In the following guest post, Burkhard Fassbach and Frank Hülsberg take a look at alternative litigation risk insurance products. These products allow insurance buyers to manage risks arising from known litigation. Frank is a Chartered Accountant and Tax Advisor in Dusseldorf, Partner and Member of the Executive Board at ADKL AG Wirtschaftsprüfungsgesellschaft in Germany and Burkhard is a D&O lawyer in private practice in Germany. I would like to thank Burkhard and Frank for allowing me to publish their article on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is Burkhard and Frank’s article.
Litigation Risk Insurance (LRI) refers to a relatively new and still largely unknown set of bespoke and tailor made insurance offerings that allow policyholders to better manage the legal risks arising from known litigation. In the case of legal disputes, companies are exposed to the risk that judgments will be appealed, have a negative outcome or damages will be reduced. The crux is the uncertainty inherent in litigation. Counsel can obviously not guarantee how a case will turn out no matter how strong the lawyers may predict the merits of a case. According to an article authored by New York based AON brokers Stephen Davidson, Head of Litigation and Contingent Risk, and Senior Lawyer Stephen Kyriacou, LRI allows counsel to provide certain assurances to his client that an adverse litigation outcome will not impact the client monetarily, or will only impact them to a certain predefined extent. Furthermore, they point out that LRI most commonly takes two forms: plaintiff-side judgment preservation insurance and defense-side adverse judgment insurance. The worth reading article “Litigation Risk Insurance: A Tool That Should Be In Every Lawyer’s Toolkit” can be found here.
II. Judgement Preservation Insurance (JPI)
JPI underwrites the risk associated with a judgment being overturned or significantly decreased on appeal. In this case, a plaintiff who has prevailed at trial can be confident that a win is insured at a certain level slightly below the total award, even in the unlikely, yet possible, event of reversal on appeal. Reference is made to an article authored by Holland & Knight’s Miami based lawyers Matthew Grosack, Alex Gonzalez, Robert Hill and Leonie Huang on “Emerging Trends In Litigation Risk Insurance” in the INSURANCE JOURNAL, March 7, 2022. The article can be found here.
Stefan Kirsten, a German lawyer specialising in dispute resolution and risk management has set the following insightful example of how JPI works in his article “Dispute Hedging: Dealing with the Risk of Losing” published by the Voldgiftsinstituttet – The Danish Institute of Arbitration, 8/2023. The article can be found here.
“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).”
The relevance of JPI to litigation practice is impressively illustrated in a recent article in THE WALL STREET JOURNAL authored by Kristin Broughton, The Niche Insurance Policy Behind a Software Company’s Big Legal Payout, dated October 17, 2023. The following excerpts from the WSJ article are enlightening for the application benefits of JPI: The article can be found here.
“Appian, a business software company, took out what’s known as judgment preservation insurance, which protects against the downside of a lengthy appellate process. It could be years before Appian, a software company, sees a dollar of the $2 billion judgment it was awarded last year in a corporate espionage case against rival Pegasystems. Still, Appian, which sells business-process automation software, is certain it will get paid at least $500 million, despite a potentially lengthy appeal. That is because McLean, Va.-based Appian last month took out what’s known as judgment preservation insurance, a niche but increasingly popular type of policy aimed at securing awards in big corporate lawsuits. This type of policy – part of an array of insurance products aimed at minimizing risks in financial transactions and litigation – protects against the possibility that an award won at the trial-court level could be wiped out or reduced on appeal. Appian’s policy effectively sets a new floor on the amount of money it could receive from the civil case, which is currently in the Virginia Court of Appeals. The policy applies until a final, unappealable judgment or a settlement is reached, even if the case is retried. Insurers would be required to pay Appian $500 million if the state supreme court rules that Pegasystems should have won. If an appeals court ultimately reduces the final judgment below $500 million, insurers would kick in the difference. Appian received its policy from a syndicate of insurers, it said in a regulatory filing, but declined to provide their names. The company paid $57.3 million to cover the 9.8% premium, taxes and a brokerage fee. As of June 30, it had $171.5 million in cash and equivalents on its balance sheet. The gains from the litigation or insurance will be recorded when Appian receives them.”
