Lenders are a significant source of repeat litigation for law firms so it is with some interest that they monitor how lenders are going to behave when faced with difficult economic climates. For the litigation teams, their interest will centre on civil claims against professionals (solicitors and valuers) in negligence, breach of duty and/or fraud.
During the recession in the 1990s, a large number of lender claims were brought against professionals for negligence and the common view is that we are at the start of another wave of such claims given the stalling house price market. As in the 1990s, incidences of property under-valuation are becoming increasingly visible to the lender community. A cessation in property price increases has revealed losses flowing from acts of negligence and fraud by surveyors, solicitors, valuers and other professionals at the points of repossession that would otherwise have been masked by price increases.
Professional advisers are a good target for recovering losses because they are usually backed by professional indemnity insurance. This of course means that professional indemnity insurers also have a very large stake in the developments of the lender claim market, as will the lawyers that represent them. Both sides are repeat litigators. There is no doubt that the legal teams for both sides around the country are gearing up for a busy period. But, is this just going to be a repeat of the 1990s?
In one sense, I don’t know the answer. I am not a professional negligence lawyer and I could not say from a legal perspective whether it will be any easier or harder to win a claim in negligence now compared with the 1990s. I have heard some say the incidence of contributory negligence will be more prevalent this time round given some of the underwriting practices undertaken since the 1990s but again I don’t know. However, I am certain that the litigation landscape has changed since the 1990s for both the lender community and the legal community. I am also certain that this change will greatly affect the decision of lenders when selecting legal firms for their panel. It is a change that some lawyers did not see coming and a change that lenders are only now beginning to appreciate the benefits of – litigation risk transfer.
So what is litigation risk transfer?
Litigation risk transfer is the term I use when describing the process of taking the lender’s financial risk in running a claim for negligence and passing it to a third party. That third party will either be their solicitor, a legal expenses insurer or a third party litigation funder. These are three very different litigation risk transfer tools and they should be considered separately albeit that they can work concurrently.
Risk transfer to the solicitor – conditional fee arrangement
The conditional fee arrangement (CFA) is a form of retainer between the solicitor and the lender that states that the payment of all or some of the solicitor’s hourly rates will be conditional upon the successful outcome of the litigation. This is a form of risk transfer, as the risk of the lender’s own solicitor’s fees is being passed to the solicitor firm itself.
The solicitor is rewarded for adopting the risk on the payment of their fees by way of an uplift on their fees (called a success fee) which is usually a percentage of their hourly rate. The success fee is recoverable from the opponent is the case is successful.
The benefit of a CFA for the lender is not only that the solicitor’s fees are not payable if the case is lost but also, by definition, there are no fees to pay during the case. This takes the cost of solicitor’s fees off the lender’s balance sheet.
Solicitors are increasingly offering CFAs for lender claims and to be successful it is essential for the firms to have robust risk assessment controls in place to ensure they have a portfolio of CFA cases that are more likely to win than lose. If they get their assessments wrong, they stand to lose a lot of money.
Whether a lender wants to instruct a panel firm on a CFA basis is dependent on how the lender views the fact that its solicitor has a stake in the litigation. Some clients will be very happy to know their legal representatives are sharing their risk in the expectation that it will increase their focus on succeeding. However, others will be concerned that they are losing a degree of control over the case.
ATE litigation insurance
An after-the-event (ATE) litigation insurance policy can be taken out by lenders to cover their own disbursements and their potential liability to pay their opponent’s costs in the event they lose their claim.
These policies were first developed in the personal injury market when the government introduced conditional fee arrangements which were designed to replace the costly Legal Aid system (taking the cost away from the public purse). ATE insurance was needed to cover the clients exposure to costs that the CFA did not cover, namely own disbursements and adverse costs. It is possible for a policy to cover a litigant’s own solicitor’s fees (i.e. time spent on the case) in some areas of law but such cover is very rare and would probably not be available to lenders.
The costs that can be insured under an ATE policy can be substantial even though the cover would not include the claimant lawyer’s time. Professional negligence claims can involve retrospective valuation reports and other expert evidence which can be several thousands of pounds, not to mention all of the billable hours and disbursements that the opponent’s lawyers will charge the lender and therefore seek to recover from the lender if they successfully defend the claim.
