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Funding Problems on the Horizon for family lawyers (and their clients)

Stuart Clark, Associate Solicitor with The International Family Law Group LLP considers the implications of increased use of s.37 MCA 1973 in setting aside payments on account of costs in financial remedies cases

















Stuart Clark associate solicitor, The International Family Law Group LLP 

The funding of family law proceedings is under real threat from several directions simultaneously.  The family law solicitor now faces all manner of problems to ensure their costs are paid. It is admittedly, an issue about which few outside the profession will shed a tear, nor will it cause anguish in the popular press or social media. Nonetheless, family lawyers face even more challenges in their practice simply to ensure that their costs are paid and that the lights can stay on!  There seems to be regular criticism from some of the High Court bench with ever more procedural demands.  Regulatory compliance is already a major expense to law firms. Added to this legal aid has almost disappeared and the spectre of the introduction of fixed fees and cost-capping looms ever larger.  These are prospects which will cause genuine anxiety for law firms.  .

Potentially, the recent decision in ABC v PM [2015] EWFC 32 has added another layer of difficulties for family lawyers.  In the appeal in ABC Moor J upheld under section 37 Matrimonial Causes Act 1973  the set aside of a charge taken by a law firm secured against a marital property as security for their (client's) costs. The possibility of such a set-aside of security for legal fees (particularly well after the event) and even fees paid in cash is alarming. It is a danger to the profession and a risk for many law firms in securing payment of their costs but importantly, it may also present difficulties for litigants too because law firms will be even less willing to continue acting without prior receipt of funds.

The Background to the Decision in ABC v PM
ABC v PM was a financial application by an applicant wife against her former husband.  It came for final hearing before District Judge Robinson at the PRFD on 29 April 2013. On that date the former matrimonial home in England was worth about £825,000, mortgage-free and the title was completely unencumbered save for the usual Land Registry encumbrances in favour of the wife to protect her position.  The wife sought a transfer of the property outright to her.  She had made serious non-disclosure allegations against the husband and also alleged the existence of offshore assets.  The property was the only onshore asset.

On the second day of the final hearing, after the wife had presented her opening case seeking the whole property and asserting non-disclosure  the husband executed a charge over the property in favour of his solicitors in respect of his unpaid costs of £40,000 (a modest proportion  of the value of the property). Of course, the husband's solicitors knew the full background including the wife's case. The wife was not told of the charge in advance of the intention to create such a charge but was told after execution on the same day. On 23 May 2013 (after the hearing and before judgment) the wife made an application to set-aside the transaction (the solicitor's charge) pursuant to section 37. On 28 October 2013 District Judge Robinson gave his judgment in the substantive financial application. He found that the husband had significant resources in addition to those disclosed by him and ordered the transfer of the former matrimonial home to the wife absolutely. He also ordered the transfer of further properties abroad and made a costs order against the husband.  The section 37 application was separately listed.

Section 37 Matrimonial Causes Act 1973
Section 37 enables the Court to set-aside a transaction by a party to financial proceedings where that transaction has the effect of "reducing the amount of any financial relief…[or] frustrating or impeding the enforcement of orders" and where the transaction was made with that intention. Transactions made within the three years prior to a section 37 application are presumed to have been intended to defeat the claims of the other party.

Third parties are protected from the effect if they entered into the transaction "for valuable consideration…in good faith and without notice of any intention on the part of the other party to defeat the applicant's claim for financial relief" (section 37(4)). The burden of proof is on the third party to prove each of these criteria..

The section 37 application
District Judge Robinson heard the wife's section 37 application on 28 March 2014. He reserved judgment until after judgment had been given in J v J-M [2014] EWHC 3769 (Fam) (as to which see below) and handed down judgment on 17 June 2014. He set-aside the charge in favour of the solicitors and made a costs order against the husband's solicitors in the sum of £8,000. In light of the fact that the transaction (i.e. the charge) was made within three years prior to the wife's section 37 application, the statutory presumption was that it had been made with the intention of reducing or frustrating her claims. The husband's team had failed to rebut that presumption.

The District Judge considered the protection to be afforded to the other party to the transaction, i.e. the solicitors. There had been valuable consideration (legal services) and good faith on the part of the solicitors which was not impugned. The key issue was whether the solicitors had notice of the husband's intention to reduce or frustrate the wife's claims. Actual notice was not present, but is not required per Kemmis v Kemmis [1988] 2 FLR 223. Constructive notice suffices to overcome the protection afforded to third parties by section 37(4).  District Judge Robinson found that the solicitors did not have actual notice of the husband's intentions but that they had constructive notice, stating:

"In this case, I remain satisfied from the evidence which is before me that the solicitors knew something which should have put them on further enquiry, which would have revealed had they thought about it that the payment of their fees from the equity in [the] property was in part to defeat the wife's claims. By continuing they did so at their own risk."

