Maximising value for creditors by selling insolvency litigation claims to litigation funders
An article by Andrew Cawkwell, Manolete Associate Director for the North East.
An Insolvency Practitioner faces several considerations when deciding what to do with litigation claims comprised within an insolvent estate.
Firstly (in accordance with Statement of Insolvency Practice 2), the Insolvency Practitioner is required (as part of their statutory role) to investigate what assets there are (including potential claims against third parties including the directors) and what recoveries can be made.
Secondly, if there are meritorious claims in the insolvent estate as well as funds to allow them to be pursued on normal fee-paying terms then this would, of course, be an acceptable basis to proceed. However, given the credible options to ‘off-set’ the risk of litigation going wrong for creditors (and using funds which perhaps should arguably be ring-fenced for dividends to creditors), it would seem a more sophisticated approach would involve exploring other forms of finance and/or selling the claims to a third party funder.#
Thirdly, the Insolvency Practitioner should undertake a consideration of and analysis of the key forms of funding (a) a Conditional Fee Agreement, (b) a Damages-Based Agreement (c) funding or (d) assignment of the proposed claims or (e) ask creditors to fund.
Fourthly, the Insolvency Practitioner must exercise commercial judgment to decide which funding model is most suitable for a particular case, as well as negotiate appropriate terms with the law firm, counsel or funder as the case may be.
The exercise of commercial judgment may involve considering:
- the circumstances of the case.
- whether the proposed target for the litigation has sufficient net worth to satisfy any possible successful judgment or enter into ADR on viable commercial terms.
- the likelihood of success in the claim (this will usually involve some element of legal assessment of the merits).
- The views of the creditors (in particular HMRC where it is a significant creditor).
There have been a number of ‘themes’ concerning the choice of funding option for Insolvency Practitioners.
There are some Insolvency Practitioners who believe Conditional Fee Agreements or Damages-Based Agreements should be the basis upon which most cases proceed leaving funding agreements or assignment of claims as the option of last resort to be reserved for particularly large or complex cases. There is a belief insolvency litigation finance is expensive and not suitable for run-of-the-mill cases.
In addition, there has been a renewed focus on the concept of ‘testing the market’ to help evaluate the different options and achieve the best possible commercial terms.
A new tactic has emerged in insolvency litigation finance of certain defendants who are also creditors in the insolvent estate challenging the assignment of claims.
Response to Themes
Joining these themes together and trying to put together a considered response, it is important to be reminded that Section 246ZD of the Insolvency Act 1986 Act was inserted into the 1986 Act by s. 118 of the Small Business, Enterprise and Employment Act 2015 (the "2015 Act") and which provides as follows:
"246ZD Power to assign
(1) This section applies in the case of a company where –
(a) the company enters administration, or
(b) the company goes into liquidation;
and "the office-holder" means the administrator or the liquidator as the case may be.
(2) The officer-holder may assign a right of action (including the proceeds of an action) arising under any of the following –
(a) section 213 of 246ZA (fraudulent trading);
(b) section 214 or 246ZB (wrongful trading);
(c) section 238 (transactions at an undervalue …;
(d) section 239 (preferences …);
As such, the policy of the UK Government (implemented through the above legislation) was to create a statutory right to sell claims which could only previously have been pursued by Insolvency Practitioners in their own right. This is clarified by the Economic Impact Assessment (IA No. BIS INSS007) produced by the Insolvency Service on behalf of the Department for Business, Innovation and Skills on 16 April 2014 which stated as follows (and referenced the benefits of the sale of the claims and increased likelihood of actions being pursued):
"To introduce a right for administrators to be able to bring claims for fraudulent and wrongful trading and to permit liquidators and administrators the statutory right to sell or assign officeholder claims to any third party. Unsecured creditors would benefit from the proceeds of the sale and officeholder claims would be more likely to be pursued. We anticipate that a market in these actions would develop, and increase the prospect of actions being taken against directors. This would occur if [Insolvency Practitioners] prefer the certainty of having up front funds or do not want to take the risk of pursuing funds or fighting a case that might involve litigation and uncertain costs that could be difficult to recover in full."
