The End-emnity Principle?

The implementation of the Civil Procedure (Amendment No.2) Rules 2023 and accompanying 156th update of the Practice Directions on 1 October 2023 will result in significant changes to the costs regime.

The reforms will bring through the final recommendations of the Jackson report and establish a new fourth litigation track, the ‘intermediate track,’ for claims worth between £25k and £100k. The recoverable costs for intermediate track cases will cease to be determined using budgeting and detailed assessment. Instead, the updated Practice Directions will introduce fixed costs for tasks undertaken. The determinative factor for recovery of those costs will be whether a particular stage of litigation has been completed, or not.

What is perhaps most interesting is that the indemnity principle, so long the golden rule of costs recovery, will cease to apply to matters allocated to the intermediate track. This represents a significant (if not unprecedented) change in approach to the principles of costs recovery. Fixed costs are not new, but the scale at which they will be implemented with the latest reforms is significant.

The Indemnity Principle

To put the incoming reforms in context, it is important to understand the proposition underlying the indemnity principle, which was summarised in Harold v Smith [1860] 5 H&N 381: "Costs as between party and party are given by the law as an indemnity to the person entitled to them: they are not imposed as a punishment on the party who pays them, nor given as a bonus to the party who receives them. Therefore, if the extent of the indemnification can be found out the extent to which costs ought to be allowed is also ascertained."

The indemnity principle operates to prevent a party seeking to recover more costs from an unsuccessful opponent than that party is itself required to pay to its lawyer. In principle recoverable costs can never exceed the liability of the client to the lawyer (although certain funding arrangements can link the clients’ liability to recoveries, and it remains open to the practitioner to decide whether to enforce any fee liability in excess of recoveries). This principle is not only an issue about the total sum paid by the receiving party, but also to its constituent elements such as recoverable hourly rates.

There is some concern that the indemnity principle will be undermined by the introduction of these changes. Fixed costs will operate on a set scale and are independent of the actual costs incurred. As a consequence, a paying party may be required to pay more in fixed costs than the successful party is liable for.

The Principle of Fixed Costs

As Jackson identified at page 80, paragraph 2.8 of his Supplemental Report on Fixed Recoverable Costs (FRC): “The indemnity principle has no application to fixed costs.” Fixed costs are pre-determined amounts set by the court for particular stages of litigation and are not intended to have any bearing on the time expended, or relative cost of the fee earner.

They provide a predictable framework for legal costs and seek to streamline the litigation process. The expanded operation of fixed costs aims to ensure greater cost certainty, enhance access to justice, and promote efficiency in resolving disputes.

Supporters of fixed costs believe that the system offers numerous advantages, particularly in terms of transparency and cost control. Fixed costs will provide parties with clarity regarding the potential financial implications of litigation, which will enable parties to more accurately assess the risks of litigation and budget for those processes. This enhanced predictability should be particularly beneficial for individuals and businesses with limited financial resources that seek to pursue or defend claims.

It is also expected that fixed costs will expedite the litigation process by minimising disputes over costs. This should enable the courts to allocate resource more efficiently and reduce delays. In combination this should help make litigation more attractive for parties. In addition, it is hoped that costs will cease to become such an impediment to settlement, as the potential costs of litigation become easier to quantify and manage.

Beyond Fixed Costs?

The court will also be empowered to depart from fixed costs, and in particular to address “unreasonable behaviour” whether by the paying or receiving party. CPR 45.13(3)(a) provides that unreasonable behaviour is “conduct for which there is no reasonable explanation”. The amendments enable the courts to apply a 50 per cent penalty that can be shifted between the paying and receiving party depending on their relative conduct. The use of this discretion is subject to a high threshold (analogous to the award of indemnity costs), and requires conduct that falls significantly outside of normal parameters.

The court retains its general discretion in relation to what costs can be recovered under CPR 45.9 such that the court can award an amount for costs that exceeds fixed costs. However, this will only be “where there are exceptional circumstances making it appropriate to do so.” Of course this is not a new provision, but is rarely used in the context of the more limited fixed cost provisions already in operation. It therefore appears likely that a departure from fixed costs will remain rare with the introduction of the latest reforms.

There is some concern that a departure from the indemnity principle could discourage thorough legal representation as practitioners seek to restrict their efforts to fit within the confines of fixed costs. However, it is unlikely that such concerns will be realised.

Practitioners will struggle to operate commercially on the basis of the recovery of fixed costs alone. There will almost always be a shortfall between incurred and recoverable costs, which the client will need to meet from their damages, or otherwise. It is an unrealistic proposition that there be predetermined amounts that clients are required to pay their lawyers for particular pieces of work given: (i) the multitude of different types of litigation to which fixed costs will apply; and (ii) the reforms will not interfere with the freedom of contract between lawyers and clients who will be left to agree such terms as they deem appropriate.

There is a risk that the shortfalls in recoverable costs will result in the successful party being undercompensated as a proportion of their recovered damages are required to bridge that shortfall. This could result in increased disputes between lawyers and their clients. It will therefore be vital that practitioners ensure that clients understand how fixed recoverable costs work from the outset of any instruction. In particular they will need to make clear that there may well be a shortfall between the recoverable costs and the amount that they incur - for which they will remain primarily liable.

Practitioners will also need to ensure that their retainers permit them to retain the full extent of the fixed costs recovered from the paying party irrespective of whether the work, if undertaken on a conventional hourly rate basis, reaches the level of those fixed costs.

Striking a balance

The intention behind fixed costs is not to eliminate the indemnity principle, but rather to expand the categories of cases where it is not relevant. The reforms aim to ensure that there is a balance between cost certainty and the reasonable recovery of costs. In this sense, fixed costs can be seen as a pragmatic compromise in an effort to promote efficiency, access to justice, and fairness in the litigation process.

In having a clearer understanding of the relative risk of litigation - including the potential impact on net recoveries, parties should be better placed to determine whether or not to pursue their claims. This provides an opportunity for practitioners, as with appropriate engagement, the reforms provide the possibility of an increased volume of claims that will be litigated.

As with any reform, ongoing evaluation and refinement will be needed to strike the right balance between cost control and ensuring a fair outcome. It will be crucial to monitor the impact of the reforms to ensure that successful litigants are not unjustly deprived of recovery of their reasonable costs or have their damages disproportionately eroded. The continued examination and fine-tuning of fixed costs will help ensure that the interests of justice and fair compensation remain at the heart of costs recovery in litigation.

Elliot Elsey is a partner at Russell-Cooke russell-cooke.co.uk