The husband's solicitors appealed on the basis that the District Judge was wrong to find that they had constructive notice of the husband's intentions. Constructive notice (per Hunt v Luck [1901] 1 Ch 45) is the knowledge that the Court will impute on a person upon a non-rebuttable presumption that they had such knowledge ascertained by the fact that they knew something which ought to have put them on further enquiry or from them wilfully abstaining from enquiry to avoid actual notice.

Moor J, hearing the appeal, upheld the finding of the District Judge. He stated that the husband's solicitors did know "something that ought to have stimulated enquiry" owing to their knowledge of the case, viz. the nature of the wife's application, her restrictions on the property, her allegations of non-disclosure, the possible defects in the husband's disclosure, the fact they had previously been paid from funds outside the jurisdiction, and the fact that the charge would encumber the only on-shore asset.

The enquiry which should have been stimulated was giving notice of the prospective charge to the wife, whereupon she would have been given the opportunity to respond and to make her case that the husband's intention was to reduce or frustrate her claims, in effect then giving the solicitors 'actual notice.'  Of course, as below, the notice had been given far too late in this particular case. 

The appeal was dismissed and the solicitors' charge was accordingly set-aside.

Impact of the decision: constructive notice
Where a client in family law financial proceedings executes a charge over an asset in favour of a law firm for their fees, it seems there is a possibility that the charge will be set-aside if:

1. by giving the charge the client is found to have been intending to defeat their former spouse's claims. If the security is given within three years prior to a section 37 application (which it invariably is in the course of the litigation), such an intention is presumed; and

2. the solicitors as third parties are found to have had actual or (more often) constructive notice of those intentions. Constructive notice can be imputed, for example, where the intended security is the subject of the other spouse's claims and including where they have placed a restriction on the security. 

In combination these are worrying features for many law firms in far less exceptional cases than those that pertained in the ABC v PM case. 

A conceivable narrow basis for the appeal decision is that the husband's solicitors were (only) fixed with constructive notice of the husband's intentions when they failed to give the wife prior notice of the intended charge. This aspect is vital for debate. Moor J distinguished the case of J v J-M (above) where, in similar circumstances, the husband executed a charge in favour of his solicitors over a £470,000 Bentley and, because there was no restriction on the Bentley, it was therefore not incumbent on the husband's solicitors in that case to give notice to the wife of the intended  charge. The High Court Judge found the solicitor did not have constructive notice of the husband's (her client's) intentions.

Moor J also distinguished ABC v PM on the basis that in J v J-M  there was no claim by the wife against the Bentley at the time of the solicitors' charge.  The implication is that if there had been a substantive claim for the Bentley at the time (but not an actual "restriction"), the decision in J v J-M may have been different, i.e. the solicitors may or would have had constructive notice..

Further, the wider discussion within the judgment implies that other factors may give rise to solicitors having constructive notice of their client's intention to defeat their former spouse's claims. Moor J listed at paragraph 41 the following facts which the firm "knew" and which ought to have stimulated enquiry :

1. There were serious allegations of non-disclosure against the husband;

2. The firm had previous been paid by funds from another country;

3. The only asset in the jurisdiction was the asset which was subject to the charge;

4. The wife sought an outright transfer of that property;

5. The final hearing had already commenced;

6. The wife had registered a restriction against the property.

A wider basis for having constructive notice: a worrying development?
Did Moor J go beyond simply stating that the failure to provide notice of the prospective charge to the wife imputed the constructive notice? Certainly, he included aspects of the merits of the wife's claim within his rationale of why the husband's solicitors had such constructive notice.  He found that the husband's solicitors could, or should have anticipated that the wife would have been successful in her application to take the onshore property absolutely, i.e. that the husband did have other assets. 

What if, for whatever reason, the wife had not placed the usual Land Registry restrictions on the property? In those circumstances would the Court have found that the solicitors had the same constructive notice? Arguably given their knowledge of the wife's claim for the property and the surrounding circumstances, the answer is yes.

