Occupational hazard?: Directors' responsibilities for lost litigation

A director of a company that funds litigation on behalf of the company (either by paying the solicitors directly, by making a loan, or by injecting capital into the company) can end up being personally liable not only for the costs of fighting the company’s case, but also for the opponents’ adverse costs.

Where the company itself cannot pay an adverse costs order, the opponent will want to see if another party, such as the director, ought to be paying the adverse costs.

So when can an opponent look to a director to pay those costs, and what should directors be aware of before deciding to fund litigation?

The background

Generally, the loser of litigation is expected to pay (part of) the winner’s costs. There are many exceptions to the rule, and ultimately the court has discretion about who pays what – but the general principle that the loser pays the winner’s ‘adverse costs’ is a significant factor in dictating strategy, managing risk, and deciding when to fight and when to settle.

There are many cases where the parties to litigation are companies, and, by the conclusion of hard fought litigation, the losing party has exhausted their resources and is insolvent. The general rule that the loser pays the winner’s costs is of little practical use to the winner who has nothing to enforce the costs order against.

The court’s discretion in making an order for costs is wide, and, pursuant to s.51 of the Senior Courts Act 1981, the court has “full power to determine by whom and to what extent the costs are to be paid”.

As such, an order for adverse costs doesn’t necessarily fall only on the parties to the litigation. In some circumstances, the court might order others to pay adverse costs, for example where a funder other than a party has driven the litigation.

These funding arrangements often arise in cases where one of the parties to the dispute doesn’t have sufficient resource to fight. Instead, a group company, a director, or a commercial funder steps in to resource the fight behind the scenes. When the litigation is over, the winning party will have incurred significant costs in the fight that they would look to recover from the losing party, but the losing party doesn’t have (and may never have had) sufficient funds to pay adverse costs.

In those circumstances, the court might look behind the losing party to consider who funded the litigation and to make them liable for the adverse costs. That power was first used by the court very sparingly, but over recent years it is more common to see non-party costs orders being made.

Here we focus on company directors who fund the company’s legal costs, and in doing so also expose themselves to a risk of adverse costs liability.

Non-party costs

S.51 of the Senior Courts Act provides broad discretion to make a non-party costs order, which is supplemented by CPR 46.2 and a raft of case law.

Established case law dictates that a non-party costs order is only appropriate where the non-party has funded and controlled the party’s unsuccessful litigation, or had a vested interest in the outcome.

Generally, non-party costs orders are not made against pure funders who have “no personal interest in the litigation, who do not stand to benefit from it, are not funding it as a matter of business and in no way seek to control its course”. In reality though, funders (and certainly directors) don’t simply write a blank cheque, but have some expectation of involvement in or benefit from the litigation.

Company directors funding legal costs will inevitably be providing instructions and making decisions as to how the case is run (subject to legal advice). In funding the case and directing strategy, the director is essentially causing the opponent to incur costs, which is why (in some cases) the director ought to be personally liable for the opponents’ costs at the end of the case.

The exercise of the court’s discretion will take into consideration:

• Whether a non-party costs order is just and appropriate in all of the circumstances: they are reserved for ‘exceptional’ cases, but really that just means that the case is “no more than outside the ordinary run of cases where parties pursue or defend claims for their own benefit and at their own expense”
• Whether the director is the real party interested in the outcome of the litigation, or whether he was advancing a legitimate case for the benefit of the company.
• Whether the director funded the proceedings, substantially controlled the proceedings, and/or is to benefit from them.
• The purpose of the director’s involvement. A finding of impropriety on the part of the director is not required; but the court will consider whether the director is responsible for bringing the proceedings, and whether they were brought in bad faith, for some ulterior motive, or if there was any other improper conduct. If a non-party acted without impropriety or on legal advice, an order may still be made against them, though see the ‘special position’ of directors below.
• Whether there is a connection between the director’s involvement in the case and the costs incurred, or the chances of recovery by the winning party (causing an opponent to incur costs in the fight, or dissipating assets against which an opponent might make a recovery could both be a factor in favour of making a non-party costs order). A direct causal link between the director’s specific funding and the costs incurred is not strictly a requirement of making a non-party costs order, but it is widely accepted as an important factor.

