The Supreme Court's significant July 2023 decision in R (on the application of PACCAR Inc & Ors) v Competition Appeals Tribunal & Ors (PACCAR) has generated much discussion and, as anticipated, led to satellite litigation as funders and funded parties alike grapple with what the decision means for litigation funding. In this article, we review two subsequent judgments that expand on some of the themes, and consider whether we have any more certainty of PACCAR's reach three months on from the Supreme Court judgment.

The detailed background to the PACCAR decision is covered in our earlier article, Supreme Court makes waves in litigation funding. In a nutshell though, in July 2023, the Supreme Court held that a Litigation Funding Agreement (LFA), which provides for the funder to receive a percentage of the successful party's damages, is a Damages Based Agreement (DBA) within the meaning of s.58AA of the Courts and Legal Services Act. The consequence is that any such LFA/DBA is unenforceable in both: (a) opt-out collective proceedings in the Competition Appeals Tribunal; and (b) any other proceedings, unless it complies with the formalities in the DBA Regulations - which most won't, as they were not intended to be DBAs.

As anticipated in our previous article, in the months since the decision, the courts have seen various related pieces of satellite litigation arising. These largely relate to parties seeking to invoke PACCAR to uphold or escape existing LFAs, and other decisions that may impact on funding workarounds being proposed in the wake of PACCAR.

Severing offending parts

One of the workarounds or solutions posited in the wake of PACCAR is whether any offending terms in an existing LFA can be severed from the agreement, leaving an enforceable agreement. For example, if (as was common) a LFA contained an alternative payment mechanism, whereby the funder was to receive the higher of either: (a) a multiple of the funding provided; or (b) a percentage of damages received, could the percentage element (which would post PACCAR render the LFA potentially unenforceable) be severed, leaving only the enforceable multiple?

The availability of severance has recently been considered, albeit in a slightly different context, by the Court of Appeal in Diag Human & Anor v Volterra Fietta. That case did not concern a LFA with a funder, but a discounted Conditional Fee Agreement (CFA) between Diag and its solicitors, entered into in relation to an investment treaty arbitration claim. The CFA was unenforceable because: (a) it provided for a success fee that could in some circumstances be 280% (exceeding the 100% maximum allowed under s.58 of the Courts and Legal Services Act and regulations made thereunder); and (b) it did not, contrary to the requirements of those regulations, state the percentage of the success fee.

In proceedings for assessment of the solicitors' fees, the solicitors argued that: (a) the offending success fee could be severed from the CFA; (b) in the alternative, they were entitled to be paid on a quantum meruit basis for work done on the arbitration at the request of their client; and (c) in any event, they were entitled to retain sums already paid by their client under the CFA. Neither Costs Judge Rowley, Mrs Justice Foster nor the Court of Appeal were persuaded by any of the solicitors' arguments.

In the Court of Appeal, Lord Justice Stuart-Smith noted the starting point (which was common ground between the parties) - the agreement as a whole was a CFA, and because it was a non-compliant CFA, the agreement as a whole was unenforceable. The court then turned to consider whether the offending success fee could be severed, using the so-called "blue pencil" test, as follows:

  1. Could the unenforceable provision be removed without adding to or modifying the wording of what remains?
  2. Would the remaining terms continue to be supported by adequate consideration?
  3. Would the removal of the unenforceable provision fundamentally change the character of the contract?

It was common ground that the first two parts of the test could be satisfied in this case. However, in the Court of Appeal's judgment, the proposed severance of the offending success fee would fail the third stage of the test, because it would fundamentally alter the nature of the contract, turning it from a CFA into an orthodox contract for the payment of fees on an hourly basis - a significant change to the bargain the parties had struck. It was not possible to split off those provisions dealing with payment of the solicitors' discounted fees, and treat them as not forming part of the unenforceable CFA - those discounted fee provisions were a core part of what made the agreement a CFA.

Even if it was wrong in these conclusions, the Court of Appeal also held that severance was precluded, because it was contrary to public policy - the principal effect of severance would be to permit partial enforcement of an otherwise unenforceable CFA. Accordingly, the solicitors were not entitled to be paid even the discounted rate under the CFA. Further, the same public policy objection precluded the solicitors from recovering the fees on an alternative quantum meruit basis that would have the effect of (as Lady Justice Andrews put it) allowing the solicitors "to claim by the back door... payment for their services which they cannot receive through the front". The final sting in the tail for the solicitors was that, since they should not have been able to recover under the unenforceable CFA at all, they were also ordered to repay sums which their client had already paid to them.