This is particularly so as the Court of Appeal in Kemmis (above) did not regard the issue of whether the wife in that case had or had not registered her interest in the property as relevant to the outcome in that case. If the registration issue can therefore be stripped away from the ratio in ABC v PM, the precedent is seemingly that where a solicitor accepts a charge as security over a property which is the subject of a specific claim (and where there are. or may be. serious doubts about the client's disclosure or similar factors), the solicitor may have constructive notice of their client's intentions to defeat their former spouse's claims over the property thereby meaning that the solicitor loses the third party protection which would have otherwise have been granted pursuant to section 37(4).  Arguably the more suspect a client's disclosure the greater chance that a Court will find that the solicitor had constructive notice and therefore their security for costs is at risk. In effect a solicitor (and barrister in conference) may have to almost adjudicate on their own client's disclosure and other aspects before taking the risk of a charge against a property for their costs and so they can be paid. The potential for conflicts of interest and friction with the client are obvious.

How far does the power extend?
Taking the above one step further: what if on otherwise the same facts as in ABC v PM a husband's only on-shore asset was £800,000 (the approximate value of the house) held in, say, shares or an investment vehicle or even just a bank account in his name. If, as in ABC v PM, a wife claimed that investment absolutely and alleged non-disclosure of assets abroad and the husband's solicitors were either paid their costs upfront from the on-shore investments or took a charge or similar protection over those investments for that sum, there would be no technical need for the solicitor to give notice as there was no restriction on dealing with those assets. But in this fictional example the solicitors still arguably ought to have known (or wilfully disregarded) the possibility that by accepting the cash or a charge for their costs they were reducing the on-shore assets which the wife could access in satisfaction of her claim. They would know she was claiming those assets in satisfaction of her claim and that she could be successful.

Could the charge or, worse still for practitioners, the cash payment, be set-aside? On some interpretations, yes!  This is very troubling.

Moor J stated, obiter, that his decision did not open the door to section 37 set-aside on cash payments. He made it clear that it would be incumbent on the applicant in such a situation to seek a freezing order to prevent this occurring. However, it remains to be seen whether that course would be followed, thereby putting a law firm at risk in the future.  What is the difference between solicitors who take their costs from onshore unfrozen funds and solicitors who take a charge on an asset with an existing restriction as in ABC v PM? Arguably, the distinguishing element of the restriction (which was disregarded as being a factor by the Court of Appeal in Kemmis) should not alter the constructive notice and therefore the lack of section 37 protection. The only difference is the practical effect of the restriction/freezing action.  If so, this will propel more safety-first freezing applications yet in a recent judicial culture of discouraging such satellite proceedings.

We may now see a growth in section 37 applications to set-aside cash payments of solicitors' fees in constructive notice type situations, perhaps even after a judgment has been handed down. This is a truly frightening prospect!

Solicitors must therefore be very wary of the potential for the payments made or security held for their fees being set-aside. Solicitor act on the instructions of their clients. The solicitor is a mouthpiece, a representative and an advocate. It is submitted that this decision seems to make solicitors have a financial stake in the veracity of their client's disclosure and their own assessment of how likely it is that the case will succeed. This is a very unpalatable and unprofessional position.  We are not filters for the court.  In any other than the most extreme cases whether we are paid should not depend on solicitors second guessing the judicial outcome.  Of course as family law specialists, solicitors or barristers, we have a duty to advise our clients on what may well be the outcome and we do so.  But how far does the constructive notice extend?  How cautious or optimistic should lawyers be? 
Many will be unwilling to take this risk and, where there is doubt, alternative payment arrangements may be needed failing which solicitors will have to stop acting.

In J v J-M the husband's solicitor was cross-examined as to her perception of her client, his position and his disclosure. A distinguishing feature of the two cases (further to those features mentioned above) is that in J v J-M the charge was executed much earlier in the proceedings (pre-FDR) rather than on the second day of the final hearing. The Husband's intentions in J v J-M were therefore more "embryonic" (per Moor J) and, by extension, the solicitor was less likely to perceive those intentions. The fact that the solicitor was cross-examined in such a way and the distinction of the timing clearly places the solicitors' perception of their client as an issue within the constructive notice. Does this not run contrary to our professional duties to our clients?  

The Alternative, Cautious Approach: Sinking One's Own Client's Case
Following on from comments in this judgment by Moor J the alternative for the solicitor or the cautious position to take when in any doubt is to give advance notice to the other side when taking costs from particular marital assets; to report how the solicitor is being paid even where there is no obligation to do so such as Land Registry restrictions. If a solicitor has any personal doubts about their client's disclosure (as can occur) and there is a possibility of a section 37 set-aside, such as in the above fictional example, giving notice may be the best or wisest protection. If the other side do not object the solicitor is seemingly protected as the giving of notice helps to obviate the argument that the solicitors had constructive notice.  But the other party will often object, especially in heavily contested litigation.  There is no better joy (as perceived) for a party than to stop the other party having their choice of lawyer and/or knock-out the existing law firm, and force the other party to instruct another law firm who may be more willing to take risks but may not be so good. The law firm which has received the refusal has to either take the unacceptable professional risk, be dis-instructed or has to tell their client to apply to the Court to regulate the situation with more costs.

