Insights

Introduction

Much has been written and said about the implications for the litigation finance industry of the recent decision of the Supreme Court in PACCAR Inc and others v Competition Appeal Tribunal and others [2023] UKSC 28, with plenty of speculation as to how various issues will play out in decisions of the courts and the Competition Appeal Tribunal.

One prominent topic is whether clauses in litigation finance agreements (LFAs) providing for the funder’s return to be calculated as a percentage of damages can effectively be severed from other clauses which provide for a return on some additional or alternative basis, so as to avoid falling foul of PACCAR.

Interest in this point has recently been piqued by an English Court of Appeal decision on severance in a different but related context, Diag Human SE (1) and Josef Stava (2) v Volterra Fietta [2023] EWCA Civ 1107.

Before turning to the detail of the case a quick refresher on the requirements under English law for effective severance of offending contract provisions, in particular the three stage test formulated in Beckett Investment Management Group Ltd v Hall  [2007] EWCA Civ 613 and approved by the Supreme Court in Egon Zehnder Ltd v Tillman [2019] UKSC 32. A contract which contains an unenforceable provision nevertheless remains effective after removal or severance of that provision if the following conditions are satisfied:

1. The unenforceable provision is capable of being removed without the necessity of adding to or modifying the wording of what remains (the “blue pencil” test)
2. The remaining terms continue to be supported by adequate consideration; and
3. The removal of the unenforceable provision does not so change the character of the contract that it becomes “not the sort of contract that the parties entered into at all“.

The Diag Human case

In Diag Human the appellant solicitors had entered into a retainer agreement with the respondent clients which was accepted to be a conditional fee agreement (CFA) subject to section 58 of the Courts and Legal Services Act 1990 (the 1990 Act). It was also common ground that the CFA was unenforceable because, contrary to section 58, it included a success fee that could in certain circumstances have exceeded 100% of the solicitors’ base costs and because the percentage was not stated.

However the solicitors argued, among other points, that the whole of the uplift section of the retainer could be severed so as to entitle them to recover their base fees.

The parties agreed that the retainer satisfied the first and second test approved in Tillman*, but the clients submitted that the third stage could not be satisfied and that, in any event, it would be contrary to public policy for the solicitors to recover fees pursuant to the CFA after severance of the offending provisions.

*Note: It is not clear from the case report whether the retainer agreement in Diag Human contained an express severance clause, but in light of the Court of Appeal’s reasoning below it is unlikely that the outcome would have been any different if it had.

As regards the third test Stuart-Smith LJ, who gave the lead judgment, said as follows at paragraph 40 of the judgment:

“… I would hold that to implement the severance proposed by the solicitors would fundamentally change the nature of the contract so that, upon severance, it would cease to be the sort of contract into which the parties had originally entered. The September 2017 Agreement, whether it was a new contract or a variation of the February 2017 Agreement, was a CFA with a substantial proportion of the solicitor’s proposed remuneration being conditional upon the contingencies outlined in paragraph 3, that being the stated consideration for the discounting of the solicitors’ normal fees under paragraph 2 of the side letter. Upon severance, it would become a conventional retainer providing simply for the solicitors to charge at a discounted rate, with no conditional element at all. The fact that severance would remove the stated consideration for the solicitors’ agreement to discount their fees emphasises the difference in the nature of the contract before and after severance – before severance the solicitors discounted their fees in return for the prospect of success fees; after severance they discounted their fees for no consideration*. The present case cannot be moulded so as to be analogous to either Beckett or Tillman: there is no question of severing one part of the provisions for conditional fees and leaving the rest in place since that would be an exercise in futility: the character of the contract would remain that it was an unenforceable CFA”.

*Note: there would nevertheless still have been consideration post-severance as the solicitors’ performance under the contract would have been unaffected and would have provided the consideration for the clients’ obligation to pay the discounted fees (and so the second Tillman test was satisfied).

