UK: An Introduction to Litigation Funding: Insolvency

Litigation Funding: Insolvency 2023 

The number of insolvencies in the UK are rising exponentially. According to the Insolvency Service’s latest statistics the number of company insolvencies in England and Wales in April 2023 was 1,685. This figure is nearly double the 925 number registered in April 2021 and is 39% higher than the 1,199 registered in April 2020. Of the 1,685 figure, there were 1,368 creditor voluntary liquidations which is 68% higher than April 2021 and 47% higher than April 2020. There were 183 compulsory liquidations, 510% higher than April 2021. This year on year increase can be expected to continue.

COVID Suppression and Support Measures 

This follows the suppression of insolvencies during the COVID pandemic when presentation of winding up petitions were restricted between 26 June 2020 and 30 September 2021 under the Corporate Insolvency and Governance Act 2020. 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 creditors voluntary liquidation or other insolvency regime.

Under the Corporate Insolvency and Governance Act 2020 the threat of personal liability for wrongful trading under section 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, GBP4.9 billion of the total to fraud. 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.

Claims Against Unconnected Third Parties 

In addition to antecedent transaction claims under the Insolvency Act 1986 and claims against the directors under the Companies Act 2006, when investigating the dealings and affairs of a company the Insolvency Practitioner may identify claims against unconnected third parties. An emerging trend has been claims in professional negligence against professional advisors - auditors in particular - and claims against banks in breach of the “Quistclose” duty. Commercial litigation of this nature against substantial and well resourced opponents (with the benefit of insurance in relation to professional negligence) is complex and costly, requiring significant financial investment. A company in an insolvency process is likely to face an application for security for costs and the Insolvency Practitioner will need to consider the options available to him to overcome this obstacle.

Most insolvent estates do not have a war chest from which to pay for litigation or to cover the risk on adverse costs, which is a risk of personal liability of an Insolvency Partitioner bringing an office holder claim. Third party finance can address both own and adverse costs.

Finance for Insolvency Litigation 

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 it is 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 achieve maximum returns into insolvent estates. Options include funding, assignment with an initial payment and 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 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. An insurance policy may fail to provide adequate cover.

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. A complete and unqualified indemnity from a third party with a strong balance sheet de-risks the insolvent estate and the Insolvency Practitioner.

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 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?

Defence Tactics 

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, Neutral Citation Number: [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 long standing reluctance of the courts to interfere with the discretion exercised by office holders in making commercial decisions, including the assignment of claims. An application by the Appellant for permission to appeal was dismissed by the Supreme Court on 16 September 2022

In a further boost for Insolvency Practitioners and assignees, on 14 July 2022 Mr Justice Zacaroli granted an appeal against a decision at first instance to limit recoveries to the amount required to discharge the creditors and the liquidation costs. In PGD Limited (in liquidation) Manolete Partners Plc v Hope & Jones [2022]EWHC 1801 (Ch) the judge recognised there were confines on the jurisdiction to limit recoveries in relation to the breach of duty element of the claim, which was not progressed pursuant to the statutory gateway under s.212 of the Insolvency Act 1986, but advanced by Manolete as assignee of the rights of P G D Limited. In further support of this decision, Mr Justice Zacaroli concluded that any discretion to limit recoveries to the amount required to discharge the creditors and the liquidation costs would be difficult to exercise if the consequence was to prejudice any third parties (which would include an assignee of the claim) who were innocent of the wrongdoing which gave rise to the claim.

Conclusion 

Third party litigation funding is a growing industry generally, and provision of third party finance for insolvency litigation will continue to increase alongside 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.