In any event and professionally worryingly, by disclosing the proposed costs payment arrangements in advance the solicitor may be tacitly telling their opposite number that they have doubts about their client's disclosure. The message received by the other side on the solicitor giving the notice of the arrangements is that the solicitor is potentially protecting himself or herself from a future section 37 application. This presents a clear conflict of interests between protecting the financial interests of the firm and making a disclosure by their notice which is potentially damaging to the client.

On this basis, the outcome of ABC v PM could create real difficulties for practitioners seeking to secure payment for their fees without the risk of either that payment or security being retrospectively set-aside or the problems of the interests of the firm conflicting with those of the client. The conflict may leave the client without representation if no firm is willing to take the risk of accepting payment. The only safe approach is a court application and inevitably, incurring yet more costs.

What of the litigant?
Even on the narrow interpretation of the outcome of ABC v PM there is a potential for unfairness for the litigant by introducing the risk of a section 37 set-aside. It will surely create greater caution amongst practitioners in future when faced with a similar position of a litigant who is suspected of or alleged to be hiding assets or (even) who just holds assets abroad. They may be denied proper representation as fewer firms will offer them the terms by which they can pay or charge the fees against a property.

The effect may not be limited to "non-disclosure" allegation cases. What of the situation where there are assets abroad which are of broadly equivalent value to those onshore? For example a £3 million property in England and £3 million in offshore property assets, albeit protected from disposal by local cautions at a land registry or similar. No substantial liquid assets to pay costs. The English solicitor would, quite rightly, regard taking a charge for costs against a foreign property as a risk, so not available for security. The litigant is left with the English property. Any solicitor would now (post ABC v PM) regard a charge for costs against the English property as a risk as the property might potentially be transferred to the other party in the final outcome and, with the risk of a section 37 set-aside, the charge would be valueless. The solicitor would have to double-guess the outcome of the case.  Those that are risk averse (or have senior partners who are cautious) are unlikely to take the security so the law firm stops acting. How is the litigant to fund their costs? Unless a creative avenue for raising capital can be explored, the litigant is left without representation. How will litigation loan providers respond, even with high rates of interest and insurances?

Conclusion
The outcome of ABC v PM raises some crucial issues for the family law practitioner.

Whilst some of the broad fears expressed above may be stretching the rationale they are very conceivable extensions of the outcome and will undoubtedly be argued by contentious litigants and their lawyers. Comfort can be drawn by Moor J's obiter indications that he was not opening the door entirely for section 37 applications for cash payment

Comfort is also to be found in the distinctive nature of the facts. This was an extreme case: only one asset onshore which was sought by the wife, apparently credible non-disclosure allegations, the security taken once the trial had actually started without notice to the wife, and much more. Unfortunately too often in our family law, extreme cases produce extreme outcomes and precedent case law which cause havoc for everyone else.  ABC v PM is in this category.  The outcome could or should not have been a surprise to the solicitors and they took the security at their own risk. This is where the sympathy in the case itself runs dry. In those circumstances a firm is of course taking a huge risk and one might say that the firm must have been aware that the charge could come to nought when they took it. This is their constructive knowledge! And this is why the case is extreme.

One lesson from the case is always to get fees sorted out with a client well in advance including of delivery of the brief fee and the final preparation for the trial. Invariably this means giving an estimate of costs immediately after the FDR and up to the conclusion of the final hearing with a timetable for payment on account and any security given.  Once the case is a few weeks beyond the FDR, and after all the hard work put into settling at an FDR, the practical realism is that there should be preparation for final hearing including making sure the costs are paid or secured reliably to the law firm well in advance of the final hearing and in advance of the time when the really big figure costs are incurred i.e. brief and final preparation.

ABC v PM should still act as a cautionary tale. There may be real risks associated with security for costs and family lawyers need to be alert to the sources of cash payments and the ultimate impact on the assets of accepting payment from certain resources. We need to be aware of conflicts of interests between law firms and clients. 

Sort out costs arrangements well in advance. It certainly makes life more difficult for matrimonial practitioners and we should all now, in appropriate cases be on high alert to the risk that fees received or security for fees may be removed following a subsequent successful section 37 application.

Thank you to David Hodson OBE (david.hodson@iflg.uk.com) for his input to this article. For the avoidance of doubt, neither of the authors were involved in ABC v PM.

12 August 2015