Life after the insolvency exemption

22 Dec 2015

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What does the removal of the insolvency exemption mean for lawyers and insolvency practitioners? Frances Coulson, managing and client services partner at Moon Beever, offers her reactions to the recent announcement.

Original news

Government plans to introduce no win no fee reforms in respect of insolvency proceedings will enter into effect in April 2016, Minister of State for Civil Justice Lord Faulks has announced. In a Written Ministerial Statement, Lord Faulks also set out the period in which a review of the reforms would be carried out.

This means that conditional fee agreements (CFA) success fees and after the event (ATE) insurance premiums will no longer be recoverable in proceedings brought by liquidators, administrators, trustees in bankruptcy, and companies in liquidation or administration.

What is your immediate reaction to the announcement?

Strangely the announcement started with the words:

‘The Government has made a priority of addressing the high costs of civil litigation in England and Wales. To that end, Part 2 of the Legal Aid, Sentencing and Punishment of Offenders (LASPO) Act 2012 reforms the operation of no win no fee conditional fee agreements. Those reforms came into effect generally in April 2013 but were delayed in respect of insolvency proceedings. After further consideration the Government has decided that the no win no fee reforms should now be applied to insolvency proceedings. The provisions will come into force for these cases in April 2016.’

This appears to miss the point of the exemption entirely. It seems that history (and reason) has been overlooked. CFAs were permitted in order to address the virtually total removal of legal aid. It was part of the ‘Access to Justice’ reforms of the Blair government when they surprisingly (to my mind) got away with very little public reaction to newspaper headlines which said ‘Legal Aid to be Abolished’.

What does this mean for insolvency litigators and insolvency practitioners (IPs) in practice?

The announcement does not impose any ban on success fees, but these will not be recoverable from the other side for cases from April 2016. Success fees were permitted in order to compensate solicitors and barristers for the risk of taking on no win no fee cases as opposed to being paid for their time, or at all, as they worked, while still paying office rent, salaries, insurances etc. It was intended to encourage them to do so, so that impecunious litigants could access justice in the absence of any other help, and not be thereby adversely affected. ATE premiums were recoverable as from the Access to Justice Act 1999. Success fees became recoverable in 2000. The Conditional Fee Regulations as variously amended, for the first time set out the requirements for legally doing what had been informally understood before.

No one is more impecunious than an insolvent estate whose assets have all been removed pre insolvency. What it does, therefore, mean for those estates is that either success fees come from the sums which should go to pay creditors and the same sum remains in the pockets of the culpable respondent, or lawyers will be under pressure to do the work without uplift. This will squeeze the availability of barristers to undertake this work in particular and removes the incentive which was originally intended to encourage lawyers to take the risk of the work.

What is the thinking behind this announcement and what does it mean for IPs?

Much has been made of the fact that in insolvency cases lawyers never expected to get paid anyway in a case where the insolvency estate was found to be asset free. This is suggested as justification for the assertion that lawyers should therefore now undertake CFA work and charge no uplift.

These suggestions mix up history with the present day. This is convenient for those who wanted to abolish the insolvency exemption, but overlooks the facts. In the 90s and before, of course often the officeholder was not charged where the estate proved impecunious. However, there is a huge difference between, for example, an asset being of less value than anticipated or a spouse successfully arguing exoneration in short proceedings on the one hand, and on the other hand entering into seriously defended proceedings for breach of duty (misfeasance) or fraudulent trading where the targeted assets are hidden or being eaten away by defence costs.

Where there are sufficient assets to merit it, why should the malfeasant defendant not cover the additional costs incurred as a result of their having removed funds pre insolvency which should have been available? Why should the IP take any personal risk on behalf of creditors who are unwilling or unable to fund any litigation having lost significant sums already? If the IP seeks ATE cover why should the premium not be a legitimate recoverable cost of the litigation? It is only needed because of the litigation having to be brought.

Furthermore, it will make many cases uneconomic because in settlement talks the defendant can point to the fact that continuing to run a case will eat into recoveries and make the costs benefit of the claim unworkable. This (combined with the recent insolvency reforms) will make old fashioned burials much more likely, just when so much work has been done to encourage IPs to bring claims under the Insolvency Act 1986 to prevent insolvency tools being used to affect creditors adversely and, what’s more, to encourage IPs to seek appointments in cases where such claims were available. If cases are not brought (because they can’t get funding and aren’t economic to run otherwise) then the malfeasors will prosper and breed. This flies in the face of the government’s focus on ‘transparency and trust’. An entrepreneurial society makes it easy to set up businesses and gives limited liability protection. The balance to having an entrepreneurial society is having appropriate and feasible remedies for victims if those businesses don’t play by the rules.

