Third party costs liability and group companies: Beware of inadvertently creating a costs exposure by funding litigation

A recent decision of the High Court has highlighted the need for group companies to be particularly cautious when considering whether to provide assistance for the purpose of bringing or defending claims.

The court has discretion to determine by whom and to what extent costs are to be paid – it can not only make orders against the parties, but also against non-parties (section 51 of the Senior Courts Act 1981). Non-parties are often referred to as “third parties” in this context. The provision embodies the fundamental principle that it would be wrong to allow a third party to fund a claim and obtain the “benefit” of it, without bearing the “risks” of the claim.

In Montpelier Business Reorganisation Ltd v Armitage Jones LLP & Ors the High Court has recently considered third party costs orders in the context of group companies and has addressed the case law generally around this subject. The judgment provides some insight as to the considerations that are relevant to an application for a third party cost order.

Key points to be aware of when considering funding a group company so that it can pursue or defend litigation include:

• What constitutes “funding”? Funding includes making a loan to pursue or defend litigation. However, it can also include not requiring the repayment of an existing liability which enables funds to instead be used to pursue or defend litigation.
• The court’s discretion is unlikely to be exercised against pure funders (i.e. those who have no potential interest in the litigation, who do not stand to benefit from it, are not funding it as a matter of business and in no way seek to control its course). A loan made by an entity on non-commercial terms (i.e. an interest-free unsecured loan) is indicative of it not being a pure-funding relationship.
• Whilst third party costs orders are exceptional (i.e. not the norm), the underlying test is whether it is “just” to make such an order. The court will look to exercise its discretion to achieve justice. This may include making a percentage costs order or limiting the order to costs incurred over a specific period.
• The court will look to determine who the “real” party to the claim is by assessing the nature and degree of the third party’s connection with the proceedings. If the court assesses the group company is a real party (it need not be the only real party), then the likelihood of a third party costs order is much increased. The court will look at who is paying for the litigation, who stands to benefit from it directly or indirectly and in whose interests the funder is acting. Benefit may be evident in “cash” terms (i.e. the group company may be more likely to receive a payment is the litigation is successful) or may be a more obscure benefit (i.e. achieving relief from liability under a personal guarantee). A contingent benefit will not suffice. Often there will be an element of the third party controlling the litigation but this is not a pre-requisite and the absence of control does not avoid the potential liability.
• There is a special distinction to be drawn between shareholders funding claims and directors doing so – this is based on the duties owed by directors of limited companies to act in the best interests of the company which would make it unjust, absent impropriety, to place them at personal risk of costs. A corporate shareholder that is not a director cannot avail itself of this special distinction.
• Whilst a defendant may apply within ongoing proceedings for security for costs from an insolvent corporate claimant, not doing so does not preclude it from seeking a third party costs order at the conclusion of the case. Similarly, a costs warning from a potential applicant to the third party is not a pre-requisite for a third-party costs order.
• An overseas group company can be made the subject of a third party order. In the recent case the application for a third party order against a US company was stayed on pragmatic grounds, presumably pending the outcome of the application against other English based third party companies.

It is clear from the above that the mere existence of a group company does not create a costs exposure - other requirements need also to be present. However, it remains important for group companies to be aware of the potential to create a costs exposure when considering or putting in place arrangements within the group which are intended to enable the pursuit or defence of litigation. A failure to appreciate the position could be extremely costly.