Funding liability: The impact of Excalibur Ventures v. Keystone on litigation funding

On 23 October 2014, the UK commercial court handed down a judgment in Excalibur Ventures v. Keystone et al which has wide-ranging consequences for law firms, litigation funders and insurers.

The judgment follows a court battle over an epic US$1.6bn claim by Excalibur Ventures against Texas Keystone. In his October 2013 judgment, the judge dismissed all of Excalibur's claims and ordered it to pay the defendants' costs on the indemnity basis. This order was made in part because of the way in which Excalibur and its solicitors, Clifford Chance, had conducted the case.

The case raises a number of issues that the litigation funding market will want to bear in mind in future. The key point is that funders will now explicitly consider the risk of an adverse indemnity costs award, both when considering whether to invest at the start and on an ongoing basis throughout the life of the case.

It remains to be seen whether this will act to increase the cost of funding and the time and effort required to obtain it. Going forward, it will benefit all parties to a funded claim to be clear on where the new risk of indemnity costs lies.

Case background

Excalibur funded its claim through third-party funding, with a further £17.5m security for costs also provided by the funders. Psari Holdings, represented by Withers in the costs hearing, was one of the professional funders. The other professional funders - Hamilton; Platinum (PPCO); Blackrobe and Blackrobe Capital; Huron and PPVA and JH - provided backing mainly towards security for the defendants' costs.

In view of the fact that Excalibur
was a shell company without money
or assets, the defendants applied under Section 51 of the Supreme Courts Act for non-party costs orders against the funders' holding companies and/or ultimate beneficial owners.

In cases of this kind, the courts have imposed the 'Arkin cap' on a funders' potential liability under Section 51, unless a funder is found to have been champertous (i.e. has exercised an element of control over the conduct of the litigation). The Arkin cap, which derives from Arkin v Borchard Lines, limits the liability of a professional funder for the winning party's costs to the extent of the funding it provided.

Psari accepted from the outset ("to its credit," as the judge said) that it would pay the defendants' costs on a standard basis, but did not accept paying costs on the indemnity basis. The judge supported Keystone's non-party costs application, but made it clear that his intention was not to penalise the funders who, in the case of Psari and its owners "were not personally responsible for the matters which caused me to order indemnity costs". The decision was driven by the unique characteristics of the case and
the way in which the claimant and its
legal advisers had run it.

Key issues

The high court judge, Justice Christopher Clarke, raised a number of other important issues.

• Standard vs. indemnity debate. Where a losing party is ordered to pay costs on an indemnity basis as a result of its and its solicitors conduct, and this conduct was not known by or attributable to the funders, should the latter be automatically fixed with the claimant's liability to pay costs on the indemnity, rather than on a standard basis? In other words, should the funder have to pay more than it would have had to pay had the claimant and its solicitors behaved properly, by virtue of the fact that the claimant did not behave properly in circumstances where a properly-acting funder cannot interfere in the conduct of the claim?

Clarke J's decision was that a funder should conduct sufficient due diligence about, and stands to win sufficient reward from, a case to justify it paying indemnity costs in one with these characteristics. He acknowledged that Psari/Mr Lemos (its sole shareholder and director) behaved properly and avoided controlling the case in any way, stating that "they were not personally responsible for the matters which caused me to order indemnity costs". Nevertheless, he held that, in the circumstances of this case, "it would be unjust that he should be absolved from contributing to the Defendants' costs assessed on the same scale as I have thought appropriate to award against the company which he backed because he was not subjectively aware of, or alive
to, the features that led to the
costs judgment".

• The corporate veil. The judge decided that the funding vehicles did not appear to have interests or assets independent from those of their owners and that he should not therefore disregard the role of the parent companies in these circumstances.

• Provision of security. The judge held that providing funding to a claimant so that the latter may provide security for costs was, in effect, an investment. One consequence of this is that providing funding for security for costs counts towards the Arkin cap - even though the funds would already be used to pay adverse costs awarded. The judgment sets a precedent preventing any one funder from taking a 'free ride' in relation to adverse costs on the back of those financing the direct costs of the claim.

