If you Litigate, be Commercial: Litigation Funding and Risk Mitigation

This article was originally published in The International In-House Counsel Journal, Vol. 15 No. 60, written by Razi Mireskandari, David Phillips and Howard Roberts, In-house Counsel at Maxima Creditor Resolutions. 

A contact, a senior in-house lawyer for a multi-national software and hardware firm, said his days were regularly punctuated with calls from members of the sales team asking whether they could dispense with one or more clauses in the firm’s standard terms and conditions. That was usually in order to, “secure the major deal as the customer won’t agree to purchase including that clause”.

The usual reply given was that: –

• it was a commercial rather than a legal issue, so the sales- person would have to take responsibility for a commercial decision;
• the standard clauses were necessary to protect the interests of the firm and if the salesperson wanted to delete a standard clause then so be it.

Obviously, the salesperson knew full well – before calling – that they were not prepared to take responsibility and probably had questionable authority to make such a decision. However, the salesperson was conscious of their bonus arising upon completion of a sale (rather than any later legal problems).

Typically, the salesperson was able to do some form of deal regardless, but ultimately, the firm avoided massive amounts of unnecessary, time-consuming and inefficient litigation.

In-house lawyers are expected – not least by professional regulators – to be “gate-keepers” whose function is to keep the company (which is of course a separate legal personality) honest. This requires a difficult balance between commerciality and legality.

There is also an element of professional ethics, whereby the lawyer’s client is the company itself – rather than a specific director or even a specific team. That can cause practical difficulties, where the actions (or potential actions of officers or employees might breach fiduciary obligations, which they owe to the company.

It is against the context of the above – commerciality v legality (plus professional ethics) – that decisions are often made about whether or not to pursue litigation.

Litigation

Litigation is often seen as a last resort for resolving disputes, and for very good reasons. The chances are, as in-house counsel, if you decide to take your commercial litigation to an external law firm they will tell you two things: 1) litigation is risky; and 2) it is expensive. They may even tell you the prospects of success (rarely greater than 60% and never greater than 70%) and a non-binding estimate of costs to take your claim to trial and advise you on your potential exposure to the other side’s (difficult to estimate) costs if you lose the claim.

They should also provide a realistic estimate of the value of the claim, and consider the other side’s assets and creditworthiness so that if you win, you can be confident that the judgment is going to be worth more than the piece of paper it is written on!

Then assume that they tell you the prospects are good, and the other side are likely to be good for the money; you will likely need to feed it back to your internal stakeholders, who will need to take a view of the risk -v- reward (how much are we going to have to spend and how much will we recover if we win). If the claim gets the internal “go-ahead”, finance will need to set aside a large (but unspecified) amount of cash to meet the ongoing and ever-increasing cost of the litigation; hard to do when cashflow projection is very difficult. Furthermore, resources will need to be diverted from your key business.

For smaller businesses, litigation may simply be out of the question as even if you win, the legal costs you have to meet in the medium term would cripple your business, and even if you could fund it, if you lose, your liability for the other side’s costs could certainly finish off your business.

Keeping focussed on the commercial rationale is vital. Is the potential reward worth the diversion of resources (both financial and business management time), and the risk of losing the claim entirely? It is generally never advisable to litigate on a matter of principle alone, so the commercial basis of your decision to litigate must be sound.

Lawyers strive to eradicate risk from their clients. Commercial people turn risk into profit.

You cannot litigate without risk. But you can limit and share the risk and financially align all the stakeholders’ (including the lawyers’) interests. Law firms often fall short in advising their clients of all the funding choices available to those with meritorious claims. This may be because external lawyers, paid for their time working on a claim, are not incentivised to consider whether commercial litigation is commercially sensible for their client.

Lawyers paid in the traditional privately funded way are paid no matter the outcome. It could however be because they are not aware of the options available for litigation risk management. After all, the market is in its relative infancy and continually evolving with new products developed by people and businesses thinking about litigation risk and legal costs in a new way. Or it could simply be that the lawyer does not want to take on any risk.

Litigation funding in the UK has only really been an option for just over a decade. Before then, lawyers got paid for what they did and their remuneration could not be linked to the outcome. The legal industry has been traditionally slow to develop and embrace new ways of working. Below we aim to explain some of the options which may be available, which allow litigants to mitigate and hedge their litigation risk, and to think about their litigation opportunities as potential business assets rather than uncertain liabilities.

After the Event Insurance (ATE)

The default position in UK litigation is that the loser pays the winner’s legal costs. Insurers realised the need for a product to protect against this risk. As a result, specialist underwriters began to appear who understood the legal market and litigation risk.

There are different types of ATE. The most common form provides cover against the other side’s costs up to the level of indemnity if the insured loses their claim. In its purest form, the premium is only payable if you win, so if you lose there is nothing to pay. The premium can also be staged to increase over time or at a particular stage in the litigation.

ATE providers stage their premiums to encourage early settlement, as even insurers, who operate in the business of risk, want to mitigate their own risk exposure and recognise that the longer a claim is litigated the greater their exposure and the greater the risk.

You can use ATE to cover your entire exposure for adverse costs, or exposure to a certain level. You can decide to pay some or all of the premium upfront to reduce the premium. You can even use ATE to cover some of your own legal fees and disbursements. This is less common, but becoming more popular.

