CFAs continue for insolvent companies

In April 2013, the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (LASPO) came into force, making the success fee applied to a Conditional Fee Arrangement (CFA), and the After the Event (ATE) insurance premiums, irrecoverable by a successful party to litigation proceedings.

However, under article 4 of LAPSO, there is an "insolvency exemption" making these costs recoverable by an insolvency practitioner.

The reason given for this exemption was that, if an insolvent company is left with no assets, and consequently no funds, it is impossible for an insolvency practitioner to investigate directors' and third parties' conduct or to fund litigation.  This means that, if directors strip companies of their assets prior to liquidation, the insolvency practitioner when appointed will have insufficient funds to investigate any misconduct on the part of the directors.  As a result of the exemption, an insolvency practitioner can still instruct a solicitor on a CFA, or "no win, no fee" agreement, with ATE cover in place, and can recover any uplift and premium from the defendant.

It was suggested by the government last year that the insolvency exemption would be removed by April 2015, bringing insolvency proceedings into line with other classes of action. However, in a ministerial statement by Justice Minister Shailesh Vara, published in February, it was announced that the reforms would be delayed "for the time being".  What that means in not clear.  What we can say is that, with a general election next week, the fate of the insolvency exemption remains uncertain.

In a recent article by R3, the Association of Business Recovery Professionals, it was suggested that the exemption was desirable for the following reasons: 

• insolvency litigation returns money to creditors, businesses and taxpayers;
• such litigation deters and punishes culpable behaviour by directors and third parties;
• when insolvency litigation is successful, often public funds benefit through returns from the insolvent estate to HMRC;
• the majority of claims currently realise £50,000 or less and are therefore unlikely to be pursued without CFAs and ATE because the costs involved in the case would be too high;
• but for the exemption, any CFA uplift and ATE insurance premium would have to be paid out of any damages, reducing the amount returned to creditors; and
• the current regime prevents defendants dragging out proceedings in the hope of the claimant running out of money.

R3 suggest that the decision to keep the exemption in place will protect £160 million of creditors' money a year that otherwise could have been kept by fraudulent or negligent directors.  Against these arguments must be set the fact that, in his major review of the costs of litigation funding, which gave rise to LAPSO, Lord Justice Jackson identified the recoverability of CFA uplifts and ATE premiums as the major reason for costs escalating out of all proportion to the claims.  The Supreme Court is currently considering whether the system of allowing claimants to recover CFA uplifts and ATE premiums is contrary to Article 6 of the European Convention on Human Rights.  Whilst the exemption may be allowing insolvent companies to pursue negligent or dishonest directors, it is also being used to pursue claims in negligence against third parties, and the additional costs liabilities continue to add to the weight of losses in the professional indemnity market.  The decision to extend the period of the exemption will therefore be considerably less welcome with insurers than it is with insolvency practitioners.