The threat of shareholder class actions, enabled by litigation funding, has become a bigger risk for listed-company boards and their directors. Company Director asks: “Should litigation funding be regulated?”
Current litigation funding regulation only requires funders to manage conflicts of interest. Pre-existing consumer protection laws such as prohibitions on misleading conduct, unfair contract terms and unconscionable conduct continue. Court rules impose obligations on funder conduct.
However, two important regulatory pillars, capital adequacy and licensing, were omitted, matters that were recognised by the Productivity Commission in its Access to justice arrangements report in 2014 and which recommended government action.
Without capital adequacy requirements there is no protection for plaintiffs (or defendants) that the funder has sufficient resources to be able to pay legal fees and meet any adverse costs order. This creates the potential for inadequately resourced funders to litigate for profit but avoid the costs if unsuccessful.
The only partial protection against this is an order for security for costs by the courts. However, it is common practice that the amount of security that a court requires to be posted is substantially lower than the costs incurred by the defendant.
As a result, the plaintiff may be liable for those costs if the litigation funder is insolvent. A large costs exposure may bankrupt the plaintiff.
Defendants, if successful, may find they secure a pyrrhic victory in which their costs are not recovered. There may also be a waste of judicial resources as cases are progressed to a certain point before coming to a halt when the money runs out or prospects of success dim.
The lack of a licensing regime means anyone or any entity can fund litigation in Australia (except for lawyers). A licence permits a person or firm to operate in a market provided they have obtained the requisite permission and comply with the conditions of the licence.
The conditions of the licence can include specified levels of competency such as education, and restrictions based on status or background. None of this is required to fund litigation in Australia. One option is to place a cap on the fee a litigation funder can charge – similar to the way lawyers’ contingency fees are regulated overseas, which should benefit the plaintiff, not the funder.
An important principle lies at the heart of the civil justice system: the role of litigation is to resolve genuine disputes between aggrieved parties. The rise of entrepreneurial litigation and litigation funders pursuing civil litigation for profit, has the potential, if left unchecked, to undermine this principle.
The litigation funders’ business model demands they actively pursue court cases, including lucrative securities class actions, with a view to extracting a settlement. The role of participants in the court process should be to quell and not promote disputes.
If litigation funders with no interest in the litigation (other than profit) are allowed to exercise a substantial degree of control over large-scale litigation, the Australian Institute of Company Directors (AICD) believes they should be regulated.
Currently, litigation funders are subject to only one requirement – they must have a conflicts of interest policy. In AICD’s view, this is only one aspect of an appropriate regulatory regime. We believe a tailored licensing regime for litigation funders should be introduced into the Corporations Act. It should, among other things, prescribe common safeguards for people entering funding agreements and require domestic and foreign funders to meet prudential requirements so they have sufficient assets in the jurisdiction to meet any cost orders.
Those who support minimal regulation of litigation funders argue that the industry provides access to justice. This fails to recognise that in recent class actions access to justice has been undermined by four key factors. First, there is a lack of data available to determine the actual returns received by successful class members. Commonly, 25 to 35 per cent (or more) of an award is taken by the funder and a percentage of the remaining amount is used for legal fees and administration costs. Second, the use of closed classes requires those who participate in an action to sign an agreement with a funder and excludes those who do not. Third, many actions are promoted by plaintiff lawyers and litigation funders, not by aggrieved persons seeking to resolve a controversy. Finally, funders, rather than aggrieved parties, exercise a high degree of control over the proceedings. The regulation of litigation funders is needed to ensure safeguards surround their conduct.
The Australian parliament has, by Chapter 7 of the Corporations Act, long recognised the utility of regulating financial products. The current imbroglio engulfing financial planners demonstrates the wisdom of that legislation. Since January 2013 litigation funding agreements have become, by regulation, financial products. The debate as to whether such agreements should be regulated is therefore moot. There is no question that they should be regulated, the question is rather what form that regulation should take.
In order to determine the form of regulation, it is first necessary to examine the substance of a typical funding arrangement. Such arrangements can involve very large monetary sums. The average class action has hundreds of millions at stake. By definition the funding agreement lasts as long as the underlying litigation, the average duration of which is around three years. The funded client needs to be certain the funder will be there to pay the bills through the course of that three years and most importantly be there if the case is unsuccessful and the court orders payment of adverse costs to the successful defendant. Litigation is a dark art often little understood by vulnerable plaintiffs in need of protection from misleading or oppressive conduct from those who seek to make a profit from funding their litigation.
In this country those who provide financial products for a living are regulated through the Australian financial services licensing system enshrined in Chapter 7 of the Corporations Act. That system allows the Australian Securities and Investments Commission (ASIC) to determine, by licence, who may provide financial products and sets out the circumstances when the court may suspend or take away that licence in order to protect the public. The system provides benchmarks for disclosure and proper conduct as well as penalties for those who would skirt or ignore them. ASIC is empowered to determine financial capacity for funders. Finally the system provides for investigations and any necessary disciplinary hearings. The choice for litigation funding is thus whether it should fall under this already existing regulatory system or whether a particular and separate system should be enacted, funded and operated.
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