UK: An Introduction to Litigation Funding: Insolvency

LITIGATION FUNDING: INSOLVENCY 2022 

The UK insolvency industry is now emerging from the unprecedented economic, financial and social effects of the COVID pandemic. Lockdowns, Government business support measures and legislation restricting enforcement action against companies and winding up petitions whilst suspending certain provisions of the Insolvency Act 1986 have all affected the work of insolvency practitioners and insolvency lawyers.

The restrictions on presentation of winding up petitions which applied under the Corporate Insolvency and Governance Act 2020 from 26 June 2020 to 30 September 2021 have suppressed the number of companies being wound up by the court. On the lifting of restrictions, there is a huge backlog of winding up petitions.

Government support measures such as Bounce Back Loans, the Furlough Scheme, Business Grants and temporary tax cuts enabled some companies to continue which would otherwise have entered into creditor voluntary liquidation or other insolvency regime. Following the withdrawal of the support measures there is a considerable increase in the volume of companies entering into insolvency.

According to the Insolvency Service’s latest statistics the number of company insolvencies in England and Wales in April 2022 was 1,991. This figure is more than double the 925 number registered in April 2021 and is 39% higher than the 1,429 registered in April 2019. Of the 1,991 figure, there were 1,777 creditor voluntary liquidations, which is 118% higher than April 2021 and 74% higher than April 2019. There were 91 compulsory liquidations, 203% higher than April 2021. This year on year increase can be expected to continue.

Under the Corporate Insolvency and Governance Act 2020 the threat of personal liability for wrongful trading under s.214, Insolvency Act 1986 was temporarily removed from directors from 1 March to 30 September 2020 and from 26 November 2020 to 30 June 2021. This may well have lulled some directors into a false sense of security in relation to their conduct. In practice, wrongful trading claims are rarely brought. What is more common are claims in damages for breach of duty or misfeasance, and directors’ fiduciary and other duties under the Companies Act 2006 and at common law have continued to apply throughout.

Support measures, the Bounce Back Loan in particular, were readily accessible by directors with minimal diligence being carried out. Evidence is emerging of wide scale abuse by directors of the support schemes and misapplication of public monies. It is estimated by the Parliamentary Public Accounts Committee that of GBP47 billion paid out in Bounce Back loans, GBP17 billion is expected to be unpaid. Many companies which received Bounce Back loans will proceed to insolvency and the only prospect of recovery will be through claims against delinquent directors.

All of the above creates a perfect storm of increased numbers of insolvencies in the months and years to come and within those insolvencies claims against directors and connected parties. Most insolvent estates do not have a war chest from which to pay for litigation, creating the need for finance from third party litigation funders.

Finance for insolvency litigation differs from funding of solvent parties in that the claim or cause of action can be assigned to a third party, whether as a company asset or an office holder claim. This unique ability to assign rather than simply fund has revolutionised insolvency litigation funding, allowing funders to provide innovative and flexible ways to assist maximum returns into insolvent estates. Options include funding, assignment with an agreed division of realisations or outright assignment.

Third party finance is a viable alternative to the traditional method of lawyers working on a conditional fee agreement with after the event (ATE) insurance in place to cover adverse costs. The uplift on a conditional fee agreement (no longer recoverable from the paying party) and high insurance premiums diminish returns to insolvent estates. A claim may fail or recoveries may be insufficient to pay legal fees or the uplift, which leaves insolvency lawyers with significant amounts of unpaid WIP.

Third party finance ensures lawyers are not required to assume risk, but are paid for the professional work they do. A properly financed claim has real credibility with opponents and is more likely to result in early commercial settlement, whilst covering all legal costs and expenses including court fees and expert witness fees in the event that the claim proceeds to trial.

An insolvency practitioner or insolvency lawyer seeking insolvency litigation funding should consider:

1. The financial strength of the funder: does it have a balance sheet which will meet all own and adverse costs and defeat any security for costs challenge?

2. Will the funder provide a complete indemnity to the estate and the insolvency practitioner (IP), or does it require the IP to take out ATE insurance?

3. Will the funder agree that the IP’s choice of solicitors are instructed, whether the claim is funded or purchased?

4. Will the funder pay lawyers for their work or require them to work on a conditional basis?

5. The expertise and track record of the funder: does it have the necessary skill and experience to assess and price risk and to work with external lawyers to run litigation in a proportionate and effective manner?

6. Does the funder have a nationwide network connecting with IPs and insolvency lawyers throughout the UK?

7. Is the funder recognised in the insolvency industry, and does it have the reputation of always following through on claims?

Defendants to assigned insolvency claims and their legal representatives will frequently seek to challenge the assignment rather than to focus on the claim. This was an increasingly employed defence tactic. Clarity was provided in a judgment handed down by the Court of Appeal on 9 May 2022 in Lock v Stanley [2022] EWCA Civ 626.

The Court of Appeal upheld the first instance decision of HHJ Halliwell refusing to set aside an assignment to Manolete Partners plc.

It was held that the Appellant as Defendant to Manolete’s claim had no standing to challenge the assignment as her interests were not aligned with those of the creditors generally. The class interest of the creditors is for the claims to be upheld and turned into as much money as possible, but the class interest of the Defendants is to defend the claims and avoid paying as much money as possible.

The Appellant complained that the claim had been assigned to Manolete without her being given a chance to make a competing offer and it was submitted on her behalf that the liquidator was under a duty to "test the market" properly. This submission was rejected by the Court of Appeal, the liquidator was under no such duty and the assignment of the claim to Manolete was not perverse.

A party seeking to challenge assignment of a claim must show a legitimate interest in the relief sought, and inevitably the interest of a defendant to an assigned claim is to defend that claim and avoid/minimise any payment. A party who can demonstrate a legitimate interest, and such party is unlikely to be the Defendant, must then overcome the very high threshold of satisfying the court that the assignment was perverse, and the formidable test applied is that set out in Re Edennote Ltd [1996] 2 BCLC 389:

"The court will only interfere with the act of a liquidator if he has done something so utterly unreasonable and absurd that no reasonable man would have done it."

This is a very welcome decision for insolvency practitioners and confirms the longstanding reluctance of the courts to interfere with the discretion exercised by office holders in making commercial decisions, including the assignment of claims.

Third party litigation funding is a growing industry generally, and provision of third party finance for insolvency litigation will increase exponentially with the rise in numbers of insolvencies and the increased numbers of claims within those insolvencies. An insolvency litigation funder can maximise returns for creditors and ensure insolvency lawyers are paid for their work whilst also providing attractive returns to investors.

Mena Halton, Head of Legal Manolete Partners plc