All civil litigation practitioners ought to know the difference between standard and indemnity basis costs. Whilst CPR 44.3(1) applies to both and provides that the court will not allow costs which have been unreasonably incurred or are unreasonable in amount, an important distinction is provided for in CPR 44.3(2)(a) and (b). Standard costs must be reasonable and necessary, and will be disallowed if they are not proportionate under CPR 44.3(5)(a)-(e). Indemnity costs, on the other hand, need only be reasonable. There is no proportionality requirement such as that they must bear a reasonable relationship to the sums in issue under, for example, CPR 44.3(5)(a).
A further important distinction is to be found in CPR 44.3(2) and (3). Where there is doubt about whether the costs have been reasonably incurred and are reasonable in amount, the court will give the party paying standard costs the benefit. The reverse is true for indemnity costs. It is the receiving party in whose favour the point will be decided.
The result? Obtain an order for costs on the indemnity basis and all your troubles will be over so far as the application of CPR 44.3(5) is concerned. There is no requirement for the costs to be proportionate or necessary. Provided your costs are reasonable, they will be allowed, even if the court is in doubt about whether they have been reasonably incurred.
Less well known is the relationship which exists between indemnity basis costs and those costs agreed or approved by the court as part of costs budgeting when the procedural judge has carried out costs management under Section II of CPR 3. That is understandable, given that, even at the top, there has been judicial doubt about what that relationship is, that is to say until, at least, the Court of Appeal handed down its judgment in Burgess v Lejonvarn on 6 February 2020, which has resolved the point.
But that is to digress. It is to be remembered that costs budgeting is a Jacksonism, that is to say, a creation which first found breath in Sir Rupert Jackson’s Report into the Costs of Civil Litigation published in December 2009, and subsequently found its way into the CPR via rules 3.12-18. It applies in the multi-track and, with one or two exceptions (for example, claims worth over £10 million are outside the scheme), the rule requires parties to file and exchange costs budgets not later than 21 days before the first case management conference. Once agreed or approved by the court, costs budgets can be revised under PD 3E.7.6, provided that the court is satisfied on application that “significant developments” since the date the previous budget was approved or agreed justify such a revision. However, if an application under the PD is not possible because, say, the case settles before the hearing for revision takes place, the costs judge at detailed assessment can allow more (or less) than the budgeted costs, if there is “good reason” under CPR 3.18(b) to do so.
What do indemnity basis costs have to do with costs budgeting in this context? The answer where the receiving party has an indemnity basis costs order, is whether the starting point at a detailed assessment is the last agreed or approved budget, or, instead, the actual figure which is being sought in the bill, which inevitably will be much higher, without first having to show “good reason” to depart [emphasis added].
That was the issue in Burgess. After years of litigation involving numerous interlocutory applications and trips to the Court of Appeal, which culminated in a five day trial when the claims of Mr and Mrs Burgess against their former friend, Ms Lejonvarn, were dismissed in their totality, the issue for the judge was whether to award costs on the standard or indemnity basis. The grounds for the latter were that Ms Lejonvarn had made an early Part 36 offer of £25,000 which had not been beaten and that the claims had been sufficiently speculative, weak, opportunistic and thin, so as to take the case “out of the norm”.
Overturning the decision of the trial judge, the Court of Appeal agreed. In allowing the appeal, Coulson LJ held that an indemnity basis costs order was justified: the next question was the effect that that should have on Ms Lejonvarn’s ’s costs budget of £415,000, in circumstances where she had spent over £725,000 defending the case.
The argument put on behalf of the Burgesses was that if the starting point for assessing the bill were to be £725,000, that would provide Ms Lejonvarn with a way round her own approved costs budget. That would mean that the mere granting of an indemnity based costs order would be rewarding her for failing to keep within that budget. It followed that the costs judge should begin the assessment looking at budgeted costs of £415,000 and not to allow more, unless Ms Lejonvarn could show “good reason” under CPR 3.18(b) for doing so.
The counter-argument for Ms Lejonvarn was short and to the point. If there is an order for indemnity basis costs, the approved budget becomes irrelevant and no “good reason” argument needs to be advanced for departing from it. The indemnity order is good reason enough. As Dyson MR, with whom Vos LJ agreed, had said in Denton v White at paragraph 43:
“If the offending party ultimately loses, then its conduct may be a good reason to order it to pay indemnity costs. Such an order would free the winning party from the operation of CPR rule 3.18 in relation to its costs budget”.
