liable for adverse costs but solicitors acting under DBAs have no such liability. This might drive funders to buy or set up law firms (whether traditional firms or ABSs) to conduct cases under DBAs, rather than putting in funding as a third party, so as to benefit from that protection.