Legal Aid, Sentencing and Punishment of Offenders Bill

Memorandum submitted by the Institute of Chartered Accountants in England and Wales (ICAEW) (LA 25)

SUMMARY

LEGAL AID, SENTENCING AND PUNISHMENT OF OFFENDERS BILL

CLAUSES 41 AND 43

1. Part 2 of this Bill includes provisions intended to limit unfairness and occasional abuses in the ‘no win no fee’ system in personal injury cases, by preventing the recovery of success fees for claimants lawyers under Conditional Fee Agreements (CFAs). ICAEW welcomes the Government’s commitment to tackle this problem, which can unfairly push up costs for businesses, and also for local councils (and ultimately the Government and taxpayers as a whole).

2. However we are deeply concerned that the legislation in its current form could have a harmful impact on the insolvency process. Unless claims brought by insolvency practitioners are exempted, this legislation would prevent potential recovery from incompetent or fraudulent directors or bankrupts, which will result in greater losses being borne by innocent creditors when a business is made insolvent.

3. Those creditors are usually small businesses or HMRC, who would lose potential tax receipts, a cost ultimately to the taxpayer. Furthermore, fraudulent directors and bankrupt sole traders would keep the gains they made from irresponsible management of their business.

4. To prevent these issues for insolvency litigation, and ultimately for creditors and taxpayers, ICAEW is recommending that the Bill should be amended to exempt insolvency litigation from the restrictions in clauses 41 and 43. These are, respectively, the restrictions on recovery from defendants of the successful claimant’s CFA success fees and of after-the-event insurance premiums.

5. If these exemptions are not included, we believe the Government should quantify the impact that these restrictions will have on creditors (including small businesses and HMRC) before the policy is implemented.

WHO WE ARE

6. ICAEW (the Institute of Chartered Accountants in England and Wales) is the largest of the Recognised Professional Bodies under the Insolvency Act, currently licensing around 700 practitioners. Representing over 136,000 Chartered Accountants in over 160 countries, ICAEW operates under a Royal Charter and works in the public interest. ICAEW’s regulation of its members and affiliates in insolvency is overseen by the Insolvency Service.

MAJOR POINTS

Policy background to Conditional Fee Agreements (CFAs)

7. CFAs were introduced in 1995 under the Courts and Legal Services Act 1990, to counter the impact of reductions to the public funding (legal aid) budget. One of the main aims was to facilitate access to justice for claimants who do not have sufficient funds to bring an action, and would otherwise have to abandon a potentially good claim.

8. In a typical CFA arrangement, solicitors do not charge fees if the claim fails, but add on success fees of up to 100% in the event they win the case – with the costs and the success fee being paid by the unsuccessful defendant. 

9. Claimants also usually take out after-the-event (ATE) insurance, which covers them for the other side’s costs should their claim be unsuccessful, although premiums are often staged and become significantly more expensive the nearer you get to trial.

The intended purpose of the Bill

10. The Legal Aid, Sentencing and Punishment of Offenders Bill contains provisions primarily intended to prevent unfairness in the system of Conditional Fee Agreements in personal injury cases (so called ‘no-win, no-fee').

11. Currently, claims (often personal injury claims) are made against larger businesses or local councils, with little or no cost risk to the claimant, which effectively means the claimant has no incentive to minimise the costs they incur in pursuing the claim. As you get nearer to trial, the costs build up and can often in themselves act as an incentive to settle (even where the company or council do not think the claim has merit) to avoid the risk of having to pay exorbitant success fees and ATE premium in the (perhaps unlikely) event that they are unsuccessful in court.

12. The Bill will restrict the recovery from defendants of CFA success fees and of after-the-event (ATE) insurance premiums (which will instead be payable from the damages awarded), to protect businesses and councils from disproportionate levels of costs over which they have no control.

How CFAs and ATE insurance are used in insolvency litigation

13. Insolvency practitioners often bring cases to recover funds or assets from the directors of insolvent companies (or from bankrupt traders), and from any other people holding assets or funds that would otherwise be available for the creditors of the business (for example, a bankrupt’s spouse who has been transferred money belonging to the bankrupt’s estate).

14. When a business becomes insolvent and there are no funds in the insolvency estate to pay for legal action, these claims are often brought under a CFA arrangement. If the insolvency practitioner (acting on behalf of the insolvency estate) is successful, they can claim their costs, the success fee and after-the-event insurance premiums from the losing defendants (usually, the errant directors or bankrupt traders). The ‘recoverability’ of success fees prevents fraudulent managers of a business from absconding with funds that belong to innocent creditors – often small businesses – or to HMRC, and ultimately the taxpayer.

