REUTERS | Mike Blake

Funders’ liability for adverse costs: scrapping the cap

It has been clear for some time that a third party who funds litigation on commercial terms may be ordered to pay the costs of the winning defendant if the funded claim is unsuccessful. What was less clear, until recently, was the extent of that liability, and in particular whether it is subject to a fixed limit in the form of the so-called “Arkin cap”.

That is the principle that a funder’s potential liability for adverse costs will be limited to the amount of the funding provided. It stems from the Court of Appeal’s 2005 decision in Arkin v Borchard, but has been the subject of much debate in the intervening years (as outlined in my previous post on this blog), both as to the breadth of its application and as to whether it remains appropriate in light of developments in the funding market since Arkin was decided.

That debate has now been settled by the Court of Appeal’s decision in Chapelgate Master Fund Opportunity Ltd v Money, which confirmed that the Arkin cap is not a binding rule; so, in other words, is not a cap at all. The court retains a broad discretion as to the extent to which a funder should be liable for adverse costs. In exercising that discretion it can take into account a range of factors, including but not limited to the amount of funding put in to the case.

The Arkin debate

In Arkin v Borchard, the claimant brought the proceedings with the benefit of a conditional fee agreement. A third party provided £1.3 million to fund expenses (including expert reports) in return for a share of any damages. The claim failed and the defendants sought to recover costs of nearly £6 million from the funder.

The Court of Appeal held that the funder should be liable for costs but only up to the amount of funding provided. Although in that case the funder had financed only part of the costs of the litigation, the court said it could see no reason in principle why the same approach should not apply where the funder had contributed most or all of the costs.

Arkin was widely assumed to establish a principle of general application, that a funder’s adverse costs liability would be capped at the amount of funding provided. It was, however, the subject of much criticism, as noted and endorsed by Jackson LJ in his Review of Civil Litigation Costs: Final Report. He stated:

“In my view, it is wrong in principle that a litigation funder, which stands to recover a share of damages in the event of success, should be able to escape part of the liability for costs in the event of defeat.”

That, he said, was unjust not only to the opponent, who could be left with unrecovered costs, but also to the client, who could be left exposed to adverse costs liability that it could not meet. He recommended that, either by rule change or by legislation, funders should potentially be liable for the full amount of adverse costs, subject to the discretion of the judge.

Chapelgate v Money

ChapelGate agreed to provide £2.5 million to fund the claimant’s claims in return for a share of any winnings (calculated as the greater of 2.5 times the amount funded or 25% of net winnings if the case won or settled after the start of trial). The funding was conditional on the claimant obtaining a suitable after the event (ATE) insurance policy, and the cost of the premium was factored into the funding amount. However, the claimant failed to obtain ATE insurance, in breach of that condition.

ChapelGate agreed to waive the condition on the basis that its total funding commitment would be reduced to £1.25 million, but its return would still be calculated on the original £2.5 million commitment. According to an internal email, ChapelGate reasoned that the £1.25 million commitment together with its “Arkin risk” (that is, another £1.25 million) meant its total risk remained unchanged at £2.5 million.

The claims failed in their entirety and the claimant was ordered to pay the defendant’s costs on the indemnity basis. ChapelGate accepted that it should similarly be liable for indemnity costs, but argued that its liability should be limited by reference to the Arkin cap, as well as to costs incurred after the date of the original funding agreement. The High Court declined to apply the Arkin cap, but accepted ChapelGate’s argument on the timing point (as the authorities suggested that there should be some causal connection between the funder’s involvement and the incurring of costs). That meant a potential liability of some £4.33 million, subject to detailed assessment.

The Court of Appeal dismissed ChapelGate’s appeal, agreeing with the High Court that Arkin did not establish a binding rule; instead the court in that case had merely set out an approach which might be considered for application in similar cases. The court’s decision is in the end discretionary and, as Moore-Bick LJ noted in Deutsche Bank AG v Sebastian Holdings Inc “the only immutable principle is that the discretion must be exercised justly”.

A broad discretion

The result of the decision is that, in considering whether and to what extent a funder should be liable for adverse costs, the court has a broad discretion to determine what order is just in all the circumstances of the case.

In many cases, the court may wish to take into account the funder’s potential return, particularly if that is large compared to the amount of the funding provided. In other cases, the court may choose to follow the Arkin approach and focus on the amount the funder has committed to the case, particularly if, as in Arkin, the funder has funded a discrete part of the claim. Other factors may be relevant, such as the nature of the claims and the extent to which applying the Arkin cap would leave the defendant out of pocket.

Good news for defendants

The demise of the Arkin cap is a positive development for defendants facing claims brought with the benefit of litigation funding. That includes many (indeed perhaps most) defendants to class actions. Although the litigation funded by ChapelGate involved a single claimant, commercial funding is commonplace for claims brought under group litigation orders or other mechanisms for bringing large multi-party claims.

In many cases where commercial funders are involved, there are likely to be significant practical difficulties in recovering costs from the claimants to the action. That may be because the claimants are impecunious (as will often, though not invariably, be the reason for seeking funding in the first place). Or it may be because, in a group action, the claimants often have the benefit of several liability, so that each is liable for only a portion of the defendant’s costs if the claim fails. In such circumstances, unless there is sufficient ATE cover in place and that cover responds when needed, the defendant may well look to the funder as its first port of call for costs recovery.

Against that background, it is helpful that the Court of Appeal has put to bed the notion of a fixed limit on a funder’s adverse costs liability. Such a limit seems incongruous in any event, given that there is no fixed limit on a litigant’s personal liability for adverse costs by reference to its own incurred costs, and bearing in mind the principle established in Excalibur Ventures v Texas Keystone that a commercial funder will normally be liable for the defendant’s costs on the same basis as the funded party (though in Excalibur the Court of Appeal said it had not been asked to revisit the decision in Arkin and so declined to express a view on it). So in both Excalibur and ChapelGate, the funder was liable for indemnity costs because the funded party had been ordered to pay costs on that basis.

The impact on funders?

While funders cannot be expected to welcome the ChapelGate decision with open arms, it does not appear to have come as a particular shock to the market. I have seen commentary from a number of funders emphasising that the decision will have little or no impact on reputable market participants. And that seems right. Funders take on cases they expect to win, based on detailed due diligence, and can mitigate their adverse costs risk on a loss through the use of ATE insurance.

In any event, the successful opponent will only be able to recover costs to the extent they are reasonable and (unless assessment is on the indemnity basis) proportionate. In addition, it seems the funder will only be liable for costs incurred after the date of the funding agreement, given the requirement for a causal link referred to in a number of authorities. That point was not challenged in the ChapelGate appeal. Even with the loss of the Arkin cap, therefore, a funder’s liability for adverse costs is not completely open-ended.

So all in all, while the decision may be a disappointment to some funders, it seems it’s not a disaster for the funding market generally.

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