Like any insurance, the policy is only attractive when the cost of buying the policy makes economic sense when compared with the financial risk that the policy is there to cover – but that is what makes ATE insurance so attractive. Unlikely any other type of insurance, the cost of the policy should be zero to the lender in all but the rarest of cases. How is this possible? It is because the premium is only payable in cases where the lender is successful in the litigation so there is no premium to pay in the event that the case is lost albeit that the lender can still avail themselves of the protection provided by the policy (i.e. the policy will provide an indemnity to the insured for own disbursements and adverse costs despite the fact that premium is not paid). What is more, in the event that the lender wins the case, the premium that is then payable is recoverable from the defendant as part of costs. In simplified terms, the insurance costs the lender nothing, win or lose.
Lenders and those representing lenders are realising that such policies are necessary to provide the complete package of litigation risk transfer where the policies operate alongside conditional fee arrangements. In such circumstances, the lender has nothing to lose in the long run in bringing a claim provided the solicitor and insurer are prepared to accept the case has sufficient merits. ATE insurance can be used with standard pay-as-you-go solicitor-client retainers and partial CFAs (where only a proportion of the solicitor’s fees are conditional upon success) but the trend is moving towards full-risk CFA retainers backed by insurance.
What is more, because the premium is contingent upon success, the premium itself is effectively deferred, as it is only payable if the case is won. Accordingly, the premium is not a drain on cash flow either.
A lender can instruct its solicitor to obtain insurance on a one-off basis. The solicitor would then need to undertake a search of the ATE insurance market either on its own account or through a specialist broker in order to find a competitive policy with a reasonable premium. However, because lenders are repeat litigators, the larger firms that specialise in lender claims are entering into delegated authority agreements with ATE insurers so they can offer insurance to their lender clients automatically without having to rely on the subjective decision of individual underwriters on every case. A good broker will have access to all the leading delegated schemes.
Third party funding
The third and newest form of litigation risk transfer is third party funding. This is where a third party will fund the cost of the lender’s litigation in return for a proportion of the damages that the lender receives from the litigation. Until recently, such practice was not possible because it was viewed as unlawful due to the doctrines of Champerty (making money out of litigation that you are not involved in) and Maintenance (helping a third party maintain their action). Following recent case law, which has held third party funding to be lawful, it is now possible for a third party to fund a case in return for a share of the rewards despite these long standing doctrines. It is likely there will be more legal challenges in the future but it certainly appears third party funding is here to stay.
Third party funders can take several forms but usually they are either professional funders that only exist to fund litigation (that being all they do) or they are hedge funds who see litigation as yet another investment vehicle, like any other, with high returns for high risk. The funding market is very immature at the moment and whilst there are some very good funders, there are also companies who are dabbling in a market that they probably know too little about.
The main benefit of third party funding is that the funder will pay the lender’s solicitor’s fees and disbursements as the case progresses. An ATE insurer will not do this, as the policy is one of indemnity and not an interim funding facility.
This is an expensive form of litigation risk transfer, generally costing 20 to 40 percent of the damages received by the lender. This is not a recoverable fee, unlike the ATE insurance premium, so any decision to use third party funding is truly a commercial decision based on cash flow. In reality, I would view it as unlikely that a lender would want to give up a large proportion of damages for the sake of having someone else pay for their own disbursements (given that CFAs can deal with any cash flow issues related to the solicitors own fees without giving away any damages). Third party funding is more likely to appeal to impecunious clients and insolvency practitioners rather than lenders.
A time of permanent change
Lender claims are big business in litigation terms and many law firms do a great job for lenders and retain large amounts of business from a small number of sources. As a result, law firm s need to differentiate themselves from their competition in order to gain a place on the panel of the largest lenders. In the past this has meant that law firms have had to lower their hourly rates to succeed in their tenders but the last couple of years has seen competition on price change dramatically because it is not as simple as who charges the lowest hourly rate any longer. The phrase of the moment is “litigation risk transfer” and firms that understand what this means will have the advantage over their rivals. By using ATE insurance, CFAs and even third party funding, some firms will make lenders re-think their current funding arrangements.
All lenders and indeed all claimants involved in litigation (including heavyweight banking litigation), with viable cases should generally expect to be able to offset at least 50 to 70 per cent of the legal costs of litigation at no cost to them. Whether they can offset 100 per cent is, to a degree, down to the funding arrangement with the law firm, but certainly litigation ought not to be as unappealing, economically, as perhaps it once was.
Right at this moment, there is a huge gap between the knowledge and understanding of the law firms specialising in lender claims so as a lender it is the right time to be thinking about how lender claims are going to be funded this time around. For law firms and lenders alike, it is time to forget about how things worked in the nineties and embrace the litigation risk transfer opportunities of the 21st century.
Matthew Amey is a director at independent risk transfer brokers, TheJudge Limited.