22 December 2020

More coal in the stocking for litigation funders: Parliamentary committee releases report on litigation funding and regulation of the class action industry

This article was written by Alex Morris, Moira Saville and Cathy Graville

The report of the Parliamentary Joint Committee on Corporations and Financial Services (“the committee”) into Litigation funding and the regulation of the class action industry was released yesterday, making 31 recommendations to reform the class action system.  The inquiry was referred in part due to concerns over the significant growth in shareholder class actions and “excessive profits” obtained by litigation funders. In making its recommendations, the committee noted that there was virtually unanimous agreement that the current regulatory arrangements are too ‘light touch’ and greater oversight of the industry is required.  The committee’s approach to reform was guided by the principle of reasonable, proportionate and fair access to justice in the best interests of class members.

The recommendations are summarised below and include making permanent the temporary continuous disclosure regime introduced as a result of COVID-19 and introducing a 90 day ‘standstill’ once a class action is filed so any competing class actions can be considered and filed.

Reasonable, proportionate and fair class action procedure (Recommendations 1 to 9)

Commencing a class action

The committee recommended the Australian government investigate legislative change which promotes ‘procedural proportionality’ in class actions, that is, the time and expense of class actions should be proportionate to what is at stake (Recommendation 1). 

In doing so, the committee acknowledged there is value in ensuring proportionality is a factor to be considered at the outset of a class action, and processes to identify at an early stage the quantum of claims and an estimate of legal costs to be expended would assist the assessment of proportionality.  

Resolution of competing and multiple class actions

The committee noted competing and multiple class actions add unnecessary cost, delay and complexity for plaintiffs and defendants, however, there is uncertainty associated with the current Federal Court of Australia (“Federal Court”) case management practices.  The committee also expressed the view that measures should be introduced to limit a ‘rush to the Court’ attitude.   

Significantly, the committee recommended the Federal Court’s Class Action Practice Notice (“Practice Note”) be amended to include a requirement that the Federal Court:

  • holds a selection hearing to determine which of the competing or multiple class actions should proceed; and
  • orders a ‘standstill’ for 90 days on the filing of a class action, so that any other competing or multiple class actions can be considered and filed, and that any book building that occurs during that period should be given no weight by the Federal Court (Recommendation 3).

In addition, the committee recommended the Federal Court of Australia Act 1976 (“the Act”) be amended to introduce an express power to resolve competing and multiple class actions (Recommendation 2) and that the government seek to ensure that state and territory Supreme Courts with class action procedures adopt a protocol with the Federal Court of Australia similar to those adopted in respect of the Supreme Courts of NSW and Victoria (Recommendation 4).

Class closure orders

The class action regime is ‘open’ meaning that it is commenced on behalf of all group members irrespective of whether they have been identified or consented to joining the class action, which can create difficulties in the settlement context if the number of class members and quantum of the claim are unknown.  The power to order ‘class closure’ prior to settlement (i.e. requiring group members to opt out or register their participation in the class action by a certain date) is not certain, and orders for class closure are often challenged.  

In light of this, the committee recommended:

  • the Act be amended to introduce an express power to order class closure (Recommendation 5);
  • if an order to close the class is made, it should be final unless the Federal Court thinks it is in the interests of justice to re-open the class (Recommendation 6).

Common fund orders
The committee recommended legislation to address uncertainty in relation to the Court’s powers to order common fund orders following the High Court’s decision in Brewster (Recommendation 7).  

Protecting class members from adverse costs

The committee considered that as a matter of principle, litigation funders should indemnify a representative plaintiff from adverse costs in every class action and that the practice should be mandatory. The committee also considered that funders should provide security for costs on the basis it is a necessary protection for a defendant to a class action.

The committee consequently recommended that:

    • Part IVA of the Act be amended:
      • so that litigation funding agreements regarding class actions expressly provide a complete indemnity in favour of the representative plaintiff against an adverse costs order (Recommendation 8); and
      • to include a statutory presumption that a litigation funder in a class action provide security for costs (Recommendation 10);
    • the Federal Court not approve a litigation funding agreement unless the agreement provides a complete indemnity for adverse costs (Recommendation 9).

Court regulation of litigation funding fees (Recommendations 11 - 17)

Approval of litigation funding agreements required

The committee recognised that the current implementation of the Federal Court’s supervisory and protective role in class actions is weak and appears to favour the provision of profit to litigation funders, and that uncertainty surrounding the Federal Court’s power to alter terms of the litigation funding arrangements undermined its ability to regulate litigation funding fees.  As such, the committee recommended the Act be amended to require Federal Court approval of litigation funding agreements in order to be enforceable, and empower the Federal Court to reject, vary or amend terms of litigation funding agreements in the interest of justice (Recommendation 11).

Litigation funding agreements must be governed by Australian law

In addition, the committee noted that domestic scrutiny of litigation funders is insufficient as a significant number of foreign litigation funders are not incorporated in Australia, recommending the Act be amended to require litigation funding agreements to be governed by Australian law and litigation funders to submit irrevocably to Federal Court jurisdiction for any litigation funding agreement to be approved (Recommendation 12).