The market has developed further since 2015 as was envisaged. There are several litigation funders specialising in insolvency claims. The market for selling claims or seeking funding is becoming increasingly more established. Insolvency Practitioners are becoming more used to seeking insolvency litigation finance.
However, it is important to address that there is still some way to go in its development. The use of CFA/DBA funding requires after the event insurance which is expensive and also may not (in all cases) properly deal with security for costs challenges. In the early stages of a case (i.e. say 0-18 months after the Insolvency Practitioner is appointed), there is often a strong desire to spend significant work in progress costs on a contingent basis to try and see if a ‘deal’ can be struck with the proposed target. This can lead to inefficiencies and increased costs with the proposed target being advised to keep delaying matters, as without litigation funding the claim may not be ultimately issued.
Clearly the stronger merits and larger quantum cases could well be suited for CFA terms but there may be a scarcity of law firms and counsel carrying sufficient resources to properly undertake such work beyond the pre-action phase.
It also important not to be led into thinking an Insolvency Practitioner is obligated to incur time costs in attempting to realise litigation claims through engaging lawyers on a no-win/no fee basis. In developing the statutory power to sell claims (including on outright assignment terms), the Government has actively encouraged and endorsed this practice.
While an IP, acting reasonably and exercising his commercial discretion, is under no obligation to do so, an Insolvency Practitioner who wishes to ‘test the market’ should be aware:
- The funding market continues to evolve with more funders having entered the market, and with new entrants, product offerings have become more diverse and difficult to measure and compare precisely. It is important to compare ‘apples with apples’ so assessing the different offers for assigning claims should not be mixed with the offer of a funding agreement for example. Also, it is important to assess the covenant strength of the funder providing the indemnity for adverse costs.
- Use of a broker excludes access to those funders who engage with Insolvency Practitioners directly rather than through brokers.
An Insolvency Practitioner has fiduciary responsibilities and duties to realise assets comprised in the insolvent estate for value.
A meritorious legal claim is such an asset. Advice from an Insolvency Practitioner’s solicitor may assist in determining if a case is meritorious and assessing its possible value.
While there has not been a reported case of a challenge to an Insolvency Practitioner’s sale to a third party funder, it appears to be a tactic which is being used on a limited basis by some defendant litigation firms. It appears unlikely to significantly trouble third party litigation funders who have taken an assignment of claims since such a challenge would involve challenging the exercise by the Insolvency Practitioner of its power to sell claims following the proper exercise of its commercial judgment. The Insolvency Practitioner is likely to enjoy a generous standard of review by the court and the Insolvency Practitioner should be able to demonstrate they have acted in good faith. To succeed in a challenge it is likely the defendant would need to show the Insolvency Practitioner acted perversely.
In all of the circumstances, Insolvency Practitioners will inevitably, over time, move more of their insolvency litigation across to third party funders especially where (a) they can monetise the asset straight away by selling it for an upfront sum and share in the net realisations or (b) sell on an outright basis as Mr Justice Snowden appeared to validate in Cage Consultants Ltd v Iqbal & Anor (Re Totalbrand Ltd and the Insolvency Act 1986)  EWHC 2917 (Ch) (02 November 2020). In addition, the benefits of a risk free approach to litigation where the action is taken in the name of the litigation funder and suitable protection is offered to the Insolvency Practitioner for adverse costs. There are, also, no headaches of case progression from the Insolvency Practitioner’s regulator since the sale of the claims puts the burden on the funder to take the action forward. The well-resourced funders have in-house capability to assess net worth, monitor assets being sold and well trained expert in-house lawyers to oversee and manage the output of external solicitors.
Associate Director for the North-East.