Adverse Cost Protection: What Are the Risks and Benefits?

This article is by Ian Hu, claims prevention & practicePRO Counsel at LAWPRO.

Adverse cost protection is a relatively new insurance or quasi-insurance product which can help lessen the financial blow of a lost case for both the client and lawyer. It may also be called adverse cost insurance, legal expense insurance, or after the event (ATE) insurance. While there is no standard contract or policy, the adverse cost provider will generally pay some amount of costs, fees, and/or disbursements should the client’s case lose. The premium or cost of the contract may be paid as a percentage of the value of a resolved case, contingent on a successful resolution by way of a settlement or trial verdict. In other cases, a firm may pay a flat fee to obtain coverage for all its files.

The contract or policy that governs the relationship between lawyer, client, and provider is complex. The issues may surprise you. A deep knowledge of the contract or policy and how it can affect the litigation is helpful to lessen the risks. Here are some considerations.

Discuss the terms and the risks with client

As with any advice, relevant information should be communicated to your client. Take care to discuss the potential costs, risks, and relevant terms of the policy or contract. This includes the nature of the relationship between your firm and the provider. Remember, under the policy or contract, you likely have new reporting and other obligations toward the provider, including sharing confidential information.

One of the biggest communication-related risks (and one that is universal to fees or expenses to be paid in the litigation context) is how adverse cost protection affects the “take-home” amount your client will receive when the case settles. Whether the policy premium or cost of the contract is paid as a disbursement or a fee, it is usually subtracted from the “all-inclusive” settlement. Where a successful resolution is highly likely, a client may perceive the cost to be unnecessary and insist on a higher all-inclusive settlement, thereby making it more difficult to settle a case. Costs or fees that a client feels are unnecessary can cause clients to question how much you are paid on the file. Unhappy clients, unresolved lawsuits, and allegedly high or unnecessary costs are all sources of claims. Keep in mind the LAWPRO policy does not cover fee disputes.

Whether the adverse cost provider is a licensed insurer or unregulated entity, remember, the payout is not absolutely guaranteed. Without government oversight, an unregulated provider may leave the jurisdiction or go broke and leave you holding the bag. While there is more comfort with a regulated insurer, past history has shown that even insurers can leave the jurisdiction and deny claims.

How much coverage is enough?

Adverse cost protection can provide a safety net for the client, typically around $50,000. Keep in mind there are scenarios where the amount covered is not enough. A two-week trial may result in a costs award of $100,000, but if only $50,000 is covered by the contract or policy, your client is on the hook for the remainder. This can occur if the case is more complex than anticipated, or if substantial indemnity costs are awarded at trial. Your client may turn around and seek to recover the remainder from you. Did you advise your client about the limited amount of coverage and the anticipated costs of trial? A false sense of security may embolden your client even when coverage is inadequate.

Avoid conflicts of interest

Ensure your duty of loyalty to your client is not negatively affected by obtaining adverse cost protection. The conflict of interest may not be immediately obvious, and may develop as a case progresses.

Take the following hypothetical case: The adverse cost protection provider agrees to pay only your disbursements, but excludes any costs, in the event your client loses at trial. Your retainer agreement with your client provides your client will owe you nothing if you cannot reach a successful resolution. As the case develops it becomes apparent the client’s case is not worth anything. Before trial, you receive a Rule 49 offer from the defendant to settle the file to withdraw the action on a without costs basis. If you accept the settlement, the adverse cost protection provider will not pay your disbursements, as the provider only pays out following a trial verdict. Merely withdrawing the action does not count as a trial verdict. You may now be in a conflict of interest. If you recommend rejecting the settlement and going to trial, knowing your client will likely lose, your disbursements will be paid but your client will have to pay the defendant’s costs (your client stands to lose, you stand to gain). If you recommend accepting the settlement, your client walks away from the file owing nothing, but you must write off your disbursements (your client stands to gain, you stand to lose).

Conclusion

It remains to be seen how and whether adverse cost protection will affect the litigation landscape. In the meantime, don’t let your client get caught unawares. Document your discussion with your client if you believe adverse cost protection is appropriate.

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