Nobody likes to talk about losing. This is particularly true for lawyers representing clients in complex disputes. At the same time, arbitration and litigation proceedings are by their very nature characterised by risks – which is why clients would certainly value a guaranty that they will prevail in their lawsuits. Obviously, lawyers cannot provide such guaranty without breaching their professional duties. However, they can – and should – advise their clients on the possibility of litigation risk insurance (LRI), writes Rechtsanwalt, Stefan Kirsten, Düsseldorf.
Contrary to traditional legal protection insurance, LRI policies can be obtained after a dispute has already arisen. While this type of “after the event” (ATE) insurance is still relatively new, it has been attracting enormous attention internationally for several years and the LRI market continues to grow rapidly. Against this background, it is essential for clients and their lawyers to familiarise themselves with some of the most useful LRI tools:
Adverse Cost Insurance
According to the “loser pays” principle applicable in all of Europe, the losing party in an arbitration or litigation is liable for its successful opponent’s costs. Depending on the jurisdiction and the number of counterparties, such adverse costs can be substantial and pose a serious risk that is all too often ignored. Adverse cost insurance offers claimants and defendants the option to hedge this risk. Moreover, corresponding insurers can also provide security instruments to meet any security for costs requests of defendants.
Adverse Judgment Insurance
As its name suggests, adverse judgment insurance (AJI) is designed to protect a defendant (or other intended beneficiary) against the risk of a potentially significant or catastrophic adverse judgment (or arbitral award).
For instance, a company being sued for €50 million can obtain AJI coverage (also called a “limit”) of €45 million above a deductible (also called a “retention”) of €5 million. In consequence, any final judgment (or arbitral award) against the company in an amount between €5 million and €50 million is covered by the insurer and leaves the company only exposed to the €5 million retention.
This ringfencing concept offers numerous benefits:
- AJI facilitates M&A, financing and similar transactions that are threatened by pending disputes.
- AJI is a useful settlement tool if the opponent no longer has the leverage of a detrimental adverse judgment.
- AJI provides certainty to help with budgets, forecasts, and expenditures.
Judgment Preservation Insurance
The purpose of judgment preservation insurance (JPI) is to hedge a successful plaintiff’s or defendant’s risk that a favourable first-instance judgment is reversed (or its payment amount altered) on appeal. JPI is equally available to secure an arbitral award against annulment or other collateral attacks.
As a first example, a claimant that has obtained a first-instance judgment (or an arbitral award) in the amount of €50 million can protect that decision against the risk of being reversed or reduced on appeal (or annulled) beyond a retention of €5 million. As a result, any reduction of the original judgment amount (or annulment of the arbitral award) is covered by the JPI policy and leaves the claimant with at least €45 million (the limit above the retention).
As a second example, a defendant that has successfully fend off a €50 million claim in a first-instance litigation (or an arbitration) can protect that outcome against the risk of being reversed (or annulled) beyond a retention of €5 million. Consequently, any final judgment (or arbitral award) against the company in an amount between €5 million and €50 million is covered by the insurer and leaves the defendant only exposed to the €5 million retention.
Ringfencing a judgment or arbitral award through JPI can be useful for many reasons:
- JPI provides certainty because regardless of the outcome of the appellate or subsequent proceedings, a claimant will recover an agreed-upon amount of the judgment or award. On the other side, a defendant using JPI limits its exposure to the retention.
- JPI can accelerate the recognition of judgment-related gains in a claimant’s earnings and, vice versa, the limitation of judgment-related provisions in a defendant’s balance sheet.
- JPI can augment additional monetisation options by allowing a claimant to seek financing at attractive conditions with the insured claim working as a collateral for the lender.
- JPI facilitates settlements (1) for claimants because it provides leverage to mitigate any notion that a cash-strapped claimant might settle cheaply and (2) for defendants since the opponent no longer has the leverage of a detrimental appellate judgment (or annulment decision).
Given the factual, legal and procedural complexity of litigation and arbitration proceedings as well as the often very large amounts in dispute, litigation risk insurance generally requires a profound depth of underwriting that focuses on two key aspects: (1) the probability of the insured’s success in the dispute and (2) the likely quantum if the insured loses. While the first aspect determines the availability of LRI per se, the latter aspect is important for the setting of the appropriate retention to prevent moral hazard and ensure an (indispensable) alignment of interest.
In consequence, not all litigation or arbitration proceedings are insurable. If an underwriter does not receive conclusive information about the case, if its outcome is too much dependent on questions of facts rather than law or if the chances of the insured’s success are either undeterminable or simply too low, no insurer will offer an LRI policy. On the other hand, if the available information is sufficient and if the outcome of the dispute is non-binary, an LRI policy might still be available even if a complete success of the insured is unlikely – albeit against a high retention.
In view of the differences between the various LRI tools and the natural idiosyncrasies of litigation and arbitration proceedings, premiums and coverage terms differ significantly on an individual basis and are customised to the needs of the specific case. That said, premium rates generally depend on the limit, the retention and the question whether the premium is to be paid upfront or at the backend of the proceedings. Needless to say, combinations of upfront and backend premiums are also common.
In light of the obvious advantages of litigation risk insurance, it is safe to assume that the LRI market will further increase its rapid growth and that more and more companies will employ LRI as a means of dispute hedging. This development is likely to eventually lead to a duty of lawyers to inform their clients about LRI solutions. In fact, such duty is already recognised in the UK with respect to adverse cost insurance. While continental Europe might not have reached that point yet, the fact that LRI is still relatively new provides both dispute lawyers and inhouse counsel with an excellent opportunity – namely to demonstrate thought leadership vis-à-vis financial departments by effectively managing the risks of disputes.
Rechtsanwalt, independent advisor Düsseldorf with high-end practice as a litigator and arbitration counsel.