Contingency fees and the changing face of litigation funding

Peter Maguire looks at the changing face of litigation funding

“Contingency fee” is the generic term used to describe fee arrangements between solicitors and clients, where payment of the solicitor’s fees is dependent upon the result of the litigation or arbitration. Often the term “no win, no fee” is used to describe such arrangements. There are two types of contingency fees:

Contingency fee

Somewhat confusingly, “contingency fee” is also the term used to describe one type of arrangement between a client and solicitor, whereby the solicitor will only be paid if he pursues his client’s case successfully. The fundamental principle of a contingency fee arrangement is that when rendering an invoice at the end of the case the solicitor cannot charge his client more than he would have done had he taken the case on the normal basis. If the case is lost no fee is payable to the solicitor.

Until recently contingency fee arrangements were unlawful and thus not permitted by the Solicitor’s Practice Rules. They had been ruled unlawful on public policy grounds; it was felt that solicitors should not have a financial interest in their client’s case that might affect their conduct of it. However, in the recent case of Thai Trading v Taylor it was held that, provided a solicitor did not charge more than his usual charge out rate in the event of success, then a contingency fee arrangement was lawful.

Since the decision in Thai Trading the Law Society has amended the practice rules and solicitors are now permitted to perform work for their clients on a contingency fee basis.

Conditional fee

A conditional fee is a second type of agreement, whereby payment to the solicitor is dependent upon the result of the proceedings. The conditional fee agreement is a creature of statute, having been created by Section 58 of the Courts and Legal Services Act 1990. The difference between a conditional and a contingency fee is that under a conditional fee arrangement, a solicitor can charge his client the usual charge out rate, plus an uplift, if he has pursued his clients’ case successfully. If the case is not successful then no fee, or a reduced fee, will be payable.

The uplift, or “success fee”, may be as high as 100% of the usual charging rate, but the Law Society recommends that the fee should not equate to more than 25% of any sums recovered in the proceedings. Because a conditional fee agreement allows a solicitor to receive a “success fee”, there are strict requirements which must be complied with in order to create a valid conditional fee agreement. If the agreement does not comply with the requirements, then the agreement will be unenforceable.

Prior to July 1998, conditional fees were only available in a very limited range of cases. However, with effect from 31st July 1998, conditional fees are now available in all civil litigation, save for certain family law matters. Conditional fee agreements can also be used in arbitration proceedings.

Now that the door is open for commercial clients to utilise these types of fee agreements, what attitude are they and their legal advisers likely to adopt and will we now see an increasing amount of litigation funded by CFAs or similar arrangements? Inextricably linked to these issues are the availability, cost and terms of “after the event” insurance.

“After the Event” Insurance

Although a claimant may have the benefit of a CFA with his solicitor (and possibly Counsel), if he is unsuccessful in the litigation, he will, in all probability, be ordered to pay his opponent’s costs. As a result, a growing number of insurers are now providing “after the event” cover to claimants (and, in a smaller number of cases, to defendants) to provide protection against that risk. Cover is also available in respect of an insured’s own disbursements (including Counsel’s and experts’ fees) and - in the absence of a CFA - in respect of a proportion of the insured’s solicitor’s fees.

Whilst policies were initially directed towards personal injury claims, insurers are now developing more sophisticated products to cater for larger, commercial litigation, following the extension of CFAs to all civil, non-matrimonial cases.

The approach of insurers

The two imponderables facing insurers are, first, the likely outcome of the action or proposed action and, second, the level of costs which are likely to be incurred. In those circumstances, insurers may be vulnerable to over-optimistic and slanted presentations of the risk by proposers and their solicitors (who are also responsible for completing a section of the proposal form).

In general terms, insurers’ objectives are therefore, to:

• encourage a fair presentation of the risk (involving, of necessity, a declaration by the proposer’s solicitor as to the prospects of success in the litigation)
• encourage a responsible approach to the litigation by the insured
• encourage the insured’s solicitors to discharge their obligations
• ensure that insurers are advised immediately if any offer or payment into court is made by the defendantthere is any material reduction in the prospects of successthe Insured fails to follow the advice of their solicitors or Counsel
• exercise some control over the litigation
• reserve the right to refuse to provide an indemnity if: any offer is unreasonably refusedthere is a material reduction in the prospect of success (based upon the declared percentage prospects of success in the proposal form)there is a material breach of the policy terms and conditions. In this regard, strict compliance is required with any condition precedent and any breach (however trivial) will be fatal, unless insurers are prepared to waive their rights
• charge an additional premium in certain circumstances.

Applications for cover - what steps must be taken by clients and their solicitors?

