Funding options for insolvent companies are about to change

What are CFAs and what is ATE insurance?

CFAs provide that, if the case is lost, the lawyer receives either no fee (on a 100% CFA) or a discounted fee, but if the case is won, the lawyer receives a success fee in addition to his or her ordinary costs.

ATE insures against the risk that, if the claimant loses the litigation, he will be ordered to pay the other side’s costs. ATE insurers receive a premium if the case is won. If the case is lost, they receive no premium.

Why do IPs like CFAs and ATE insurance?

CFAs and ATE Insurance are popular with office-holder claimants because they protect against costs exposure (both their own costs and the other side’s costs), and, in the event of a successful outcome, recover from defendants their ATE insurance premiums and CFA success fees.

This is about to change.

The Future

From April 2016, CFA success fees and ATE insurance premiums will no longer be recoverable from defendants.[1]

This development was ferociously resisted by industry professionals including R3[2], who commissioned a research committee and an 80 page report on the likely effect of the abolition of recoverability on insolvency litigation.[3] The crux of that report was that insolvent companies frequently have few or no assets to fund litigation. Without CFAs and ATE coupled with recoverability, the report predicts that fewer insolvency claims will be brought, which is “likely to have a negative effect on creditors (both in the public and private sectors) and on public confidence in the rigorous enforcement of the insolvency regime.”

Like it or loathe it, the die has been cast. What does this mean for the future of insolvency claims where the company has insufficient assets to cover its own costs of litigation?

CFAs and ATE

CFAs and ATE insurance are not being abolished, only the ability to recover the uplift and premium from defendants. Office-holders will need to work closely with their solicitors to (a) define “success” in CFAs and (b) carefully consider the merits of any claim before starting proceedings. Successful litigation will result in the creditors’ pot being reduced by the success fee and insurance premium, but in cases where there is a decent sized pot at stake and strong prospects of success, CFA funding (with or without ATE backing) may still be a good option.

Damages Based Agreements (“DBAs”)

DBAs were introduced in 2013[4] and make a solicitor’s fee contingent upon the success of the case, and determined as a percentage of the compensation received by the client. The maximum payment a solicitor may receive is capped at 50% of the damages.

The use of DBAs in insolvency litigation is virtually unheard of for a few main reasons. Firstly, there is a conflict between office-holders’ and solicitors’ interests. In weak claims, office-holders may propose a DBA to minimise their own and the creditors’ risk, but there is no incentive for a solicitor to take on a weak claim where they will not even cover their base costs if there is no win. Conversely, in a strong case, DBAs substantially reduce the realisation for the estate, which is not attractive to office-holders. Secondly, there is doubt that the DBA Regulations permit hybrid DBAs, whereby solicitors could take on a case partly funded and partly under the terms of a DBA.

Independent Third Party Funding

Litigation funding for insolvency claims by an independent third party is a relatively new arrival on the scene. Memery Crystal works with a number of third party funders, who may be willing to maintain or support an office-holder in bringing a claim on behalf of an insolvent company, and provide an indemnity for adverse costs, in return for a share in the eventual proceeds. Often, we work with the funder on a CFA basis.

If you are considering this type of funding, make sure that your solicitor team:

• has a good relationship with the right kind of funders. This will save time and money at the early stages of an action;
• is mindful of the office-holder’s fiduciary duty not to fetter its discretionary powers. This will be important in terms of the drafting of the funding agreements, managing the relationship between those with an interest in the claim, and generally in terms of the ongoing conduct of the case.

Creditor Funding

Creditor funding often works effectively. Creditors may well have valuable insight into the misconduct complained of, and they certainly have the most to gain from a successful claim. Again, it will be important for your solicitor team to take care to protect the office-holder’s fiduciary duty not to fetter its discretionary powers in the conduct of the case and drafting of funding agreements.

Where one creditor, or a small group of creditors, is prepared to take on the funding burden, they may expect to receive a greater share of the recoveries than those who do not participate. This requires careful procedural and drafting attention, which should be discussed in detail with your solicitor team.

Assignment of Claims

Since October 2015[5], officeholders have the ability to assign “”officeholder claims” such as wrongful trading, transactions at an undervalue, preferences and unfair preferences. Categories of potential assignees may include shareholders or creditors of the insolvent company, and office-holders can assign the right to bring the action itself, as well as the proceeds of such action.

Some claims remain incapable of assignment by an office-holder. This is something to discuss with your solicitor team at the outset.