The Diag case is clearly a salutary tale for solicitors entering into CFAs, which highlights that they must abide by the strict formal requirements - but does it have any wider application to the availability of severance in post-PACCAR LFAs? Would the Court of Appeal's rationale for refusing to allow severance (and thus partial enforcement of a non-compliant funding agreement) transpose into the world of LFAs and DBAs? While Diag didn't give us any firm answers on that, we didn't have to wait long for a court to consider the question...

Bugsby

Just two weeks after the Diag judgment, the Commercial Court grappled more directly with the enforceability of LFAs in Therium Litigation Funding A IC v Bugsby Property LLC. The respondent, Bugsby, had succeeded at trial in proceedings that had been funded by Therium and others, by reaching a favourable settlement prior to appeal. In broad terms, Bugsby contended that the LFA was unenforceable following the decision in PACCAR such that the funders had no claim to the settlement proceeds. The funders sought an injunction to freeze the settlement proceeds, and a declaration that they were held on trust for Therium, and to be distributed in accordance with the terms of the LFA and related agreements (such that the funders would receive their return).

It is important to note that the issues were ventilated in the context of an injunction application, and the court was not being asked in this hearing for a final determination as to the enforceability of the LFA (which will be a matter for LCIA arbitration in accordance with the arbitration agreement in the LFA). The task at hand for the Commercial Court was to determine a threshold question - was there a serious issue to be tried (by an arbitrator) in this regard, such that the court should exercise its powers to preserve the assets pending arbitration?

Therium argued that the decision in PACCAR was not fatal to the enforceability of its LFA, relying on the 2021 Court of Appeal decision in Zuberi v Lexlaw - a decision also mentioned in PACCAR, but not overturned. Zuberi concerned a DBA that made provision both for the solicitors to receive 12% of the client's recoveries, but also for the client to pay certain costs and expenses in the event they terminated the retainer early. The client later contended that those termination payment provisions contravened the DBA Regulations, and so invalidated the whole DBA. The Court of Appeal disagreed. For present purposes, the key takeaway from Zuberi is Lewison LJ's approach in the case, where he preferred the view that "if a contract of retainer contains a provision which entitles a lawyer to a share of recoveries; but also contains other provisions which provide for payment on a different basis... only those provisions... which deal with payment out of recoveries amount to the DBA".

Therium pulled at this thread to argue that only that part of the LFA which provided for a percentage share of recoveries constituted an unenforceable DBA, while the remaining provisions (including a multiple of funding advanced) were not part of the DBA itself and so remained enforceable notwithstanding PACCAR. The Commercial Court was persuaded that this argument met the threshold test, and that there is therefore a serious issue to be tried as to whether PACCAR renders the whole LFA unenforceable, or only those parts providing for a percentage of recoveries.

Severance

In addition to its argument based on the Zuberi decision, the court also found that Therium had a serious case to be tried on severance. Bugsby advanced the Diag decision which had been handed down two weeks prior in support of its argument that the offending items could not be severed from the LFA, and that the agreement as a whole was therefore unenforceable. However, the Commercial Court found that the decision on severance in Diag "cannot simply be read across and applied by analogy to the issue of severance in the DBA in issue here". Mr Justice Jacobs continued: "It can be argued, reasonably, that there is no public policy objection to a severance which removes those provisions in a [LFA] which place the agreement within the regime, leaving behind an entirely lawful agreement to which the regime does not apply... Accordingly, a non-compliant CFA may well present a more difficult case for severance than a LFA which includes a DBA."

Wider implications of the decision

These two cases are no doubt only the start of post-PACCAR wranglings, but they present interesting counterpoints. Although the Bugsby decision only asks threshold questions and does not determine the issue (which, sadly for interested spectators, will now be played out before a LCIA tribunal behind closed doors), it gives an indication that PACCAR may not be entirely fatal to non-compliant LFAs, and that the concerns which led the court to condemn the CFA in the Diag judgment may not apply as readily in the context of DBAs, given the different statutory regime which applies. It is also likely that arguments revolving around severance and Zuberi will readily reappear in the courts in respect of existing and recently concluded LFAs.

Read the original article on GowlingWLG.com

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Ms Emma Carr
Gowling WLG
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