Since the early 2000s many more claims have been brought under the CFA regime which simply would not have been brought before. HMRC didn’t start provisional liquidations until circa 2002. Those liquidators brought very significant claims on CFAs entirely on risk against billions of pounds of losses caused by rogue directors and those directing them. Those recoveries not only paid HMRC but also some smaller victims, landlords, suppliers etc. They did also pay fees to IPs and lawyers—who paid tax on those fees and employed people and paid PAYE and charged VAT.

Creditors could potentially fund claims themselves, but they will not. One cannot blame them in not wanting to pay further monies to chase what they have lost. Even institutional creditors have very tight belts these days and cannot fund claims. Instead, third party funding is hailed as a cure all for the ban.

However, a CFA adds a maximum 100% (usually less) to legal costs. Funding is always (at present) at least 100% more on top of the cash advance and usually requires ATE to be in existence as well. It also usually comes off the top. Solicitors on the other hand will often fund disbursements interest free in insolvency cases and be realistic in terms of their final bill.

IPs will need to take care when considering assignment of actions or funding as an option. They have also to consider the availability of CFAs and interest free disbursement funding as potentially producing the best return to creditors. CFA uplift will always be 100% or under. Solicitors will also very probably be more flexible than third party funders answering to distant investors.

There is of course room for funding in the market-and some cases will always need it, such as where expert evidence is required. It will thrive so long as funders want to be in the market and so long as pork belly futures don’t prove a better investment than litigation in our clogged courts—however, don’t pretend this makes litigation cheaper. In truth, cheap litigation would only be produced by having an efficient court system, early hearing dates and speedier and cheaper mediation—but there is certainly no sign of that happening (even though it would increase a superb export for UK plc) and so government continues to tinker around the edges with a lack of understanding which is quite staggering.

The Independent recently reported that ‘critics of such funding methods [CFAs] say they prompted a glut of claims of dubious merit, especially in personal injury cases’.

Not in insolvency. IPs are officers of the court, they are not bringing claims for their own benefit. Rather, they are risking their own money in bringing claims for the benefit of creditors, which claims are invariably backed by solicitors and counsel also risking their own time and money. You might be able to convince someone that you have a sore neck or a limp when you haven’t (particularly if as in many insurance claims they just give up and settle) but try convincing a chancery judge that you have a good undervalue or breach of duty claim when you don’t. It can be hard enough when you do. I can understand why weak defences are run—the defendant may as well take a chance that he can escape the consequences of his actions, but bring weak claims, why? There are too many strong claims out there.

So what now?

The government accepts that it has carried out no impact assessment regarding the abolition of the insolvency exemption. Worse, it hasn’t even apparently canvassed views across a spectrum of the profession or creditors. R3 has been supported in its lobbying to retain the exemption not only by professional associations such as the ICAEW and Bar Council, but also by the Federation of Small Businesses and the Institute of Credit Management and British Property Federation. The academic research published from Wolverhampton University in 2014 showed probable losses to the creditors of some£160m per annum if the exemption went. That was, of necessity, based on older data. Further research from the same source, published in December 2015, showed that loss was now thought to be nearer £500m per annum—supporting the hypothesis above that the numbers of cases brought have been continuing to increase. The Ministry of Justice chose not to wait for, or to consider, that learned research.

It has already been announced that there will be a post-implementation review of LASPO 2012, Pt 2 between April 2016 and April 2018. The Minister says that review will take place towards the end of that period. However, given the change only occurs on 1 April 2016 and cases take time to work through, one wonders whether any true picture of the damage can be ascertained during that period.

Finally, I would say to practitioners, think about the CFA option. It can be more productive for the estate than other options. Lawyers, sharpen your pencils and pick the right cases and have a fair negotiation over uplifts.

Interviewed by Lucy Trevelyan.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.Further Reading

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Conditional fee agreements—questions answered

Security for costs—use and the court's discretion

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First published on LexisPSL Restructuring and Insolvency