Legal experts warn that temporary reforms aimed at shielding directors from the threat of class actions could have unintended consequences.
Managing class actions risks
Investigations of a potential negligence claim against the Ruby Princess over the disembarking of sick passengers is likely to be the first of many pandemic-related class actions, with ever-increasing risks keeping the heat on company directors in all sectors. Deeply affected industries such as tourism, travel, health and retail could face substantial exposure to litigation for years.
Experience shows that claims are likely to become more prevalent as the full pain of economic dislocation bites and cases increase in line with trends in other jurisdictions such as the US. Adding to the risks and pressures confronting the corporate sector is the prospect of securities class actions linked to COVID-19 impacts, says Jones Day partner John Emmerig. “When the government is undertaking extraordinary measures to protect the health of the community and economy, there’s a rational case for introducing buffers to dampen more speculative filings and prevent or suspend certain types of securities class actions linked to specific challenges presented by COVID-19,” says Emmerig.
Business leaders have been steadfast in pressing for action and the outcome has been a slew of recent changes following Attorney-General Christian Porter’s initial cautious steps of establishing a parliamentary inquiry into class actions and the litigation funding industry on 13 May. It follows three previous inquiries by the Australian Law Reform Commission (ALRC), Victorian Law Reform Commission and Productivity Commission.
A temporary reprieve from continuous disclosure
The government has heeded calls by the AICD with Treasurer Josh Frydenberg on 25 May announcing a reprieve for companies and directors against continuous disclosure laws for the next six months. The temporary amendments to the Corporations Act 2001 mean companies and their officers will only be liable for continuous disclosure breaches if there is “knowledge, recklessness or negligence” with respect to updates on price-sensitive information.
It is clear from the Treasurer’s media release that the objective of the amendments is to enable companies and officers to more confidently provide guidance to the market during the COVID-19 pandemic. However, there are important caveats some say could impact on the effectiveness of the amendments in creating better safeguards for companies against the threat of class actions amidst COVID-19 shocks.
Jason Betts, a partner with Herbert Smith Freehills, says the disclosure reform is more akin to a negligence standard for disclosure. “The precise impact of that change may be more modest that initially intended given most shareholder class actions advance allegations that are close to negligence in any event, although the legalities of that need to be tested.”
He says it remains important in volatile markets for listed entities to continue to focus on core risk areas such as earnings guidance and forward-looking statements that may be affected by current unprecedented circumstances. “This is particularly important given there’s generally an uptick in volumes of class actions following periods of high market volatility.”
Critically, the amendments don’t touch the prohibitions on misleading or deceptive conduct for which claims can still be made, University of NSW law professor Michael Legg points out. “These prohibitions have been paired with continuous disclosure in almost every shareholder class action,” says Legg. “There is still a very high risk for companies and directors in the market disclosure space.”
He adds that making it harder for funders to bring claims could increase risk, which in turn leads to higher costs for claimants. “What we want is for funders to be good corporate citizens and for transaction costs to be driven down,” he says. “These changes are unlikely to reduce costs. Rather, more of any recovery will be consumed by legal fees and funders’ fees than go to the entity that actually suffered the loss.”
The impact on bringing class actions and litigation funders
An important impetus for the changes has been the growing litigation funding industry, but chair of the Association of Litigation Funders John Walker says there’s little likelihood of shareholder class actions during COVID-19. “Litigation funding is a panacea to wrongdoing by companies, not the cause of it. Rigorous disclosure laws are there to protect the community from unscrupulous behaviour by companies. If companies didn’t contravene these laws, there would be no need for class actions to address wrongdoing.”
Andrew Saker, CEO and managing director of Australia’s biggest — and only — listed litigation funder, Omni Bridgeway, says a better approach would’ve been a six-month moratorium to enable business to focus on more pressing issues. “We propose there would be no ‘absolution’ for any misbehaviour, but the dilution of the continuous disclosure laws may have that outcome, and with it, the unintended consequences of increasing risks for corporates in the capital markets, and the cost of capital.”