It is essential for clients and their solicitors to take the following steps when seeking “after the event” cover:

• very considerable care must be exercised when completing the proposal form, particularly in relation to the estimated prospects of success.
• the likely level of the opponent’s costs and, hence, the limit of indemnity required from insurers, must not be under-estimated. If it is, the client will find himself under-insured.
• it is important for solicitors to understand and to highlight the key terms and conditions of the policy to clients, in order to try and avoid any subsequent coverage problems which could vitiate the policy and leave the client facing an uninsured loss. Where certain terms are considered unduly onerous, certain insurers may be prepared to negotiate and agree amendments.
• solicitors must explain that they will, in respect of the conduct of the action, owe a duty to both their clients and to insurers and that the normal solicitor-client retainer will be subject to the relevant terms and conditions of the policy. Insurers also commonly require an undertaking from the solicitors to keep them closely advised of developments, including any failure on the part of the insured to meet their obligations under the policy.

If the position is not understood at the outset, it is likely to give rise to tensions between the insured and their solicitors and, possibly, coverage problems.

• it is essential to analyse the merits or demerits of the claim in detail before making any proposal to insurers.

Current disincentives to proceeding with CFAs

One disincentive of entering into CFAs, with the protection of “after the event” cover, is that when a client believes that he is going to succeed in the litigation, his net recovery will be reduced by both his solicitor’s success fee and the premium paid to insurers. It is, however, proposed in the Access to Justice Bill (which is due to be enacted during the next few months) that successful litigants will be able to recover from the loser both the success fee payable under the CFA and the premium paid to their insurer. If, as is anticipated, these proposals become law, CFAs and “after the event” cover will become very attractive for clients. If they lose an action, they will not have to pay their solicitors anything, whilst Insurers will provide cover for their opponents’ costs up to the relevant limit of indemnity; if clients are successful, they will, subject to assessment by the Court (i.e. costs assessment), be able to recover their own solicitor’s success fees and the insurance premium from the opponent.

What attitude will advisers adopt?

The Solicitors Practice Rules oblige solicitors to give clients the best possible information about the likely costs of a case. The Law Society Costs Information Code, which will come into effect on 3rd September 1999, includes specific provisions in relation to conditional fees and “after the event” insurance. It provides that a solicitor should discuss with his client how, when and by whom any costs are to be met and that he should consider, inter alia:

“whether the client’s liability for another party’s costs may be covered by pre-purchased insurance and, if not, whether it would be advisable for the client’s liability for another party’s costs to be covered by after the event insurance (including in every case where a conditional fee or contingency fee arrangement is proposed)......”

It is, therefore, incumbent upon all advisers to discuss these issues with their clients since, even if a CFA is not entered into, “after the event” insurance cover may still be available (albeit, possibly, at substantial cost).

Many City law firms may be unwilling to enter into CFAs for large complex commercial cases given the difficulties of assessing the risk of success or failure at an early stage when there has been little opportunity to explore in detail the relevant facts which may determine the outcome of the case, not to mention the cashflow implications arising out of the absence of interim billing and the need to finance the very substantial working capital which will be tied up in long running, uncertain and expensive litigation.

One solution may be for firms to enter into arrangements whereby a success fee will be payable in the event of a “win”, with a reduced, discounted fee payable if the litigation is unsuccessful - i.e. “no win, part fee.” Similarly, firms may be willing to enter into CFAs for parts of the proceedings, including interlocutory applications or even appeals (where the issues are well defined).

Attractions for clients

If the current proposals relating to the recoverability of the success fee and the insurance premium become law, it is difficult to see the downside for a client in entering into a CFA or some similar fee arrangements. Whilst some concerns have been expressed about a loss of control of the action to insurers, this should not present an overriding difficulty if a client’s objectives and expectations are defined at the outset; that is particularly so when balanced against the potential benefits of insurance cover. Similarly, whilst certain policy terms are potentially onerous, there is likely to be a degree of flexibility on the part of insurers if the proposer’s solicitors have the expertise to identify the key policy issues and put forward suitable amendments to the wording.

Implications for settlement negotiations

The extension of CFAs and the growth of “after the event” insurance is likely to introduce a new dimension into settlement negotiations. Many claimants who have the benefit of insurance cover may wish to disclose this on a voluntary basis in order to demonstrate that they are not at risk as to the costs of the action and that their claim has been independently assessed by insurers and accepted as a good risk. Conversely, if a defendant is found liable, he faces, not only an award of damages, interest and standard costs, but - if the current proposals become law - liability for the claimant’s success fee and insurance premium. This may be a powerful incentive to settle.

By the same measure, where liability is a “live” issue, a defendant may be able to exploit the concerns of a claimant’s solicitors acting under a CFA in order to achieve settlement on more favourable terms. Solicitors are subjected to significant commercial pressures and there is a real risk that some advisers will allow these additional financial pressures to influence their judgment and advice to clients. In addition, defendant’s solicitors - if properly informed - will be aware of the terms commonly found in “after the event” policies which enable insurers to control the action and they will be able to exert pressure on their opponents through carefully reasoned offers.

We currently face a period of unprecedented change in civil litigation, with both the advent of the Civil Procedure Rules and the enactment, within the next few months, of the Access to Justice Act. Clients and their legal advisers need to work together in adapting to these challenges and also to exercise a degree of imagination in striking a commercially acceptable balance of risk and reward in relation to any new fee arrangements. The manner in which they do so will help to determine the future shape of litigation and the manner in which it is funded, as we go into the millennium.