DBA insurance could expand the use of damages-based agreements in commercial litigation, with law firms able to boost their profit while limiting their exposure

By James Delaney – as published in The Lawyer on 25 May 2017

Sharing the DBA fee risk

Damages-based agreements (DBAs) were introduced as part of the package of Jackson reforms in 2013. However, while 2016 saw several large law firms running some sizeable DBA cases, take-up by commercial litigators generally has been limited, primarily due to concerns about the drafting of the DBA Regulations and, in particular, the inability to offer ‘hybrid DBAs’.

While law firms are understandably attracted to the potentially large upside available from contingency fees, many are concerned about the requirement that the DBA must be ‘all or nothing’. Unlike their US counterparts, lawyers in England and Wales do not have the flexibility to offer a hybrid contingency fee, whereby they are paid some element of their fees irrespective of the outcome of the case. A partial DBA would provide a balance between taking risk and sharing in some of the upside rewards whilst safeguarding some income for the firm.

Following a successful trial with several top-50 law firms, TheJudge has developed a product designed specifically for commercial disputes teams which enables law firms to share the fee risk they incur under a DBA with the insurance market. While the term ‘insurance’ rarely conjures excitement, in this instance it could be a key facilitator to large increased profits.

DBA insurance explained

DBA insurance is a policy taken out by the law firm (not the client) to cover a portion of the firm’s fee risk under the DBA.

As between the law firm and the client, the arrangement is an all or nothing DBA. However, if the case is lost or a judgement cannot be enforced, the law firm can make a claim under the policy to be reimbursed up to an agreed level of hourly fees incurred. Policies will typically cover around 50 per cent of the fees to ensure some risk alignment between the firm and insurer.

How is the premium paid?

The premium under a DBA policy is contingent upon the law firm collecting the contingency fee and is only paid out of the contingency fee recovered. If the case is lost the law firm pays no premium and the insurer reimburses the firm for the insured fees.

Why is this so significant?

Many UK lawyers will have encountered good commercial cases that would have been ideally suited for a contingency fee.

However, whilst a case may have excellent merits and be worth substantial damages, the economic reality of taking the full fee risk for two or three years is often too much of a hurdle for the law firm’s alternative fees committee. In other instances, the firm may already have reached its maximum contingent fee exposure and be unwilling to take on more.

With prospective (and even existing) clients increasingly tendering opportunities, having the flexibility of being able to offer alternative options to the pure billable hour is becoming increasingly significant.

We are seeing more examples of traditionally conservative law firms losing opportunities to firms who have more flexibility over their billing arrangements. The firm’s flexibility might only extend as far as providing discounts in the hourly rate to attract work, but this approach may not be sustainable in the long term. A race to the bottom on hourly rates may not be in the client’s interests if it means compromising on quality.

Larger firms may also be mindful of increased competition from mid-sized firms and boutiques, perhaps considered by Chambers & Partners as being ‘band two’ firms, but who have contingency cases on their books whereby the firm’s entitlement could be 35 per cent of the damages across a pool of cases worth potentially hundreds of millions.

There are many examples of smaller US law firms who became significant market players on the back of some hugely successful contingency cases. Many of the partners at such firms had to take on significant personal risk in the early stages, but have now amassed substantial war chests from which they can finance future contingency fee cases.

The opportunity now available to law firms in England and Wales is potentially enormous. There is no need to ‘bet the firm’ like those US firms in the above example, nor is there a need to have a huge war chest to underpin the expansion of a contingency book. The insurers with whom TheJudge has secured support to write DBA policies are the war chest. These insurers are all large international insurance carriers, ready and waiting to underwrite hundreds of millions of pounds of capacity by sharing the fee risk with law firms who have access to good cases.

No-one is suggesting that DBA insurance will give rise to the rampant use of DBAs in the UK commercial litigation market. Firms needs to manage their cash flow and therefore reach a sensible balance between billable hour work and alternative fees.

However, by cherry-picking the cases the firm believes in and laying off  a portion of the fee risk, the law firm could off set much, if not all, the discounts provided on their billable hour retainers, boosting realisation returns across the department or firm.

A solution to the age-old dilemma – how to account for contingent WIP

Because the insurer is agreeing to insure a fixed portion of the WIP incurred under a DBA, the firm has the financial certainty that it will realise at least (typically) 50 per cent of the fees incurred. This provides financial controllers with far greater budget certainty when forecasting revenues.

Taking a leaf out of the litigation funding book

The third-party litigation funding market has seen exponential growth in recent years. Standing at an estimated $4bn and growing, the industry’s global expansion represents the decade’s most significant development in how legal disputes are financed.

Most of these funds are highly sophisticated investors, with a singular outlook for maximising investment returns. Litigation is treated as just another asset class. It ought not to come as any surprise therefore that many of these funds will have an insurance arrangement behind the scenes to mitigate their capital risk.

DBA insurance effectively allows the law firm to do the same thing, mitigating downside risk whilst collecting substantial upside in the event of success.

Portfolio or individual risk cover?

Litigation finance or DBA insurance? Like funders, DBA insurers can provide cover on a case-by-case or a portfolio basis. Funders are increasingly promoting the viability of portfolio financing to law firms, which is beneficial for firms seeking to monetise and/or develop their alternative fee book with an injection of positive cashflow.

DBA insurance on the other hand, provides a different mechanism to hedge the risk. Rather than provide the interim cashflow, the insurer provides an indemnity to reimburse the fees incurred if the case is lost. Quid pro quo, the insurer does not charge anywhere near the level of return charged by funders.

This means that if a contingency case is successful, the law firm keeps the lion’s share of the profit. Both models provide advantages.

Which of these is of greater appeal might be driven by the firm’s cash reserves. If the firm can carry the cashflow for the duration of the case, the DBA insurance model is likely to lead to substantially higher net returns to the fi rm. On the other hand, if the firm does not have such cash reserves the funding-led model will be of greater applicability, but the law firm must cede a much larger share of the contingency fee recovered to the funder.

That said, the two products need not be mutually exclusive. The firm could have the benefit of DBA insurance and still arranging funding to finance the disbursements.

Summary of key benefits

  • Provides a mechanism to share the DBA fee risk with insurers
  • A product designed to drive law firm profit
  • A key business acquisition aid
  • A solution to accounting for contingent WIP
  • Quick decisions – insurers typically complete their review within 10 days

DBA insurance represents another key development in the litigation risk transfer market and one specifically developed to aid law firms.

With the ever-growing mix of products and suppliers, commercial litigation lawyers in England and Wales who have their finger on the pulse have much to look forward to; perhaps insurance can be exciting after all.