Banning recoverable conditional fee agreement uplifts in UK insolvency cases would cost creditors, industry warns

Out-Law News | 22 Apr 2014 | 3:01 pm | 2 min. read

Ending the exemption for insolvency litigation from court reforms preventing the recovery of after the event (ATE) legal insurance premiums and conditional fee arrangement (CFA) success fees from the unsuccessful party could cost creditors more than £150 million per year, according to industry body R3.

The current insolvency litigation exemption from the so-called 'Jackson reforms', which came into force on 1 April 2013, is due to come to an end next year. The Ministry of Justice has said that doing so would create consistency, but the industry has argued that insolvency litigation is in the unique position of already achieving the reforms' aims of better protecting public funds and the public interest.

Insolvency law expert Nicholas Pike of Pinsent Masons, the law firm behind Out-Law.com, said that many in the industry had expected the UK government to use the two year exemption either to put forward alternative proposals for insolvency cases, or else extend the exemption indefinitely. "It seems bizarre that the exemption would be introduced at all if it was only to be withdrawn, given that nothing material has changed in two years," he said.

"Insolvency cases are very different from insurance-based personal injury litigation, the rising costs of which the Jackson reforms were designed to crack down on," he said. "These are complex cases, and if a miscreant director has been really clever there may be no assets to fund litigation. Feasibly, at the moment, the only way in which a lawyer can justify taking on the risk and expense of these cases is under a conditional fee arrangement, enabling them to recover most of their costs from the unsuccessful defendant without significantly reducing the assets available to be distributed to the creditors."

"Getting rid of the recoverability of the CFA uplift in these cases removes a significant incentive to litigate on behalf of creditors, as payment of the CFA success fee will have to come out of whatever the damages the court awards, reducing the sums payable to creditors – which in almost all corporate insolvencies will include HMRC. Creditors would therefore be faced with a dilemma: either not to approve the insolvency practitioner litigating at all, enabling a rogue director to escape scot-free; or to authorise the pursuit of the case but lose a significant amount of what is owed to them," he said.

In 2010, Lord Justice Jackson recommended that CFA success fee uplifts and ATE premiums should no longer be recoverable from the losing party in civil litigation cases. The aim of these proposals was to crack down on the rising cost of civil litigation and to better protect public funds and the public interest. The changes were introduced along with substantial changes to the Civil Procedure Rules (CPRs) on 1 April 2013, with a temporary exemption for insolvency litigation after substantial industry lobbying.

According to a new report by Professor Peter Walton of Wolverhampton University, commissioned by R3 with the support of a number of industry bodies, most of the money currently recovered through insolvency litigation would be lost if the changes were extended to cover these cases (80-page / 2.7MB PDF). At particular risk would be the 78% of cases with less than £100,000 at stake, the costs of which would be disproportionate to the amount recovered. Professor Walton also found that removing the Jackson exemption would remove the incentive to settle before court in the vast majority of cases brought by insolvency practitioners.

"The threat of having costs recovered from them encourages directors to settle before cases reach court," said R3's deputy vice-president, Phillip Sykes. "This means lower legal costs, lower insolvency practitioner fees and higher returns for creditors. Without the threat of recoverable costs, directors know most creditors won't be able to afford a lengthy court fight to retrieve funds."

"Insolvency litigation is absolutely in the public interest, and it is absurd that the government is considering making it all but impossible for such cases to continue. Should the exemption be removed, only a few large cases involving wealthy, motivated creditors would go ahead. SMEs and taxpayers would lose out – and irresponsible directors would be laughing," he said.