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Litigation Funding and Third Party Costs – further developments: A Practical View from the Bar
Reproduced from Practical Law with the permission of the publishers. For further information visit www.practicallaw.com
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James Bickford Smith discusses Legg and others v Sterte Garage Ltd and another  EWCA Civ 97, a decision upholding the award of a non-party costs order against insurers.
- Claims being advanced against an insured party (in this case Sterte Garage).
- There being a doubt as to whether the relevant policy of insurance responded to the claims.
- Insurers funding the defence of the claims but reserving their position on cover.
The unusual feature of the case, however, was that the insurers subsequently ceased to fund the defence of the claim, on the basis that the policy did not respond to the claim, but before the findings of fact had been made that would have confirmed that view. Subsequent events provide a salutary warning for those funding and/or controlling litigation about the risks of departing the scene too early.
The insurers’ appeal stemmed from the fact that after judgment had been entered for the claimants, the claimants had successfully applied for:
- A non-party costs order pursuant to section 51(3) of the Senior Courts Act 1981.
- A declaration that they had succeeded to Sterte Garage’s rights under the Third Party (Rights Against Insurers) Act 1930, and that these included a right to indemnity in respect of the claimants’ legal costs.
The insurers appealed against both determinations. The Court of Appeal chose to address the non-party costs order first, thereby rendering the decision on the policy wording obiter. Further, their treatment of the insurance
point was contingent on a finding concerning the correct construction of the relevant policy of insurance. As such, it is of only background relevance to this column.
APPEAL AGAINST NON-PARTY COSTS ORDER
In dealing with the insurers’ appeal against the non-party costs order, the Court of Appeal applied the test in TGA Chapman Ltd v Christopher and another  EWCA Civ 2052, in which a costs order was made against insurers because:
“(1) the insurers determined that the claim would be fought;
(2) the insurers funded the defence of the claim;
(3) the insurers had the conduct of the litigation;
(4) the insurers fought the claim exclusively to defend their own interests;
(5) the defence failed in its entirety.”
(Legg v Sterte Garage, at paragraph 49.)
The court further approved the dicta in Palmer v Estate of Kevin Palmer and others  EWCA Civ 46 that a critical issue was whether the insurers were “motivated either exclusively, or at least predominantly, by a consideration of its own interest in the manner in which it conducted the defence of the litigation.”
CEASING TO FUND DEFENCE OF THE PROCEEDINGS TOO SOON
What becomes clear from the judgment, however, is that the feature of the case that left the insurers open to a non-party costs order was not that they had taken a losing case to trial and lost, but rather that, having taken over conduct of the defence, they had then ceased to conduct that defence of the proceedings before a determination of whether the damage the claimants complained of had been caused by events to which the policy responded or not. Thus:
- The policy responded only to pollution or contamination caused by “a sudden identifiable unintended and unexpected incident which occurs in its entirety at a specific time and place during the period of insurance”.
- The claimants had pleaded that such an incident had occurred, when a surface fuel tank leaked some 300 litres of fuel.
- The insurers denied this, instead contending (beyond the usual standard form denials) that contamination had occurred through gradual leakage from underground fuel tanks. In this contention, they drew support from an expert’s report commissioned by the claimants.
- Following that report, the claimants had amended their pleading to capture gradual, as well as sudden event, causation of pollution.
What the claimants had not done, however, was to withdraw the claim of sudden event pollution. Accordingly, when the insurers ceased to fund the defence of the action and Sterte Garage went into liquidation (as had always been foreseen if they were facing the claim alone) and also ceased to defend the claim, the claimants secured judgment on the basis of a pleading that still included an allegation of sudden event causation.
In facing the ensuing third party costs application, the insurers ran into the difficulties encapsulated by the first instance judgment, which the Court of Appeal upheld. The Court of Appeal cited the following extract from the first instance judgment:
“The judgment was entered on the Claimants’ pleaded case which included non-gradual pollution. Had Aviva wanted to take the points it now raises in response to this application it had every opportunity to do so by continuing to instruct its solicitors to act for the Defendant, file a Defence to the Amended Particulars of Claim. It chose not to do so.
The reason for Aviva’s involvement despite its stated position from September 2006 onwards that it was not going to provide an indemnity to the Defendant would appear to be that the Particulars of Claim contained a claim of non-gradual pollution which would be covered under the policy. What changed in September 2010? Only the addition of a further allegation of pollution, not a substituted allegation. Aviva’s insured still faced the original allegation of non-gradual pollution in the amended pleading, but despite this Aviva withdrew representation from the Defendant.
Aviva took a view on the case as they saw it before a trial on the issues. The decision may well have been premature. Aviva had the opportunity to maintain its representation of the Defendant but instead unilaterally withdrew that support when the issues were still live.
