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23/10/2015

Why insolvency should remain exempt from LASPO - a response to Lord Justice Jackson

On the 16th October 2015, Lord Justice Jackson, author of the 2010 ‘Jackson Reforms’ that contributed to part two of the 2012 Legal Aid, Sentencing and Punishment of Offenders (LASPO) Act, gave the Chartered Institute of Arbitrators’ North East branch’s Mustill Lecture.

In this lecture, Lord Justice Jackson set out four reasons why he thinks insolvency litigation should no longer be exempt from the LASPO Act. Below is R3’s response to Lord Justice Jackson’s four reasons for ending the exemption.

1. Creditors, not the insolvency profession, benefit from the insolvency exemption

Lord Justice Jackson: The recoverability regime was principally designed to assist individual claimants of modest means, in particular those who ceased to qualify for legal aid in April 2000. The insolvency profession has had an unfair ‘windfall’ advantage from these reforms that should be ended.

R3 response: Creditors and the public enjoy the ‘windfall’ benefit from the 2000 reforms – not the insolvency profession.

Jackson argues that insolvency litigation had an undue ‘windfall benefit’ from the 2000 litigation funding reforms, which were designed to benefit those who were losing access to legal aid. Jackson focuses on a supposed ‘windfall’ for the ‘Big Four’ accountancy firms. He also claims that the insolvency profession ‘[managed] perfectly satisfactorily’ before the 2000 reforms were introduced.

While insolvency litigation unexpectedly benefitted from the 2000 reforms, it is ordinary creditors and the public at large who have primarily benefitted rather than the ’Big Four’ and wider insolvency profession. The 2000 reforms meant creditors – from small businesses to HMRC – received money back from rogue directors that they otherwise would not have done, while the public has benefitted from the deterrent effect the reforms have created for would-be rogue directors.

Jackson’s argument that the insolvency profession operated ‘perfectly’ well before the 2000 reforms does not consider that the 2000 reforms allowed the profession to do something it could not before: the 2000 reforms enabled the insolvency profession to pursue creditors’ money that was previously inaccessible, by enabling assets to be returned to estates when there was no money in the estate to pay for litigation. Without an exemption from the LASPO Act, much of this money would be inaccessible again. Anecdotal evidence from insolvency practitioners suggests the number of cases being brought now that would not have been brought prior to 2000 is rising.

Insolvency firms of all sizes – not just the largest – use the recoverability of CFA uplifts and ATE premiums on behalf of creditors. Insolvency practitioners’ fees can be paid using recoveries, but unlike other professions that used the reforms, insolvency practitioners are not always repaid in full. The ‘windfall’ effect in insolvency is very different to other types of litigation.

Using Lord Justice Jackson’s own argument, should the insolvency exemption end, the LASPO Act would create a ‘windfall’ for third party funders, who would represent the main way of funding cases. Third party funders do not have public interest responsibilities, whereas insolvency practitioners do.

2. The alternative is not a level playing field

Lord Justice Jackson: Recoverability is an ‘instrument of oppression’, which is liable to ‘crush’ defendants who may have a good defence.

R3 response: Advantage in insolvency litigation is mutually exclusive: either creditors have an advantage, or rogue directors do.

Lord Justice Jackson is concerned that the threat of recoverability forces defendants to settle, regardless of the strength of their case, rather than go to court. He argues that there is currently an uneven playing field, to the advantage of creditors; scrapping the exemption would restore an even playing field, he says.

It is true that under the current regime, there is an incentive for defendants to settle. However, the alternative is not, as Jackson suggests, an even playing field: it is an advantage for defendants.

Typically, Insolvency practitioners will seek to use CFA uplift and ATE insurance recoverability when they are dealing with a no- or low-asset case, where there are low assets because of the director’s or bankrupt’s (or a third party’s) actions. For example, a director may have loaned themselves company money then not paid it back. As there is no money in the insolvent estate, the insolvency practitioner (and creditors) cannot afford litigation to retrieve money from a director, associates of a bankrupt, or third party (possibly in another jurisdiction or tax haven) without being able to recover the costs of doing so. Consequently, without the insolvency exemption from the LASPO Act, insolvency practitioners and creditors will struggle to retrieve assets wrongly taken from insolvent estates: directors, associates of bankrupts, and others can essentially act with impunity, knowing they can keep assets and money from their creditors without the threat of being litigated against. This is not a level playing field.

The current regime ensures that not only are directors, bankrupts or third parties deterred from withholding money from creditors, creditors do not have to pay money directly to retrieve what is rightfully theirs.

