Given the nature of the insurance business, conditional fee agreements offer opportunities. Robert Hogarth and Rebecca Life report.

Conditional fee agreements (CFAs) are big news in the legal world, but they are big news for insurers as well and not all bad. In fact given the nature of insurers' business - pricing risk - they ought to be looking eagerly at the opportunities that CFAs present. After all insurers bring claims as well as defend them.

Conditional Fee Agreements Order 1998
This extended the use of CFAs to all civil proceedings except matrimonial. The regulations governing conditional fees provide that a lawyer can charge an uplift of up to 100% on his normal profit costs if he wins, but nothing if he loses. In the event of success, the client has to pay this success fee out of any damages awarded. The Law Society recommends that the solicitors' uplift be capped at no more than 25% of these damages.

Normal costs rules apply to CFAs and after the Access to Justice Bill becomes law, it is expected that the losing party will be liable to reimburse both the successful claimant's reasonable success uplift and his “after the event insurance”. By taking out this insurance and entering a conditional fee agreement the claimant (and an insurer) may by one sole payment, transfer all of the financial risk of litigation to his solicitor and legal expenses insurer.

So the first question is, should insurers do so for their subrogated actions? The first thought may be no, as insurers are (much as they may try to avoid it) bulk purchasers of legal services. Legal expenses insurance and lawyers offering conditional fee agreements do so to make a profit, so for insurers to avail themselves of these services will probably result in their paying more overall. But claims managers may have reasons for wanting to spread the litigation risk of recoveries - such as not having to explain to their parent corporation on Mars that they have just lost three times the amount of the original claim in abortive legal proceedings.

There is nothing in the rules to prevent a solicitor from undertaking a preliminary review on a conventional charging basis and then switching to a CFA when convinced of the merits of the case. Indeed there is nothing in the regulations at present that forbid changing over to a CFA at any point in the proceedings. This may be enticing when some new evidence comes to light that strengthens the case and convinces the solicitor that he will win and obtain the success fee. The reasonableness of the uplift will, however, be judged in the light of the perceived merits at the date of the CFA.

In order to create an enforceable CFA, the procedure laid down in The Conditional Fee Agreements Regulations 1995 must be followed. This states, amongst other things, that the CFA must be in writing and must specify the circumstances in which the legal representative's fees are payable. The Law Society has produced a model agreement which, although not mandatory, is recommended since compliance will ensure the legality of the CFA. Failure to comply with the statutory provisions will render the agreement unenforceable, unless it falls within Thai Trading.

Thai Trading Co (a firm) v Taylor and another

The Court of Appeal in Thai Trading held that “there is nothing unlawful in a solicitor acting for a party to litigation to agree to forego all or part of his fee if he loses, provided that he does not seek to recover more than his ordinary profit costs and disbursements if he wins”. The agreement in question did not comply with the then current regulations relating to conditional fees, but was nonetheless pronounced lawful. This type of arrangement is now sometimes referred to as a speculative fee.

A speculative fee is likely to be very attractive to a client since he obtains the “reduced fee” or “no fee” element of a CFA without having to pay the accompanying uplift in the event of a win. The Access to Justice Bill makes it clear that CFAs include speculative fees and so they will have to comply with the statutory framework. The Bill further makes a provision that any reasonable insurance premium paid to cover against having to pay the other side's costs can be recovered from the loser.

The second question is why a solicitor would prefer a speculative fee to a statutory conditional fee agreement, since there is no provision for uplift? An answer may be that when working for insurers the solicitor may not need an “uplift”. In our experience insurers can now command hourly rates well below what High Court taxing masters are prepared to allow on taxation and well below the rates negotiated by non bulk purchasers. There seems to be no reason in principle why insurers should not agree higher “normal” rates, which are recoverable on taxation, in exchange for even lower rates on losing cases. This could apply to defence as well as claims.

Overall the solicitor would subsidise losing cases with the higher normal rates for success and might end up better off over all if he is a successful risk taker. The insurer would save through paying deeper discounted rates for losing cases, while on winning cases recovering the higher non discounted rates from the losing party. Clearly one man's CFA could be another's discounted speculative fee. It will be interesting to see whether losing parties succeed in persuading taxing masters to treat part of a speculative fee as a disguised (and currently irrecoverable) uplift. This issue will become academic once (and if) provisions in the Access to Justice Bill permitting recovery of uplift become law.

