In the game – will new rules on success fees see litigators take a gamble?

Three years after the Jackson review, reforms to litigation costs have finally arrived. But one change in particular, damages-based agreements, has polarised disputes lawyers. Can contingency fees work in mainstream commercial litigation?

When Lord Justice Jackson completed his year-long review of costs in civil litigation in January 2010 he proposed, in his words, ‘a coherent package of interlocking reforms, designed to control costs and promote access to justice’.

The reforms, which were introduced through a combination of legislation, regulation and rule changes on 1 April 2013, aim to improve the project management of litigation cases and manage costs. But the most significant changes have seen the end of the ‘loser-pays’ status of success fees under conditional fee agreements (CFAs) and after-the-event insurance, and the introduction of ‘damages-based agreements’ (DBAs). For the first time, lawyers can take a share of the damages recovered by their client, as happens with contingency fees in the US.

Under DBAs, the cap on the amount of damages that can be taken as a contingency fee is 25% for personal injury claims, 35% for employment tribunal claims and 50% in all other cases. And there is no doubt that the 50% cap on general commercial litigation will incentivise firms because of the potential for significant reward. Professor Dominic Regan, a solicitor and costs adviser to Lord Justice Jackson, explains: ‘If you get the right case you can take up to half of the winnings as your payment, regardless of the work done. That’s the killer.’

The debate regarding DBAs sounds esoteric but its potential impact on the City disputes market is huge. The use of CFA-backed success fees in high-end commercial litigation has already risen substantially since the banking crisis. This development gave UK corporate litigators their first real experience of having ‘skin in the game’ and was a shift from the previous view of CFAs being a funding tool largely restricted to low value personal injury and libel cases. The prospect of huge payouts under DBAs could in theory up-end the conventional economics of contentious legal practice and encourage far more firms to pursue such cases.

But before we start seeing a raft of cases using this model, DBAs require some fine-tuning. Many firms have identified problems with the new rules and are calling for ‘hybrid’ mechanisms that allow them to blend fixed-fee or hourly billing with a DBA. The idea is to have a ‘no win, low fee’ arrangement, rather than the high risk ‘no win, no fee’ approach. Currently the new rules make no provision for this type of arrangement: it is all or nothing.

Joanna Page, partner and head of Allen & Overy’s corporate and commercial disputes group, says: ‘The first thing we’re going to see is an amendment to the rules, and we would expect a revision that would permit claims to be funded partly by payment from a client and partly subject to a contingency fee; this will make it more attractive for firms and clients alike.’

Gary Milner-Moore, partner at Herbert Smith Freehills (HSF), agrees. ‘Excluding partial DBAs from the drafting is not ideal, because that would enable law firms – and in particular smaller ones – to spread their risk more evenly,’ he says. HSF has already lobbied the Ministry of Justice (MoJ) about the permissibility of hybrid structures for its clients.

Regan adds: ‘I am aware of at least two Magic Circle firms who have made lengthy submissions to the MoJ, to say “those regulations are unworkable” and the regulations are under review. The hybrid is what they want – one agreement, and the ability to charge.’

According to Regan, changes are already underway and hybrid DBAs can be expected by October or next April at the latest.

Another drawback is that DBAs by their nature only apply to damages and therefore can only be used by claimants.

Ian Gascoigne, disputes partner at Eversheds, explains: ‘Many people thought that DBAs would apply both to claimants’ recoveries and defendants’ savings, but this scheme doesn’t work in that way. DBAs can only be used by claimants and defendants with a counter-claim. This means there isn’t the possibility of rewarding a successful defence from the amount saved. It’s a drawback that DBAs apply only to one side of a dispute.’

Neil Mirchandani, a partner in Hogan Lovells’ securities, investment banking and funds litigation group, sums up current sentiment: ‘The UK DBA model is broadly along the lines of contingency fees but with some wrinkles which are proving unattractive to lawyers considering acting on a DBA basis. There is a feeling among litigators at the moment along the lines of one-wouldn’t-touch-DBAs-with-a-bargepole, because all the risk is placed on the lawyers and the reward is not quite what it’s cracked up to be.’

The damages effect

Nonetheless, DBAs will have a direct impact on the business of any law firm with a significant disputes practice. Partners will have to carefully assess the merits of the claim and pre-action analysis will be critical.

Tony Williams, principal of Jomati Consultants, advocates taking a ‘private equity’ approach. ‘You’ve got to analyse: what are the chances of winning? How much are you likely to win? How long will it take? How much will it cost? And how likely are you to get payment out of the defendant?’ he says. He suggests these factors will push firms to be tighter with their budgets and seek early settlements in cases. And that is exactly what the clients want – at a reasonable cost.

