A Free Pass for Fraudsters? Funding Reforms to Affect Insolvency Litigation

The last two years has witnessed major changes to the civil litigation regime known collectively as the ‘Jackson Reforms’. These reforms, sculpted by Lord Justice Jackson, have had a major impact on the litigation landscape, especially regarding costs and funding. Most of the reforms came into effect in April 2013. However, insolvency litigation has been exempt from the Jackson Reforms until April 2015. Now that the due date approaches, this piece explores the changes and their probable impact for insolvency proceedings.

The reforms relate to Conditional Fee Arrangements (CFAs) and After the Event Insurance (ATE). CFAs are an agreement between lawyers and those wishing to litigate where payment of a lawyer’s fees are only triggered if the litigation is successful. This is designed as an incentive for those who wish to litigate but do not have the requisite funds. The incentive for the lawyer is that, on top of their fees, they can also receive a ‘success fee’ payment if the litigation is successful.

ATE is a further incentive for those wishing to litigate who are concerned about having to pay the other side’s legal costs if they lose the litigation (a standard rule in civil litigation). ATE provides the prospective litigant with an option to secure insurance to protect against having to pay the other side’s costs if they lose.

A significant proportion of insolvency professionals use CFAs and ATE to fund insolvency litigation, including many of our own clients. Importantly, the Government believes that insolvency litigation is in the public interest as it acts as both a deterrent and a regime to punish fraudulent directors who deliberately wind-up their companies in order to avoid creditors. Such creditors are often HMRC so insolvency proceedings also provide a mechanism for the Government to recover tax. This public benefit is the main reason why insolvency proceedings have remained exempt from the Jackson Reforms, until now.

From April 2015, success fees deriving from CFAs and ATE premiums will no longer be recoverable (by lawyers and insurance companies respectively) for insolvency proceedings. This has caused controversy in the insolvency profession who unsuccessfully lobbied for insolvency proceedings to be exempt from these reforms. They argue that the abolition of the recoverability of success fees and ATE premiums will discourage insolvency litigation which will allow fraudulent directors to profit and the public purse, as well as private creditors, to suffer accordingly.

In April 2014, Professor Peter Walton published ‘The Likely Effect of the Jackson Reforms on Insolvency Litigation – an Empirical Investigation.’ This research was supported by many organisations with an interest in this issue, such as the Insolvency Practitioners Association.

In his report, Professor Walton argues that the Jackson Reforms are not applicable to insolvency litigation as their main aims were to address the disproportionality of legal costs to the value of the claim (such claims often being frivolous) and the ‘cherry picking’ of only the strongest claims by lawyers. In contrast, Walton argues that insolvency litigation, as it is in the public interest, is never frivolous nor the costs disproportionate as it allows the public purse to be reimbursed.

The statistics in the report also suggest that the Jackson Reforms may have a negative impact on the insolvency industry. For example, insolvency proceedings currently backed by CFAs enforce claims of approximately £300 million per annum. Of that figure, up to £70 million is money owed to HMRC.

Spring Law specialise in the SME market and, worryingly, it is the small to mid-market that may be most vulnerable to the actions of fraudulent company directors. The report points out that the majority of insolvency claims realise £50,000 or less. The concern is that due to the reforms, these smaller value cases are less likely to be pursued. This could have the unsavoury side-effect of giving fraudulent directors a carte-blanche to deliberately fold companies which owe creditors £50,000 or less and avoid any recourse through insolvency litigation.

It has yet to be seen how these reforms will impact insolvency litigation but if the problems outlined above do come to bear, then the Government may be forced to introduce amendments to these reforms. Spring Law work with providers of litigation and ATE funding and they have informed us that insolvency practitioners will need to move quickly to file claims before April 2015 in order to retain CFAs with success fees and ATE insurance. If you would like more information on how to bring such a claim or attain litigation insurance, please contact Andrew Day or Rory Lynch in the Dispute Resolution team.