Third party funders held liable for costs on an indemnity basis
13 December 2016
Excalibur Ventures LLC v Texas Keystone Inc & Ors  EWCA Civ 1144, 18 November 2016
The Court of Appeal has provided important guidance on the extent to which third party litigation funders may be liable to pay the costs of a defendant who has successfully defended a funded claim. In particular, the Court held that a commercial funder should ordinarily be required to contribute to a successful defendant's costs on the same basis as a funded claimant; that it was appropriate to include funds provided in order to furnish security for costs in calculating a funder's liability under the Arkin cap; and that an order could be made against a party who in reality had funded the litigation, irrespective of whether they were a party to any funding agreement.
This decision marks the latest chapter in the now infamous Excalibur litigation, one of the largest and longest-running Commercial Court cases of recent years. The underlying litigation involved a claim made by Excalibur Ventures LLC (Excalibur) against Texas Keystone Inc and others (the defendants), in which Excalibur alleged that it was entitled to an interest in a number of profitable oil fields in Kurdistan and sought an order for specific performance of an agreement under which it could exercise this interest or damages in the sum of USD 1.6 billion. Four groups of funders (the Funders) had provided Excalibur with funding on commercial terms in return for a share of any proceeds of the litigation. Between them, the Funders provided GBP 14.25 million to cover Excalibur's own costs and GBP 17.5 million towards the payment of security for the defendants' costs.
At first instance, Christopher Clarke J (as he then was) dismissed the claim in its entirety, describing it as a "resounding, indeed catastrophic, defeat" for Excalibur. Excalibur was ordered to pay the defendants' costs on an indemnity basis. The defendants' costs were, for the most part, met by the security ordered, but there was a shortfall of some GBP 4.8 million, which largely represented the difference between standard and indemnity costs. The defendants applied for, and were granted, a third-party costs order under section 51(3) of the Senior Courts Act, stipulating that the Funders were jointly and severally liable to pay the defendants' costs on an indemnity basis. Each Funder's liability was capped at the amount of funding it had provided and each was only liable in respect of costs that had been incurred after it had provided funding. The Funders appealed. In dismissing the Funders' appeal, the Court of Appeal provided important guidance on the extent to which third- party funders may be liable to pay the costs of a defendant who has successfully defended a funded claim.
Appropriateness of indemnity costs
The Funders accepted that they were liable to pay the defendants' costs, but argued that those costs should be assessed on a standard basis, rather than an indemnity basis, because the Funders themselves had not been guilty of any discreditable conduct. The Court rejected this argument. Tomlinson LJ, giving the leading judgment, pointed out that this is only one factor to be considered. The Funders' argument ignored the character of the action which they were funding and the effect that it had upon the defendants, who had expended significant time, energy and expense in defending an unmeritorious claim. There was no principled basis upon which a funder could disassociate themselves from the conduct of those whom they had chosen to fund and from whom they stood to make a return on their investment.
The Court was at pains to agree with Christopher Clarke J's conclusion that the derivative nature of a commercial funder's interest in litigation should ordinarily mean that they were required to contribute to the costs on the basis upon which they had been assessed against the party whom the funder choose to fund. The Court explained that such a presumption was not irreubuttable, but represented the outcome that would usually be just and equitable.
Commercial funders were making an investment and were not motivated by promoting access to justice. That investment carried risks, the nature of which a funder was able to inform themselves of both prior to providing funding and throughout the course of the litigation. In this regard, the Court endorsed the first instance judge's determination that it is expected that a responsible funder would carry out a "rigorous analysis of law, facts and witnesses, consideration of proportionality and review at appropriate levels" and that such action would not be champertous. The Court also explained that on‑going review of the progress of litigation by lawyers who were independent of those actually carrying out the litigation was essential in reducing the risk that an unsuccessful funded party would have indemnity costs awarded against it.
Treatment of funds provided for security for costs
In Arkin v Borchard Lines Ltd (Costs Order)  EWCA Civ 655, the Court of Appeal held that a commercial third-party funder's liability for adverse costs is limited to an amount equivalent to the funding provided. This principle is known as the "Arkin cap". In the instant case, some of the Funders argued that funds provided in order to meet a court order for security for costs should not be taken into account when calculating the Arkin cap.
The Court rejected the Funders' argument. There was no basis upon which a funder who advances funds to meet an order for security for costs should be treated differently from one who advances funds to meet a litigant's costs of its lawyers or expert witnesses. The Court explained that both types of costs were general costs of the litigation, which, if not met, would result in the litigation being unable to proceed and that "[a]ll the sums advanced are used in pursuit of the common enterprise and for the benefit of all of the funders".
Relevance of separate corporate personality
Three of the four groups of Funders had provided funds on a back-to-back basis via companies with no sources of funds and no assets and had not entered into direct funding agreements with Excalibur. These Funders argued that a contractual nexus was a prerequisite to their being subject to a third-party costs order under section 51(3).
The Court of Appeal dismissed that argument. As Gloster LJ noted, any other conclusion would allow funders to insulate themselves through the use of special purpose vehicles. Citing Threlfall v ECD Insight Ltd  2 Costs LO 129, Tomlinson LJ explained that, when making a section 51(3) order, "the court is not fettered by the legal realities but can look to the economic realities". The exercise of the court's discretion in making a third-party costs order did not amount to an enforcement of legal rights and therefore the doctrine of separate corporate personality was not relevant. The Court reiterated the well-established principle that it is just and appropriate to make a third-party costs order against a funder not just where that funder substantially controls proceedings, but also in circumstances where the funder stands to derive a substantial benefit from the litigation.
The Court of Appeal's decision provides a further incentive, if one was needed, for commercial funders not only to conduct a thorough due diligence prior to funding a litigant, but also to maintain a robust process for reviewing the litigation as it progresses. Furthermore, it provides clarity that funders can, and sometimes should, engage independent external counsel to review litigation strategy in order to minimise the risk of indemnity costs being awarded against a funded litigant. In this respect, the Court's confirmation that such courses of action will not constitute champertous conduct is particularly welcome.
Although users of commercial litigation funding may now find their cases subject to more thorough and on-going scrutiny, given that professional commercial funders do not typically fund cases as unmeritorious as Excalibur's, the case is unlikely to have a seismic impact on the funding industry. In this regard it is worth remembering that the Funders were not members of the Association of Litigation Funders (ALF) (who had intervened in the appeal) and that only one of the Funders had any litigation funding experience at all. Indeed, the decision has in fact been welcomed by the professional funding community, including the ALF, as a welcome reaffirmation that funding is not only part of the modern legal landscape but also, in Tomlinson LJ's words, "an accepted and judicially sanctioned activity perceived to be in the public interest".
The Court of Appeal was not asked to decide on the appropriateness of the Arkin cap principle; however, Tomlinson LJ twice commented upon the fact that some view the principle as over-generous to commercial litigation funders. It therefore remains to be seen whether the principle will survive intact if and when it comes properly before the Court of Appeal for consideration.
This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication. For more information please contact Amy Edwards at email@example.com.