February 25, 2020

If the cap fits…. when one size does not fit all

The Court of Appeal has today handed down its judgment in ChapelGate Credit Opportunity Master Fund Ltd -v- Money & others. The Court of Appeal has upheld the decision of the High Court not to limit a commercial funder's liability for payment of the costs of the successful BDO administrators to the extent of the funding provided. The judgment provides welcome clarity on the status and application of the so-called "Arkin cap", and is of significant interest to commercial funders of litigation and to any professional services firm defending a claim which is, at least in part, backed by a commercial funder.

Our view is that the decision helpfully clarifies that the Arkin cap is only guidance and not a rigid rule.  Whilst the Court of Appeal has said that the cap might still be appropriate on the facts of some cases, it is nevertheless clear that the Court considered that the litigation funding market had moved on from the early days when Arkin itself was decided, such that there was a less obvious case for protecting successful funders by means of a special cap not otherwise available in litigation.

In a more evolved and sophisticated market, other techniques, particularly ATE protection, are frequently utilised by prudent and careful funders in order to limit their downside exposures in ways that do not burden successful defendants.

Background facts – Davey v Money & Others      

The Joint Administrators of Angel House Developments Limited, who were partners of BDO and Dunbar Assets Plc (together "the Applicants") had successfully defended a claim made against them by Ms Davey (the "Claimant").  The Applicants then applied for a non-party costs order against ChapelGate Credit Opportunity Master Fund Limited ("ChapelGate"), who was the commercial funder of Ms Davey in the underlying litigation.

The Court had characterised the conduct of the underlying litigation as significantly outside the norm and had ordered costs on an indemnity basis. The Claimant had been ordered to contribute £3.9 million towards the Applicants' costs and whilst ChapelGate did not resist a non-party costs order, it sought to rely on the Arkin cap to contend that their total liability should be limited to the overall maximum of the funding that it had provided to the Claimant, which was some £1.2 million.

The power to order a non-party to pay costs is derived from section 51 of the Senior Courts Act 1981. The so-called Arkin cap takes its name from the decision of the Court of Appeal in Arkin v Borchard Lines Ltd (Nos 2 and 3) [2005] 1 WLR 3055. In Arkin, a company which had provided funding on a commercial basis for an unsuccessful claim was ordered to pay the winners' costs only to the extent of that funding. The Arkin cap has been considered in a number of subsequent court decisions. 

High Court decision: Davey v Money & Others [2019] EWHC 997 (Ch)

Mr Justice Snowden said that the Arkin cap is "best understood as an approach which the Court of Appeal in Arkin intended should be considered for application in cases involving a commercial funder as a means of achieving a just result in all the circumstances of the particular case" and was not "a rule to be applied automatically in all cases involving commercial funders, whatever the facts, and however unjust the result of doing so might be".

In striking the balance between (1) enabling commercial funders to provide finance to facilitate access to justice, and (2) the principle that the successful party should have its costs, Mr Justice Snowden decided it would not be just to apply the Arkin cap in ChapelGate's favour for the following reasons:

  1. ChapelGate had approached its involvement throughout as a commercial investment;
  2. Whilst ChapelGate had not directed the conduct of the case, it had entered into the funding agreement with the Claimant after discovery and exchange of witness statements, therefore having had every opportunity to investigate and assess the type of allegations it was choosing to fund. If the Arkin cap was applied, ChapelGate would be "insulated" from the indemnity costs arising from how the claim was pursued;
  3. ChapelGate must have known that the Applicants' costs were likely to be very substantial and more than ChapelGate was willing to invest in the litigation, and that the Claimant was unlikely to be able to pay them;
  4. ChapelGate had been closely focused on its own self-interest in funding the litigation, with no correlation between the amount of its investment and the costs to which the Applicants were exposed;
  5. The evidence showed that the Claimant's access to justice had been a less important factor to ChapelGate than its return on its commercial investment;
  6. The Court rejected ChapelGate's argument that not applying the Arkin cap would signal an open-ended exposure to adverse costs and deter future commercial litigation funding.

ChapelGate was ordered to pay costs incurred after the date of the funding agreement (23 December 2015) without any cap. ChapelGate appealed against Mr Justice Snowden's decision not to cap its liability at the extent of its funding to the Claimant. 

Court of Appeal: ChapelGate Credit Opportunity Master Fund Ltd -v- Money & others

The Court of Appeal has dismissed ChapelGate's appeal. Lord Justice Newey gave the judgment, with which Lord Justices Patten and Moylan agreed.  

(1)  Status of the Arkin cap

The Court agreed with Mr Justice Snowden that judges do not necessarily have to adopt the Arkin cap when determining the extent of a commercial funder's liability for costs. The Arkin approach does not represent "a binding rule". Lord Justice Newey said:

"Judges, as it seems to me, retain a discretion and, depending on the facts, may consider it appropriate to take into account matters other than the extent of the funder's funding and not to limit the funder's liability to the amount of that funding. In the case of a funder who funded only a distinct part of a claimant's costs, a judge might well decide that it should pay no larger sum towards the defendant's costs. A judge could also, however, consider the funder's potential return significant. The more a funder had stood to gain, the closer he might be thought to be to the "real party" ordinarily ordered to pay the successful party's costs…."