Any order for non-party costs:

• Should not exceed the costs which the claimant or defendant in the litigation would be ordered to pay.
• Is not limited to the amount of funding the director provided.
• Can be in respect of all adverse costs or just a proportion of them.
• Can be on a joint and several basis with the parties (so if the company were to discharge the adverse costs, the effect on the director would be mitigated).

The above points are simply guidelines, not exhaustive rules. The court has expressed that previously reported cases do not provide a comprehensive checklist of factors to be taken into account when exercising the Court’s jurisdiction.

The “special position” of directors

Directors of limited companies are said to be in a "special position" as officers of a company with statutory obligations to act in the company’s best interests.

As such, there is an inherent risk that a director will be drawn close to litigation and may be the only party that can fund litigation if the company is in an insolvent position. The directors may have to take such steps in order to comply with their statutory duties, and in order for it to be just to make a non-party costs order against a director who has funded unsuccessful company litigation, "it is necessary to show something more", for example, that the claim was not made in good faith, or it is made for the benefit of the director, or has been improperly conducted. That principle derives from observations in of Housemaker Services Ltd and another v Cole and another [2017] EWHC 924 (Ch), later approved in a recent Court of Appeal decision.

Goknur Gida Maddeleri Enerji Imalet Ithalat Ihracat Ticaret Ve Sanayi AS v Aytacli [2021] EWCA Civ 1037 saw a company as a defendant and counter-claimant. The company was balance sheet insolvent at various times during the course of 10 years of litigation, and the director provided security for fees in order to continue with the counter-claim. The director had exercised significant control over the litigation and was said to have provided funding (by the provision of security), but the court held that there was no individual benefit to the director in pursuing the litigation,and there was no evidence of impropriety or bad faith on his part. Although the counter-claim had ultimately been unsuccessful, there was a claim with underlying merits which the company was entitled to pursue.

There was also a further reason relating to the conduct of the opposing party that meant that a non-party costs order would be unjust, though that is an aside from the general principle that a director must not only control and fund the company's conduct of the unsuccessful litigation, but also that the director benefited (or sought to benefit) personally from the litigation, acted in bad faith or was responsible for some sort of impropriety.

What does that mean for directors? 

That recent decision brings together existing relevant factors and asserts a focus on directors’ intentions.

It will be welcome news to directors that helping their company through a costly dispute does not give rise to automatic adverse costs risks personally, but the risk needs to be kept in mind – particularly when a company is likely to live or die by the outcome of the dispute, and the directors put everything on the line to try and secure the right result. Despite clear guidance about when non-party costs are appropriate, hindsight will often reveal blurred lines: directors have to make difficult decisions when wearing the hat of a company director whilst remaining individuals with an interest in the outcome of a dispute.

Generally speaking, where a director promotes and funds proceedings by an insolvent company solely or substantially for the director’s own financial benefit, the director should be liable for the costs if the claim, defence or appeal fails.

The limited liability of the company will be the starting point, but if the director is funding and directing the litigation with the expectation of a benefit, then they are at significant risk of personal liability.

What does it mean for solicitors?

There are two obvious points to bear in mind when litigating with a company at risk of insolvency:

1. When acting against the company, consider who is funding the litigation and if there is a basis upon which a non-party costs order might be appropriate in order to secure a recovery of adverse costs in the event of insolvency.
2. When acting for the company, consider how litigation costs (and adverse costs) will be funded – and if that funding is from a director ensure that the director is aware of the risk of a non-party costs order.

Thomas Bond is a Senior Associate at Russell-Cooke: russell-cooke.co.uk