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Beyond adverse costs cover

Clients increasingly ask for “alternative fee” options, and most lawyers are now well-versed in discussing litigation funding as a part of that. In contrast, litigation insurance remains under-utilised and I suspect this is due to a misunderstanding that its role is limited to adverse costs (or after the event (ATE)) cover).

Litigation insurance does so much more. (While this blog focuses on coverage for litigating parties at various stages of a claim, another key area is coverage for the risks faced by lawyers themselves, for example, insuring law firms when they act on contingent fees such as damages-based agreements (DBAs).)

Insure or fund own costs?

Lawyers often overlook the possibility that a claimant’s own litigation spend can be insured. The risk being covered is that the fees and expenses paid by the insured party during the case are lost for good if the claim fails. If that happens, the insurer reimburses the insured party in respect of their financial outlay incurred in the running of the case.

This type of cover is relevant to claimants keen to manage their risk exposure but not to concede what can be a meaningful share of their damages to a litigation funder. It may be ideal for well-resourced corporate claimants as, whilst an insurance policy does not provide access to cash flow for legal spend, it is a significantly cheaper way of hedging risk than using external funding. I expand on pricing at the end of this blog but the key message is that own-costs cover should, at the very least, be discussed as an alternative or supplement to litigation funding.

Stopped before you start – risks at the outset of a claim

Claimants face numerous costly risks when getting a case off the ground – which defendants use as an opportunity to stifle, delay or force a settlement. For example, I spend an increasing amount of time helping clients manage the risk of an anticipated security for costs application. It’s become common to use an ATE policy as security, but often defendants require additional comfort that the claimant’s policy will benefit the defendant if the need arises.

Deeds of indemnity and anti-avoidance endorsements (AAEs) are becoming common but there are some less well-known – but crucial – considerations which lawyers should be ready to discuss with clients early on if security issues are anticipated. For example, there can be significant savings by incepting a policy with a Deed or AAE from ‘day 1’ rather than structuring an option to purchase one or other at a later date. Also, certain types of claimant – insolvency practitioners or class representatives for example – may have a commercial/strategic imperative to ensure this additional comfort is in place early on.

Less common, but as vital to sustain certain claims, is insurance cover for the cross-undertaking in damages which a claimant must provide if pursuing a freezing order or other injunctive relief. An inability to provide such security – for example because the claimant is impecunious – may frustrate the claim. A cross-undertaking policy secures the risk of having to pay out under the cross-undertaking, facilitating the injunction (all other things being equal) and thus the underlying claim.

It’s not over until….- risks at the end of a claim

A successful claim has no value until the damages award is in the claimant’s bank account. Lawyers identifying potential judgment or enforcement risks may be unaware that insurance could be deployed to mitigate them. Where there are concerns over a case, or the defendant’s profile, it may be worth involving insurers or brokers in early conversations to consider the cost versus benefit of mitigating risk.

One such risk is that an award is overturned on appeal. Specialist insurance markets will consider covering the risk (in terms of legal fees and a portion of the damages) that a judgment or award is reversed or annulled. This means the insured has certainty of recovery up to an agreed limit regardless of the outcome of the appeal. This may be vital in cases where timely financial recovery (more than the legal principle at stake) is important.

Another risk, specifically in investor-state arbitration, is that the respondent state refuses to pay an award, pushing the claimant into undesirable and costly enforcement processes. In a politically volatile climate, claimants may perceive this as an increasing risk. Whereas some funders will consider monetising awards, a less familiar solution is award default insurance. This guarantees recovery of the award up to an agreed level.

What does all this cost?

Discussing the pricing of these bespoke products would easily require a blog of its own, but I’d encourage lawyers to speak direct to a broker if any of the risks resonate for a current case.

However,  as I explained above, own-costs insurance can – more economically – simulate the risk mitigation function of litigation funding. The fundamental price difference is because insurance covers risk without providing cashflow. Where a client has the means to pay (fully or partially) its legal fees and disbursements, lawyers should definitely factor insurance into their discussions with clients.

As an example, let’s assume in a claim where the costs budget is £5 million:

  • The premium for obtaining litigation insurance is 1 x (charged on a fully contingent basis requiring no upfront payment); and
  • The cost of obtaining litigation funding is around 4 x (repayment of monies borrowed + a success fee of 3 x).

At the two extremes, if the client took own-side’s legal fee insurance for 100% of their exposure, and the case succeeded, they would pay the insurer a premium of £5 million. If the client took litigation funding for 100% of the budget, and the case succeeded, they would pay the litigation funder £20 million. The litigation insurance solution is significantly (£15 million) cheaper, but the downside is that the claimant had to utilise £5 million of their own cash.

What if the client took litigation funding for £3 million of the legal budget but self-financed and insured the remaining £2 million? They would be achieving a position where:

  • They are 100% insulated from their own legal costs risk,
  • They would be benefiting from external financing for 60% of their legal spend; and
  • Would be retaining £6 million more of any damages realised than they would be if they exclusively utilised litigation funding.

The point applies to the dreaded costs to damages ratio for litigation funding. Disproportionate costs to damages is probably the most common reason for funders to reject a case. But combining insurance and some funding as described above improves proportionality and potentially makes an otherwise unsuitable case viable.

For whatever reason, litigation insurance outside of adverse costs is being consistently under-utilised. In a world where law firms are coming under increasing pressure from sophisticated clients to explore finance arrangements, adding elements of insurance into the discussion to better meet the financial and risk appetite of a client would be a strong differentiator.

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