Intake risk: Accepting new instructions on a contingency fee basis

 

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Key takeaway points:

• Ensure rigorous conflict checks are completed before accepting instructions on a new matter

• Allocate specialist staff to undertake both external and internal conflict checks

• Take account of reputational and commercial issues when considering ‘own interest’ conflicts

• Consider putting in place value thresholds for fees and/or damages

• Agree a definition for high-risk cases and decide whether a case should be given a high-risk status at the outset

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At Stewarts Law, we have been conducting contingent litigation of one kind or another for more than 20 years, risk-sharing with clients across a variety of practice groups. In the UK, we currently use a mix of pre-litigation contingencies, damages-based agreements (DBAs) and full and partial conditional fees. In this article, I will refer to these funding methods as contingent litigation.

The procedures we now have in place to decide whether or not to accept a new contingent litigation instruction reflect the lessons we have learned. Our initial evaluation covers:

• rigorous new case, client and conflict procedures;

• value thresholds; and

• proper consideration of investment and recovery issues.

Crucially, we deploy experienced individuals to help us in making this determination.

Conflicts analysis

The initial evaluation of cases is supported by a case and conflicts analyst (CCA) and a conflicts and investment committee (CIC) made up of the managing partner, the business development partner, the knowledge management partner and the compliance partner.

The CCA plays an integral role in the file-opening process and has responsibility for carrying out the usual conflicts and other checks, such as politically-exposed person and sanction checks. The CCA also supports the fee earner with anti-money-laundering compliance and in ensuring that client engagement documents are sent and signed. Importantly, even partners cannot self-authorise the acceptance of new instructions.

Once the conflict check of clients and opponents is passed (which is usually the case, given our relatively conflict-free status), the CIC considers whether any 'own interest' conflict exists. This might include not acting in cases that could lead to adverse reputational issues, or difficulty in the final recovery of costs and/or damages. Other criteria include compliance with the predefined value thresholds which we apply to each of our litigation departments.

We consider these value thresholds necessary to maintain and enhance our brand as a leading complex litigation practice. We believe we are defined as much by the work we turn away as by the work we retain. Value thresholds also stress the importance we place on fees being proportionate to the sums in dispute.

 

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Managing the risks of contingent litigation

• Consider appointing an investment committee to review and approve the funding of contingent litigation

• Make certain that high-risk cases are monitored centrally from beginning to end

• Ensure that more than one partner has responsibility for pricing the firm’s investment in a case, balancing risk with reward

• Balance laying off the firm’s risk with the client or a third-party funder and consider what collective basket of risk is appropriate at any one     time

• Don’t assume risk in the absence of an adequate capital structure that will respond to the firm’s exposure on losing cases

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Risk analysis

The CIC has the additional responsibility of undertaking a more detailed review of cases identified at the outset as 'high risk' contingent litigation cases. In these cases, the CIC assists the fee earner with strategic issues and helps to manage client expectations, as well as to review all settlement offers and proposals. This is done within a framework of case plans and regular reviews, which become more detailed once work in progress has exceeded £100,000.

The firm identifies high risk cases as those for which there is a significant risk of us not being paid for work completed and, as a consequence, where a substantial write-off of work-in-progress will result. As a rule of thumb, any case where the prospect of non-payment is 40 per cent or greater (or, to put it another way, where the prospect of us winning and getting paid is 60 per cent or less) is designated as high risk. Cases that rely on the testimony of a sole witness and/or a sole expert for success will generally also be categorised as high risk.

There are other scenarios that may result in a high risk designation: for instance, where there is doubt about the possibility of enforcing a judgment abroad. Cases with a combination of distinct determinative issues, any one of which could result in a loss, will often be given a high risk status as, given the fourth rule of probability, such risks tend to compound.

Funding analysis

In contingent litigation, where fees are fully or partially at risk, our firm needs to fund substantial work in progress (WIP) and potentially other case-related fees. This lock-up is the firm's investment in the case and has a very real cost, as overheads and direct outlay of expenses will not be repaid until the case is won, and may never be repaid if the case is lost. Accordingly, it is helpful for the CIC to take both a micro and a macro view of the investment in question.

The micro view will need to reflect potential returns on the case. Sometimes in the biggest DBA cases (where fees are assessed as a proportion of the damages recovered), the investment return will diminish as more work is undertaken.

It is important to cost budget carefully to ensure that, if the case can only be won at trial, it does not result in a loss to the firm. Each firm will adopt different methods of formulating a suitable investment return for the business. Third-party funders would ordinarily seek a return of capital, plus a multiple of between two and three times the capital advanced.

 

 

Figure 1 details how return on capital may be assessed alongside the more familiar conditional fee arrangement (CFA) success fee which, in the example given, requires a 3x return on capital to equate to a 100 per cent uplift on hourly rates.

The macro view should reflect, on a departmental or firmwide basis, the need to limit the basket of high risk cases being undertaken at any one time. On the basis that it is undesirable for any firm to carry an excess of risk, the principle of 'laying off' risk is an important one. This is why our firm balances monthly billing departments against those that undertake all or some of their cases as contingent litigation.

Cashflow remains king and contingent litigation fee income can be lumpy at best. Monthly overheads are a constant demand on cash resources. Monthly billing departments, balanced with strong internal capitalisation, help to fund the more adventurous investment decisions. There are other means that can deployed to lay off risk, including after-the-event insurance and third-party funding.

A careful balance must be struck between the use of third-party funds and internal funding. That balance will dictate the appetite the firm has for investment in contingent litigation at any given moment. With the use of internal checklists, prescribed forms, the CCA, the CIC and a mix of partners who are able to add value and common sense to the decisions that need to be made, cases can be accepted or rejected in an informed and timely way.

Professor Richard Moorhead recently wrote that "the practice of law has flipped from vocation to business". I agree, and would add that this is not an intrinsically bad thing: indeed, much good can come from this change. However, as he also notes, this fundamental change places an even greater onus on solicitors to maintain integrity and professionalism in balancing private and public interests. This becomes yet more complex when you throw into the mix the sharing of risk with clients. We have had good reason to review our practice and procedures to ensure the right balance is struck. We must all have the right people with the right values to avoid the many pitfalls that can arise.

John Cahill is managing partner at Stewarts Law (www.stewartslaw.com)