Cost assessors

The committee recognised that advice of counsel and opinion of cost assessors retained by the plaintiff are inappropriate to assist the Court in ensuring that litigation funding costs are reasonable, proportionate and fair.  To overcome the lack of expertise and independence in the current mechanism, the committee considered it critical that independent financial experts be appointed to assist the Federal Court’s assessment of litigation funding agreements.

The committee recommended:

  • the Practice Note be amended to empower the Court to appoint a referee to act as a litigation funding fees assessor at any point in a proceeding (Recommendation 13);
  • the appointed litigation funding fees assessor be a professional with market capital or finance expertise (Recommendation 14);
  • the Act be amended to expressly allow the making of a costs order against a litigation funder (Recommendation 15); and
  • the Practice Note be amended to state that the Court may order the litigation funder to pay the costs of the work undertaken by an appointed litigation funding fees assessor (Recommendation 16).

Increased transparency

The committee considered that increased transparency in the litigation funding industry to enhance scrutiny and accountability is warranted given the excessive profits obtained from class actions.

The committee recommended the Federal Court should require certain information to accompany an application for approval of a class action settlement, which should then be published following the judgment approving a settlement (including the settlement sum, the funding commissions payable, the total costs, and payment to the representative plaintiffs) (Recommendation 17).

Contradictors and the interests of class members (Recommendations 18 and 19)

The committee noted that class members faced significant barriers to object to a settlement, which limited the representation of class members’ interests at the settlement stage.  The committee also recognised there is little incentive for other involved parties to delay settlement approval, and the limited ability of judges to champion the interests of group members. The committee considered contradictors (an independent third party appointed to represent the interest of class members, often a senior counsel) are ‘an effective tool’ to represent the interests of class members, leading to ‘improved outcomes for class members’. 

The committee recommended:

    • the Practice Note be amended to:
      • include a presumption in favour of the use of contradictors, where there are complex matters at issue in a proposed settlement, or the potential exists for significant conflicts of interest;
      • provide guidance on a range of scenarios likely to give rise to a conflict of interest;
      • ensure the Federal Court continues to retain discretion to appoint a contradictor, and to provide non-exhaustive guidance on when the Federal Court may elect to do so; and
      • ensure that the Federal Court is able to order costs associated with the appointment of a contradictor be paid by the plaintiff law firm or litigation funder where justified (Recommendation 18).
    • the Australian government implement a procedure to facilitate communication of class member’s concerns and objections to the settlement to a contradictor (Recommendation 19).

Reasonable, proportionate and fair litigation funding fees (Recommendation 20)

The committee identified that the current percentage-based billing practice significantly facilitated the making of excessive profits by litigation funders.  After considering a range of alternative approaches, the committee recognised that a guaranteed statutory minimum of the gross proceeds to class members was the most appropriate solution to protect class members and maintain access to justice. 

In light of this, the committee recommended the Australian government to consult on:

  • the best way to guarantee a statutory minimum return of the gross proceeds of a class action;
  • whether a minimum gross return of 70 per cent is the most appropriate floor; and
  • whether a graduated approach taking into consideration the risk, complexity, length and likely proceeds of the case is more appropriate (Recommendation 20).

Reasonable proportionate and fair legal costs (Recommendations 21 and 22)

Contingency Fees

The committee formed the view that a law firm that undertakes to run a class action on a contingency fee basis (which is presently only permitted in Victoria) should be subject to similar regulatory arrangements as litigation funders.

As such, the committee recommended the Australian government review the feasibility of applying the AFS Licence and managed investment scheme regimes to lawyers operating on a contingency fee arrangement in class actions (Recommendation 21).

Uplift Fees

The committee considered the charging of an uplift fee up to 25 per cent, on the entirety of the legal costs when receiving payments at regular intervals from the litigation funder, to be neither reasonable nor proportionate with the risk assumed by lawyers (as it does not reflect the level of risk assumed). As a result, the committee recommended that the Australian government consider establishing rules governing the ability of lawyers to charge an uplift fee on the total amount of legal costs (Recommendation 22).

Conflicts of interest in litigation funded class actions (Recommendations 23, 24 and 25)

The committee noted that the difference in interests between the representative plaintiff, their lawyers and litigation funders can become problematic when the interests of the litigation funder determine and influence outcomes in the litigation, and when the interests of the funder are prioritised over the interests of the representative plaintiff and class members. 

Ultimately the committee acknowledged that:

  • class action litigation as a mechanism for the vindication of legal rights for a collective group of similar claims should not be expropriated by litigation funders for their commercial gain and that the representative plaintiff on behalf of the class and with legal advice should have decision-making power on matters pertaining to those claims and their case; and
  • a standard should be set that the lawyers and litigation funders have an obligation to avoid conflicts of interest and where conflicts arise there should be robust and appropriate disclosure and management processes and requirements. 

