Who pays the costs?

Despite the aims of the Woolf reforms, costs of litigation have not been reduced. Sometimes, unsuccessful parties to litigation do not have the resources to pay the often significant costs incurred by the successful parties.

Sometimes, the party who loses has been funded by a third party, which is not named as a party to the litigation, or a third party has controlled the way the unsuccessful party has approached the litigation.

It is unsurprising that the number of cases where a court is asked to order that a non-party pay the costs of a successful party is significantly on the rise. The pace of development in this jurisdiction will be of interest to all parties involved in litigation.

Insurers will be familiar with this jurisdiction and may recall the Court of Appeal decision of Chapman v Christopher [1998], which was subsequently distinguished in Gloucestershire Health Authority v Torpy [1998] and other cases. Those cases concerned the possibility of insurers funding defences to pay claimant costs.

Broadly speaking, insurers would be exposed to an order for payment direct of a claimant's costs if they were funding the litigation for their own purpose. For example, the insured may be prepared to concede liability, or the claim may not affect the insured's reputation.

Many recent cases have related instead to the liability of parties funding claimants in respect of a defendant's costs of unsuccessful litigation. The impact these cases will have on both an insurer's potential own exposure and their ability to obtain recovery of costs from a non-party are now examined. The principles (see box) were applied to the following cases.

A claim had been unsuccessfully brought by Petromec Inc v Petroleo Brasileiro [2005] following the purchase, upgrade and subsequent total loss of an oil platform. The issue was whether various parties, including German Efromovich, the managing director and majority shareholder of a company called Maritima, who had conceived the project, would be liable to pay the defendant's costs.

The Commercial Court made an order against Efromovich because he was the "the real party", but released the other parties from liability in respect of the winner's costs.

The judge held that funding for the litigation "came from sources under the control of Efromovich and were made available at his direction", and that Efromovich was "one of the people, if not the only person, who stood to gain from the outcome...".

Continued litigation
Efromovich has apparently been granted permission to appeal and his appeal is due to be heard in June this year. (Petroleo Brasileiro SA & Others v Petromec Inc & Others; Petromec Inc v Petroleo Brasileiro SA and Others)

A director of a claimant debt recovery company had directed the continuation of litigation notwithstanding that the underlying debt had been recovered.

The Court of Appeal upheld a non-party costs order against the director for the entire costs of the successful defendant on the basis, again, that the director was the "real party" controlling the litigation for his benefit rather than solely for the benefit of the party named in the court proceedings. (Goodwood Recoveries Ltd v William Peter Breen ('Goodwood') [2005]).

Similarly, in a case successfully brought by a pension trustee against several companies and individuals, for alleged misrepresentation, the Court of Appeal upheld a costs order made against a shareholder of one of the defendant companies on the basis that he had funded and controlled litigation in order to promote or protect his own interests (CIBC Mellon Trust Co and Other v Stolzenberg [2005]).

Bad faith
Another issue which arose during the year was whether bad faith on the part of the funder had to be established. In B E Studios v Smith & Williamson [2005], the principal creditor of a defunct company of which he was a director, had funded and controlled an unsuccessful claim for professional negligence.

He unsuccessfully argued that conducting the claim with impropriety was a pre-requisite to the imposition of a non-party costs order. Again, a costs order was made against that director.

Each case will, however be fact specific. In Barndeal & Cherry Walk Properties v Richmond-Upon-Thames London Borough [2005], it was argued that two directors and one "manager" of the claimants should be liable to pay the costs of the defendant after a claim for property damage failed because of the absence of satisfactory evidence.

Despite allegations of fabricating of evidence, the judge was unable to make the costs orders sought because there was no evidence that they acted other than in the bona fide interests of the claimant companies, nor was the judge convinced that the evidence of funding or controlling the litigation was sufficient.

A further issue is the extent of liability which will be found where there has been limited funding of the unsuccessful party's costs.

Arkin v Borchard [2005] and others involved an appeal against a first instance ruling that the claimant's funders were to be liable for the defendants' costs on the ground that the funders had only contributed £1.3m to claimants' costs.

Liability capped
Notwithstanding that the funders stood to gain a very substantial proportion of any recoverable damages (25% of the first £5m and 23% thereafter) the Court of Appeal held that a professional funder's liability for the defendants' costs was capped to the amount of funding it provided, as this struck a balance between fairness to the successful defendants and access to justice for impecunious claimants.

The recent cases do not increase the risk of insurers being exposed to non-party costs orders.

The sheer volume of orders that have been made recently against non-parties does however indicate an increasing tendency among litigants to seek such orders and the court's willingness to make them.

Lord Justice Rix described this area of law as "a developing jurisdiction" (Goodwood). Parties facing claims (or defences) run and/or financed by commercial funders, directors or shareholders for their own benefit ought to consider putting such parties on notice that a non-party costs order will be sought after judgment.

It puts such parties at risk of direct liability which they may not otherwise have expected.

With the demise of legal aid and claimants seeking alternate means of funding litigation, the threat of, and possible application for, non-party costs orders represents a tactical weapon worthy of proper consideration by insurers. IT

' Philip Murrin is a partner and Polly Mackay an assistant in Davies Arnold Cooper's insurance group