Legal cost insurance is a welcome option for smaller firms that have to submit to the threat of conglomerate litigation fees, whether they win or lose.
The impression I get is that the industry is weary of change, and particularly sick of panaceas such as new reports, legislation, forms of contract and procurement methods, that promise so much but deliver so little. What the industry needs is real solutions to practical problems, not more airy-fairy concepts that are hard to grasp and harder to translate into practice.

One of the biggest problem areas is still disputes. Statutory adjudication, the new arbitration procedures and the impending Woolf reforms of civil court procedures will assist in the long term. But one of the most promising developments in securing access to justice is the advent of legal cost insurance.

Before explaining how this relatively novel form of insurance works, imagine for a moment that you are a small subcontractor, locked into a dispute with your main contractor. You believe you are owed a substantial amount for work done. The main contractor, wrongfully in your view, is withholding payment, blaming you for the substantial delay and project cost overrun.

Your contract or legal adviser tells you to issue a writ to recover the money. If you are lucky, he will also tell you how much it will cost to pursue the claim – and explain about the "litigation risk". This means that, even if you win, you will not recover all the legal and expert costs that you have incurred. If you lose, you will end up bearing all your own costs, as well as paying most of those incurred by the main contractor. He might also warn you of the likelihood that if the main contractor is impressed by your claim, it will pay money into court to transfer the litigation risk on to your shoulders.

Faced with that advice, you might decide to close the file, vowing never to do business with that main contractor again. Not an unreasonable decision either, since not only are those "litigation risks" real, but the main contractor knows about them, too – and about the pressure they will put you under.

Legal cost insurance could change all that. In simple terms, its purpose is to cover a party against the financial consequences of losing a claim in litigation or arbitration. You pay the premium, calculated to reflect the size of the claim and its merits, to transfer the risk of that worst-case scenario to the underwriters, which are in the business of bearing commercial risks of that sort. This insurance is fairly new in construction, but has been around for years to help plaintiffs claiming compensation for personal injuries.

  • The “litigation risk” means, even if you win, you will not recover all the legal and expert costs incurred
  • Legal cost insurance lets you transfer the risk of losing a claim to the underwriters

Abbey Legal Protection, which manages this form of insurance on behalf of the Law Society Panel, has arranged 40 000 such policies and continues to do so at a rate of more than 1500 a month. Along with a number of other organisations, it is now venturing into the construction sector.

So, what can this cover do for you? First, for the price of the premium, it will safeguard you against that worst-case scenario. But, potentially, it can do a lot more. Suppose, during negotiations in our subcontract dispute situation, you could have produced a certificate showing you had purchased legal cost insurance. It may have persuaded the main contractor you had the means to take the dispute all the way, and you might have settled it without having to issue the writ. I predict that, in future, many disputes that would once have been dropped or gone to litigation or arbitration will be settled, largely as a result of this type of insurance.

There are two basic types of cover. You can purchase insurance for a period, say, a year, to cover any disputes that arise in that period. Or you can purchase more costly cover for a dispute that already exists. Not surprisingly, this product has come to be known in the insurance world, rather appropriately, as the "morning-after pill".

In the right circumstances, I have no doubt that legal cost insurance can prove a good investment. But, be warned, it costs money. Approximately 20% of the premium is usually payable up front and cannot be recovered, however the case progresses. It probably will not be available for bad claims: the underwriter will generally have the claim assessed by technical and legal experts before it commits to providing cover. Importantly, the Access for Justice Bill contains a provision that would permit recovery of the premium for a losing party in litigation.

As with all insurance, you should check the fine print. Points to look out for are the extent of control over the conduct of the case that the underwriter seeks. In particular, can it force you to accept a settlement offer despite the fact that you and your advisers think it can be improved on? Does the policy cover your own costs as well as those of the other party? Watch out for limitations on the extent of cover and, importantly, check that the underwriter is fairly close to home.