(2) Comments on the use of the Arkin cap

Lord Justice Newey gives an example of a situation where a funder had met only a discrete part of the total costs (as had happened in Arkin) but that the Arkin cap might not be "just":

"Suppose, for example, that the total costs of pursuing a claim for £10 million had been £300,000 and that £100,000 of this had come from a funder who would have taken 90% of the net proceeds had the claim succeeded. On that doubtless unlikely set of facts, a judge might very well consider it "just" for the funder to bear more than £100,000 of the defendant's costs. In such a case, a judge might wish to have regard to what the funder had stood to gain, not just to its outlay. The course favoured by the Court of Appeal in Arkin, however, focuses exclusively on "the extent of the funding provided".

The Court explained that Arkin was decided at a time when third party funding of litigation, conditional fee agreements, and ATE insurance were relatively new – given this backdrop, it was important that commercial funders were not deterred by the fear of disproportionate cost consequences. The position is now very different and "a funder should now be able to protect its position by ensuring that either it or the claimant has ATE cover".

However, the Court stressed that there will continue to be cases in which judges decide it is right to follow the Arkin approach. Lord Justice Newey said that the Arkin "solution" is "particularly likely to be relevant on facts closely comparable to those in Arkin", where the funder had only covered the costs incurred by the claimant in instructing expert witnesses.

(3) Exercise of the court's discretion

The Court refused to interfere with the exercise of Mr Justice Snowden's discretion. Lord Justice Newey said:

"In short, a different judge might or might not have arrived at the same conclusion as Snowden J, but that is not the point. The order he made was plainly one that was reasonably open to him and his decision cannot be said to have been founded on irrelevant considerations."

In the circumstances, Mr Justice Snowden was entitled to attach importance to ChapelGate's prospective gains as well as to its outlay, and to have regard to the extent to which the Arkin cap would leave the Applicants out of pocket.  The following points were made:

  • The present case was distinguishable from Arkin because in Arkin the funder was only funding a distinct part of the claimant's costs (the provision of expert evidence). In the instant case, ChapelGate was funding all of the Claimant's costs from the date of the funding agreement;
  • If the underlying claim had been successful, ChapelGate would have received a profit amounting to a multiple of what it had spent. Indeed, Chapelgate would have received far more than the Claimant from an award of £10 million (the value of the claim set out in the opinion of the Claimant's Counsel).
  • It was inevitable that the Applicants would incur costs greatly in excess of funding which ChapelGate provided to the Claimant – the litigation involved very serious allegations against more than one party and the parties could not be expected to share legal representation;
  • In waiving the requirement for ATE insurance, ChapelGate very much increased the exposure of the Applicants.

Analysis

There is a difficult balance to be struck between (1) enabling commercial funders to provide finance to facilitate access to justice, and (2) the principle that the successful party should have its costs. It is clear from the Court of Appeal's judgment that this balancing exercise does not take place in a vacuum - rather the dynamics change over time. For example, commercial funders, conditional fee agreements and ATE insurance are now much more established than they were at the time of Arkin.

In recent years there has been a growth in the litigation funding market and in the sophistication of its participants. Funders are often institutional investors seeking out high value and high risk claims with the potential for high returns. Professional indemnity claims against professionals have been seen as particularly likely to attract the attention of funders.

Whilst perhaps understandable in the early stages of a new market, it is fair to say that the Arkin cap has come under increasing criticism as the market has matured, as representing an advantage not enjoyed by "other" litigants.  The Court of Appeal referred to Sir Rupert Jackson's "Review of Civil Litigation Costs: Final Report" published in 2009 in which Sir Rupert said there was no evidence that full liability for adverse costs would stifle third party funding or inhibit access to justice, and that it was "wrong in principle that a litigation funder, which stands to recover a share of damages in the event of success, should be able to escape part of the liability for costs in the event of defeat".

The Court of Appeal's refusal to classify the Arkin cap as a "rule" is a blow to commercial funders of litigation seeking to limit their exposure to the winning side's costs. The example given by Lord Justice Newey of a situation where it might not be "just" to apply the Arkin cap even when the funder is only funding part of the total costs (as in Arkin) is interesting because it would potentially further restrict the use of the Arkin cap. Strictly speaking this is an obiter comment, so it will be interesting to see if it is followed in subsequent cases.

When a commercial litigation funder is assessing at the outset its potential downside liability to costs in any given case, it must have regard not just to the level of funding it is providing to a claimant, but also to a broader range of other factors, including the extent of its prospective gains.  In reality, prudent funders will long have hedged their costs exposure by requiring effective ATE cover to be in place.  The decision confirms that this is a sensible way to proceed, and better balances the positions of both funder and successful defendant.

Despite anecdotal concerns, there is no logical reason why defendant professional services firms should fear that properly advised funders will pursue hopeless claims, and – given where we are – perhaps it is better to see funding with incentives to put adequate ATE cover in place.  The case does, though, demonstrate the obvious good sense of underwriting discipline and rigour in the assessment of funding proposals, and particularly in the evaluation of legal opinions provided on behalf of the party seeking funding.

Clyde & Co LLP acted for the Joint Administrators of Angel House Development Limited.