Aviva now ask the Court to conclude that the Claimants failed to establish non-gradual pollution despite the fact that the Claimants’ pleaded case up to and including the point when Judgment was entered for the Claimants remained that the cause was non-gradual pollution.
In the absence of any Defence being led to the Amended Particulars of Claim, the case proceeded as described above and it is not appropriate to go behind the judgment made. Aviva had an opportunity to run a Defence setting out the issues it raises in this application.
I am satisfied that the judgment entered for the Claimants on the basis of their pleaded case did establish the pollution was caused by the failure of the above ground tank.”
(Legg v Sterte Garage, at paragraph 43.)
The flaw in the insurers’ position was explained in some detail by David Richards LJ:
“Taking first the critical question whether the insurers were acting exclusively or predominantly in their own interests in defending the claims, it appears to me that there was ample material on which the judge could conclude that they were. As the insurers knew from the start of the proceedings, Sterte would be unable to meet any award of damages if it was not covered by the policy. The purpose of the insurers in defending the claim as originally pleaded was not to protect Sterte against an award of damages that it would otherwise be unable to meet, but was to seek to defeat a claim which, as pleaded, fell within the narrow class of pollution incidents covered by the policy. The insurers had no interest in defending the claim if and to the extent that it was based on any other polluting causes, as they made clear when they withdrew their support of the defence in September 2010. There was no doubt that the claimants’ property had been damaged by the presence of diesel oil and no real grounds for doubting that it was caused by leakages from Sterte’s property. Sterte asserted no grounds for defending the claims against it. The only reason for the conduct of the defence by the insurers, and their only interest in it, was to avoid a claim falling within the cover provided by the policy.
The insurers would have had a good answer to the claim for a non-party costs order against them if, following the Firth report, the claimants had in fact abandoned their claim based on the 1997 incident. In substance, then, the insurers would have funded the successful defence of such claim. But the claimants did not abandon that claim. I have earlier referred to the way in which the particulars of claim in the action brought by Mr and Mrs Legg were amended and the way in which the particulars of claim in the other action were framed. Both specifically plead the 1997 incident. DDJ Baehr had refused to strike out the claim based solely on that incident precisely because the claimants might be in a position to establish that it had caused loss within the limitation period. Neither in form nor in substance was this claim abandoned.”
(Legg v Sterte Garage, at paragraphs 52 to 53.)
SCOPE OF EVIDENTIAL ENQUIRY
The Court of Appeal also returned to the vexed issue of the scope of evidential inquiry to be undertaken in third party costs applications. The recent decision in Deutsche Bank AG v Sebastian Holdings Inc and another
 EWCA Civ 23 (see Legal update, Court of Appeal rejects director’s appeal against non-party costs order) suggested that the Court of Appeal is returning to the position that such inquiries main proceedings (which, given that non-party costs orders are axiomatically made against non-parties, can produce harsh results). A similar approach was taken in Legg, with the insurers’ attempt to reopen the causation issue being given short shrift:
“I regard it as wholly unrealistic to expect the judge to have decided the issue of fact as to whether damage to the properties was caused by the 1997 incident. Beyond the reports referred to in the particulars of claim, there was no evidence before the court on which this issue could be decided. All the reports, other than Mr Firth’s, attributed the damage to the 1997 incident. Mr Firth’s report indicated, in answer to the second question which he was instructed to answer, that at least some of the damage to the claimants’ properties could have resulted from the 1997 incident.”
(Legg v Sterte Garage, at paragraph 55.)
THE LESSONS TO BE DRAWN
The key lessons from the case concern the risks of withdrawing support for litigation, having initially provided it. Put simply, crossing the line into control of the litigation and/or running it for one’s own benefit, and later withdrawing support, carries significant risks.
This is not simply an issue effecting insurers. There are a raft of cases in which a party or non-party may fund a defence or claim for tactical or commercial reasons. Many readers will have conducted defences on behalf of directors, sub-contractors, employees, nominees or small companies who have been brought (at times somewhat incongruously) into significant litigation and who another party or commercial entity considers have to be supported in their defence of it. While many such representations pass off successfully, tensions between the supporting party and the supported (actual) party are far from unknown. Further, as tactical or commercial dynamics can and do change, the temptation to “bail out” when they do can be a strong one.
Often, of course, such temptations can find ready support from developments in the litigation itself. These can and do lead to arguments that “the focus of the case has shifted” or “the dispute has moved on”. What Legg reminds one, however, is that unless and until the pleadings have been amended to reflect alleged shifts or concessions by the opposition, there remains a real risk that withdrawal or dramatic scaling down of support can lead to the worst of all worlds: the entry of judgment against the supported party and the making of a non-party costs order against the supporting party.