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If you get an order for indemnity costs, does your cost budget go out of the window?

A recent TCC decision potentially increases the significance of obtaining an order for indemnity costs.

In Kellie v Wheatley & Lloyd Architects Ltd, the successful defendant sought to recover costs of over £166,000 despite having had its cost budget slashed from over £140,000 to £91,700. It sought to get around the effect of the cost management order (CMO) by seeking an order for indemnity costs.

Indemnity basis v standard basis

Before the CPR came into force, the only effect of an order for indemnity costs was to reverse the burden of proof as to whether costs had been reasonably incurred:

  • On the standard basis, any doubt about whether costs had been reasonably incurred or were reasonable in amount was resolved in favour of the paying party.
  • On the indemnity basis, the benefit of the doubt shifted to the receiving party.

The CPR introduced the requirement of proportionality to assessment on the standard basis. Thus:

  • On the standard basis, costs could only be recovered if they were proportionate and reasonably incurred (the paying party having the benefit of the doubt on reasonableness).
  • On the indemnity basis, disproportionate costs could be recovered (with the receiving party having the benefit of the doubt on reasonableness).

This was confirmed by the Court of Appeal in Lownds v Home Office, where Woolf LJ set out a two-pronged approach to assessing proportionality.

Proportionality and cost budgeting

The concept of proportionality has now been carried into cost budgeting. Practice direction 3E (paragraph 7.3) provides that, when reviewing cost budgets, the court will consider whether the budgeted costs fall within the range of reasonable and proportionate costs. Whenever a CMO is made, CPR 3.18 requires the court, when assessing costs on the standard basis, to have regard to the last approved budget and not to depart from it unless satisfied that there is good reason to do so.

In Elvanite Full Circle Ltd v AMEC Earth & Environment (UK) Ltd, Coulson J considered the effect of this. He concluded (obiter) that “as a matter of logical analysis”, the approved budget should also be the starting point for an assessment on the indemnity basis. He gave two reasons:

  • The cost budget was an estimate of all the costs that would be incurred and was therefore the appropriate starting point for both bases of assessment.
  • This approach had the benefit of consistency and certainty. If an order for indemnity costs allowed a party to ignore its cost budget, indemnity costs would be applied for every time.

In Kellie, HHJ Keyser QC disagreed with Coulson J. In his view it was no quirk of drafting that CPR 3.18 referred only to assessment on the standard basis:

  • The first of Coulson J’s reasons was only valid if the budget was approved as submitted. If the budget was approved in a reduced figure (as in Kellie), the point falls away. It was wrong to suppose that the imposition of a cost budget set a limit as to the reasonable costs, given that cost budgeting involves proportionality as well.
  • The second of Coulson J’s reasons went further than was justified by the costs management regime. That regime is not intended to give litigants an expectation that they will not incur a liability for disproportionate costs pursuant to an order for indemnity costs. Coulson J’s concerns could be addressed by careful scrutiny of indemnity cost applications and the proper application of the assessment to the facts of the case.

Where does this leave us?

HHJ Keyser’s views are also obiter, as he declined to order costs on the indemnity basis. Therefore, there are two conflicting first instance decisions on this point and it is surely only a matter of time before the Court of Appeal is called upon to consider the question. In the meantime, I think that HHJ Keyser’s approach is to be preferred. It is the most recent pronouncement on the subject, it retains the distinction that exists in the wording of the CPR and his reasons for disagreeing with Coulson J are persuasive.

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