Unlawful success fee cannot be severed from retainer, Court of Appeal holds

4 October 2023

The Court of Appeal has upheld a ruling that it was not possible to sever part of a retainer that provided for an unlawful success fee so that the hourly charging element could survive.

The court described the appeal as “an attempt to carve out a special regulatory regime for discounted CFAs, with potentially far-reaching consequences”.

Mrs Justice Foster had last year in turn upheld the decision of Costs Judge Rowley that London law firm Volterra Fietta, which had nearly $3m in fees tied up in the conditional fee agreement (CFA), had to return whatever it had been paid.

It acted for Luxembourg company Diag Human in an arbitration under a bilateral investment treaty against the Czech Republic. The original retainer in February 2017, based on hourly rates, was terminated in May 2019 with Diag in substantial arrears.

However, on 7 September 2017 – by which time the law firm had billed $107,000 – Diag and its founder Josef Stava signed a side letter creating a new retainer that incorporated the terms of the original retainer so far as they were consistent with it.

Under this, Volterra agreed to discount the fees it invoiced by 30% in return for a success fee far exceeding the legally permitted 100%. It was common ground that, as a result, the agreement did not comply with the requirements for CFAs and was not enforceable.

Volterra sought to sever the success fee provisions so that it could charge hourly rates at a 30% discount.

In Diag Human SE & Anor v Volterra Fietta (Re Assessment Under Part III Solicitors Act 1974) [2023] EWCA Civ 1107, Lord Justice Stuart-Smith said the courts below were correct to conclude that the third stage of the three-stage test for severance was not satisfied.

This is that “the removal of the unenforceable provision does not so change the character of the contract that it becomes ‘not the sort of contract that the parties entered into at all’”.

By severing the success fee, the agreement was converted from a CFA into an agreement for payment on a conventional, if discounted, hourly basis.

“On any view, this is a major change in the overall effect of the provisions as they existed before applying the ‘blue pencil’; alternatively it may be said that the agreement after the ‘blue-pencilling’ (a standard contract for the payment of fees on an hourly basis) is not the sort of contract that the parties entered into (a CFA) at all.”

The judge said that, if he were wrong on this, he would hold that severance was precluded as contrary to public policy.

“The principal effect of severance would be to permit partial enforcement of the unenforceable CFA. As was pointed out during submissions, if the client lost the arbitration, the effect of allowing severance would be that the solicitors would recover precisely the same amount of their fees as if the CFA had been held to be enforceable. That is not, in my view, a tolerable outcome.

“Nor is it any answer to submit that there is no disadvantage to the client in enforcing the discounted fee element in respect of work carried out for and at the client’s request. The regime imposed by the 1990 [Courts and Legal Services Act] Act is concerned with conflicts of interest giving rise to potential harm to clients.”

Stuart-Smith J went on to reject the alternative argument based on quantum meruit: “It would be contrary to the public policy that forbids partial or total enforcement of the CFA and severance to permit the solicitors to recover on a quantum meruit basis.

“Not only is this clear as a matter of principle based on the scope of the public policy prohibition, it would also be contrary to authority.”

He dismissed as well a submission based on restitution, finding that the costs regime in the Solicitors Act 1974 “leaves no room for the solicitors’ argument in the present case that sums paid on account by reference to an agreement that is held to be unenforceable shall only be repaid if the client justifies repayment on restitutionary principles”.

He explained: “To my mind it must be irrelevant whether an item of costs is disallowed because it is unreasonable or because it is claimed pursuant to an agreement that is unenforceable. In the present case it is common ground that the solicitors’ bill should be assessed at nil.

“In other words, no sums at all should have been paid to the solicitors at any stage pursuant to the September 2017 agreement.”

Concurring, Lady Justice Andrews described the appeal as “an attempt to carve out a special regulatory regime for discounted CFAs, with potentially far-reaching consequences”.

It was for Parliament, not the courts, to make “any further inroads into the established public policy prohibition on champertous agreements”, she went on.

“There would be little incentive to solicitors to adhere to the straightforward requirements of the regulations laid down for the protection of their clients, if the worst that could happen if they failed to do so would be that they would be paid the amount that the client had agreed to pay for their services win or lose.

“It makes no difference to the principle if that amount is based on a discount from the solicitors’ usual hourly rate, or subject to a financial cap. If Parliament had wished to provide for the consequences of entry into a non-compliant CFA to be limited to loss of the success fee or other form of contingent remuneration, it would have done so.

“There has been no indication that Parliament considers a discounted fee arrangement to be any different in character from a ‘no win, no fee’ arrangement or intends that a distinction be drawn between them.”

On the claim in quantum meruit, she added: “The short answer is that it is not open to the solicitors to claim by the back door any payment for their services which they cannot receive through the front.”

In his opening comments, Stuart-Smith LJ stressed that the labels of ‘discounted’ or ‘hybrid’ CFA were not terms of art and did not provide them with any special status. “What is important and common ground is that the agreement between the parties as a whole is a CFA.”

He noted too that, while the sums in play here were considerable, “the issues that arise in this appeal are important irrespective of the sums at stake in the present case.

“They are capable of arising in much less exalted circumstances and could be of major significance to solicitors and clients even where the sums involved are more modest by many orders of magnitude.”

Nicholas Bacon KC and Simon Teasdale (instructed by Saunders Law) for the appellant. Jamie Carpenter KC (instructed by Mishcon de Reya) for the respondents

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04 Oct 2023

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