Subsequent judgments at High Court level had followed that guidance (see Optical Express Limited v Associated Newspapers Ltd and Kellie v Wheatley and Lloyd Architects). As HHJ Keyser expressed it in Kellie:
“Proportionality is central to assessment on the standard basis and it trumps reasonableness… However, proportionality is not in issue if costs are to be assessed on the indemnity basis; see r. 44.3(3). I therefore find it difficult to see why logical analysis requires importing the approach in r. 3.18 into assessment on the indemnity basis”.
For that reason, so Ms Lejonvarn’s argument went, the costs judge should ignore the last approved budget and begin the costs assessment at the actual sum she had spent, namely £725,000.
Here another digression to bring the point into sharp focus. In Chalfont St Peter Parish Council v Holy Cross Sisters Trustees Inc, an application by the trustees to revise their budget from £544,000 to £908,000 to address a Part 18 request had failed before Sir Alistair MacDuff in its entirety. It followed that even though the trustees had gone on to win at trial, the standard basis costs order made in their favour meant that they would need to meet the shortfall out of their own pockets, having lost their application under PD 3E.7.6.
Any lifeline? Potentially yes: a successful appeal to the Court of Appeal to have the costs order changed to the indemnity basis, in which case, relying on Denton, Sir Alistair’s decision would be irrelevant. The last approved budget of £544,000 would be torn up and the starting point for the costs judge would be the £908,000 which the trustees had actually spent. In giving permission to appeal, Lewison LJ agreed that that was a point which had a real prospect of success, and perhaps the council agreed. Although floating in the Court of Appeal in April, the case has now settled!
Back to Lejonvarn. The difficulty here for Ms Lejonvarn was that in two decisions before his elevation to the Court of Appeal, Coulson J (as he then was) had reached precisely the opposite conclusion to the judgments of Dyson MR in Denton and HHJ Keyser in Kellie. In Elvanite Full Circle Ltd v AMEC Earth & Environmental (UK) Ltd, he had said this at paragraph 28:
“Prima facie, whether under PD 51G para 8 or CPR 3.18, the costs management order (with its approval of the costs budget) is expressed to be relevant only to an assessment of costs on a standard basis. However, as a matter of logical analysis, it seems to me that the costs management order should also be the starting point of an assessment of costs on an indemnity basis, even if the ‘good reasons’ to depart from it are likely to be more numerous and extensive if the indemnity basis is applied”.
His judgment at paragraph 16 in Governors and Company of the Bank of Ireland v Watts Group PLC was to the same effect:
“… It seems to me that our there are great difficulties in arguing that, because the successful party is entitled to indemnity costs, the approved costs budget figure becomes irrelevant and no longer acts as a cap. I think the approved figure should be the starting point for an assessment of costs on an indemnity basis, as well as for an assessment on the standard basis”.
All uphill for Ms Lejonvarn in that case, it might be thought, since her arguments were to be put to the very Lord Justice who had decided exactly the point, not once but twice, against the way she was going to run her appeal before the Court of Appeal.
Not so. Perhaps taking a leaf out of Lord Denning’s book who famously overturned a decision he had, himself, given some years before, Coulson LJ at paragraph 92 said of Kelllie:
“I would respectfully agree with that analysis. In principle, the assessment of costs on an indemnity basis is not constrained by the approved costs budget and to the extent of my obiter comments in Elvanite and Bank of Ireland v Watts suggested the contrary, they should be disregarded”.
What is the upshot of this judicial humble pie?
The answer is that a costs order on the indemnity basis has real teeth. First, there is the already established feature under the rules that any doubt as to whether an item of cost has been reasonably incurred, or is reasonable in amount, is to be decided in favour of the receiving party. Second, and importantly given the random way in which the judicial scythe is being used to cut down costs under CPR 44.3(5), in order to reduce them to so-called proportionate amounts (see for example Malmstem v Bohinc, where £47,500 was chopped to £15,000), the proportionality test is of no application. Finally, we have it at Court of Appeal level, that an indemnity order really will free receiving parties from the last agreed or approved costs budgets, thereby enabling them to claim, in principle at least, everything that the procedural judge may have refused them on an application for more under PD 3E.7.6.