Legal Aid
One objective of the reforms codified in the Access to Justice Bill is the transfer of litigation risk in civil liability claims from the state sector to the private sector. Some insurance defence lawyers are already campaigning to restrict the applicability of CFAs in cases where the plaintiff already has legal expenses insurance, or liability is not in issue or cases are settled before trial. This seems to miss the point. Uplift will be recoverable from the defendant only to the extent that the proportion negotiated was reasonable at the time the CFA was reached. In the three circumstances quoted there may still be risk in CFAs that justifies the recovery of an uplift.

Currently legal aid work is less well paid than privately funded litigation. With the addition of uplift and after the event legal expenses premiums it is clear that the average cost per hour of legal work for plaintiffs paid for by defence insurers is set to rise steeply. The issue that remains to be resolved is whether the implementation in the UK of the Woolf litigation reforms will produce a compensatory reduction in the number of hours spent in working on each case.In the case of “fast track” claims the trend is towards fixed costs and that may produce a positive reduction in the amount of recoverable work that can be done on a case (but will it stimulate more trials, if their cost is better controlled?). It is generally thought that the reforms have the effect of “front loading” the work in litigation, so saving in work may only arise in the comparatively small proportion of claims that actually go to trial.

Overall it is probably safer for insurers exposed to civil liability claims and their reinsurers to assume that their spend on claimant's legal costs is unlikely to reduce in consequence of the current reforms.

Risk assessment
Currently not all claimants will want to use a CFA - if they win they stand to lose a portion of their damages in meeting the lawyer's success fee. The stakes are obviously even higher for the solicitor who stands to recover nothing by way of fees if the case is lost. The idea that the solicitor pays from his own pocket in litigation is also echoed in the Civil Procedure Rules, where solicitors can be made personally liable for costs if they have acted in a dilatory or wasteful manner.Solicitors will therefore have to become experienced at risk assessment and this is something that troubles insurers who offer after the event insurance. The news that 30 firms on the Law Society's Accident Line Protect scheme have been suspended amid concern over their claims record shows these fears have foundation. The demands of a commercial insurer are undoubtedly greater than the publicly funded Legal Aid Board and firms' results will be subject to monitoring. Insurers have already expressed concern that firms will cherry pick claims and only apply for after the event insurance cover in cases where they are less confident of winning. If the premium offered is to remain of economic sense to insurers, enough policies will have to be sold to spread the risk, but the problem of how to do that may not yet have been cracked.

Before entering into a CFA, it will be imperative that calculations are done balancing the likelihood of success against the amount of damages interest and legal costs at stake in the proceedings. Firms are already developing sophisticated models for risk assessment to supplement if not replace that trusty old standby, “gut feeling”. The success fee is related specifically to the merits of the particular case and will be calculated on two discrete components: the assessment of the risk and the level of financial subsidy needed to run the case. Generally, the greater the perceived risk, the higher the allowable success fee.Under the new Civil Procedure Rules, on an assessment of costs the Court has the power to reduce the success fee where it considers it “disproportionate having regard to all the relevant factors as they reasonably appeared to the solicitor or Counsel when the conditional fee agreement was entered into” (Rule 48.9 (5)). The Law Society has produced a probability table to help firms calculate the appropriate success fee. However, the level of costs likely to be incurred must also be factored in to each individual case.

There is, without doubt, great potential for conflicts of interest between the solicitor and client, particularly in regard to settling cases. As soon as it becomes apparent to solicitors that the recoverable uplift has reached the 25% of damages cap or that the risk has been underrated, there will be a temptation to undersell the claim. Conversely, where the cap has not been reached and the case appears strong, solicitors may want to run up more chargeable hours to earn more uplift. But no doubt they will heed their duties under the Solicitors Practice Rules, of which Rule 1 states they must act in the best interests of the client. Better still insurers, as the oldest profession of risk takers, should develop their own models to beat the lawyers at their own new game.

Robert Hogarth, partner, and Rebecca Life, Reynolds Porter Chamberlain.