Funding options for legal services - Alternative funding mec...

Learning Outcomes

This article explains the main alternative funding mechanisms for legal services in England and Wales, focusing on third-party funding, conditional fee agreements (CFAs), damages-based agreements (DBAs), and legal expenses insurance (LEI). It examines the legal and regulatory framework (including the Courts and Legal Services Act 1990, LASPO 2012, the Conditional Fee Agreements Order 2013, the Damages-Based Agreements Regulations 2013, and the Insurance Companies (Legal Expenses Insurance) Regulations 1990), distinguishes solicitor–client costs from inter partes costs, and details practical application to client scenarios, ethical and professional conduct considerations relevant to SQE1, statutory caps and enforceability requirements for CFAs and DBAs, the non-recoverability of success fees and most ATE premiums post-LASPO 2012, and client rights to choose their own solicitor once proceedings are issued.

SQE1 Syllabus

For SQE1, you are required to understand the range of funding options for legal services, with a focus on alternative funding mechanisms, with a focus on the following syllabus points:

• the main types of alternative funding for legal services (third-party funding, CFAs, DBAs, LEI)
• the legal and regulatory framework for each funding option
• the practical operation and limitations of each mechanism
• the ethical and professional conduct issues arising from alternative funding arrangements
• how to advise clients on the suitability and implications of different funding options in realistic scenarios.
• the distinction between solicitor–client costs and costs between the parties, including the “loser pays” principle and shortfalls after assessment
• statutory caps and enforceability requirements for CFAs (Courts and Legal Services Act 1990, LASPO 2012, the Conditional Fee Agreements Order 2013) and DBAs (Courts and Legal Services Act 1990 and DBA Regulations 2013)
• client rights and insurer obligations under LEI, including the freedom to choose a solicitor once proceedings are issued and common policy restrictions (panel solicitors, prospects of success)
• the liability of third-party funders for adverse costs (including the Arkin cap and circumstances where courts may depart from it)
• the role of ATE insurance with CFAs/DBAs and the limited circumstances in which ATE premiums are recoverable (e.g., clinical negligence expert report premiums).

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the main difference between a Conditional Fee Agreement (CFA) and a Damages-Based Agreement (DBA)?
2. Under what circumstances can a third-party funder be liable for the opponent’s costs in litigation?
3. What is the distinction between Before-the-Event (BTE) and After-the-Event (ATE) legal expenses insurance?
4. What ethical risks must a solicitor consider when advising a client on third-party funding?

Introduction

When clients seek legal services, the cost of pursuing or defending a claim can be significant. Alternative funding mechanisms allow clients to access legal representation without paying all costs upfront. These options include third-party funding, conditional fee agreements, damages-based agreements, and legal expenses insurance. Each mechanism has its own legal framework, practical requirements, and professional conduct considerations. Understanding these options is essential for advising clients and for SQE1 assessment.

In litigation, always distinguish between solicitor–client costs (what the client pays their own solicitor under the retainer or funding arrangement) and costs between the parties (sums a court may order one party to pay to the other, usually the “loser pays” general rule). Even a successful client remains contractually liable for their own solicitor’s fees, subject to any recovery from the opponent. Costs recovered inter partes are typically assessed and may be less than the solicitor’s total bill, leaving a shortfall for the client. If the opponent is insolvent or the court makes no costs order, the client may recover nothing from the opponent and must still meet their own solicitor’s costs.

Third-Party Funding

Third-party funding is an arrangement where an external funder (not a party to the dispute) pays some or all of the legal costs in exchange for a share of any damages or settlement if the case succeeds.

Key Term: third-party funding
An agreement where a non-party funds legal proceedings in return for a share of any recovery if the case is successful.

Key Term: maintenance and champerty
Historic doctrines prohibiting third-party support of litigation (maintenance) or funding in return for a share of the proceeds (champerty). These are now largely abolished for commercial funding.

Key Term: Arkin cap
A principle from Arkin v Borchard Lines Ltd [2005] limiting a third-party funder’s liability for adverse costs to the amount of funding provided.

Third-party funding is most common in substantial commercial claims, group actions, and insolvency litigation. Funders will typically require:

• a merits assessment demonstrating strong prospects of success
• an economic analysis showing a clear ratio between expected recovery and budgeted costs
• robust case management plans, including cost budgets and risk controls
• agreed reporting obligations on case progress and any material changes in prospects.

Funding terms vary. The funder’s return may be a percentage of damages or a multiple of the amount funded (for example, 2x–4x the outlay), and funders may require priority over other stakeholders in any recovery via a deed of priority. The return structure, termination rights, and adverse costs cover must be scrutinised to ensure the arrangement remains compliant and in the client’s best interests.