John Cowling FAICD, CEO of the Australian Shareholders Association, argues the current balance in the law is about right and actions should be looked at on a case-by-case basis. “If directors feel the proposed temporary legislation enables them to give meaningful guidance for retail shareholders, we welcome that guidance,” says Cowling. “Retail shareholders need to be advised of the impact of uncertainty on the company to help them make informed decisions about their shares and capital raisings.”
Andrew Watson, national head of class actions at Maurice Blackburn, has slammed the move as unnecessary, pointing out that rules already provide exceptions where there is uncertain information. “These changes could allow companies to hide bad news that has nothing to do with COVID-19. There should be no green light for company directors to hide information from the people who actually own a company.”
Similarly, Damian Scattini, a partner at Quinn Emanuel Urquhart & Sullivan, says the lesser standard could increase uncertainty giving more room for argument by lawyers. “Directors are not expected to be clairvoyant. The current duty is to neither mislead nor deceive — it really isn’t a high bar,” says Scattini. “More uncertainty and increased litigation is hardly what business is crying out for right now.”
Norton Rose Fulbright partner Tricia Hobson cautions boards that exposure to claims for breaching directors’ duties remains, notwithstanding the temporary relaxation of disclosure laws and reprieve from liability for insolvent trading. “Directors are confronting difficult decisions, particularly concerning debt and financing, as they steer companies through COVID-19,” she says. “Creditors’ interests as well as that of shareholders must be taken into account. Directors could end up facing questions about whether they acted with due diligence and care, and in good faith, in the event of a failure as liquidators and others look to recovery via insurance policies.”
Licensing for litigation funders
Requirements for funders to hold an Australian Financial Services Licence have been proposed for a long time, but the sudden introduction as part of the government’s changes has surprised the market. Omni Bridgeway has long supported licensing as well as minimal capital adequacy requirements, disclosure obligations and reporting standards. “No-one wants litigation funders with no real controls stymieing legitimate risk-taking that boards should be considering,” says Saker.
But the effect of licensing on restricting competition is a key concern of the Association of Litigation Funders, with Walker suggesting that along with it potentially not adding any meaningful value to consumer protection — it could add more costs.
Legg says while it may slow down the commencement of cases as funders get their house in order, it is unlikely to decrease the number of COVID-19-related class actions given the statutory time limits for bringing most actions is six years. “It’s not going to stop people from suing if there’s a viable cause of action,” says Legg, adding that the most uncertain aspect of this reform are plans to treat class actions as managed investment schemes.
“Litigation funding is a form of non-recourse lending and is a financial product in some sense,” he says. “But regulating class actions as an MIS adds a whole new layer of responsibilities and complexities. It could lead to fewer funders who will have to charge more — leaving claimants with less.”
King and Wood Mallesons partner Moira Saville argues it’s a positive move that could provide greater protection for often-unsophisticated class action claimants and reduce ability of funders, particularly offshore and unlisted operators, to be opaque in disclosure given they aren’t bound by Australian market disclosure obligations. “Litigation funders provide their services to litigants who are in substance no different to retail investors,” she says. “ASIC will have additional powers to make intervention orders to safeguard consumers including in relation to the content of advertisements — and even banning some schemes.”
Funding a future class actions boom
COVID-19 hit just as the Victorian government was preparing to introduce landmark legislative changes approving lawyers’ contingency fees. Along with the recent changes, this will have dramatic implications for companies and directors. Experts are warning companies to expect an increase in the number of claims, competition amongst plaintiff law firms and litigation funders.
Emmerig suggests plaintiff firms are holding back on court filings as they await a decision on contingency fee changes in Victoria. “If that occurs, it will be game on for the plaintiff market and hugely unhelpful for the corporate sector,” he says.
