UK Supreme Court decision renders many litigation funding agreements unenforceable

Enforceability issue

The enforceability issue arose in the context of competition law, where it is common for proceedings to be brought by groups of consumers with individually modest claims collectively funded by an LFA. The Competition Appeal Tribunal (CAT) only allows such claims to continue where it is satisfied that the class representative has sufficient resources to pursue the claim and satisfy any adverse costs order made against it. In this case, UKTC and RHA applied to bring collective proceedings, for breaches of competition law, on behalf of a group who had acquired trucks from DAF and other truck manufacturers. The truck manufacturers sought to defeat the applications by challenging UKTC’s and RHA’s funding arrangements. They argued that the funding arrangements were inadequate as the LFAs were damages-based agreements (DBAs) within the meaning of s.58AA of the Courts and Legal Services Act 1990 as amended (CLSA 1990) but did not comply with the requirements of the regime regulating DBAs (that is the DBA Regulations 2013) and so were unlawful and unenforceable.

Section 58AA of the CLSA 1990 defines a DBA as an agreement between a person providing advocacy services, litigation services (in relation to any sort of proceedings for resolving disputes) or claims management services and the recipient of those services, which requires:

1. the recipient to pay the provider if the recipient obtains a specified financial benefit in connection with the matter in relation to which the services are provided; and

2. the amount of that payment to be determined by reference to the amount of the financial benefit obtained.

There was no suggestion that the funders of the claims were providing advocacy or litigation services. The question was whether the funders were providing “claims management services.”

Section 58AA of the CLSA 1990 defines “claims management services” by reference to s.4(2) of the Compensation Act 2006 |(CA 2006) pre-1 April 2019 and s.419A(2) of the Financial Services and Markets Act 2000 (FSMA 2000) thereafter.

• CA 2006 defines “claims management services” as “advice or other services in relation to the making of a claim.”
• FSMA 2000 provides that “claims management services” means “advice or other services in relation to the making of a claim,” where “other services” includes “financial services or assistance.”

It had been assumed that “other services” would only be “claims management services” if they were part and parcel of services that included the active management of claims. On this basis, LFAs where funders purely provided capital were not drafted to comply with the DBA Regulations 2013. In this context, it is worth noting that in 2018 the Ministry of Justice asked Professor Rachael Mulheron and Nicholas Bacon KC (who represented the truck manufacturers in this case) to review the DBA Regulations 2013 and they produced the draft Damages-Based Agreements Regulations 2019 which specifically provided that LFAs were not DBAs. However, these draft regulations have never been introduced.

The CAT and the Divisional Court rejected the argument that the LFAs were DBAs, on the basis that they did not involve the provision of “claims management services,” and the matter was referred to the Supreme Court.

Supreme Court decision

In the absence of the 2019 draft regulations, “claims management services” had to be construed by applying the rules of statutory interpretation to a web of dated and disparate provisions. In a 4:1 majority decision, the Court determined that the primary legislation did not expressly provide that “claims management services” must include the active management of claims, and that there was no established and generally accepted meaning of “claims management services” which qualified or coloured the express language of the primary legislation.

The Supreme Court noted that regulations, which had not been introduced contemporaneously with the primary legislation or as part of a coherent scheme, could not be used as an aid to its interpretation. Part 2 of the CA 2006 was drafted widely to afford the Secretary of State broad powers to determine the regulatory response to what, at that time, were new types of litigation services. Interpreting the language of s.4(2) of the CA 2006 in a narrow sense was therefore contrary to the overall purpose of Part 2 of the CA 2006 and the government’s intention.

The consequence of giving the words their natural meaning was that LFAs, where the funder takes a share of the damages recovered, are DBAs within the meaning of s.58AA of the CLSA 1990 and must comply with the DBA Regulations 2013.

Consequences

While it is not explicitly stated that the regulatory regime which governs funding arrangements in England and Wales applies to arbitration, and s.58AA of the CLSA 1990 does not expressly confirm that “claims management services” may relate to any sort of proceedings for resolving disputes (as it does for advocacy or litigation services), most arbitration practitioners adopt a conservative approach which is consistent with recent case law and anticipate that both the regulatory regime and the Supreme Court’s decision will apply to funding arrangements for English- seated arbitrations.

In compliance with the DBA Regulations 2013, LFAs which include a percentage return:

• must include a justification for the level of the percentage return;
• cannot provide a return which is more than 50 percent of the damages recovered in the proceedings;
• must not require the client to pay an amount other than (i) the percentage return, net of any costs and disbursements in respect of Counsel’s fees that are payable by another party to the proceedings and (ii) any expenses incurred by the funder, net of any amount payable by another party to the proceedings.

In most instances, these criteria will not create insurmountable barriers to new agreements, albeit that funders will need to restructure their offering and may take measures to avoid their LFAs being DBAs. However, where non-compliant agreements are already in place, the only safe way to proceed is to enter into a re-drafted agreement. Depending on the payments made and the progress of the proceedings, this may prove to be problematic.

In many cases, the funded party will need further investment to continue the proceedings, and it will be in both the provider and the recipients’ interests to find a workable solution. However, reopening negotiations may have detrimental consequences for one side or the other. There will also inevitably be cases where recipients who are “in funds” or reaching the end of proceedings are reluctant to take measures to enforce their LFAs and cases where successful parties seek to avoid payments or even to recover payments already made pursuant to their LFAs. In these circumstances, funders might seek to rely on a severance provision to remove the provision allowing for the percentage return, leaving only the fixed multiple. However, it is unclear whether an agreement which the DBA Regulations 2013 provide is unenforceable can be rendered enforceable by removing the element which makes it a DBA. There may also be change-of- position defenses, unjust enrichment defenses and, depending on when the funding took place, limitation defenses.

Parliament is expected to legislate to resolve the issues that have arisen because of the Supreme Court’s judgment, but the timing is unknown, and it is unclear whether the legislation will be retrospective. In the meantime, parties and funders are considering their options and searching for clarity as they line up to renegotiate their funding arrangements.