And at paragraph 45:

“If the “blue pencil” is applied to the paragraphs that provide for a success fee, the agreement between the parties in relation to all work carried out by the solicitors is converted from being a CFA into an agreement for payment on a conventional (if discounted) hourly basis.  On any view, this is a major change in the overall effect of the provisions as they existed before applying the “blue pencil”; alternatively it may be said that the agreement after the “blue-pencilling” (a standard contract for the payment of fees on an hourly basis) is not the sort of contract that the parties entered into (a CFA) at all”.

Stuart-Smith LJ distinguished the circumstances from those in Lexlaw Ltd v Zuberi (Bar Council Intervening) [2021] 1 WLR 2729. That case involved a damages-based agreement (DBA) which, in addition to providing for the solicitors to receive a share of the proceeds, also contained a clause saying that if the client terminated the retainer prematurely the client must pay the solicitors’ normal fees and disbursements. The issue for the Court of Appeal in that case was whether the existence of that clause invalidated the whole contract.

Lewison LJ held that it did not, and that only those provisions in the contract of retainer which dealt with payment out of recoveries amounted to a DBA. The existence of other provisions which provided for payment on a different basis did not invalidate the entire contract. While recognising that severance was not in issue in that case, Lewison LJ expressed the view that the conditions for severance were “amply fulfilled”.

The Court of Appeal in Diag Human distinguished Zuberi for a number of reasons, including that section 58(2)(a) of the 1990 Act precluded the offending clauses in Diag Human from being split off as contended for, and also because public policy did not support severance as it did in Zuberi. Indeed the Court held that public policy considerations alone precluded severance, irrespective of compliance or non-compliance with the three stage test.

As Stuart-Smith LJ pointed out “The principal effect of severance would be to permit partial enforcement of the unenforceable CFA. As was pointed out during submissions, if the client lost the arbitration, the effect of allowing severance would be that the solicitors would recover precisely the same amount of their fees as if the CFA had been held to be enforceable”. That was not, in the Court’s view, a tolerable outcome.

Position with LFAs

How does the decision in Diag Human impact on post-PACCAR severance of provisions in LFAs which provide for percentage-based returns in addition or as an alternative to other bases for compensating the funder?

Take the not untypical example of an LFA with provisions for multiple-based returns, but with provision for an additional percentage-based return if recoveries above a particular figure are achieved. Assuming that the first two tests in Tillman (blue pencil and consideration) are satisfied (and there would certainly be consideration for the remaining multiple-based formula) would severance of the clauses providing for the additional percentage return also pass the third Tillman test? In other words, would severance so change the character of the LFA that it would become “not the sort of contract that the parties entered into at all”?

It is difficult to see how such a conclusion could be reached when the effect of severance would be simply to keep one of the two bases for calculation of the funder’s return (the multiple base), which the parties had freely agreed to from the outset, and remove the other (the percentage base). In all other respects the bargain struck between the parties in the LFA would be exactly the same.

The considerations which led the Court in Diag Human to distinguish the position in Zuberi, including the public policy point, would also not apply in the above example. The effects of allowing severance would not be analogous to those in Diag Human as there would still be no circumstances in which the funder could recover its returns in the event that the underlying claim failed.

Could severance of the LFA percentage provisions be precluded by broader public policy considerations? That would seem an unlikely outcome. For example it would not be possible to argue (as it might be in the case of lawyers who act under non-compliant CFAs or DBAs) that the reward arrangements pre-severance were both illegal and unenforceable and so should not be saved by severance. Unlike DBAs and CFAs for lawyers, litigation funding was legal at common law even before the 1990 Act was passed and so the question of illegality does not arise.

Conclusion

There will no doubt be attempts to attack LFAs post-PACCAR by those with a vested interest in doing so. This article considers some of the arguments that may be raised in relation to severance, but for the reasons canvassed suitably drafted LFAs should not be prone to such attacks. This should be the case whether or not such LFAs contain express severance provisions, as it remains moot whether such clauses add anything to the common law doctrine of severance.