Lenders and creditors benefit from third-party financing of insolvency litigation claims

October 2020  |  SPECIAL REPORT: BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

October 2020 Issue

There is a common public perception that, following an insolvency, any creditor is lucky to get even a tenth of their money back. Sadly, this perception is based firmly in truth, if not bitter experience.

The impact of these losses is significant to HMRC, to suppliers, to banks and pension funds alike. Shareholders are invariably wiped out. This is not a hard luck story about backing the wrong horse. This failure is systemic and contrary to the national economic good. Moreover, there are often assets which should be recoverable for creditors but invariably are not.

However, there has been a measurable shift toward more just and highly effective insolvency solutions, and legal reforms have supported this evolution. The major change has been an increase in cases being funded or purchased by specialist third-party finance providers leading to far quicker completions and much healthier returns for all stakeholders.

The timeline from the start to the completion of an insolvency claim through a traditional ‘no-win no-fee’ conditional fee arrangement (CFA) can be painfully long. From the appointment of the insolvency practitioner to the final allocation of funds to the creditors can take three, four, five years or longer. During that yawning wait, legal costs eat away at the dwindling pot. There may be a host of other costs too: after the event (ATE) insurance, administration, investigation, consultation and brokers’ commissions.

By the time a case is settled it may be only a derisory ‘nuisance-value’ offer from the defendants, which is grudgingly accepted to defray some of the insolvency practitioner and lawyer costs. It is unfair, and unjust.

Lord Justice Jackson’s reforms

Litigation costs in general have been a contentious issue for decades. When Lord Justice Jackson was commissioned by the UK government in 2009 to review the costs of litigation, it was clear previous good intentions from legislators had created an unsustainable regime where creditors and litigants invariably lost out. In the insolvency sector, Lord Justice Jackson found profound levels of unfairness – claimant costs in CFA and ATE cases ranged from between 158 to 203 percent of the damages awarded.

The reforming legal change to insolvency claims – which commenced in April 2016 – has been instrumental in making those old inefficient models very unattractive.

A shift to financing cases

The insolvency litigation sector has since been evolving rapidly. The leading academic in the sector, professor Peter Walton (University of Wolverhampton) published a report in April 2020, ‘Insolvency Litigation Funding – in the best interests of creditors?’ The document included a detailed examination of the impact of the ‘Jackson Reforms’ on the insolvency litigation market.

Professor Walton identified a substantial shift to financing cases by specialist third-party finance organisations from ‘no-win no-fee’ methods. He said third-party funding was now an integral and important part of the insolvency litigation market which had increased by 50 percent since 2015 to £1.5bn per annum. The total claims being pursued in the third-party financing market was estimated to be in the region of £50m.

A better model for creditors

To better understand the potential for improved returns for creditors for cases of insolvency, it is necessary to look in detail at a business model that is delivering on that commitment.

The key is to minimise costs by progressing purchased or funded cases rapidly – on average 11 months – without a CFA or ATE policy. When a recovery is made, the funder gets back its costs and only then are the remaining proceeds split between the creditor estate and the company (which usually starts at a 50/50 split, but the estate’s share rises as the level of recovery rises). So, if the company does well on a case, by definition, the creditor estate will have always done better.

There is a mutual, and fully aligned, interest with the insolvency practitioner and their lawyers in keeping legal and associated costs under control and proportionate to the realistic recoverable amount of the claim. If a case is lost or no recovery made, the funder bears the full cost, including adverse costs. The insolvency practitioner, the creditor estate and the lawyers are always fully protected.

There must, of course, be money to be recovered in the first place. A careful case review and diligence process is carried out by an in-house ‘net worth review’ team into potential cases submitted by insolvency practitioners.

You may wonder why insolvency practitioners do not simply go after the directors for monies owed, for example from a director’s loan account. Invariably there are insufficient funds in the estate to finance the necessary litigation and most insolvency practitioners operate with personal liability. Directors can treat written demands from insolvency practitioners contemptuously.

The case is altered once the claim is assigned. The insolvency practitioner is granted full indemnity, existing and ongoing costs are covered, and directors are informed of the intention to move quickly to recover funds for the creditors and other stakeholders. Suddenly, the insolvency practitioner has a very big brother to help. Directors very often conclude it is better to seek an early, commercial, cost-efficient resolution, rather than pay huge costs attempting to defend the indefensible.

There is an almost endless variety to directors’ attitudes and circumstances, so it pays to keep a flexible outlook on the process of actually enforcing a settlement. Many directors are straightforward and realise their mistakes need to be reckoned for – they pay up with hardly a murmur. Others have genuine difficulties, and these should be accommodated as far as possible with instalment payments.

Quick insolvency resolutions mean minimising costs and give much fairer returns, at last, to the deserving creditor and other stakeholders.

Steven Cooklin is chief executive of Manolete Partners Plc. He can be contacted by email: steven@manolete-partners.com.

© Financier Worldwide

BY

Steven Cooklin

Manolete Partners Plc

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