Insolvency litigation is not pursued lightly. Insolvency practitioners are highly regulated and act as Officers of the Court: were an insolvency practitioner to pursue an illegitimate claim using CFA uplift and ATE insurance recoverability they may be at risk of losing their licence to practise if investigated by their regulator. Additionally, as insolvency practitioners are only paid when money is recovered, and as settlements are not guaranteed, litigation will only be pursued in cases where there is a reasonable expectation that the claim would be successful in court; according to insolvency practitioners, ATE insurers require a 65%+ chance of success to insure a claim.

Further, scrapping the insolvency exemption from the LASPO Act may not ‘fix’ Jackson’s uneven playing field problem. If the insolvency exemption is removed, only third party funders would be available to back insolvency litigation (where funding from company assets is not available). The funders could also be perceived as having a “significant advantage” over defendants in terms of having access to the funds needed to continue litigation long-term. There could still be perception that defendants may need to settle early to avoid a long and costly dispute.

3. Recoverability drives up recoveries for creditors 

Lord Justice Jackson: Recoverability drives up the overall costs of litigation.

R3 response: Recoverability drives up recoveries for creditors.

Lord Justice Jackson argues that there is no incentive for claimants to control costs that they will not have to pay.

The effect of recoverability on costs needs to be seen in perspective: without recoverability in insolvency litigation, returns to creditors would be significantly diminished. Moreover, these costs would not have to be paid if directors, bankrupts, or third parties had not wrongfully withheld money or assets from an insolvent estate in the first place.

The effect on costs of the existing recoverability regime should also be seen as the other side of the coin of directors benefitting from limited liability.

Finally, creditors are incentivised to control insolvency practitioner fees in civil litigation, as the more an insolvency practitioner charges, the less the creditors receive out of recoveries. This helps keep overall litigation costs down. Whereas creditors have statutory powers over insolvency practitioner fees (and these powers have been significantly strengthened in October 2015), creditors do not have such powers over third party funders’ fees.

4. There is no alternative that produces the same returns to creditors

Lord Justice Jackson: It is perfectly possible to bring insolvency litigation without the benefit of recoverability.

R3 response: Alternatives to the current regime do not bring the same returns to creditors.

Jackson claims that the pre-2000 regime worked well. He argues that HMRC is ‘not cash-strapped’ and should pay for its own litigation. Jackson also argues that the litigation landscape is improved compared to the pre-2000 reforms, citing the emergence of third party funders, the ability to assign administrators’ and liquidators’ claims, newly introduced Damages Based Agreements (DBA), and the fact that insolvency practitioners already bring claims without the use of recoverability.

As stated above, the pursuit of the type of claims enabled by the 2000 reforms did not take place before then, and would struggle to continue without an exemption from the LASPO Act for insolvency litigation. Jackson is correct that insolvency practitioners can bring claims without seeking to recover CFA uplifts and ATE insurance premiums: they can do so only in cases where there are assets in the estate to fund litigation, or where creditors or others are willing to fund litigation. It is the frequent cases where there are no assets left in the estate or where there is a low-value claim that will not be able to continue if the exemption is removed.

While third party funders are a welcome part of the existing funding landscape, Jackson acknowledges that third party funders are unlikely to support small cases (54% of cases involve claims under £50,000), and he admits that the new DBA regime is problematic. The insolvency profession also has concerns about the usefulness of the ability to assign claims.

Lord Justice Jackson’s arguments about the ability of HMRC to fund cases do not reflect reality. Across the insolvency regime, HMRC’s resources are such that they are often unable to act as an active creditor in insolvencies and would be highly unlikely to fund cases if the exemption for insolvency litigation from the LASPO Act was to end. HMRC may not be ‘cash-strapped’ but it is subject to the same funding squeeze as the rest of the public sector. HMRC will not risk taxpayers’ money pursuing litigation through a third party such as an insolvency practitioner where the claim is subject to litigation risk. 

Lord Justice Jackson is also concerned that the insolvency exemption allows HMRC to act unfairly towards individuals. However, defendants can be seen as potential tax evaders or avoiders, rather than ‘innocent taxpayers’. When HMRC is a creditor in a case where a defendant is withholding assets from the insolvent estate, the defendant is essentially deliberately withholding tax owed to HMRC. HMRC should be allowed to approach them as it would any other potential tax evader or avoider: HMRC has other significant powers to pursue missing tax payments, such as its new Direct Recovery of Debt or Advanced Payment Notice powers. The insolvency exemption from the LASPO Act should be considered in this context.

 

Notes to editors:

  • R3 is the trade body for Insolvency Professionals and represents the UK’s Insolvency Practitioners.

  • R3 comments on a wide variety of personal and corporate insolvency issues. Contact the press office, or see www.r3.org.uk for further information.

  • R3 promotes best practice for professionals working with financially troubled individuals and businesses; all R3 members are regulated by recognised professional bodies
     
  • R3 stands for 'Rescue, Recovery, and Renewal' and is also known as the Association of Business Recovery Professionals.