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01/10/2018

The LASPO Act two years on – the impact on insolvency litigation so far

Over the summer, the Government has been carrying out its long-awaited review of the impact of the 2012 Legal Aid, Sentencing and Punishment of Offenders (LASPO) Act. The Act had major implications for the ways in which the insolvency profession could fund litigation to retrieve money owed to insolvent estates by directors, bankrupt individuals and others.
 
Although it is too early to know the full impact of the reforms, R3 members, through a members’ survey and evidence from R3’s Fraud Group, have indicated that the early signs are that concerns raised before and during the passage of the Act are being borne out: R3 members have said that they have become less likely to litigate in insolvency cases since 2016 and that creditor returns have suffered, too.
 
Background
 
In 2010, Lord Justice Jackson recommended that Conditional Fee Arrangement (CFA) uplifts and After the Event Insurance (ATE) premiums should no longer be fully recoverable from a defendant in all civil litigation cases (including insolvency). The proposals were then introduced through the LASPO Act.
 
The aim of the Jackson reforms was to crack down on the growing ‘compensation culture’ and to better protect public funds and the public interest. The reforms swept up all types of civil litigation, including insolvency litigation. Problematically, insolvency litigation very much falls outside the ‘compensation culture’ and achieves many of the Jackson reforms’ objectives: insolvency litigation protects both public funds and the public interest.
 
R3 campaigned extensively to secure an exemption for insolvency litigation from the Act, and was able to secure a two year temporary carve-out from April 2013 to April 2015. An R3-led campaign, supported by a number of business bodies, secured an extension to this exemption up until April 2016 when the Government finally pulled the plug. The Government claimed that it wanted to ensure the Act was applied ‘consistently’ (litigation relating to mesothelioma sufferers also lost its exemption from the Act around this time, although this decision was subject to a judicial review and the exemption remains in place for now). 
 
The role and value of insolvency litigation to the UK economy
 
The insolvency and restructuring profession plays a key role in tackling fraud and director misconduct. As part of this role, the profession will use litigation to retrieve money owed to insolvent estates by directors, bankrupt individuals and others. This money is then returned to creditors. This process discourages individuals and businesses from withholding money owed to insolvent estates, or from wrongly taking money from an estate in the first place. By ensuring money is returned to creditors in the wake of an insolvency, the profession helps create the conditions required for businesses and individuals to trade and lend with confidence.
 
Insolvency is a unique situation: litigation can only be used when it can be paid for; but, due to the nature of insolvency cases, there is often limited or no money available to an insolvent estate to fund litigation.
 
Without the ability to use litigation, money owed to an insolvent estate is put out of reach of creditors, including small businesses and the taxpayer. Those who withhold money from insolvent estates do not face pressure to return what is owed, and there is no disincentive to take money in the first place.
 
Until the end of the exemption from the LASPO Act for insolvency litigation, the insolvency profession was able to fund cases relatively easily and cost-effectively. Thanks to the full recoverability of ATE premiums and CFA uplifts, the cost of litigation was essentially borne by those who wrongly withheld money from insolvent estates. The end of the exemption has increased the cost of litigation for insolvent estates, while funding for cases is not always available. This hurts creditor returns – and lets people and companies get away with fraud and other types of misconduct.
 
Research by the University of Wolverhampton in 2016 found that the type of litigation enabled by the insolvency exemption from the LASPO Act helped retrieve £480 million owed to creditors per year, and enabled the pursuit of over £1 billion of claims in 2014. These figures include the annual retrieval of £115 million for HMRC and the pursuit, in 2014, of £240 million in outstanding taxes.
 
Two years on: the impact
 
Two years is a relatively short time in terms of litigation, so it is too soon to assess fully the impact of the loss of the insolvency exemption. However, early indications are that the concerns expressed by the insolvency profession and the business community before, during and after the passage of the Act are being borne out.
 
R3 believes that the end of the insolvency litigation exemption has reduced the number of cases in which litigation is commercially viable, has led to a reduction in returns to creditors, and has left money in the hands of people and businesses to whom it does not belong.
 
R3 2018 member survey on the insolvency litigation landscape
 
In May 2018, R3 carried out a member survey on the impact of LASPO on insolvency litigation. 117 responses were received, reflecting approximately 5% of R3’s membership. Key findings include:
 
  • 55% of respondents said that they were either much or somewhat less likely to litigate in insolvency cases since April 2016 (when the exemption ended).
  • 70% of respondents said that returns to creditors were either much or somewhat lower than they were before April 2016. On average, respondents estimated that returns were 43% lower.
Other funding options  
 
The insolvency profession is still able to partially recover ATE premiums and CFA uplifts, and a market for alternative funding methods is developing, but R3 members say that these options are not always as cost effective or beneficial for creditors as the pre-LASPO Act regime. While funding mechanisms like third party funding have always been a crucial part of the litigation funding landscape, the more funding options available for insolvency litigation, the better.
 
Alternatives
 
R3 would encourage the Government to restore the insolvency exemption from the LASPO Act, and, at the very least, to conduct a full analysis of the impact of the end of the insolvency exemption once sufficient time has elapsed. If restoration of the exemption is not possible, we would like to see the Government explore further funding reforms, including the below.
 
Section 564 of the Australian Corporations Act 2001
 
In the 2016 University of Wolverhampton report on insolvency litigation funding, report author Professor Peter Walton examined the use of Section 564 of the Australian Corporations Act 2001 as a way of funding insolvency litigation and suggested that its introduction in the UK could offer a viable alternative to the use of CFAs, albeit not one as effective as the pre-LASPO regime.
 
In short, Section 564 gives the Court power to make an order in favour of creditors who have funded or indemnified the liquidator in litigation to recover, protect or preserve property for the benefit of the liquidation. If the litigation is successful, the liquidator will apply to the Court to assess how the funding creditors should be rewarded for providing financial support for the action. The decision as to whether or not to make an order and, if so, on what terms, is left to the discretion of the Court after the recovery or preservation has been made.
 
The role of public sector creditors in funding insolvency litigation
 
R3 would also welcome public sector creditors, such as HMRC, doing more to fund insolvency litigation. While recognising that HMRC already funds insolvency litigation to a limited extent in a small number of cases, R3 members believe that tasking HMRC with a specific duty to fund litigation could help to ensure that those cases that can no longer be funded as a result of the LASPO Act changes can be taken forward for the potential benefit of all creditors.
 
Next steps
 
R3 looks forward to engaging with the Ministry of Justice further when it publishes the outcome of its review later this year.

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.