15. These costs do not escalate unreasonably or disproportionately because insolvency practitioners are under a duty to minimise their costs. There is also no risk that claims made by insolvency practitioners on behalf of an insolvent estate would be inappropriate – or worse, ‘manufactured’ – in the way that some personal injury claims have been, because insolvency practitioners are professionals who are appointed to administer insolvent estates and, in cases where a company is in liquidation (this would be likely if a claim is made against the former directors) then creditor approval would be needed before the claim could be brought.

Likely impact of the Bill on insolvency litigation

16. The Bill’s provisions are more wide-ranging than personal injury cases, and extend to all civil litigation practitioners who undertake work on a CFA basis. Unless claims brought by insolvency practitioners are exempted from the recoverability restrictions in the Bill, success fees and after-the-event insurance expenses would need to be paid out of any damages awarded, meaning a smaller return to creditors (usually including HMRC).

17. Insolvency practitioners have an overarching legal duty to maximise returns for creditors, but this Bill may limit their ability to fulfill it. This legal duty requires the insolvency practitioners to pursue, through the courts if necessary, directors/managers or third parties that have harmed a business and possibly committed fraud, using either the funds in the insolvent estate, or contributions from creditors, or by using CFA or ATE arrangements.

18. However, if the Bill proposals go ahead, solicitors and barristers may not be prepared to agree to acting on behalf of the insolvency practitioners on CFA terms. This would mean that, in cases where there are no available estate funds, insolvency practitioners would be unable to bring legal proceedings unless either the creditors are willing to fund the action (unlikely, as they would see it as ‘throwing good money after bad’, especially if not all creditors contribute), or unless the insolvency practitioner is able to obtain funding from third-party funders, such as insurance companies or investment funds. These parties currently take a percentage of any damages that are awarded. In our view these percentages claimed by third party funders are likely to increase if insolvency practitioners have nowhere else to turn.

19. If solicitors do continue to agree to CFA terms, in cases where creditor approval is required in order to commence legal proceedings (for example in liquidations), the costs of bringing the claim would reduce the level of potential recoveries, and so it may be more difficult to convince creditors to agree the pursuit of a court action, meaning funds would go unrecovered, creditors would not be reimbursed, and HMRC would recoup less unpaid tax.

20. Furthermore, as Insolvency practitioners pursue cases in their own name, they may become less willing to commence cases, especially if there is a risk that the success fees and ATE costs might exceed the damages award (there is no cap on these costs outside personal injury claims, where they will be limited to 25% of damages), as any shortfall would fall to be paid by the Insolvency practitioner out of their own pocket.

21. Another likely consequence is that insolvency practitioners will be less likely to take on appointments where there are no estate funds, which is likely to significantly increase the workload of the Official Receiver and the Department for Business, Innovation and Skills legal departments, at taxpayers' expense, but with no benefit of recovery for the creditors.

22. The proposals in the Bill will therefore essentially change the risk/reward balance for bringing claims on behalf of an insolvent estate. Many cases that would have been brought on behalf of creditors under the old rules would not be brought under the new system. More money will remain in the pockets of errant and possibly fraudulent directors and bankrupts, rather than passing to the creditors of the business including HMRC.

Example to illustrate l ikely impact of the Bill on insolvency litigation

23. The following is a real life example of a recent case brought by one of our members, who was appointed as liquidator of a property development company by HMRC (who were the major creditor, being due well over 80% of the company’s debts).

24. On behalf of the creditors, the liquidator successfully pursued the directors for monies the directors owed to the company and was awarded £250,000 plus interest plus costs.

25. The costs were approximately £95k, plus a CFA success fee of £75k, plus ATE insurance premium of £85k.

26. Under the current system, the full £250K is payable to the estate and ultimately creditors, with costs payable by the defendants. However, under the proposals in the Bill, the success fee (£75k) and ATE insurance premium (£85k) would be payable out of the damages, reducing damages to £90,000 (compared with the £250,000 under the old system).

27. The IP concerned has informed us that this case would almost certainly not have been brought if the proposed recoverability restrictions had been in place, meaning the creditors would not have received any of the monies owed by the directors, and the errant directors would have kept such funds that were owed to the insolvent company.

OUR RECOMMENDATIONS

28. ICAEW therefore believes that insolvency litigation should be exempted from the recoverability restrictions in clauses 41 and 43 of the Bill, as we believe it is more equitable if these additional costs continue to be payable by the defaulting managers, and not payable out of the settlement (and ultimately creditors).

29. We understand that the Ministry of Justice is aware of the concerns that insolvency practitioners have regarding the potential impact of the reforms for insolvency litigation, and is in dialogue with HMRC and others. It would be helpful if the Minister could confirm whether any progress has been made.

30. If these exemptions are not included, we believe the Government should quantify the impact that these restrictions will have on creditors (including small businesses and HMRC) before the policy is implemented.

July 2011

Prepared 18th July 2011