Winning fees: Alternative litigation funding in commercial cases

Prior to 1 April 2013, UK law firms were only permitted to offer alternative litigation funding to clients through conditional fee agreements (CFAs). Originally considered the preserve of personal injury/clinical negligence lawyers, CFAs had more recently come to be employed in the wider litigation market, including by commercial litigators. However, despite their greater prevalence in commercial cases, most commercial firms, if they have done CFAs at all, have only dabbled in them. It is only a handful of firms that have committed themselves in a significant way to an alternative funding practice.

On 1 April 2013, the Legal Aid Sentencing and Punishment of Offenders Act 2012 (LASPO) introduced damages-based agreements (DBAs). Such agreements permit lawyers to take a share of the damages recovered from the opponent, up to a cap of 50 per cent in commercial cases.

Further changes brought into effect by LASPO at the same time were the loss of the recoverability of CFA success fees and after-the-event (ATE) insurance premiums from the losing party in litigation. The introduction of DBAs was intended in part to make up for this. Whereas CFAs are linked to a percentage of the fees incurred in a case such that the law firm can never receive more than a 100 per cent uplift on its fees, DBAs are unconnected to fees and turn entirely on a percentage of the damages recovered by the client.

Assume a simple scenario where the value of the claim is £10m and the legal fees to be incurred are £1m on the standard basis. With a CFA based on a 100 per cent success fee, the law firm would receive a total of £2m in legal fees in the event of success. With a DBA based on a 50 per cent share of damages, the legal fees would amount to £5m. In such a case, the difference in remuneration for the law firm on a DBA as compared to standard hourly rates or a CFA is sizeable. In high-value cases, it is therefore easy to see why a law firm might be attracted to DBAs and the potentially mouth-watering rewards that they can offer.

Is this likely to mean that there will be a large take up of DBAs in commercial cases? I doubt this will happen in practice, for the reasons explained below.

The 'hybrid' issue

Anecdotal evidence suggests that the vast majority of CFAs that have been entered into to date in commercial cases have been 'hybrid' or 'discounted' CFAs. This means that the law firm has only risked a proportion of its fees, with the balance being paid in any event either by the client or a third-party funder. Given the high legal fees involved in many commercial cases, it is understandable that law firms have taken the commercially prudent step of limiting their risk, albeit for a smaller success fee in return.

At the time of the government's consultation on the introduction of DBAs, there was a general expectation amongst the profession that DBAs would be permitted to follow the same hybrid ?model (i.e. a law firm could risk a proportion of its fees on the DBA, with the balance being funded either by the client or a third-party funder).

However, despite the Civil Justice Council having responded to the consultation confirming its view that there was no reason why hybrids should not be permitted, and despite the strong commercial imperatives in favour of hybrid DBAs being allowed, the DBA regulations which came into effect on 1 April 2013, taken together with their guidance notes, seem to suggest that hybrids should not be permitted and only no-win, no-fee DBAs should be allowed.

Some commentators have argued for a contrary interpretation of the DBA regulations. However, any fee agreement entered into between a law firm and its client that falls foul of the regulations risks the firm being unable to recover any fees at all. In those circumstances, where the permissibility of hybrid DBAs is unclear, it seems likely that law firms will shy away from hybrid DBAs - at least until the regulations are amended or the matter is clarified by the courts.

That leaves no-win, no-fee DBAs. A number of third-party funders have indicated that they would be prepared to offer law firms backstop funding to cover a proportion of the law firm's fee, in exchange for their own fee in the event of success, so as to simulate the share-of-risk effect that would be in place with a hybrid DBA. In this scenario, the funding arrangement would be separate from the fee arrangement with the client. The latter would be no-win, no-fee, thereby complying with the DBA regulations. However, there is a question mark over whether the commercial terms of such funding arrangements (which are likely to involve a multiple of funds committed rather than a proportion of damages recovered) are likely to be commercially acceptable to law firms.

Leaving aside backstop funding, ?a number of firms, like our own, will still ?be willing to consider no-win, no-fee ?DBAs in appropriate cases. However, it seems likely that the majority of commercial firms would be unprepared to take on the risks involved.

Drawbacks of DBAs

Taking into account that legal fees in commercial cases are significant and that a law firm's recovery on a DBA is tied entirely to the amount of damages actually recovered from the opponent (as opposed to the fee being triggered by some other defined event of 'success', such as a win at trial), it is evident that DBAs are not suitable for all cases.

There are certain prerequisites to be satisfied before a DBA can be even remotely viable in practice. ?The three main ones are the following:

1. the case must be a high value claimant case;

2. there must be good merits; and

3. there must be good prospects of recovery against the defendant, with no significant issues likely to arise in relation to enforcement.?