A successful security for costs application can thereby leave the claimant and its advisors in a position where they have to ask the funder to put more money in or accept dilution. This then runs the risk that the funder will simply abandon its entire investment and let the case collapse. Solicitors and funders should remember that securing after-the-event insurance can be an effective way to reduce the risk of being required to provide security for defendants' costs.

• Timing of the funding. The judge's view was that, where one funder enters later than others, it should not be liable for any of the costs incurred prior to its entry. This leaves the receiving party in the position of having to divide its costs into periods of investment and then apportion the costs incurred between each funder.

Market impact

The Excalibur judgment is an important development for the funding industry, but it is unlikely to be fatal. The judge himself said that he had "some doubt that [his] decision will send an unacceptable chill through the litigation funding industry, whose aim is not to finance hopeless cases but those with strong merits".

However, the judgment will act as a clear warning to professional funders, who no longer have certainty over the scale of their liability, the extent to which they should exercise control in order to safeguard their investment or how far up the corporate chain the court may go to extract funds.

The legal industry should pay heed
to the judgment and re-examine the way in which claims are funded and conducted. In particular, all parties involved in bringing a claim should
give thought to actively managing the
risk of indemnity costs.

There are a range of practical steps that litigation funders, insurers and law firms can take to reduce this risk. The starting point should be that the funder is now financially responsible in the event that indemnity costs are awarded against a funded claimant - even if there is no champertous control.

However, there is every chance that the funder will seek to spread the risk amongst other parties by taking the following actions.

• Seeking indemnities from lawyers and experts involved, should their behaviour lead to the award of indemnity costs. However, managing partners are likely to be highly reluctant to sign off on this type of arrangement. Solicitors need to be aware that, in a worst-case scenario, the funder may pursue the lawyers/experts for negligence in relation to the indemnity costs award. Lawyers should think carefully before giving bullish estimates in order to increase the chance of obtaining funding.

• Passing the risk of adverse costs back to the funded party via the funding agreement. This makes logical sense, as the party has ultimate control over the case, and should be accountable for any behaviour occasioning the adverse costs award.

• Expanding ATE insurance to cover the risk of an indemnity costs award. This would increase the costs of the cover, or increase the amount of cover required, and would need to be specifically provided for in the ATE policy. ATE insurers should already be well placed to appraise and price this risk, but lawyers may be more inclined to pursue extremely aggressive case strategies if they feel that they are accordingly protected from indemnity cost risk. If none of these options are available, funders may just accept that they could incur an unexpectedly large adverse costs bill and pass the risk back to the client by increasing the price of funding. Funders may even consider taking out behind-the-scenes insurance contracts to pass on some or all of the risk.

The timing elements of the judgment create other possible solutions where indemnity costs are a real concern. Excalibur makes clear that funds provided for later elements of a case are less exposed to adverse or indemnity costs. This means that, for large cases, it may be worthwhile to raise funds in tranches and to use a syndicate of funders, as is increasingly adopted in ATE insurance.

Litigation funders will note from Excalibur that proper due diligence prior to investment is now even more important. Funders are also likely to look more closely at how cases are run, as well as what the cases are, and are now less likely to take it as given that even a magic-circle law firm will run a case in an acceptable manner.

This may mean that the due diligence process for obtaining funding will become more time consuming and expensive. For a claimant or lawyer looking to obtain funding, the obvious answer is to make sure that they have a well structured and articulated claim to take to the funding industry and to ensure that they allow enough time and resources to negotiate the agreement.

Circumstances leading to an indemnity costs award can arise midway through a case and from the behaviour of one or more actors in combination. Funders may then explicitly request that the lawyers notify them in the event that circumstances arise that could lead to indemnity costs being awarded. This might then be linked to a 'no further funding' option in the event that such a notification is received.

Christopher Coffin is partner and Andrew Dunkley is practice change architect at Withers (www.withersworldwide.com)

---