New insolvency reforms came into force 6th April 2016 to increase the amount of money creditors receive when insolvent companies are taken to court. The new rules, known as the Jackson reforms, mean insolvency litigation is no longer exempt from the Legal Aid, Sentencing and Punishment of Offenders Act 2012.
The rules bring the insolvency industry inline with the rest of the UK for the first time. In practice, legal teams offering no win/no fee deals in insolvency litigation will no longer be able to claim damages from the defendants, such as directors accused of fraudulent trading. Instead, the legal team’s fees will now come out of the winner’s purse.
The situation until now
Lord Justice Jackson identified the need for change in his 2013 report. He said officials were guilty of milking each case by ramping up the legal costs. These would be paid from the creditor’s pot. Lawyers and insurers would employ delaying tactics which meant some cases could drag on for more than four years. The result was that by the time the case was concluded, very little money would remain for the creditors, leaving small businesses, banks and HMRC out of pocket.
In some cases, the legal fees for a case could be 200 percent more than the original claim. So, in the case of a claim for £50,000, there would be another £100,000 to pay in costs. A recent report from the Insolvency Service supported these claims. It found that in 96 no win/no fee cases from the past three years, only four percent resulted in any cash being returned to creditors. Nearly 80 of the cases were still ongoing.
Could the reforms actually be a blow to creditors?
Although the reforms are designed to get more money into the hands of creditors and less into the pockets of the legal professionals, there are claims that the new rules are actually a blow for creditors.
Philip Sykes, president of the insolvency trade body R3, said: “The end of the exemption leaves a huge funding black hole for insolvency litigation. This is a blow to the wider community and the insolvency profession as a whole.
“The government is potentially writing off hundreds of millions of pounds per year owed not just to HMRC, but to hundreds, if not thousands, of ordinary businesses as well. The only winners are rogue directors and others who refuse to repay money owed to creditors after insolvency. We’re back to an uneven playing field, where rogue directors hold all the cards – and the cash.”
Recent research carried out on behalf of R3 supports Sykes’ views. The report said that given the removal of no win/no fee litigation cases, 86 percent of insolvency professionals believed less money would be returned to creditors; 69 percent said they would take on fewer ‘no asset’ cases; and 49 percent said they would stop or decrease litigation altogether.
The rise of third party litigation funding
In response to the reforms, insolvency industry insiders expect to see a rise in third party funders, who provide the funds to run the case in return for a share of the outcome. Typically, they will pay the lawyers fee and insurance premium for around 20 percent of the proceeds of a successful case. This could provide insolvency practitioners with a viable alternative, and represent the best way to secure the best possible return for creditors.
In 2015, cases that were funded by third parties represented a relatively small part of the insolvency litigation market. Research for R3 calculated that an estimated 160 cases were funded by third parties, bringing creditor returns of approximately £45million. This is likely to increase greatly in 2016.