Insolvency claims on the rise but costs remain high

Walton: Competition has not yet had the desired effect

The impact of the Jackson reforms on the funding of insolvency litigation – though significant – has not been as serious as some had predicted but costs remain high, new research has found.

The study, written by Professor Peter Walton of Wolverhampton University, estimated that the size of the UK insolvency litigation market has increased by 50% in the last four years to claims worth £1.5bn per annum.

Insolvency litigation was initially exempted from LASPO and the end of recoverability for conditional fee agreement (CFA) success fees and after-the-event (ATE) insurance, but this ended in April 2016.

The research included an online survey of 173 people, mainly IPs but also lawyers, and 42% said returns to creditors have reduced since then, with 29% saying they stayed the same. Just 6% said they had increased, while rest did not know.

This is the academic’s third look at the state of the market, after reports in 2014 and 2016. It was commissioned by Manolete Partners, the listed insolvency litigation funder, with the support of the Insolvency Practitioners Association (IPA) and Institute of Chartered Accountants in England and Wales.

Nearly six in 10 said they had either started to use, or increased they use of, third-party funders or assignees since 2016 – Manolete generally takes an assignment of claims so it can control the litigation.

But CFAs remain the most popular form of funding. Some 49% said they had used a CFA in the previous year. The 85 who had, did so in 656 actions between them.

Prof Walton received details of the outcome in 358 of the cases; 298 generated a net return to the estate after fees and costs, and 61 no return, making an average net return of £121,000 – which he speculated was probably half of what was received gross.

Using this figure for the other claims reported, and then extrapolating out on the basis of an estimate of how many active IPs there are, Professor Walton calculated that a total net figure of around £200m was recovered for insolvent estates by the use of CFAs in 2019, or £400m gross.

It was, he continued, “widely recognised” that the amount recovered from defendants averages out at around 50% of the initial amount claimed in the action, meaning claims initially valued at £800m might have been brought using CFAs.

The academic had used a similar method in his report in 2016 to estimate there were £1bn in claims in 2015, suggesting that ending recoverability has depressed the number of claims being pursued via CFAs.

Some 43 respondents had used a third-party funder or assignee in the previous 12 months, of whom 26 had also used CFAs as they took different options depending on the case.

These 43 brought 206 actions, although less than a handful accounted for just over half of them. The returns cited for 148 of them led to a net figure of £73m, at an average of £492,000 per action.

Professor Walton said this suggested that funders tended to be used in bigger-value cases, with “often informal” CFAs used for smaller ones.

Using the same method of extrapolation reached a claim value of £720m for 2019, taking the overall total to £1.5bn.

“A note of caution must be sounded at this stage,” the professor wrote. “Although the survey was completed by a significant number of IPs, it is entirely possible that predominantly only those IPs who have an interest in the use of funders found the time to complete the survey.

“It is possible that the extrapolation made therefore overstates the extent to which funding is being used.”

But he said the £720m was broadly consistent with Manolete’s figures. In 2019, it was offered 386 claims representing 432 individual causes of action, valued at £900m – not all of these would have received funding from any source.

He recorded that another funder used the average numbers of insolvencies and values of actions brought over the past decade to work out that the average annual amount claimed was £1.3bn.

Half of respondents saw the use of funders as most likely to lead to a swift commercial resolution to an insolvency claim, although over a third favoured the use of CFAs and ATE.

Prof Walton said: “The answers do suggest that the abolition of recoverability… has reduced the impact upon defendants of using CFAs and ATE. It would appear that a larger number of IPs now see the pressure brought by the use of a funder is more likely to encourage early settlement by a defendant.”

Manolete’s records showed that its acceptance rate rose from 22% of proposals to 30% in 2019. Prof Walton said: “This change is consistent with the view that in the past, funders were seen as a ‘last resort’ and therefore tended only to be shown the ‘orphan’ cases where a CFA had failed to get a result or was deemed too risky even for pursuit under a CFA.

“Equally, it is clear from publicly available data that Manolete now has the requisite financial support to make offers on a much wider variety and size of claims, particularly bigger claims.”

Prof Walton said “it seems that the costs of CFAs and ATE on the one hand and funding and assignments on the other have remained high. Competition has not yet had the desired effect of maximising returns to creditors.

“This may be partly because the market is not yet operating in a fully informed manner. As its users become more informed, they are likely to become more efficient users of the market.”

He recommended issuing guidance to IPs on what they need to consider when conducting litigation. Other recommendations included making damages-based agreements “fit for purpose in an insolvency context”, allowing the assignment of bankruptcy office-holder actions, that the Official Receiver should consider taking advantage of assigning (or otherwise realising) claims for the benefit of creditors, and the Secretary of State liaising more closely with the private sector to apply for more compensation orders under the Company Directors Disqualification Act 1986.

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