The WSJ article further points out that companies often take out judgment preservation insurance with the intention of borrowing against the policies, including from litigation-finance firms, to fund operations or help cover legal fees. Insurers underwrite the policies by examining the case and the most likely outcomes. Litigation insurance is inherently different from other types of policies, which use historical data to predict the likelihood of a bad event. Insurers charge a premium, and only typically pay out if the company they are insuring loses on a final appeal, or if the award is reduced below the value of the policy. If the company wins, then insurers don’t pay out, and the company collects damages as it would have without insurance.
In their article in the INSURANCE JOURNAL the Holland & Knight’s lawyers emphasize: “The larger the damages award at trial, the greater defendant’s motivation to pursue a vigorous appellate challenge to that outcome. On top of an already lengthy trial process, appellate timelines are often measured in years, significantly reducing the practical value of a hard-fought judgment. Another concern is that the uncertainty involved in preserving the value of the judgment may be material to a corporate earnings report or other important communications with investors, commercial partners or the market. All things considered, even after a victory at trial, uncertainty still looms.”
JPI can have several application benefits. Stefan Kirsten mentions that 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. Furthermore, JPI facilitates settlements for claimants because it provides leverage to mitigate any notion that a cash-strapped claimant might settle cheaply.
III. Adverse Judgment Insurance (AJI)
The AJI is intended to protect the policyholder from a judgement brought against themselves and thus protect them against damages of significant magnitude. The risk is transferred to the insurer, which in turn frees up reserves, improves balance sheets and represents a quantifiable insurance value. According to product information by HDI Global Specialty SE, Linn Dolp, Head of Litigation Risks / Legal Expenses, points out: “Based on a worst-case scenario, a customized insurance policy is created that can help the defendant present financial and economic security in the marketplace and thus present a healthy balance sheet to investors, employees, shareholders and other stakeholders. It also mitigates the risk of overcompensation due to the pressure placed on the defendant. The policy deters frivolous and unmeritorious claims.” The product information by HDI Global Specialty SE can be found here.)
Stephen Davidson and Stephen Kyriacou set a convincing example for AJI in their article: “Adverse judgment insurance protects defendants in pending litigation, or parties that may become defendants in future litigation, against the risk of a potentially significant or catastrophic adverse judgment. For example, a company being sued for $100 million in damages can buy $90 million in “limits” (i.e., the amount of insurance coverage the company purchases) attaching above a $10 million “retention” (i.e., the policy’s deductible) and, if the company ultimately finds itself on the losing end of a $100 million judgment, the insurers on the policy will pay out $90 million, leaving the company responsible only for the $10 million retention. And if the plaintiff obtains a final judgment against the company for an amount less than $100 million, the policy will pay out everything over the retention such that a $50 million damage award would result in a $40 million payout under the policy, with the company still being responsible only for the $10 million retention. Accordingly, so long as the company purchases enough limits to cover the worst-case scenario damage award, adverse judgment insurance can offer assurance that the company will not be out of pocket for any amount above the retention on the policy.”
The application benefits of AJI can in particular be shown in three areas: Firstly, the M&A context. Secondly, AJI is a useful settlement tool if the opponent no longer has the leverage of a detrimental adverse judgment. Thirdly AJI provides certainty to help with budgets, forecasts, and expenditures.
The Holland & Knight’s lawyers explain that Litigation risk can be one of the biggest problems in the context of M&A deal diligence. In addition to the substantive risk of loss, in many cases prospective buyers will find litigation risk much harder to evaluate than the ordinary course aspects of the business: “As such, open litigation can be a significant problem for otherwise attractive target companies, especially where target companies are defendants. In some cases, open litigation will make an otherwise attractive target too risky to acquire. Adverse judgment insurance is an option that can help to cabin the risk of pending litigation – and give comfort to a potential buyer – without having to deal with an adverse party or the potential complexity of an indemnification situation.”