In its 2018 inquiry into class actions and litigation funding, the ALRC recommended in favour of contingency fees for lawyers. The AICD has been vocal about its concerns regarding the approval of contingency fees, in particular that they create conflict of interest for lawyers. It argues existing fee arrangements are sufficient to promote access to justice and any alteration could further exacerbate problems in the current class actions system. Corporate defenders add that the billable hours model gives plaintiff law firms less incentive to settle cases sooner and cost-effectively, drawing out claims for all parties.
The consensus is that the Victorian move is likely to proceed notwithstanding the parliamentary inquiry — and will ricochet to the other states. In the meantime, Victoria will become a capital for class actions, forcing companies to defend litigation in that jurisdiction.
The impact of contingency fees
The Victorian model permits lawyers to charge a blend of percentage-based fees on any successful recovery and hourly rates, whereas the federal ALRC model proposes that lawyers can only charge a contingency fee or hour rates, not a hybrid. “The hybrid option could be seen by some plaintiff firms to be highly attractive because it may provide a less risky cashflow option in running these claims generally, but particularly the more speculative ones,” says Emmerig. Being able to invest in class actions gives plaintiff firms more incentive to hunt cases, leading to greater competition in the space and, of course, the threat of more actions.
Walker says most law firms will be unable to meet the huge capital costs required to fund class actions alone. The complexities and advantages in reducing risk means they will continue to rely on litigation funders, which Walker says have underwritten the enforceability of market protection laws over the past decade. “More capital coming into the market could create more competition in class actions, but the incentive for law firms and litigation funders to combine services, as would be permitted under reform, is probably not all that great,” says Walker.
Common funds: a brake on class actions growth
Among prominent law firms with the financial wherewithal to run contingency fees are Maurice Blackburn Lawyers, Shine Lawyers, and Slater and Gordon. The closest thing we’ve seen yet to a contingency fee arrangement is the speculative “no win, no fees” Maurice Blackburn approach in the AMP class action. Maurice Blackburn’s claim is one of five competing shareholder class actions that has been allowed to proceed following a landmark decision by the NSW Supreme Court on 24 May. The case is now before the High Court. Watson acknowledges the boon for plaintiff firms, describing contingency fees as the “single greatest opportunity to make a good system better”.
One of his key concerns stems from the High Court decision last December concerning the validity of common funds. The issue of common funds was raised in two separate High Court cases brought together for determination. Both involve litigation funders — the first concerning BMW over supply of vehicles containing allegedly defective airbags; the other relating to Westpac’s alleged breaches of statutory and fiduciary obligations in the provision of financial advice.
Common fund orders enable litigation funders to clarify the scope and economics of a claim against a company by confirming their entitlement to a commission from all group members, whether or not they sign up to a funding agreement, unless group members specifically opt out. The High Court ruling concerning BMW and Westpac — that the Federal Court of Australia and the NSW Supreme Court do not have power to make common fund orders — makes life harder for funders because they no longer have certainty at the outset of a case that all class members will contribute to their commission. It also potentially means they could get lower returns.
However, company officers and directors can take comfort in the High Court decision, which offers some added protection against opportunistic claims. Litigation funders must now resort to the slower, more complex process of “book building” (signing up claimants) group members before they head to court. The lower levels of individual loss for claimants in areas such as consumer disputes and employee underpayments may force some of these actions to be wound back.
Watson argues that common fund orders provide better outcomes to consumers by placing significant downward pressure on funding commissions. However, this would all be moot if contingency fees become the norm. “The decision may have no long-term adverse impact if contingency fees are introduced and if courts make common fund orders at the settlement approval stage,” he says.
Bruce Cowley FAICD, a former chair of both MinterEllison and the AICD Law Committee, says funders could increase the percentage of their takings out of damages or settlements to account for the extra book-building costs. “In the absence of regulation, we remain dependent on the courts to be vigilant in ensuring that claimants are not taken advantage of and receive settlement or damages awards that are genuinely compensatory, without too great a proportion going to litigation funders and lawyers.”