Regulation and Practice

Third-party funding is not directly regulated by statute, but the industry is self-regulated through the Association of Litigation Funders (ALF) Code of Conduct. The Code sets standards for capital adequacy (e.g., maintaining sufficient resources to meet funding obligations), transparency of terms, and funder conduct. It requires clear provisions on termination and prohibits funders from exerting undue control over litigation. Although the Code is voluntary, it is influential, and solicitors should prefer Code-compliant funders. When advising, solicitors should explain the Code’s purpose and how membership indicates minimum standards of probity and financial capacity.

Courts have relaxed the doctrines of maintenance and champerty for modern commercial funding, but agreements may still be challenged if a funder exerts improper control over the litigation or if the arrangement is contrary to public policy. Terms giving the funder a veto over settlement or strategy must be carefully drafted. Client control must be preserved, and any funder rights must be limited to reasonable consultation rather than directive control.

Funder liability for adverse costs is an important consideration. The Court of Appeal in Arkin suggested that a professional funder’s liability should be capped at the amount they have funded (including any security for costs funded). However, later authorities have confirmed that Arkin is not a rigid rule. In cases where funders assume greater control or fund speculative claims, courts may order funders to pay adverse costs on an indemnity basis and may depart from the cap. The message is that funder liability depends on the facts: the extent of the funder’s involvement, the quality of the claim, and overall fairness.

Ethical and Professional Issues

Solicitors must:

• avoid conflicts of interest between funder and client
• maintain client confidentiality when sharing information with funders
• ensure the client retains control of the proceedings and settlement decisions.

In practice:

• confidentiality and privilege must be protected when sharing case materials with funders. Implement written confidentiality agreements and consider common interest privilege once a funding relationship is established. Avoid wide disclosure before a confidentiality framework is agreed.
• the retainer should explicitly state that the solicitor acts for the client, not the funder, and that instructions are taken only from the client.
• termination rights in the funding agreement must be clear. If the funder can terminate for “deteriorating prospects,” there must be a fair mechanism for resolving differences in merits assessment and a plan for continuity of representation where termination occurs.
• transparency obligations require solicitors to advise on all viable funding options, cost risks, and the client’s potential liabilities (including adverse costs and shortfalls on inter partes recovery).

Worked Example 1.1

A small business wishes to sue a multinational company but cannot afford the litigation costs. A third-party funder offers to pay all legal costs in exchange for 30% of any damages recovered. The funder agrees to pay any adverse costs up to the amount funded.

Answer:
This is a standard third-party funding arrangement. The funder’s liability for adverse costs is capped at the amount funded (the Arkin cap). The solicitor must ensure the client understands the arrangement and that the funder does not control the litigation strategy.

Note: courts can depart from the Arkin cap where fairness requires (for example, where the funder’s role is extensive or the claim is hopeless). Advise the client that adverse costs risk may exceed the sums funded in exceptional cases.

Conditional Fee Agreements (CFAs)

A Conditional Fee Agreement (CFA) is a contract where a solicitor agrees to be paid only if the case is successful, often called a "no win, no fee" agreement.

Key Term: conditional fee agreement (CFA)
An agreement where the solicitor’s fee is payable only if the client’s case succeeds, with a possible success fee uplift.

Key Term: success fee
An additional fee (up to a statutory cap) payable to the solicitor under a CFA if the case is successful.

Key Term: LASPO 2012
The Legal Aid, Sentencing and Punishment of Offenders Act 2012, which changed the rules on recoverability of success fees and ATE premiums.

CFAs are governed by s58 Courts and Legal Services Act 1990. To be enforceable, a CFA must be in writing and state the success fee as a percentage uplift on base costs, together with the definition of “success” for the matter. “Discounted” CFAs are common, where the solicitor charges a reduced hourly rate if the case fails, with full base costs and a success fee if it succeeds.

Post-LASPO 2012:

• success fees are generally not recoverable from the opponent; they are payable by the client from damages if the case succeeds
• a statutory cap applies in personal injury claims: the client’s liability for the success fee is capped at 25% of damages for pain, suffering, and loss of amenity plus past financial losses (excluding future losses). The success fee cannot exceed 100% of base costs in any case
• ATE insurance premiums are generally not recoverable inter partes (with a limited exception for the portion of the premium relating to expert reports in clinical negligence proceedings)
• CFAs are not permitted in most family proceedings.

Practical points:

• disbursements (court fees, expert reports, counsel’s fees) are usually payable by the client whether the case wins or loses, unless covered by insurance or other funding
• if the client wins, the opponent may be ordered to pay costs assessed on the standard basis. The client remains liable to their solicitor for the full bill; inter partes costs recovered are credited, and the client pays any shortfall plus the success fee
• if the client loses, the client typically pays no base costs to their solicitor under a full “no win, no fee” CFAs. However, they may still be liable for opponent’s costs and their own disbursements. ATE cover is often advisable to protect against adverse costs.

