New Law Journal – 14 June 2019

Security for costs: Rakesh Kapila reports on the forensic accountant’s role

In Brief

  • A defendant can ask the court to order a claimant company to pay funds into court by way of security for the defendant’s costs if there are doubts on the claimant’s ability to fund litigation.
  • Since sworn financial evidence often needs to support applications for security for costs, forensic accountants can play a crucial role in the process.

Litigation may be undertaken on a tactical basis or may be ‘frivolous’ without the claimant having the objective of an ultimate hearing in court. The courses of action open to defendants in these instances include relatively expensive proceedings as a defence to any claim. It is also important for defendants to consider the ability of claimant companies to fund litigation in which they are involved. It may be useful in these circumstances for a defendant to consider asking the court to order a claimant to pay funds into court by way of security for the defendant’s costs, primarily as protection if the claimant is unable to satisfy a costs order following a failure of the case.

Applications for Security for Costs

The principal circumstances for an application to the court for security for costs are set out in the Civil Procedure Rules (CPR 25.13). One of the most routinely invoked conditions is CPR 25.13 (2) (c), highlighting the court’s power to make a security for costs order against a limited company where there is reason to believe that it will be unable to pay the defendant’s costs if ordered to do so.

The courts have held that security for costs may also be granted if a counterclaiming defendant is unable to pay the costs of the claimant. Factors determining whether the claimant’s application is likely to be successful include the relative size of the claim and counterclaim and the extent of the expert evidence supporting the counterclaim.

The granting of an application for security for costs is discretionary and the judge will consider the justness of the circumstances in each case. Since such applications are regarded as serious matters and courts need to be persuaded that they are essential, sworn financial evidence is often needed. It is in this context that forensic accountants may be particularly useful by providing sworn statements as financial evidence based on a review of the financial statements of and other financial information on the claimant. This article highlights the objectives in deploying forensic accounting skills and the role of the expert accountant in underpinning an application for security for costs.

Objectives in Deploying Forensic Accounting Skills

The principal objective is to convince the court that an action cannot proceed because a review of pertinent financial information on a claimant’s circumstances shows that there is reason to believe that the claimant will be unable to comply with an order to pay the estimated legal costs of the defendant.

The expert may be unable to form a view without obtaining comprehensive financial information. It may be particularly useful to instruct a forensic accountant if the data at hand is outdated and does not necessarily depict the litigant’s present ability to fund litigation.

If the financial information indicates that the claimant may be unable to pay legal costs, the forensic accountant will be asked to support such conclusions by swearing an affidavit. The swearing of an affidavit by a qualified accountant will focus the court’s attention on two key features: independence and expertise. These aspects of an expert accountant’s involvement are likely to assist in persuading the court that an award of security for costs is essential.

If the expert is unable to form a conclusive view as to whether a litigant is able to fund legal costs, it may be appropriate to provide a report analysing the claimant’s position. Such a report is likely to be useful to instructing lawyers if they have not necessarily decided whether to make an application for security for costs and it may assist in negotiating with the other side.

Skills in Use

Obtaining current, reliable and relevant financial information is the major issue in forming a professional opinion as to the claimant’s financial standing. The role of the forensic accountant will depend on the circumstances of the claimant. Although analysis of recent financial statements may be sufficient, it may also be appropriate to request additional financial information as noted below.

Analysis of Past Information

The accountant will address the following aspects in appraising past financial information:

  • the accounting policies and notes included in financial statements either filed at Companies House or made available by the claimant, one of the objectives being to identify changes in accounting policies and ‘incorrect’ policies;
  • past trends in the volume of trading and profitability as an indicator of the company’s future activities;
  • the impact on the company’s present viability of changed circumstances in the industry or in the economy, e.g. increases in interest rates considered to be detrimental to businesses with large borrowings;
  • the company’s cash flows relative to its profitability given that the former are a crucial factor in the ‘funding’ of litigation;
  • the financial position of a company as distinct from that of a group of which it is a member given that past financial information may be incorporated in consolidated data and not identifiable separately; and
  • the formulation of views on the technical insolvency or otherwise of a company, including the availability of details of the lines of finance and credit open to the claimant.

The above aspects represent some of the key features addressed by an expert in analysing past financial information. The nature of the analysis may be dependent on the type of past information available. Information in the public domain will include credit status reports and statutory information filed at Companies House. It may also be possible to obtain information from the other side, including unaudited management accounts and forecasts.

Analysis of Future Information

Financial information concerned with the future of a company which is relevant to the question of security for costs is likely to be available only from the other side. The analysis undertaken by the expert accountant in this regard will need to take into consideration the following aspects of the company’s business:

  • appraising its forecast profitability and cash flows relative to past data and with a view towards evaluating its ability to fund legal costs at some future date;
  • evaluating contingent liabilities and the prospects of such liabilities crystallising in the future; and
  • assessing changes in the company’s liabilities with particular reference to liabilities classified as ‘longer-term’ at present or in the past but which may be regarded as current liabilities in the future, therefore detrimentally affecting the company’s ability to pay its debtors as they fall due.

Requests for Additional Information

In many instances, the forensic accountant will only have access to historical data and usually only publicly available information. In such situations, the expertise required will include requesting additional information such as the following:

  • the financial statements for the most recent financial year, whether audited or unaudited, if audited financial statements have not been filed at Companies House;
  • the company’s management accounts for the period since the last financial year-end;
  • information on contingent liabilities and the status of any legal proceedings in which the company is involved given the need to take into account contingent and prospective liabilities in assessing the claimant’s ability to pay its debts as they fall due; and
  • the company’s profit and cash flow forecasts for a period of at least one year from the date at which the assessment is being carried out.

The expert accountant may be able to state that final judgement is reserved pending the receipt of additional information but that there is reason to believe that the claimant will be unable to fund the defendant’s costs based on the available information.

Complexities

In analysing financial information relating to a company, the forensic accountant will need to be discerning about specific factors which could make the information misleading or incomplete. Particular factors to take into consideration will include the following:

  • the status of the financial statements, i.e. management accounts or financial statements, and whether these are unaudited;
  • the compliance or otherwise of the financial statements with generally accepted accounting practice;
  • whether the data presented within a set of financial statements clearly represents the updated status of the company;
  • whether financial statements provide ‘complete’ information on a company, since this may not be the case for companies with foreign parent companies which are members of groups, or those taking advantage of exemptions, especially with regard to published information available on smaller companies;
  • examining financial information on the future critically and with a view towards judging its ‘consistency’ with data in the past; and
  • the company’s relationship with other entities, imposing upon it certain set-off arrangements or contingencies (or providing it with guarantees) in relation to which there is limited information.

Even if a company appears to have insufficient net assets to fund prospective litigation costs, an application for security for costs will not succeed if the claimant can successfully argue that its impecuniosity arises as a result of the defendant’s action.

Conclusion

An application for security for costs is unlikely to be successful unless it is both reasonable and realistic. It is therefore important to instruct a forensic accountant at the right stage so as to provide sufficient time for the analysis of information on a comprehensive basis. Objectivity and impartiality will clearly be important attributes for the forensic accountant given the requirement to provide evidence in a sworn statement and given the primary objective that the expert is there to assist the court.

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This article was first published by New Law Journal on 14/06/19, and is reproduced by kind permission.

The information contained in our Articles is provided as general information only. It does not constitute professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. In addition, since the Articles were published in recent years, the information contained in them may not be applicable at the current time.