Damage limitation

For an industry that already operates on low margins, the legal costs of construction disputes can be disproportionate due to the complexity of the issues raised and the extensive documentation that can be involved. However, the extensive reforms to litigation costs that came into force on 1 April, inspired by the recommendations of Lord Justice Jackson, could make a real change to the way in which construction companies pursue claims.

One of the most significant aspects of these reforms is the introduction of damages-based agreements (DBA), a type of “no win, no fee” arrangement under which the solicitor is only paid if the case is successful and receives nothing if the case is lost.

The introduction of the Jackson reforms has denied parties the ability to recover after-the-event (ATE) insurance premiums and any uplift payable on conditional fee agreements from the other side. Not a great start. However, DBAs - which were previously unlawful - are now permitted in an effort to increase access to justice and parties’ freedom to choose how they wish to share the cost and risk of litigation.

In exchange for taking the risk of a claim being unsuccessful, solicitors are paid a share of the damages recovered. Their potential share is capped at 50%, inclusive of VAT and counsel’s fees. Combined with an ATE insurance policy to cover any potential liability for the opposing party’s costs, a litigant would therefore have no exposure to legal costs should their claim be unsuccessful. There would also be no up-front costs of running the proceedings save the ATE premium, which could be up to 45% of the sum insured.

Effect of a DBA

If successful, a claimant can recover its costs from the other side, assessed in the conventional manner according to the reasonableness and proportionality of the time spent and hourly rates charged. Should the costs recovered be less than the agreed percentage of the damages, the claimant will make up the shortfall.
For example, if company A were to agree a 35% DBA and pursue a claim against company B, a recovery of £1m would mean a legal bill of £350,000 (inclusive of VAT). If company B’s liability for company A’s costs is assessed at £250,000, there would be a £100,000 shortfall such that company A would clear £900,000
in total.

Interestingly, company B - the hypothetical defendant - could also benefit. As a matter of general principle, a party can only be liable for the opposition’s legal fees to the same extent that that party is liable to its own legal team. Therefore, company B’s liability is capped at the agreed percentage of damages recovered, no matter what costs are ultimately expended.

So, if company B’s liability for costs is assessed at £400,000 in the conventional manner, company A can keep the full £1,000,000 awarded but company B’s liability for costs is capped at £350,000.

Thus DBAs act as an effective cap on legal fees and could lead to a substantial loss of fee income for the poor lawyers! The flip side of course is that there could be a potential windfall for the lawyers if the case settles early or the costs (on the traditional hourly rate basis) have not exceeded the percentage of the damages payable.

No hybrid DBA

Presently, an unfortunate aspect of the legislation that reduces the flexibility of DBAs and therefore the situations where claimants may be able to use them is that “hybrid” DBAs appear to be prohibited. These would allow the solicitor to charge a reduced fee as a retainer with a smaller contingency fee due if the case was successful.

The drafting of the legislation on this point is poor and so the position is not clear. However, many had hoped that a form of “no win, low fee” would be permitted. This may change so that it is not “all or nothing” and there could be lower hourly rates in exchange for a smaller slice of the pie.

Despite the lack of a hybrid option, DBAs could be extremely beneficial in an industry where cash flow is vital and open the door for construction companies to pursue claims that they otherwise could not afford.

However, the entry into the market of litigation funding, insurance-backed products and DBAs will mean that innovative funding products will need to be developed to assist the construction industry in pursuit of its legitimate entitlements.

Steven Carey is head of construction and engineering at Speechly Bircham. James Worthington is a senior associate in the construction and engineering team at Speechly Bircham