For companies, process and cost risks are often associated with uncertain liabilities, which can lead to difficulties in budget or liquidity planning, among other things. A litigation risk insurance policy can now offer protection.
Litigation Risk Insurance (LRI)
Litigation risk insurance (LRI) has become increasingly widespread in the USA and in the Lloyd’s of London insurance market in recent years. Around 20 insurance companies worldwide underwrite litigation risks. Recently, the policies have also been offered in Germany. The customized policies insure specifically defined litigation risks. In contrast to conventional legal expenses insurance, these must be known risks, i.e. pending court or arbitration proceedings. The cover concepts of litigation risk insurance are based on the uncertainties that exist for the litigant regarding the outcome of the case. With an LRI policy, an unfavorable litigation outcome has no financial consequences for the insured company, or only to a certain defined extent. The policies are structured differently for plaintiffs and defendants due to the respective risk situation. The cost risk of the unsuccessful litigant is also insurable.
Judgement Preservation Insurance (JPI)
For plaintiffs, LRI policies in the form of so-called Judgement Preservation Insurance (JPI) are widespread. A JPI policy covers the risk of a first-instance judgment being overturned on appeal or the first-instance judgment amount being reduced by the court of appeal. An example case illustrates the benefits promised by a JPI policy: a plaintiff who has won a first-instance judgment in the amount of €100 million can insure the judgment sum against the risk that the judgment will be overturned on appeal – sometimes after many years – or that the judgment sum will be reduced by the court of appeal. JPI policies always provide for a deductible. If the deductible in the example case is €10 million, then any reduction in the amount of the first-instance judgment by the court of appeal is covered by the JPI policy. In the worst-case scenario, the plaintiff would receive € 90 million. One application benefit of JPI policies is the monetization options. Companies often take out the policies in order to use them as collateral for loans – for example with litigation financiers – and to obtain liquidity.
Adverse Judgement Insurance (AJI)
With Adverse Judgement Insurance (AJI), defendants can protect themselves against the risk of an adverse judgment. The litigation risk is transferred to the insurer. The tailor-made insurance policy is based on the worst-case scenario of a judgment upholding the claim in full. Upon conclusion of the policy, the balance sheet of the insured company is not burdened with provisions, provided that the defendant covers itself with a sufficiently high sum insured. An example illustrates how an AJI policy works: a company is sued for €100 million in damages. After the lawsuit is pending, the defendant company covers itself with an insurance sum of € 100 million. In the example case, the insurer demands a deductible of €10 million. In the event of a judgment upholding the claim in full, the insurer will pay € 90 million and the policyholder will only bear the deductible of € 10 million. If the plaintiff only wins a judgment in the amount of € 50 million, the AJI insurer pays out € 40 million to the defendant / policyholder. AJI policies are particularly useful in the M&A context. As a rule, litigation risks represent a major challenge in the context of due diligence carried out by the buyer. Ongoing legal disputes can prove to be a deal-breaker for otherwise attractive target companies. AJI policies are an option to reduce litigation risks and give a buyer peace of mind.
“After-the-event insurance (ATE)
As legal expenses insurance, ATE insurance covers the costs associated with a legal dispute. ATE insurance policies cover the legal costs that the unsuccessful party has to pay to the other party following the court’s decision on costs. In practice, the policies are mainly used by plaintiffs. The plaintiff’s own costs are also insurable. ATE policies are also generally eligible for all types of legal disputes.
Conclusion
The advantages of litigation risk insurance can best be summarized with an old saying: “In court and on the high seas, you are in God’s hands”. The insurance solutions provide security for uncertain liabilities with regard to budgets, forecasts and liquidity planning. Looking ahead, it can be assumed that more and more companies will use the policies as a means of risk management (“dispute hedging”) in the future.
Recommendation for action
The pros and cons of LRI policies must be carefully weighed up in each individual case. A lawyer experienced in the legal structuring of LRI policies can avoid pitfalls and design an optimum cover concept for the individual case. An independent insurance broker should also be consulted to place the best possible insurance cover.
References
Dr. Burkhard Fassbach together with Dr. Frank Hülsberg, Die Versicherbarkeit von Prozessrisiken, NZI – Neue Zeitschrift für Insolvenz- und Sanierungsrecht, Heft 3, 2024, p. 65 ff., available (for a fee) at https://beck-online.de/
Dr. Burkhard Fassbach together with Dr. Frank Hülsberg, D&O Diary from November 17, 2023: Eye on Litigation Risk Insurance, available here: https://www.dandodiary.com/2023/11/articles/insurance-coverage/guest-post-eye-on-litigation-risk-insurance/