‘The private equity analogy is sound,’ says Regan. ‘The lawyer is investing in the action and like any other significant investment, due diligence is essential.’

Clive Zietman, head of commercial litigation at Stewarts Law, points out that for these reasons, firms will need to create sophisticated risk assessment mechanisms since any DBA in a major dispute will be considerable and potentially hazardous. ‘Very few DBA cases will be sure-fire winners,’ he warns.

Undoubtedly, law firms entering into a substantial number of DBAs will have to manage their risk profile very carefully, according to Mirchandani. ‘In so far as DBAs are all or nothing arrangements, then any cases being run on a DBA basis will generate work-in-progress but no income,’ he says.

‘If, say, a practice has 100 cases that form the bedrock of its annual turnover, then if 30 of those cases are run on a DBA basis, suddenly a substantial proportion of your income has disappeared or at least been delayed. You might well get it back if you have selected the cases properly and carefully, but that could be in two or three years’ time.’

Law firms will therefore have to adapt quickly to ensure proper risk assessment of cases to make sure that cashflow does not become a problem. Unsurprisingly, third-party litigation funders in the market are alive to these issues and are already looking to offer solutions to help law firms manage a possible DBA portfolio.

‘It is important for lawyers to offer a variety of fee arrangements to suit clients’ needs,’ says Nick Rowles-Davies, solicitor and consultant with third-party funder Vannin Capital. ‘The key is identifying which cases to take on and having a balanced portfolio of retainers across a caseload.’

Claims types

For sizeable disputes teams with broad portfolios, choosing the right cases in which to use the DBA model will be critical. Offering a DBA may work in theory but will involve plenty of negotiation with the client.

Page at Allen & Overy explains: ‘When we did calculations with clients, we found that even if you took quite a modest percentage of a case that had a high headline claim number, it can be perceived as too great a windfall for the solicitors. So it is quite hard to find the right balance.’

Even if the claim is successful, the client could contest the lawyer’s share of damages with the Senior Court Costs Office. According to Graham Huntley, a former Hogan Lovells partner and founder of boutique Signature Litigation, this is bound to happen in multimillion-pound cases that settle early, while Regan adds: ‘The danger is that your own client might knife you and they’ll get not 60% but 100% of the damages.’

The most high-profile recent example of a dispute regarding contingency fees involved Leigh Day in the Trafigura oil company case. In 2010 Leigh Day submitted a legal bill of £105m following a group action representing 30,000 victims of toxic waste in a claim against Trafigura. The firm’s bill was calculated to include a 100% success fee uplift, which Trafigura claimed was unjustified. In a preliminary judgment, a senior costs judge agreed, and said the prospects for the claimants had improved after progressing from the original group litigation stage in 2007. As such, he ordered that the success fee be lowered by 42%. The dispute was settled at the end of 2011.

Alexandra Anderson, partner at Reynolds Porter Chamberlain, comments: ‘There were quite a few firms that were caught out when CFAs first came in; they became unenforceable agreements and the firms were told they couldn’t get any of their money. That’s another reason firms will be fairly cautious now.’

Another interesting case is that of the late Boris Berezovsky’s $6.5bn battle royale with rival oligarch Roman Abramovich last year, which saw a major case run using a CFA play out in the full glare of the world’s media. Despite losing the case Berezovsky’s legal team at Addleshaw Goddard, led by partners Mark Hastings and John Kelleher, is reported to have been paid £50m for representing Berezovsky on the dispute with Abramovich and a separate dispute with Georgian billionaire Arkady Patarkatsishvili. The firm was also understood to have agreed to act on a 50% fee basis for all of the work, with an 100% uplift if successful.

Mirchandani says that in many international cases before the English courts, the amounts are so vast the client is prepared to pay the cost of leaving no stone unturned. He adds: ‘Smaller firms may not be able to afford to take these cases on because of the cashflow issues they can give rise to. The larger firms may be prepared to take cases on but they will be very selective in so far as they jump into this market at all.’

Page points out that judges don’t really have a true grasp of how much the case can cost across multiple jurisdictions. She says a firm will need to have that debate with the client, but what can change the whole dynamic of the case is having that discussion with the other side as the case proceeds.

It follows that DBAs may be better suited to larger firms with a substantial litigation practice and a strong balance sheet, says James Farrell, partner from the commercial litigation department of HSF. ‘Taken to another extreme, putting all your eggs into one basket to fight a single large case could put a small firm into financial trouble,’ he adds.