It is important to remember, however, that in most types of claims the premium is the insured’s liability, and it cannot be recovered from the other side. ATE is also relatively expensive compared to other types of insurance products. Typical premiums for claims which run to trial can range from 30-60% of the level of the cover required. Unlike other insurance products, which are often obtained to protect against a future risk which may never arise, ATE provides cover when the potential exposure (to the other side’s costs) has been triggered, so the risks to insurers are considerably greater.

Some ATE insurers also offer disbursement funding to pay expenses such as court fees, expert fees etc. These loans usually incur interest, but, again, the principal and interest are only repayable if the claim is successful. The creation of disbursements funding facilities has made it easier for lawyers to take on claims “at risk” under CFAs or DBAs (see below), by removing the need to cashflow such expenses.

Litigation Funding / Finance (LF)

Until relatively recently it was illegal in the UK for a third party to fund litigation in exchange for a return on that investment. There has however been an evolution in the law and consequently, the LF market popped up in the UK, both with homegrown LF businesses and those importing their experience in more developed markets such as the US, where LF has been commonplace for much longer. The market has expanded rapidly, and in 2020 was valued at around £2 billion.

LF can pay, in whole or in part, your own lawyer’s fees, the ATE premium, disbursements and/or any other cost associated with your claim. This is usually the most expensive means of funding litigation. Typically, a funder will be looking for a return of money x2 – x5. This means that funders are unlikely to seriously consider any claim with an investment ratio of less than 8-10 (legal costs -v-the total damages figure), depending on the investment size.

For example, assume a funder has invested £100k in a claim worth £500k where an offer of £300k has been made which you wish to accept. If the funder has agreed on moneyx2 there may be nothing left. The claimant could be left with the prospect of ending the litigation with nothing or continuing the claim to trial with huge uncertainty for minimal potential benefits.

To reduce the chances of this sort of conflict arising, many funders only look at much larger claims, where legal costs are shadowed by the potential damages. The most publicised are large consumer claims (Diesel emissions / Mastercard / Sony Playstation etc.), but funding is often available for large private claims, and there are specialist funders who fund “smaller” claims with investments of less than £500k. There has also recently been an emergence in p2p lending for litigation, where claimants pitch for funding of part of their claim (such as disbursements and a percentage of their legal fees) in exchange for a return on that investment.

Contingent Fee Arrangements

Commonly known as “no-win no fee” arrangements, these are mostly associated with road traffic incidents and personal injury claims. However, they are regularly used for commercial claims by sophisticated legal services users. Essentially, they are arrangements where the lawyers (often both solicitors and barristers) only get paid if the claim is successful, and in exchange for the risk they take on, get a success fee on top of their normal fees. There are 2 different arrangements: Conditional Fee Agreements (CFAs); and Damages Based Agreements (DBAs).

CFAs are arrangements whereby on the success of a claim the client pays the lawyers’ normal fees, plus a success fee of up to 100% of those incurred fees. The lawyers’ “upside” is therefore capped at their incurred fees x1. So, if a settlement proposal is received early in the litigation, the overall cost to the claimant is likely to be modest.

As the claim progresses, and the time costs increase, so does the contingent liability. However, the cost is only actually paid if the claim is successful and assuming your lawyers have given you an accurate estimate of fees before the claim commences you will know your maximum liability at any particular stage in the litigation. It is also likely to be much cheaper than LF, which as mentioned usually requires investment multiples of all the money invested x2-x4.

DBAs on the other hand are arrangements whereby the lawyers receive an agreed percentage of the damages recovered from the other side. The maximum percentage solicitors can charge under a DBA is 50% of the damages.

Our approach

At SMB, when a client comes to us with potential litigation we consider carefully the options which may be available, and we like to understand a client’s appetite to risk. The options discussed above are not available in every case. The basic principles set out in the introduction still apply, i.e. what are the prospects of success and is the other side good for the money. Additionally, we will need to consider the likely cost of the litigation compared to the potential reward. Only then will we know whether the claim makes commercial sense.

If a client is happy to pay for their legal costs as the litigation progresses, and is willing to accept the risk of a potential adverse costs order, then that is the cheapest option overall (assuming they win).

Often, however, a client is either unable to afford the litigation or wants to hedge some or all of the risk. In which case, assuming it makes commercial sense, SMB’s preference is usually to offer a CFA or a DBA, perhaps backed by an ATE policy. This reduces the risks of conflicts arising between different interests and SMB and the client retains the rewards if the claim is successful. It is also comparatively cheaper for the client than LF, which allows more flexibility when it comes to settlement proposals.

For larger claims, which we estimate will go on for a longer period (usually more than 18 months) we may suggest partial a CFA or DBA, with some of the costs met by the client or a third-party funder. This mitigates both the lawyers’ risk and the risk to the funder, whether that be the client or an LF provider. It also increases the likelihood that a claim is commercially viable, as the overall cost is reduced when compared to a claim which is fully funded by LF.

Summary

When you are considering whether to litigate, make sure you discuss all the options available with your external legal team and internal stakeholders. You will know best your organisation’s appetite to litigate and its risk tolerances. If your legal team do not feel equipped to advise, consider consulting a specialist regulated ATE and funding broker who will have a better view of the market and the different options available.

If your lawyers are reluctant to shoulder some of the litigation risk, consider why. Especially if the prospects of success are good, and the chances of enforcing a claim against the other side are high. Lawyers and law firms naturally have their own cash flow and billing pressures, and for smaller firms in particular it can be difficult to carry a claim for years without being paid at all, but never be afraid to ask difficult questions. You might be surprised at the response.