Legg says regulatory reforms for funding and changes to continuous disclosure are taking place at a time of significant uncertainty around key class action procedures, with the proposed introduction of contingency fees and questions around common funds. “All this uncertainty means more risk for a funder, which means a higher fee needs to be charged,” he says. “Equally, this uncertainty can mean higher legal bills for the companies and directors who are the subject of a class action.”
Scattini, who is leading the Takata airbag suit against BMW and other car manufacturers, says the Commonwealth’s intervention in the High Court action in support of common fund orders signals a preparedness to formalise them through legislation.
Litigation funding reform
The unfortunate reality for directors is that while the High Court ruling could slow some funders down, it’s unlikely to slow growth of the class actions industry or the number of suits. The disruptive events caused by COVID-19 are strengthening calls for more reform to the class actions regime and the regulation of litigation funders.
Lifting the current low thresholds for bringing class actions with a new merits test and certification process are ways to ameliorate the imbalance between companies and those who bring actions, suggests Betts. “It could help weed out spurious claims or those [cases] better litigated by other means as well as deal with the problem of competing class actions.”
The turning point in Myer
Another key challenge for companies is sorting through the practical implications of the landmark judgment against Myer on 24 October 2019. It is the first Australian class action by shareholders against a listed company to go to judgment. This confirmed that shareholders in listed companies may be entitled to recover damages for breaches of continuous disclosure obligations and for misleading and deceptive conduct on the basis of “indirect market-based” causation.
Myer and lead plaintiff TPT Patrol announced on 6 May an end to proceedings with each party bearing their own costs. It was deemed too difficult to continue because of the pandemic and the difficulty of proving shareholder loss.
Class action defenders are steadfast in calling for better, permanent safe harbour provisions. But plaintiff firms warn that the litany of recent corporate scandals, including those revealed by the banking Royal Commission, provide evidence against any weakening of disclosure laws or watering down of director’s duties.
According to Monash University business law professor Vince Morabito, shareholder claims account for almost a third of all actions. Investor, product liability, mass torts and employment class actions are also prevalent. An average 47 class actions have been filed in each of the past five financial years; the most, 59 in FY19. Morabito suggests personal liability risks for directors are overstated. Directors were conjoined in just 23 of the 122 shareholder class actions brought in the past 27 years (in two of the 19 filed in 2018–19). Many lawyers expect that to change, particularly as Side C cover gets harder to obtain.
Different kinds of class actions
Just as COVID-19 disrupted pretty much all aspects of business and society, the potential for class actions is broad. The experience in the US gives some indication of what’s on the cards for Australian companies, says Allens partner Kate Austin, noting there have been numerous cases filed in the US, with giants such as Amazon facing allegations of excessive pricing for essential items, and Uber over its classification of drivers as “independent contractors”, leaving them with no employee rights such as sick leave.
Aside from negligence claims such as with the Ruby Princess, shareholder claims arising from increased market volatility and revenue shocks, there’s likely also to be more misleading and deceptive conduct claims over things such as false advertising and price gouging, and possible consumer claims for failing to appropriately reimburse customers for cancellations. The Australian Competition and Consumer Commission (ACCC) has stated it will clamp down on price gouging.
“Another key area of risk is employee claims for infection in the workplace and injuries resulting from inadequate home working set-ups or the impact of forced leave or termination,” says Austin. “Heightened cyber risk in remote-working environments also makes it imperative that companies focus on data privacy and security.”
Aside from the increased risks of COVID-19-related cases, boards across all sectors can expect general growth in areas including consumer and wage theft class actions, product liability, mass torts and environmental claims.
Legg says novel areas such climate-related litigation pursued as a continuous disclosure breach will become more prevalent in future. Another worrying development is class actions that springboard off existing lawsuits or regulatory action. “These sorts of class actions are the most egregious because you’re punishing a company for not disclosing something that, in many instances, they could not have known about, and often shareholders have benefited from that conduct,” says Legg.
