A new judgement from the Supreme Court has rendered litigation funding agreements (LFAs) in which the funder’s remuneration is calculated by reference to a share of the damages unenforceable. This brings ramifications for both law firms who use third-party LFAs within their practices, and those facing professional negligence claims where one or more of the counterparties is proceeding with litigation funding.

Implications of the Supreme Court decision

In a 4 to 1 majority decision on 26 July 2023, the Supreme Court in R (on the application of PACCAR Inc and others) (Appellants) v Competition Appeal Tribunal and others (Respondents), [2023] UKSC 28 (the “PACCAR Decision”) held that LFAs with third-party funders who play no part in the conduct of litigation, but who are due a percentage share of any damages recovered by the claimant, are ‘damages-based agreements’ (DBAs), as defined by the Damages-Based Agreements Regulations 2013. As these LFAs do not comply with the statutory requirements for DBAs, they will now be unenforceable.

The decision will have implications for funders and funded parties, particularly in respect to group actions, where litigation funding has historically served to remove economic barriers to pursuing legal action. Where otherwise valid LFAs do not seek a percentage share of any damages, but are instead calculated based on a multiple of sums invested, they will remain enforceable. Likewise, firms may seek to enter into damages-based agreements with clients, with the firms themselves backed by external funders – an arrangement not currently barred by the Supreme Court.

Understanding is key to compliance

Firms whose disputes practices rely heavily on LFAs should seek to understand the implications of the decision for both them and their clients. Whilst doing so, firms will need to ensure compliance with their regulatory obligations, including:

• Advising clients on funding arrangements (including the potential implications of the Supreme Court’s decision and litigation strategy)
• Avoiding situations which may give rise to a conflict of interest between the firm and its clients
• Actively monitoring the firm’s financial stability and business viability
• Notifying the Solicitors Regulation Authority promptly of any indicators of serious financial difficulty
• Despite uncertainty about its precise ramifications, failure by law firms to properly consider the implications could lead to professional negligence claims being made against law firms. Potential scenarios may include:
• Allegations of negligent drafting of LFAs
• Failure to provide appropriate advice in relation to entering a particular type of LFA
• Failure to advise a client to obtain after-the-event insurance

In light of the current economic environment, it is likely that many law firms have built up a backlog of unbilled or unpaid fees on funded cases. It is therefore particularly important that law firms ensure all LFAs in which they are involved are legally compliant.

Insurance considerations for law firms

When it comes to professional indemnity insurance (PII) renewal, firms should expect greater scrutiny around their case load as insurers look to ascertain a firm’s financial exposure and the potential for a negligence claim.

For firms already engaged in a high volume of cases in which the claimant is funded, insurers are asking firms to explain how the PACCAR Decision will affect their business and client arrangements. To minimise the heightened risk exposure firms should provide evidence of measures taken to mitigate against any identified risks.

Moving forwards, firms will need to amend their documentation to evidence that all LFAs entered into comply with relevant law. Firms may also be required to show evidence of steps taken to ensure compliance, including the provision of advice to clients regarding LFAs and litigation strategy.

To mitigate against claims in relation to LFAs, firms may wish to adopt the following measures:

• Where parties to litigation have been using LFAs, legal teams should be cognisant of issues around risks that a party may no longer be able to continue with the litigation or meet the costs of the law firm
• Make an early application for security for costs to protect against an unsatisfactory response from funded claimants
• Ensure all solicitors employed by the firm are made familiar with the implications of the PACCAR Decision and kept up to date on any other relevant legal developments

For further information, please visit our Lockton for Solicitors page, or contact:

Steve Holland, Senior Vice President

T:+44 (0)20 7933 2444

E: steve.holland@lockton.com