In the 200th anniversary year of Darwin’s birth, the world of litigation funding is witnessing its own form of convergent evolution between After-the-Event insurance (ATE) and Third Party Funding (TPF).

In the natural world, two entirely distinct species with differing ancestries can evolve to develop similar characteristics. One or more features of two species will develop so that they are the same or appear to be the same, sometimes to such an extent that it is hard to tell the descent of the animal. This phenomenon occurs as a result of the environment that these species inhabit and similarly it is the commercial litigation funding environment that is causing ATE and TPF to share the same attributes, despite being of very different origins.

I have already been privy to situations where the actions of Third Party Funders are indistinguishable from the services of ATE insurers. Now, I am beginning to see ATE insurers mimicking the products of Third Party Funders but before I discuss how and why, let’s remember how different the two creatures are.

Happy Families?
Commercial After-The-Event, belonging to the legal expenses insurance family, has developed over a reasonably short history to provide risk transfer for commercial litigation, having spawned primarily from policies covering personal injury and civil litigation. ATE has existed for a while but when the ATE premium became a recoverable part of costs (provided that the premium is reasonable) following the introduction of s.29 of the Access to Justice Act 1999, market growth accelerated.

Third Party funders on the other hand are not a member of the insurance family. I think they are better termed as a product of the financial investment family. TPF can’t really be described as having much of a history as professional TPF has only really emerged following the favourable decision in Arkin – a judgement that provided funders with some comfort that they could avoid falling foul of the doctrine of champerty.

Core differences
There are two major differences between the two species:

The method and amount of their return. An ATE premium is a recoverable cost so it may potentially cost the litigant nothing, in terms of the net effect, if the case is successful and the premium is fully recovered. There can be a shortfall but in most situations, the full premium is paid from recovered costs and ATE does not therefore act as a deduction to the damages awarded. A funder, on the other hand, is paid a success fee from the compensation which cannot be recovered from the paying party, which is a fundamental difference between the two species.
Funding own-party costs as the case progresses. ATE insurance policies are not designed to pay the insured’s own-party costs during the course of the litigation. The contract is one of indemnity for the insured’s liability in the event that the case is unsuccessful, as defined by the policy. In contrast, Third Party Funders exist to pay the costs as the case progresses.
So, ATE and TPF have very different origins and there are some real core differences between these two beasts. Yet despite this, they appear to be stealing each other’s roles from time to time.

Funders behaving like insurers
I have seen examples of where the funders are behaving like insurers. The funder is not actually funding anything on an interim basis but is simply providing an indemnity contingent upon the outcome of the case (i.e. accepting liability for adverse costs).

I find this odd. There will be cases where the funder is the only party willing to take the adverse cost risk but, unless the case has been declined by ATE insurers, insurance is generally a cheaper way of protecting the client from this risk. In my opinion, funders are the solution to a litigant’s liquidity problems, as opposed to a pure risk transfer solution and this is how I believe most solicitors see them also. I suspect that where such arrangements exist, it is probably because the funded litigant simply doesn’t understand that by reducing the amount of funding they need from a funder, they can reduce the funder’s fee and thereby reduce their deduction from damages.

As a side note, providing ATE insurance is a regulated activity under the Financial Services and Markets Act 2000 (FSMA) but Third Party Funding does not appear to be a regulated activity from an FSA point of view. That being the case, funders have to be careful when acting like insurers, at least in the UK. Some of the members of the TPF community have co-drafted a voluntary code of conduct as a form of self-regulation of course, so the TPF market is moving towards a form of regulation, albeit self-regulation.

Insurers behaving like funders
It is when I started to notice more and more insurers behaving like funders in relation to funding own party costs that I began to first consider the notion of convergent evolution.

One domain of the funder that is being encroached upon by ATE insurers is funding an order for security for costs. The willingness of ATE insurers to provide bonds or deeds of indemnity in order for a case on risk with them to satisfy a security for costs application has increased dramatically in the last year.

This is a very welcome development from my perspective as many cases struggle to proceed, even with the benefit of ATE insurance as, depending on the circumstances, the ATE policy is not always adequate security on its own. This is because of the risk that cover under the policy could be void or withdrawn for a breach of the policy terms and conditions.

Until recently, most claimants without sufficient funds to meet an order for security for costs would have little choice but to engage with a third party funder in order to put up a bank guarantee or pay money into an escrow account. This would cost the claimant a multiple of the amount guaranteed, whereas deeds of indemnity tend to cost a fraction of the funder’s fee. I predict that this is an area where insurers will increasingly become the solution instead of funders. That said, there are always going to be cases where TPF is the only option to satisfy security, as insurers will generally not support very large sums with a deed of indemnity, in the same way funders have.

Perhaps one of the more extreme examples of an insurer behaving like a funder involved the insurer providing a deed of indemnity to guarantee the payment of counsel’s fees by a specified date. This was an unusual situation in which we had to intervene to help construct an innovative solution. In the end, the underwriter offered to ensure the claimant was able to instruct suitable counsel who required payment at a certain longstop date. This was a reasonably isolated situation brought about by the defendants conduct throughout the case and fortunately the underwriter moved mountains to support the client. However, this example begs the question: will we see more situations where insurers will find a way to pay disbursements, either to support live cases or perhaps more radically to simply attract new ones?

We already have precedents for how ATE insurers have edged closer to funding to help attract new business. Pre-investigation cover for expert reports in clinical negligence cases is not actual funding but given that an unsupportive report results in an immediate claim, then insurers are getting closer to funding the investigation themselves. How much of a leap will it be for an insurer to agree to actually pay the experts report once obtained whether positive or negative? At least a positive report increases the chance of recovering a return on investment.

It is not that hard to believe ATE insurers could evolve to fund disbursements, after all, their close relation, before-the-event, is part of the insurance family and most of these policies fund own party costs on an interim basis.

With Sir Rupert Jackson’s review on the costs system, we may see ATE insurers adapting in more ways to be like funders. There may even come a time when the insurers will seek a share in the proceeds of the recovery in return for interim funding?

We can see there is some convergence with possibility of more to come but why?

I believe that answer is that both ATE insurers are trying to cater for demand. How different can these species continue to be when they both hunt the same prey in same place?! They both want to select the best cases from the pool of claims this country currently has to offer.

Whilst it is true that that pool is getting bigger as more commercial firms embrace risk transfer and undoubtedly there is demand for both ATE and TPF, it is inevitable that they will find themselves competing for the same opportunities. It is natural that each will try to adapt itself to fill any gaps in their current offering when they compare themselves to their competition.

The majority of the time, funders and insurers find a way to work together with the funder providing the interim finance for own fees whilst an insurer indemnifies the client for adverse costs (for example). Indeed, sometimes they compel the client to engage the services of the other. Some funders will insist upon ATE being sought before they fund and some ATE insurers won’t support a case without comfort that the Insured has access to a source of funds to see the case through. However, occasionally one will be more suitable than the other given the specific needs of the client in question.

I believe deciding which is more suitable is becoming even more difficult for solicitors given the effect of this convergent evolution.

Matthew Amey is a director of risk transfer broker TheJudge (