If any of those three prerequisites is not in place, the case is unsuitable. This means that, in reality, there are a limited number of cases that will ever be suitable for a DBA. The average commercial law firm, unless it has a name for alternative funding and is thereby able to attract the right kinds of cases, may see no more than a small number of cases that could satisfy these prerequisites in any given year. In some years, there may be none.

Law firms must remember that they are still under a duty to provide the best possible information to clients about costs and to act in their clients' best interests. This includes advising clients on the funding options that may be available in the market, even if that firm is not prepared to offer all of those options. This means that the law firm must advise the client about the possibility that its case could be funded on a CFA. Despite the falling away of the recoverability of CFA success fees, in high-value cases a CFA may still be a cheaper option than a DBA and the client may choose to go elsewhere to have its case dealt with on a CFA if the firm is not prepared to offer one.

There is an additional obstacle to the commerciality of DBAs from the client's point of view: if the case settles early for a large sum of money, the lawyer may receive a windfall completely out of proportion to the time or effort invested. As a result, the client may well decide that a CFA might again be more attractive.

Despite all of the above factors, however, some clients may still choose a DBA over a CFA because a DBA has the effect of aligning more closely the lawyer's and the client's interests - with a DBA, the lawyer's remuneration is tied not just to succeeding but to doing so as quickly as possible and at as high a value as possible. With a CFA, it is in both the lawyer's and the client's interest to succeed, but it is in the lawyer's interest for the success to take as long as possible so that higher fees are incurred in the meantime. Also, the lawyer has no interest in the value of the settlement/win, as long as there is a success as defined in the CFA. Some clients will take the view that they will ultimately recover more on a DBA because their lawyers will be more motivated to maximise recovery.

But what happens if a DBA case is lost? In large commercial cases, where legal fees are likely to be significant, the loss of the work-in-progress risked can be devastating. For firms that are able to develop a portfolio of cases, the risk in any one case can be mitigated across the portfolio. However, in those circumstances, the firm is likely to have an issue around cashflow, with potentially a significant proportion of its work in progress being tied up at any one time. The law firm ?would need to consider how to fund this delayed cashflow, i.e., whether through self funding using the firm's capital, through bank financing or via some alternative funding arrangement (such as with a third-party funder).

Funding arrangement terms

From our firm's perspective, if we consider that a case is strong and meets the prerequisites, we may well be prepared to offer both a DBA and a CFA as alternatives, leaving the client to choose between them. The commercial terms that we offer on each must always ensure that we are adequately compensated for the risks involved.

In respect of a DBA, while a high percentage of damages can result in a windfall if the case settles early for a high sum, conversely, if the case does not conclude until after a hard-fought trial (or perhaps even not until the conclusion of enforcement action after trial) and the sums recovered are lower than expected, we could be significantly out of pocket. There is of course also the risk of losing and receiving nothing - a potentially devastating result in a large case. The percentage of damages that we would be prepared to accept therefore needs to strike a balance between the potential risks and rewards involved in all scenarios.

Similarly, in respect of a CFA, the percentage uplift must compensate for the risk we take. Therefore, if we offer a hybrid CFA based on 50 per cent discounted fees, depending on the strength of the merits and our calculation of the risk and other factors related to reasonableness, we may seek a commensurate success fee of 50 per cent above basic rates. On a similar basis, if we offer a no-win no-fee CFA, we may seek a commensurate success fee of 100 per cent above ?basic rates.

Below the surface

At first blush, the prospect of DBAs may seem attractive to law firms. However, the current regulatory framework and commercial considerations for clients and lawyers mean that DBAs will not be widely used, at least for the foreseeable future, until the permissibility of hybrids under the regulations is clarified.

In reality, therefore, few commercial firms are likely to be newly entering the alternative funding market in any significant way. However, CFAs will remain very much on the table. It seems more likely that ?firms that have to date had a significant CFA practice, with a business model geared around this, will continue to undertake commercial cases on CFAs and will also undertake the majority of those DBAs that are entered into in the foreseeable future. ?

 

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Tips on offering alternative funding in commercial cases

• You need a high level of confidence in the strength of the merits of the claim. Getting this wrong can be devastating.

• In the case of a DBA (or a CFA where all funds are expected to be recovered from the opponent), you need a high level of confidence in the likely value of the claim and the ease of enforcement of a judgment. If you get this wrong, you may win but fail to recover anything from which to be paid.

• Can you manage the delayed cashflow? Where the case is significant, or the firm takes on a number of cases on alternative funding arrangements, the firm may need to arrange financing to cover the delay.

• Can you afford to lose? Having a portfolio of cases on alternative funding may be an effective way to hedge the risk.

• While the rewards for the firm may be higher with a DBA, consider offering the client a CFA as an alternative – this may be more attractive commercially to the client.

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Tamar Halevy is a partner in the ?litigation and dispute resolution team ?at UK law firm Lewis Silkin ?(www.lewissilkin.com)