Corporate commercialisation of consumer data is also creating more privacy claims. The NSW Supreme Court approved the first settlement on 10 December over the on-sale by a NSW government contractor of ambulance workers’ records to personal injury law firms.
Weighing up the risks
The increasing cost and reduced availability of directors and officers’ (D&O) insurance, already a huge concern at board level and for the insurance industry, has been heightened by the pandemic and with the prospect of further withdrawals by insurers from the D&O market. The government’s temporary changes to continuous disclosure obligations will help give insurers some comfort, but it will be short-lived without some level of permanent change.
Boards are making difficult decisions as they reassess risk appetite, says Hobson. In a soft market, with a growth in boards/directors taking up insurance, this was a sweet spot for insurers, but concerns about the growth in the number and size of class action claims, coupled with a rise in D&O insurer payouts, has troubled insurers so much that many are dumping their offerings. Some companies have been hit with premium increases as drastic as 400 per cent, adding to that the imperative to maintain coverage for class actions along with other growing areas of reputational and cyber risk. “Self-insured retention is being raised in some cases from the likes of $1m up to $5m,” says Hobson. “This requires companies to have more skin in the game.”
Alternatively, more companies will opt to absorb risk into their balance sheets. The threat of class actions should be on every listed board meeting agenda, urges Hobson. “These are critical assets, but directors are often unaware what their policies say or insurance covers.”
Under the microscope
The COVID-19 pandemic has touched all parts of Australian business. No company or director will be spared scrutiny, writes Arnold Bloch Leibler dispute resolution and litigation partner Teresa Ward.
Since the GFC, boards across Australia have focused on improved risk assessment, risk analysis and risk management. How then did lawyers, advisers, consultants and regulators all miss the risk of severe social and economic disruption from a pandemic? More importantly, what are the class action litigation risks for directors and companies that have arisen as a result?
COVID-19 will have a significant effect on the class action landscape and on the way boards operate in Australia. We need only look to the US where class actions have already been filed against cruise ship, biotech and retail companies.
As investors, employees and creditors look to shift losses, the risk of class actions escalates, particularly when responsive insurance policies and willing litigation funders are involved.
While some claims are obvious (Ruby Princess), the spotlight will also focus on risk management, both from a board decision-making perspective and how risks are disclosed to and priced by the market. Against a history of SARS and MERS, questions may be asked whether boards adequately protected and continue to protect the interests of investors, employees, and creditors, and whether some of the value destruction we are seeing could have been avoided.
Those looking to recover value and shift loss will scrutinise the widespread withdrawal of financial guidance by listed companies, decisions by large retailers to close stores and stand down workforces while others remained open, landlord dealings with tenants, and reductions in pay, working hours and entitlements across the board. This may lead to questions about the adequacy of companies’ disclosures to the market more generally, particularly those already under stress as a result of significant debt or unsustainable cost structures; or where shareholder equity has, in effect, been wiped out. Continuous-disclosure breaches are a class action favourite, as are claims that companies/directors misled the market when making disclosures or by failing to identify risks.
Inevitably, these decisions will be examined in hindsight when the risks seem obvious and the intense uncertainty around the rapidly shifting regulatory, financial and public health landscape is forgotten.
Weighing directors’ judgements is a difficult exercise and it may take courts and companies as long to resolve these questions as it does for Australia to recover from the wider socio-economic effects of the pandemic. For directors, the reality is that the decisions they make to balance the needs of investors, employees and creditors will be the subject of intense scrutiny and increased litigation appetite. While there is some relief via temporary relaxation of insolvent trading laws, directors’ other duties and obligations still expose them to the risk of claims arising from class actions against their companies. Even the safe harbour provisions, intended to support solvent restructures, may be more difficult for directors to rely on.
The AICD has called for more protection for listed company directors to support rehabilitation and solvent restructuring. At the time of writing, no such protection is in place. As always, good governance and good advice remain crucial.
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