The committee recommended:

    • the Practice Note be amended to:
      • require that the first notice provided by legal representatives to potential class members describe the formers’ obligation to avoid and manage conflicts and the details of any conflicts (Recommendation 23);
      • require that in a funded class action the first notice also clearly describe the obligation of litigation funders to avoid conflicts of interest, the funder’s obligations as an AFS Licensee and (if applicable) as a responsible entity for a managed investment scheme, and the details of any conflicts (Recommendation 24);  

    • the representative plaintiff’s lawyers and litigation funders be required to disclose to the Federal Court any potential conflicts of interest, any new or potential conflicts arising after the first case management conference, and the conflict management policy when they apply to the Federal Court for approval of a litigation funding agreement (Recommendation 25).

Dual interests of lawyer and litigation funder in a class action (Recommendation 26)

The committee noted that a conflict of interest arose where the lawyer or law firm is in some way connected to the litigation funding entity financing the case, that such conflicts were unmanageable and compromised the lawyer’s duties to the court and to their client, and that there should be strict separation between the funder and the representative plaintiff’s lawyers.

The committee recommended that the conduct rules for solicitors and barristers be amended to prohibit having a financial or other interest in a third-party litigation funder that is funding the same matter in which the solicitor, law firm or barrister is acting (Recommendation 26).

Statutory standards of conduct (Recommendation 27)

The committee considered that litigation funders should be held to the same standards as parties and lawyers to the litigation, particularly given the level of control that funders can exert over proceedings.   

The committee recommended that the Australian government consider options for the Federal Court to have the power to hold parties, their lawyers and funders to the same standards of conduct in class actions including:

  • amending sections 37N and 43 of the Act to oblige funders to act consistently with the overarching purpose in section 37M of the Act (the facilitation of the just resolution of disputed claims according to the law as quickly, inexpensively and efficiently as possible) and to permit the Federal Court to order costs against litigation funders for failure to act consistently with the overarching purpose; and
  • amending the Act to reflect the overarching obligations and the paramount duty in sections 16 to 26 of the Civil Procedure Act 2010 (Vic) including also the Federal Court having the express power to order costs against litigation funders for non-compliance with the overarching purpose of section 37N as well as the power to order disciplinary sanctions (Recommendation 27).

Financial services regulation of litigation funding (Recommendation 28)

Since August 2020, litigation funders in class actions have had to comply with the requirements of the AFS Licence and managed investment scheme regimes.  The committee considered that the AFS Licence and managed investment scheme regimes were ‘a step in the right direction’ but required certain modifications in order to ensure that they did not impose an undue regulatory burden on the litigation funding industry. 

The committee recommended that the Australian government:

  • legislate a fit-for-purpose managed investment scheme regime tailored for litigation funders; and
  • consult on the best way to exempt not-for-profit funders who held charitable status at the time the regulations were issued, have run no more than three class actions in the last five years, and exist solely to support and protect the members of the associated charitable entity (Recommendation 28).

Shareholder class actions and litigation funding (Recommendations 29 and 30)

The committee considered that shareholder class actions are generally economically inefficient and not in the public interest, as such claims can be easily triggered by an alleged breach of Australia’s continuous disclosure regime and successful actions amount to shareholders suing themselves.  In this regard the committee quoted data collated by King & Wood Mallesons to show that the transactions costs involved in shareholder class actions are significant – consuming between 20 to 60% of settlement sums.  In addition, some submissions argued that class action lawyers and litigation funders were taking advantage of Australia’s continuous disclosure regime to launch opportunistic shareholder class actions. 

With the impact of COVID-19, the continuous disclosure laws were amended to enable companies and officers to provide guidance to the market more confidently during the crisis, by removing the strict liability associated with continuous disclosure such that plaintiffs would be required to prove fault.[1]  The purpose of the amendment was to help to reduce the prospect of class actions against companies operating in the circumstances of the pandemic.  The committee considered that it was appropriate to retain the fault element in order to raise the bar for establishing a breach and stem the flow of opportunistic class actions, recommending that the changes made as a result of COVID-19 be made permanent (Recommendation 29). 

The committee also considered it appropriate to limit the hearing of claims pursuant to Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001 to the Federal Court only in order to avoid additional challenges arising from competing shareholder class actions being lodged in different jurisdictions (Recommendation 30).

National consistency (Recommendation 31)

The committee noted that the Australian class action regime was intended to operate nationally in a consistent way, however, issues had arisen due to the inconsistencies in the approaches of different jurisdictions to class actions regimes (e.g.  Victoria is the only jurisdiction in which continency fees are permitted).  The committee recommended that in order to increase certainty and reduce complexity the federal, state and territory governments should work towards achieving consistency in class action regimes across jurisdictions (Recommendation 31).

[1] See Corporations (Coronavirus Economic Response) Determination (No. 2) 2020.

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