by Elizabeth Taylor

Third Party Litigation Funding: A Risky Business

When I made the move from being an insolvency lawyer in private practice to working in litigation funding, being a firm advocate of funding myself, I was surprised at the level of scepticism with which I was met from insolvency practitioners especially. One former client in particular told me that he held funders in low regard because they only ever cherry picked the best cases.

Was he right about that? Well, probably yes, but can you blame funders for this? There have been a number of cases recently which have put funders firmly in the firing line when it comes to third party costs orders and applications for security for costs. Funders are no different from any other investors in that before committing their money they need to be reasonably satisfied that they are going to make a return on their investment. Litigation funding is after all intended to be an investment, not a gamble. As such thorough due diligence is essential and the development of case law in this area means that, forgive the contradictory metaphor, funders are going to be even more keen to ensure that they only back winners.

CPR 25.14 states that the court may make an order for security for costs against a person other than the claimant where that person has contributed or agreed to contribute to the claimant’s costs in return for a share of any money or property which the claimant may recover in the proceedings and that person is a person against whom a costs order may be made. Section 51 of the Senior Courts Act provides that the Court shall have “full power to determine by whom and to what extent the costs are to be paid” and as such the court has power to make a costs order against a non-party. It is therefore quite clear that the court has power to make a costs order against a funder.

Since 2005, the Court of Appeal decision in Arkin v Borchard Lines Ltd [2005] 1 WLR 3055 has been good authority for the principle that a professional funder can be liable for the winning party’s costs but only to the extent of the funding provided. This is known as the Arkin Cap.

In the case of Excalibur Ventures LLC v Texas Keystone Inc and others [2016] EWCA Civ 1144 the court held that a funder was liable to pay the Defendant’s costs on an indemnity basis even though the funder had no influence over the manner in which the claimant and its legal team conducted the litigation. The court went further and, noting the very wide discretion afforded by Section 51, held that the costs order could be made against the funder’s parent company as the ultimate source of the funds and the ultimate beneficiary in the event of a successful outcome to the litigation. The judge at first instance commented that a professional funder should follow the fortunes of those from whom he hoped to derive a small fortune. Although the Court of Appeal was not asked to comment on the Arkin Cap, in dismissing the appeal it upheld the judge’s decision at first instance to apply the Arkin Cap and held that funds advanced by way of security for costs should be treated in the same way as sums advanced to pay the Claimant’s costs and should therefore be included in calculating the limit of the funder’s liability under the Arkin Cap.

In Wall v Royal Bank of Scotland Plc [2016] EWHC 2460, Mr Wall had a claim against RBS for around £700 million in respect of a mis-selling claim. The claim was funded by a third-party litigation funder pursuant to whose funding agreement they were liable to advance funds of a maximum of £9 million. ATE policies were also in place. The first layer of ATE was in the sum of £2 million, supported by a deed of indemnity. The second layer was in the sum of £2m and included anti-avoidance provisions. The third layer also contained an anti-avoidance endorsement. Notwithstanding these safeguards, RBS made a security for costs application against the funder, alleging that that the terms of these policies were insufficient to cover their anticipated costs exceeding £17 million and that the deed of indemnity and anti-avoidance provisions would offer no protection in the event that the underlying ATE policies were avoided, which they contended could still happen. Amongst the arguments run by the funder was that any security for costs order should be limited to the extent of their funding obligations, namely, £9 million. The judge declined to make a security for costs order against the funder on the basis of a last minute increase in the ATE funding package to £13 million and he was therefore not required to deal with the Arkin Cap point. On the one hand this looks very positive for the funder. However, the outcome means that third-party funders are likely to be looking very carefully at the terms of ATE policies as part of their due diligence where a security for costs application is likely, to ensure that either deeds of indemnity are in place or the policies include anti-avoidance provisions.

Premier Motorauctions Ltd (In Liquidation) v PwC LLP [2017] EWCA Civ 1872 was a case brought by the liquidators of the claimant against their former professional advisors in the context of which reliance was to be placed upon evidence provided in the form of witness statements given by the claimant’s former directors. Despite ATE policies being in place, a security for costs application was made by PwC but at first instance Snowden J held that an appropriately framed ATE insurance policy can in theory be an answer to an application for security, thus following the decision in Wall v RBS. Snowdon J refused to find that there was reason to believe that the ATE policy provider would seek to avoid the policy for non-disclosure or misrepresentation despite the fact that doubts had been expressed as to the credibility of one of the directors. The Court of Appeal took a different view. Because there were no anti-avoidance provisions in the ATE policies and no deed of indemnity from the insurers, the court concluded that the policies could be avoided in the event the court disbelieved the evidence of the directors and went on to order the provision of security in the sum of £4 million.

In the case of Bailey v GlaxoSmithKline [2017] EWHC 3195 QB the defendant applied for security for costs amounting to £6.8 million from a third party funder. The funder in question was balance sheet insolvent, relying upon its sole shareholder for liquidity. The funder argued that its liability should be capped at £1.2 million, being the extent of its obligations under the funding agreement. However, the defendant argued that the Arkin Cap did not apply to applications for security for costs and that applying the cap would cause substantial injustice. Foskett J decided that the Arkin Cap did not apply to security for costs applications and that this would cause no injustice because if at the end of the trial the defendant was awarded its costs and the trial judge applied the Arkin Cap, the difference could be refunded. On this basis he ordered that security be provided in the sum of £1.75m. The figure would have been much higher but for the fact that an ATE policy was in place. The policy had no anti avoidance provisions and so to reflect the risk that the policy could potentially be avoided the judge ordered a deduction from the security figure amounting to two thirds of the value of the ATE policy.

Foskett J went on to cast doubt as to whether the Arkin Cap would apply in all cases at the end of the trial. He commented that the trial judge has a wide discretion when it comes to costs orders and that it was inappropriate for that discretion to be fettered by the mandatory application of the cap. This clearly leaves a funder very exposed.

However, he went on to decide that the defendant should provide a cross undertaking in damages to compensate the funder for the cost of borrowing the required funds and its inability to generate revenue from the application of the funds elsewhere. I suspect that this aspect of the judgment was based very much on the specific facts of the case as it would be highly unusual for a professional litigation funder to encounter the liquidity issues faced by the funder in this case. As such, I doubt that there is much comfort to be drawn by funders from this aspect of the judgment.

It is clear from the above cases that the approach of the courts towards the position of litigation funders is evolving rapidly alongside the growth of the litigation funding industry in general. The prospect of the abolition of the Arkin Cap looms following the comments of Foskett J in Bailey v GlaxoSmithKline which creates uncertainly for funders as to their potential maximum exposure in respect of adverse costs and security for costs. This makes assessing the risks even more challenging for a funder and, as a consequence, claimants can expect funders to be even more thorough in their due diligence, to insist that ATE policies contain anti-avoidance provisions and to have their baskets at the ready for picking only the ripest of cherries.