Litigation | 27 September 2017
Corporate clients are of course no strangers to litigation. Listening to in-house counsel talk about how they approach litigation, they will often regard it as an inevitable, if undesirable, by-product of doing business. When it arises out of their core business activity, and particularly for large organisations – banks and insurance companies, for instance – they will frequently regard themselves as sophisticated users of the litigation or arbitration process. In run-of-the-mill cases for which they budget and, where necessary, appropriately reserve, they will typically consider that they and their advisers are well placed to understand and manage the risks. Not all litigation claims of course fall within this category and from time to time businesses will be drawn into one-off disputes, often as defendant, but on those they are likely to have no (or little) choice but to engage.
There is, however, a third category of claims, which are neither run-of-the-mill nor so significant as to be unavoidable, where in-house counsel have a choice whether or not to get involved. Competition damages claims are a good example. A company may have suffered as a result of anti-competitive activity, and may have a good claim, but pursuit of the claim is not a business priority and certainly not one which would justify diverting scarce resources away from core activities. This will be exacerbated where the costs involved may compare unfavourably against the losses suffered by that individual claimant. The natural tendency on the part of in-house counsel in such cases will often be to conserve resources to support business-critical activities and to leave the value of such claims on the table.
This reluctance to invest in realising the value of claims is unsurprising given the way that the cost and value of litigation claims are accounted for. Broadly speaking, companies will treat the costs of litigation as an expense in the year in which it is incurred. This will drive up expenses as the costs are incurred and correspondingly drive down profitability.
At the same time, the company will be unable to reflect the value of unrealised claims in their balance sheet. So, while the company’s cash decreases, the litigation asset in which the company is investing has no corresponding value on the balance sheet. This gives a worst-of-all-worlds outcome while the case is ongoing.
The company takes an ongoing hit to its profitability which will be reflected (possibly many times over) in the company’s share price (if that reflects a methodology referencing profit), while the company’s net assets are reduced by the expenditure without reflecting any value for the asset being realised. Even should the claim conclude successfully (and there is of course no guarantee of that), the revenue is likely to be regarded as a one-off item not included in gross profit and therefore may be stripped out by analysts in their assessment of the company’s underlying profitability for valuation purposes. Any in-house counsel considering allocating resources to pursuing a claim will therefore have to consider whether the future benefit from the claim outweighs the negative impact of tying up cash, the drain on management time and also the drag on the company’s perceived financial performance for the life of the case.
In recent years, however, in the UK, we have seen offerings to corporates which ameliorate these effects through the use of litigation funding and adopting a group approach to litigation. By utilising litigation funding, companies are relieved of the ongoing burden of funding the claim, as well as the risk if the case is unsuccessful. The effect is to tip the balance away from a likelihood of not pursuing the claim towards pursing it providing that the risks are properly addressed. By joining forces with other claimants, companies are able to share the legal costs and funding cost, making the proposition attractive for funding, making the case more robust commercially and therefore protecting the company’s economics.
In the competition space, recent examples include the claims being pursued with funding from Therium by Humphries Kerstetter on behalf of a group of companies, including the Co-op, against Visa and Mastercard for damages relating to the practice of overcharging of merchant interchange fees to merchants. Similarly, Therium is funding the Road Haulage Association in bringing collective proceedings in the Competition Appeal Tribunal on behalf of hauliers and other buyers of trucks against manufacturers who have been fined by the European Commission for fixing prices of certain kinds of trucks over a 14-year period. Such claims are not restricted to the competition space; the recent shareholder claims against The Royal Bank of Scotland, Lloyds Bank and Tesco are also examples of group litigation involving litigation funding and the clients included large institutional investors.
Funded group litigation offerings like these provide corporate clients with alternatives to shouldering the entire burden of litigation alone. As issues emerge in the public domain which are likely to give rise to a claim in which a company is a potential claimant, in-house counsel should now be considering what options are likely to be available to prosecute the claim, whether their interest in the issue is sufficient that they would wish to issue proceedings individually as against the benefits of joining a broader group, and whether to use third-party funding rather than self-funding. It may even be possible to answer the issues of individual versus group claim and funding independently – for instance pursuing the case individually on a funded basis or joining a group but with the company self-funding, bearing its own share of the costs. Whatever the answer in an individual case, it is clear that the emergence of these litigation options is changing the perspective of in-house counsel on accessing the value locked up in the company’s claims and that trend looks set to continue.