Another feature of DBAs that law firms need to consider is that even a small claim can cause problems. Anderson says: ‘It doesn’t matter how strong a claim you have, if it is only worth £100,000 and you know you’re going to write up costs of over £50,000 doing it (particularly if up to 50% on a DBA) no lawyer is going to want to touch that case. That is the real issue here because it’s really an access to justice point.’

For cases where a client is very confident they can win, there is always the possibility of a number of firms being approached for the best agreed fee. Farrell says this is already happening, with many clients putting litigation and arbitration disputes out to tender and asking firms to pitch in the same way.

Mirchandani argues these would likely be high-value cases involving relatively simple issues and a defendant who is clearly good for the money. ‘A client with that kind of case may be able to drive quite a hard bargain if they have several firms pitching for the work,’ he says. ‘That will encourage firms to come up with the most compelling fee propositions.’

DBAs will have an inevitable effect on the actual damages a firm will get paid, after costs. Kerry Underwood, chairman of South East disputes firm Underwoods Solicitors, says that the concept of contingency fees will lead to larger firms taking advice from costs firms and individual specialists.

‘It’s ironic – reforms that are meant to reduce costs, are actually creating them. Obviously quite a lot of American firms are based here, and I see them continuing to do what they are doing. But we’re moving towards a more American litigation system, there’s no doubt about that.’

Kevin Shannon, a barrister with expertise in costs at Ten Old Square, has a particular interest in the Jackson reforms. He says that choosing counsel with both costs and advocacy experience is critical when using a DBA and anything else would be risky. He adds: ‘I was up against a costs draftsman who knew his figures inside out, but had very little courtroom experience. The consequences for his client were pretty devastating.’

Steven Kobre, co-founder of New York-based litigation boutique Kobre & Kim, agrees but suggests another ingredient is equally important for firms moving towards DBAs: ‘I would actually say costs, advocacy and, for international cases, knowledge on the enforcement of judgments. If you win, it’s a hollow victory if you cannot recover the asset.’

Ethical considerations

Given the controversy that DBAs have attracted, professional ethics are also at the core of the debate. One school of thought suggests that as DBAs encourage early settlement, they will discourage firms from stretching out cases and notching up costs by the hour.

Shannon says that settling early will provide an incentive for solicitors to reduce costs. ‘As there are a certain number of “ambulance-chasing” lawyers who concentrate solely on CFAs, there will likewise be firms who will concentrate solely on DBAs, to very good effect,’ he comments. He also refutes notions that DBAs are less suited to small firms as some firms remain small because it ensures a greater profit share for the partners.

But there is a danger that DBAs will allow partners to cherry-pick cases for their own benefit, impacting access to justice. This is especially true with regard to fee arrangements, although it is inadvisable for lawyers to recommend a DBA to a client, just so their firm can get a windfall.

Regan comments: ‘Can you imagine – a £1m claim, done at 40%? What if it settles in a month? £400,000 and it’s nothing to do with how many letters you’ve written or how many hours you’ve done. However, there is a real concern about who is really running the case if the lawyer gets more than the client.’

Huntley says: ‘One might ask what social good is served by creating a situation where a professional, who is meant to be utterly independent, is going to have to try to cope with the risk of operating a case knowing that if the client wins, he might get paid gargantuan sums bearing no relationship to the work and effort put in? What social good is achieved if a client settles a huge case for $100m in a few weeks and pays a firm $50m? And, actually, this could happen.’

Although the Solicitors Regulation Authority has not issued specific guidance on this point so far, such behaviour would undoubtedly fall under the remit of the fourth of the ten overarching principles of the SRA’s new outcomes-focused regulation – ‘You must act in the best interests of each client.’ Many disputes experts believe that firms will be expected to provide a written and oral explanation as to why they recommended a DBA in the first place.

Gascoigne at Eversheds comments: ‘There’s already been a manifestation of some of the changes, but it’s too early to say whether they’re going to have a profound effect on people’s behaviour. My view is that UK litigation practices will prove to be more cautious than their American counterparts. There will be a reluctance to risk all legal fees in return for a share of the damages if the claim succeeds. Many clients won’t want that either.’

Shannon warns that as the new regulations are under review, law firms should be very careful of any DBAs they put together and take specialist advice on drafting. ‘As the statute is brand new and its precise details have not been ironed out through cases and experience, any draft DBAs should be as conservative as possible until their full extent is realised,’ he says.

He adds: ‘A perfect business model would be one that is profitable without DBAs but has the expertise to recognise when the “cash cow” of a DBA-suitable case arrives and the ability (in the form of appropriately drafted DBAs) to take advantage of it. Such a business will thrive in the post-Jackson future.’

However this ultimately plays out, there look to be plenty of litigators ready to place a few bets. LB