Key Features (CFAs)

• The success fee is capped (e.g., 25% of damages in personal injury claims).
• Since LASPO 2012, the success fee is paid by the client from damages, not by the losing party.
• Disbursements (e.g., court fees, expert reports) are usually payable by the client, win or lose, unless covered by insurance.
• CFAs must be in writing and define “success”; if unenforceable, the client may not have to pay the solicitor’s fees.
• ATE insurance is commonly paired with CFAs to protect against adverse costs; premiums are usually deferred and contingent on success, but generally not recoverable from the opponent.

Worked Example 1.2

A solicitor agrees to act for a client in a personal injury claim under a CFA. The solicitor’s normal fee would be £2,000. The CFA provides for a 25% success fee. The client wins £10,000 in damages.

Answer:
The solicitor is entitled to £2,000 plus a £500 success fee (25% of £2,000). The success fee is paid from the damages. The client receives £9,500 after paying the solicitor’s total fee.

In personal injury, check the statutory cap: the client’s success fee liability cannot exceed 25% of general damages and past losses. Here, the £500 success fee falls below that cap, so the CFA is compliant.

Damages-Based Agreements (DBAs)

A Damages-Based Agreement (DBA) is a contingency fee arrangement where the solicitor receives a percentage of the damages recovered if the case is successful.

Key Term: damages-based agreement (DBA)
An agreement where the solicitor’s fee is a percentage of the damages awarded, payable only if the client wins.

DBAs are regulated by the Courts and Legal Services Act 1990 and the Damages-Based Agreements Regulations 2013. The DBA must be in writing and specify the proceedings covered, the circumstances in which payment is due, and the reasons for the percentage selected. If the client loses, the solicitor receives no fee (subject to disbursements, which often remain the client’s liability).

Caps:

• personal injury: 25% of sums recovered (excluding future losses)
• employment cases: 35%
• other civil claims: 50%

The cap includes VAT and counsel’s fees. The regulations for non-employment DBAs prevent charging any amount beyond the DBA payment and recoverable disbursements paid or payable by another party. The solicitor must credit any inter partes costs recovered against the DBA payment.

Practical operation:

• the DBA payment is deducted from damages; inter partes costs recovered are set off against the DBA payment, with any shortfall made up from the damages
• other disbursements (e.g., experts, court fees not recovered) remain the client’s responsibility
• hybrid DBAs (charging both a percentage of damages and other fees) are generally not permitted under the 2013 Regulations in civil litigation. The arrangement must be a “pure” DBA, save for allowable disbursements.

Courts have emphasised fiduciary duties and fairness where the lawyer’s remuneration is a share of recovery. Although independent advice is not legally mandated, solicitors should consider recommending it where the DBA percentage is high, the damages are substantial, or the client is vulnerable. Unfairness or undue influence may jeopardise enforceability.

Key Features (DBAs)

• The DBA must be in writing and comply with statutory requirements.
• The solicitor’s fee is deducted from the damages recovered.
• The client may still be liable for disbursements and the opponent’s costs if the case is lost.
• Statutory caps apply (25% PI, 35% employment, 50% other civil).
• Hybrid DBAs are generally not permitted in civil claims; the DBA must be “pure”.

Worked Example 1.3

A client enters a DBA with a solicitor for a commercial claim. The DBA is set at 30%. The client wins £100,000 in damages. The opponent is ordered to pay £20,000 towards the client’s costs.

Answer:
The solicitor is entitled to £30,000 (30% of £100,000). The £20,000 paid by the opponent is set off against the solicitor’s fee, so the client pays the remaining £10,000 from their damages.

Remember the cap: for non-PI civil claims, a 30% DBA is permissible (up to 50%). The client remains liable for disbursements not recovered inter partes.

Legal Expenses Insurance (LEI)

Legal Expenses Insurance (LEI) covers the cost of legal advice and representation. There are two main types:

Key Term: legal expenses insurance (LEI)
Insurance that covers legal costs for specified types of disputes, either before or after a dispute arises.

Key Term: before-the-event (BTE) insurance
LEI purchased before any dispute arises, often as part of home or motor insurance.

Key Term: after-the-event (ATE) insurance
LEI purchased after a dispute arises, usually to cover the risk of paying the opponent’s costs if the case is lost.

BTE policies are often add-ons to motor, home, or business insurance. They can cover solicitor’s fees, court fees, and sometimes adverse costs for specified disputes (for example, employment, contract, or personal injury), subject to policy limits, exclusions, and a “reasonable prospects of success” criterion. Policies may restrict the choice of solicitor at the pre-action stage (usually to panel firms), require prior notification to the insurer, and cap hourly rates.

