Keep the litigation hedge in shape

IMAGINE YOU ARE a significant shareholder in a medium sized UK company. You are aware the company has recently pursued a claim against a supplier for breach of contract. You know the claim was a substantial one, running into millions of pounds and what is more, the legal costs to pursue the claim also amounted to a seven figure sum. The legal expenses were financed largely by retained profit reserves but inevitably the cash drain meant less investment in the business and a restriction over other legal claims being pursued due to a fixed legal budget.

Unfortunately and much to your surprise, the claim was unsuccessful. The company not only wasted money on funding their lawyers but worse still, the company is now footing the bill for the opponent’s costs too, having lost the case.

How would you then feel if it later came to light that your FD had decided not to purchase an established form of legal expenses insurance – called After-the-Event (ATE) insurance – to cover the risk of paying the opponent’s costs in a losing scenario?

Perhaps you would think the FD weighed the pros and cons of buying the insurance and decided it wasn’t worth paying a hefty premium for a case they expected to win? But you discover that the ATE insurance premium, under current rules, would have been recoverable as part of costs from the opponent had the case been successful. In effect, if the company had won, it shouldn’t have cost anything. Instead, in the lost case scenario it would be the insurers footing the bill.

Perhaps the litigation’s cash drain precluded any additional outlay for an insurance premium? To the contrary, you discover ATE premiums are deferred and contingent upon success – meaning the company would only ever have had to pay the premium at the end of the case and only if it won!

The company’s performance last year was being dragged down by various cash drains, one which was this litigation. You discover it was open to the FD to search for a Litigation Funding partner to finance your legal costs on a non-recourse basis. The litigation funder would only be paid from the “winnings”, i.e. following recovery of costs and damages after winning the case. In this example, a funder would have lost their investment because the case lost. However, the company could have taken solace from knowing that the legal costs had been completely hedged and were effectively off the balance sheet.

As a shareholder you might want to understand why the FD passed up the opportunity to obtain insurance or funding to protect the company.

So why do many companies fall into this trap? In the FD’s defence it could be that the company’s lawyers failed in their duty to provide advice about all available funding options.

Lawyers’ awareness of insurance and funding products varies greatly, partly because of the speed at which products have evolved. Worryingly, even in today’s economic climate some lawyers comment along the lines of “why would my client be interested in hedging their position, they have deep pockets and are happy to pay me by the hour”. Most shareholders would be pretty displeased by such a statement.

Awareness of ATE and funding products has been slowly improving and recent debate ahead of the Legal Aid, Sentencing and Punishment of Offenders Act (LASPO) has helped stimulate interest.

The integration of ATE insurance and funding products (i.e. to provide a complete hedge on costs) is not limited to one-off legal disputes but may apply to portfolios of litigation where businesses have legal departments regularly instructing lawyers to pursue claims. Many businesses are repeat litigators in certain areas due to the nature of their trade, whether it is protecting intellectual property rights, debt recovery, breaches of contract or negligence claims. If in-house counsel has a fixed legal spend of X, meaning they can only pursue five of potentially ten income generating actions, then surely it’s more viable to pursue all ten actions if it can be achieved within the same legal budget using the available products in the market?

A claim for damages is in fact a contingent asset which can be monetised efficiently with the right lawyers, products and understanding. Rather than products of sole relevant to impecunious clients, many of the largest companies in the world have the risk of individual legal cases hedged, or a dispute portfolio funded using external funding and insurance options.

Recoverability of the ATE insurance premium (a feature which makes the product a virtual ‘no brainer’) is being abolished under LAPSO (probably in April 2013), so those advising FDs in live cases ought to urgently prioritise the question of how litigation is funded to ensure companies can take full advantage of the current rules. If in doubt about the available options or law firm selection, speak to a specialist broker who can help identify the options.

Matthew Amey is a director at TheJudge, a litigation insurance and funding broker