by Elizabeth Taylor

Acquisition of claims by Third Party Litigation Funders

 

As third-party litigation funders, we are often asked by insolvency office holders whether we are interested in acquiring claims as opposed to funding them. The answer to that question depends on the type of claim because not all claims are capable of assignment.

Schedules 1, 4 and 6 of the Insolvency Act 1986 give administrators, liquidators and trustees in bankruptcy respectively the power to sell the property of the company or bankrupt. Section 436 of the IA86 contains a definition of the word “Property” which includes “things in action”. As such it is quite clear that the office holder has the power to sell or assign any claim that vested in the company or the bankrupt prior to the commencement of the insolvency.

The IA86 also creates causes of action that vest in the office holder. These give the office holder the power to challenge a variety of prior transactions such as preferences, transactions at undervalue (including their Scottish equivalents), wrongful and fraudulent trading and extortionate credit transactions. Historically these office holder claims were not capable of assignment but changes to the legislation introduced by the Small Business Enterprise and Employment Act 2015 (which created a new Section 246ZD IA86) mean that liquidators and administrators can now assign office holder claims where the liquidation or administration commenced on or after 1st October 2015. However, the law has not changed in respect of trustees in bankruptcy who remain unable to assign office holder claims.

Section 212 IA86 provides a liquidator with a summary remedy against delinquent directors who are guilty of misfeasance or breach of duty. However, the section does not give rise to a new cause of action. Rather, it simply allows the liquidator to pursue a claim in place of the company. Claims under section 212 have therefore always been capable of assignment. However, for limitation purposes, time starts to run from the date of the conduct complained of, not the date of the liquidation so unless the claim can be brought within the parameters of Section 21(1)(b) Limitation Act 1980[1] they can become statute barred early on in the liquidation and as such not assignable.

The advantage for the funder of acquiring claims as opposed to funding them is that they take control of the litigation and as such take charge of their own destiny as opposed to assuming the passive role required of a funder in order to avoid infringing the rules against champerty and maintenance. Whilst this clearly has its attractions, it is not without risk. Obviously, before taking an assignment of the claim the funder will undertake the usual due diligence in order to satisfy itself as to the merits of the claim. However, particularly for office holder claims, the funder is likely to require significant input from the office holder going forward to provide input into the case and even to act as a witness, so the funder will need to take care to ensure the deed of assignment imposes an obligation upon the office holder in this regard. After all, one of the reasons that the office holder wishes to assign the claim could well be that he or she has lost interest in pursuing it. The office holder may require payment in order to provide advice and assistance post assignment, which would not be unreasonable and, given his knowledge of the case and the documents, it is likely to be cheaper to ask the office holder for his assistance than an independent insolvency practitioner or accountant. The cost of this is likely to be factored into the price a funder is willing to pay to acquire the claim.

A funder may be willing to pay a large upfront payment to acquire the claim outright or it may prefer to offer a smaller upfront payment plus a share of the recovery. The former needs to be at a level that will enable the funder to make a return on its investment, taking into account the costs of pursuing the claim. The latter exposes the office holder to the possibility of a third-party costs order so he or she is likely to require an indemnity from the funder. Therefore, in either case the funder will need to be satisfied that the claim has excellent prospects of success which begs the question as to why the office holder wishes to assign the claim in the first place. Often the reason is that in reality the claim is not strong and the office holder does not wish to run the risk of pursuing it himself. I was recently asked by solicitors acting for a trustee in bankruptcy if we were interested in acquiring a preference claim. Apart from the fact that a trustee is not able to assign a preference claim, the covering email even stated that the merits were doubtful. If the office holder and his legal team don’t have confidence in the merits of the claim, it is unlikely to be an attractive acquisition for a funder.

On the face of it, book debt collections seem fairly straight forward. If a funder was asked at an early stage in the liquidation whether it was willing to acquire a book debt ledger, this might be an attractive proposition as a certain proportion of the debts are likely to be recoverable for little effort and expense. To be asked to purchase a stale rump of old debts just so that the office holder can close the case is unlikely to be an attractive proposition.

We were asked recently if we were interested in acquiring a straight forward book debt claim from the liquidator of a construction company. We declined this for several reasons. Book debts are never straightforward in construction cases. There are inevitably counterclaims for the cost of delays and arguments over the cost of variations and additional work. Often supporting documentation is missing or never existed and therefore the claim relies upon oral evidence from the director who may or may not be willing to assist and whose evidence may not be believed.

Before acquiring any claim from a liquidator or administrator, a funder will enquire as to whether the claim is subject to an outstanding debenture. Most standard debentures will include choses in action in the class of assets covered by the floating charge. The office holder is free to assign such claims without reference to the debenture holder who simply acquires corresponding security over the proceeds of the assignment. However, choses in action and book debts are sometimes included in the class of assets covered by the fixed charge. There are of course numerous and well-rehearsed arguments as to why a fixed charge over these classes of assets might be invalid and operate instead as a floating charge[2], but a funder will be very cautious before agreeing to take an assignment in these circumstances without first being provided with a deed of release from the lender or, in the case of administrations, sight of a court order[3] because without this the funder risks acquiring the claim subject to the security.

Notwithstanding the issues outlined above, many funders are willing to acquire claims from insolvency office holders. However, in practice, the most common reason for turning the application down is that the funder has identified the same concerns about the merits and commerciality as those which prompted the office holder to conclude he or she did not have the appetite to pursue the claim. As such the funder’s decision will come as no surprise.

 

[1] Section 21(1)(b) Limitation Act 1980 provides that no limitation period applies to claims to recover from a trustee trust property or the proceeds of trust property in the possession of the trustee, or previously received by the trustee and converted to his use.

[2] See Re Spectrum Plus Limited [2005] 2 AC 680

[3] Under Paragraph 71(1) Schedule B1 IA86