ATE insurance is taken out after the dispute arises. It commonly covers the opponent’s costs if the case is lost and often the client’s own disbursements. ATE premiums are usually deferred and payable only on success, making them compatible with CFAs or DBAs. Premiums are set based on risk (prospects of success, estimated adverse costs exposure, and budget). Save for a limited clinical negligence exception (expert reports), ATE premiums are not recoverable from the opponent.

Features

• BTE insurance covers a range of potential disputes, subject to policy limits and exclusions.
• ATE insurance is commonly used with CFAs or DBAs to protect against adverse costs.
• The Insurance Companies (Legal Expenses Insurance) Regulations 1990 give clients the right to choose their own solicitor once proceedings are issued.
• Insurers may insist on “reasonable prospects of success” and reserve rights to withdraw cover if the case ceases to meet that threshold or if the client unreasonably refuses settlement.
• LEI policies can require compliance with notification provisions and cooperation duties; breaches may jeopardise cover.

Practical points:

• always check whether a client already has BTE cover before recommending CFAs/DBAs; failing to explore existing cover may breach professional obligations
• where BTE is in place, discuss the client’s right to select their own solicitor after proceedings are issued. Pre-action, the insurer may require panel representation; once issued, clients can choose, subject to reasonable cost terms
• when pairing ATE with CFA/DBA, ensure the client understands premium terms (deferred and contingent) and non-recoverability inter partes in most cases.

Worked Example 1.4

A client is injured in a road accident. Their home insurance policy includes BTE legal expenses cover up to £50,000. The insurer appoints a panel solicitor, but the client wants to use their own solicitor.

Answer:
Under the Insurance Companies (Legal Expenses Insurance) Regulations 1990, the client can insist on using their chosen solicitor once proceedings are issued, subject to the insurer’s approval of reasonable costs.

Ethical and Professional Conduct Issues

Solicitors must ensure that alternative funding arrangements do not compromise their independence, create conflicts of interest, or breach confidentiality. They must provide clear, written information to clients about the funding arrangement, risks, and potential liabilities. The client’s best interests must always come first.

Transparency and costs information are central. At the outset and throughout the matter, solicitors must:

• explain likely overall costs, how the chosen funding structure works, and potential shortfalls
• identify adverse costs risks and whether ATE is advisable
• set out disbursement liabilities and whether any are covered by insurance or funders
• disclose any referral fees or financial benefits received from third parties, and obtain informed consent where applicable.

For CFAs and DBAs:

• ensure the client understands caps, definitions of success, and what happens if the case settles early
• ensure the agreement is compliant (written, required terms included). If a CFA/DBA is unenforceable, the client may not have to pay, and recoverability of inter partes costs may be affected.

For third-party funding:

• avoid undue funder control over litigation strategy or settlement decisions
• manage confidentiality and privilege when providing case materials to the funder
• ensure termination rights are fair and do not expose the client to abrupt withdrawal without provision for continuity.

For LEI:

• check for existing BTE policies and explain rights and obligations under the policy. If using ATE, advise on premium terms and limited recoverability.

Exam Warning

Solicitors must not allow a third-party funder or insurer to control the conduct of litigation or settlement decisions. The client must retain control, and the solicitor must act independently.

Revision Tip

When advising on funding, always check for existing BTE insurance before recommending a CFA, DBA, or third-party funding. Failure to do so may breach professional obligations.

Summary

Key Point Checklist

This article has covered the following key knowledge points:

• Alternative funding mechanisms include third-party funding, CFAs, DBAs, and legal expenses insurance.
• Third-party funding involves an external funder paying costs in exchange for a share of damages if the case succeeds; funder liability for adverse costs may be capped but courts can depart from the cap.
• CFAs are "no win, no fee" agreements with a capped success fee, payable by the client from damages, and must be in writing to be enforceable.
• DBAs allow solicitors to take a percentage of damages as their fee, subject to statutory caps and compliance with the DBA Regulations 2013; hybrid DBAs are generally not permitted in civil litigation.
• Legal expenses insurance may be BTE (before a dispute) or ATE (after a dispute), covering legal costs and sometimes adverse costs; clients have the right to choose their solicitor once proceedings are issued.
• ATE insurance premiums are usually deferred and contingent on success; except for a limited clinical negligence exception, ATE premiums are not recoverable from the opponent.
• Solicitors must ensure funding arrangements comply with legal and ethical requirements, including independence, conflicts, confidentiality, and transparent client information about costs and risks.
• In all litigation, distinguish solicitor–client costs from inter partes costs; even a successful client may face shortfalls.

Key Terms and Concepts

• third-party funding
• maintenance and champerty
• Arkin cap
• conditional fee agreement (CFA)
• success fee
• LASPO 2012
• damages-based agreement (DBA)
• legal expenses insurance (LEI)
• before-the-event (BTE) insurance
• after-the-event (ATE) insurance