De-risking causes of action

It is not uncommon for a trust’s assets to include one or more valuable causes of action. Indeed, trustees owe a fiduciary duty to decide whether to pursue any such causes of action. Very often, however, this is not a straightforward decision.

The trustee’s usual starting point is to attempt to weigh up the costs, benefits and risks associated with litigating the cause of action, but litigation is a notoriously unpredictable process. Any merits assessment at the pre-action stage will usually be highly provisional, especially in complex claims. It is seldom possible at the beginning of a case to predict with any degree of certainty what the other side will say, what new material will come to light or how a particular judge might analyse the evidence.

The decision is further complicated by considerations of costs recovery. In cases where the litigation will take place in a jurisdiction with no costs recovery regime, the trustee must consider whether it is worth the effort. In cases where the jurisdiction does have a costs recovery regime, the trustee must consider not only what proportion of the trust’s costs might be recoverable in the event of success, but also the fact that further trust assets will be put at risk in the event of failure at trial or in the context of any interim applications.

The potential downsides are greater still in cases where the trustee is considering seeking injunctive relief against the proposed defendants, e.g., freezing injunctions against trustees who are believed to have fraudulently misappropriated trust assets. It is standard practice in common-law jurisdictions for a claimant who obtains an injunction to be required to pay any associated third-party costs and to compensate the defendant if the injunction later turns out to have been wrongly granted. This is sometimes described as the ‘price of an injunction’ and a payment of security is often also required.

In other words, causes of action should be regarded by trustees as assets whose value is contingent on success in a process (litigation) that tends to be risky and unpredictable. In the authors’ view, such assets by their nature cry out for an insurance product and the prime candidate is the commercial litigation funding market, alongside costs insurance. These products effectively allow the trustee to ‘de-risk’ causes of action before pursuing them by insulating the trust’s other assets from the hazards of litigation.

Is commercial funding always the answer?

It would go too far to suggest that all contentious trusts disputes should be commercially funded. To take an extreme example, if the claim is straightforward and unanswerable on its merits, the trustee will often be able to conclude that the benefits of using other trust assets to fund the claim (and of avoiding any need to pay a premium to a funder in the event of success) outweigh the risks of failure and adverse costs orders.

Conversely, an extreme example of where funding would be the obvious solution for trustees is where the cause of action is the trust’s only valuable liquid asset. In such a case, funding will likely be the only way of unlocking value for the trust.

Most cases, though, fall somewhere between these two extremes. In the authors’ view, subject to one caveat, trustees should regard the use of commercial litigation funding not merely as an option to be considered from time to time in extreme cases, but as an option that should always be given careful consideration. Moreover, one would be concerned that a trustee who fails to consider this route runs the risk of breaching their fiduciary duties. Indeed, it would plainly be best practice on Beddoe applications, where a trustee is seeking guidance on whether to pursue third-party claims, to show in its evidence that it has considered and weighed the benefits of commercial funding in the circumstances of the case, and to explain why, if it nevertheless decides to proceed at the expense of, and so at risk to, the trust fund, that it is still a sensible thing to do in all the circumstances.

The caveat is that the litigation funding industry has developed at different rates in different jurisdictions. The above conclusion only applies to those jurisdictions in which there is a mature litigation funding market that is not, for example, inhibited by ongoing restrictive rules against champerty and maintenance.[1]

The authors’ general understanding, however, is that litigation funding already has a strong foothold in many of the key trust jurisdictions. In others, the momentum is towards liberalising the funding market via a combination of legislation and judicial authority.

The liquidation funding model as a useful precedent for trustees

As STEP members will be aware, the use of litigation funding for actions by trustees is not yet commonplace. Many trustees will never have had to address the issue before and so in approaching their deliberations they may benefit from considering the jurisprudence that has developed in another fiduciary context: that of liquidators.

Liquidators often face the illiquidity or absence of any assets other than a cause of action discussed above. Litigation funding has provided access to the courts that would otherwise not have been available and many of the factors relevant to assessing the benefit to creditors and other stakeholders in such liquidations apply mutatis mutandis to beneficiaries.

The British Virgin Islands courts have been consistently supportive of the use of litigation funding by liquidators and are expected to be similarly supportive of its use by trustees in appropriate cases. The matters that the courts will want to consider in a Beddoe application to approve a funding agreement are very similar to those on a liquidator’s sanction application, specifically the:

• merits of the proposed claim;
• ability to pursue without funding; and
• appropriateness and competitiveness of the terms of the funding.

It is worth noting that there is express English and Welsh Court of Appeal authority that a non-lawyer liquidator forming their own view on the merits of a claim without taking legal advice was ‘most unsatisfactory’: Faryab v Smith.[2]

Conclusion

The authors therefore expect to see significant short-term growth in the commercial litigation funding market in the field of contentious trusts. It is recommended that trustees in jurisdictions with mature funding markets be proactive in exploring the economic benefits for the trust of applying for funding for disputes, as opposed to risking trust assets. Indeed, trustees should regard doing so as arguably being a matter of compliance with their fiduciary duties.

Practitioners may have seen doom-filled headlines regarding the recent decision of the UK Supreme Court in R (on the application of PACCAR Inc) v Competition Appeal Tribunal that certain types of litigation funding agreements are unenforceable.[3] However, that decision relates only to non-compliant damages-based agreements, which are litigation funding agreements where the funder receives a percentage of the damages. Such funding agreements are more common in class actions and are unlikely to have been used in trust litigation, where the funder’s return on investment in the event of success is usually calculated as a multiple of the funds deployed.