With regard to the AJI application benefit for certainty to help with budgets, forecasts, and expenditures Atlantic Global Risk, a U.S. specialist insurance broker focused on designing complex insurance products, gives the following reasons, which can be found here.
AJI establishes a cap on what was previously an unknown contingent liability. AJI accelerates distributions in liquidations (both in and out of court) and fund wind-ups. When AJI is obtained as part of a sale process, it reduces or eliminates escrows and cash holdbacks, meaning a seller can distribute proceeds of a sale immediately on closing. AJI decouples bankruptcy proceedings from related litigation, allowing faster confirmation of restructuring plan.
Regarding the AJI Policy Details David Haigh, Co-Founder of Atlantic Global Risk, explains that AJI involves paying a one-off, upfront premium, which typically falls in the 5 % to 12 % range (though 20 % + is possible for the riskiest insurable cases). The Policy limit is as little a $ 5 million and up to $ 1.5 billion for a sin.gle risk. The article by David Haigh, Putting a Lid on Litigation Liability, can be found here.
The Holland & Knight’s lawyers explain that due diligence and underwriting of these policies are fact-intensive and detailed: “While this process is unavoidably involved, the insured not only benefits from the coverage that may be afforded by the policy, but also the value of an objective review and assessment of litigation risks by a carrier that has aggregated hard data on litigation trends and risks.”
IV. After-the-Event- Insurance (ATE)
According to product information by HDI Global Specialty SE, ATE Insurance, as legal expenses insurance, covers the legal costs and expenses involved in litigation. It can be used in any type of litigation and by either a claimant or a defendant, although in practice ATE Insurance is mainly used by claimants. ATE Insurance policies cover the legal costs which (usually) a claimant must pay to a defendant when a claim is unsuccessful – when the claim is either lost at trial, or abandoned / settled after the defendant has incurred costs which the claimant is liable to pay. Also the claimants’ own disbursements can be covered. Not that common, but also seen, is the insurance of own costs of the claimant. The overall concept of an ATE Insurance policy is that it will protect the claimant against costs risks. ATE insurance is not only bought by individuals (e.g., to enable access to justice), companies also use this form of insurance to manage the level of exposure to legal expenses and disbursements that they wish to retain in the end if they lose a claim. The ATE insurance model can also be chosen for class actions and being bought by law firms to insure the adverse costs risks on behalf of their clients or also their own cost risks.
Thomas Kohlmeier, Co-Founder of Switzerland based Nivalion, a provider of legal finance solutions in Europe, and Tanja Lansky point out that well capitalized clients may not necessarily have any cash issues, yet nonetheless seek ATE insurance to mitigate the risk of their case losing or judgment proving unenforceable. ATE insurance, litigation finance and various forms of law firm retainers are not mutually exclusive and can interplay in different ways depending on the case circumstances and client objectives. Their article on “ATE insurance and litigation funding” in the Online Magazine Dispute Resolution dated October 23, 2019, can be found here.
V. Conclusion and Outlook
The benefits of LRI can best be summarized with the wisdom of an old German saying: “In court and on the high seas, you are in God’s hands”.
“Pre and post judgment insurance solutions are designed to help make uncertain liabilities certain” is the No. 1 key takeaway from a recent Howden Insurance Brokers Podcast Series moderated by Katie Armstrong, Client Development Director at Howden for Litigation Risk Management, with guest speakers Ed Yell, Managing Director of Litica Europe, a UK provider of commercial ATE insurance, and Sarah Vasani, Co-Head of International Arbitration at the law firm CMS in London, which can be found here: LRI expert Stefan Kirsten forecasts that 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.
Last, but not least: LRI provides certainty to help with budgets, forecasts, and expenditures. In this respect the Chief Financial Officer (CFO) is the key decision-maker for the deployment of LRI solutions. The pros and cons of LRI must be weighed up on a case-by-case basis. This is foremost a Business Judgment by Executive Management. In the light of increasing litigation risks the consideration of using LRI becomes almost compelling for C-level. Finally, LRI can mitigate the risks regarding potential “follow-on” D&O-claims.