Justice or profit?

The recent launch of an inquiry by the Parliamentary Joint Committee on Corporations and Financial Services into litigation funding has brought about a heated debate around the current regulations on a growing class action industry in Australia and its potential outcome for plaintiffs.

When opening the inquiry, the committee said its key objective remained to ensure that the legal system in Australia would deliver justice to those who deserve it and “did not exist to benefit lawyers or others seeking to profit from it”.

However, since the committee first announced its decision to look at proposals allowing lawyers to enter into contingency fee arrangements, there has been a number of submissions being made by both sides. 

The litigation funders and law firms argued their profits were often exaggerated and misunderstood while, at the same time, there was a number of submissions which strongly indicated that profit has become a key motivation for starting proceedings in many cases.

One of the most contentious issues has become the proposed stricter regulations and discussion around whether litigation funders and law firms seeking contingency fee commission should hold the Australian Financial Services (AFS) licence and the entire sector should be regulated through the Australian Securities and Investments Commission (ASIC).

At the same time, the report from the Liberal Party’s think tank Menzies Research Centre (MRC), found that returns available for those investing in litigation in Australia exceeded, by a considerable margin, the returns available in nearly every other alternative asset classes. The largest litigation funders operating in Australia reported a return on invested capital (ROICs) of over 150% with a high success rate of more than 80%.

“The numbers speak for themselves,” James Mathias, MRC’s chief of staff and co-author of the report, said. “What our report shows is the percentage actually paid out to successful plaintiffs has reduced significantly over the last three years. The returns are excessive when you think about [how] the returns they actually make are a percentage of the victims’ damages pool.” 

“We feel that the litigation funders have too much of a say in the proceedings and we want to ensure that litigation funders do not have that so we certainly feel that there should be a prohibition for them exerting control over the proceedings.”

FAIR AND REASONABLE?

However, Patrick Moloney, chief executive officer at Litigation Capital Management (LCM), said the quantum of any fees payable to a funder of a class action was already regulated by the court in the context of the approval of a settlement and it was the court which determined what was a fair and reasonable fee to be paid to the litigation funder.

“Therefore, in the context of class actions, a litigation funder’s fees are already the subject of regulation. And in terms of the balance of LCM’s business, we are dealing with sophisticated professionals, or corporations, who agree contractually to an acceptable fee,” Moloney said.

“There is no reason why a commercial arrangement between sophisticated parties should need to be regulated. The terms agreed to by commercially sophisticated parties reflect the fact that litigation finance is non-recourse lending which is high risk for the funder.

“This is demonstrated by the fact that it is only litigation funders (and not any other financial institutions) who are willing to lend capital with the only recourse being the uncertain proceeds of litigation,” he said.

Mary Nemeth, Australian head of litigation and insolvency and principal lawyer at DWF, was of a similar opinion. According to her, most members of the public did not understand how class actions were run and funded. 

“This is why we commonly advise clients on the risks associated with being part of a class, and what they may get from being involved in a class action funded by litigation funders.

“Over the last 20 years that litigation funding has become a common form of funding litigation in Australia, the courts have ensured that class members’ interests are paramount and that the funders’ remuneration is acceptable, considering the risks which the litigation funder takes on,” she said.

Before the Victorian parliament passed legislation that allowed for contingency fee arrangements, there had been a long history of lawyers in Australia who were only able to charge a fair and reasonable fee for their service. However, this all changed with the arrival of the litigation funders who began to charge a percentage of the damages. 

According to Mathias, law firms see this as a great way for ensuring that their fees are guaranteed and will always be paid, meaning that the relationship that exists between plaintiff, lawyers and litigation funders is a commercial one.

“If it is a commercial agreement then the litigation funders should be subject to the same regulatory requirements of other commercial operations. That’s just common sense and currently they are not,” he said.

The MRC report also found that many litigation funders in Australia were foreign entities with little or no local presence where, additionally, the enforcement of their clients’ rights will be difficult if not impossible unless the funding agreements are governed by Australian law.

Mathias said: “Some funders pay no tax here, and all the while this vehicle of justice for people has been seen as a vehicle for profits, at the expense of the very people they are meant to be representing. All we ask for is that litigation funders are subject to some of the same regulatory and reporting requirements as Australian companies”.

LICENCE OR NO LICENCE?

One of the proposed recommendations around litigation funding was to look at it as any other financial product. However, this would imply that litigation funders and the practices of any law firms seeking contingency fee commissions would need to be regulated by ASIC and the litigation funders would be required to act in the best interests of class members, placing the lawyers in the same regulatory boat as financial advisers.

The think tank pointed out to a decision made in 2013 by the Minister for Financial Services, Superannuation and Corporate Law, the Hon Chris Bowen, who exempted this industry from investment regulation and litigation funders were no longer required to hold an AFSL, something required of all other providers of financial products and services, as a starting point since when the litigation industry has begun to flourish.

According to the think tank, while the introduction of provisions allowing plaintiffs to litigate collectively in 1992 was well intended the system got “corrupted by predatory practices by legal companies backed by investors looking for a return on capital”.

“We touched on it a little bit in the report, but to say that class actions which were established in 1992 and within that set of frameworks that government’s class actions in 1992 could have never foreseen the advent of litigation financing,” Mathias noted.

Moloney said that LCM supports increased regulation of the industry and his firm has long supported the introduction of a relevant licensing regime as an added means of ensuring continued integrity within the industry.

“LCM already holds an AFSL and, as a publicly listed company, is subject to market regulation including financial reporting and continuous disclosure requirements,” he said.

Moloney said the licensing of litigation funding should be tailored to address the specific features of litigation funding otherwise the objectives of licensing such as greater transparency and ensuring that litigation funders hold and maintain the appropriate level of competence and organisational ability to provide these financial services, may not be met.

“LCM supports the regulation of the litigation funding industry by ASIC. Class actions are, however, already subject to detailed and close supervision by the courts, so the role of the regulator needs to be carefully considered so as to sit alongside this court supervision,” Moloney said. 

However, he warned that the current proposal that class actions should be subject to the managed investment scheme (MIS) regulation “is not without problems”. 

The current class actions regime is based on an ‘open class’ and ‘opt out’ system which is inconsistent with the notion of a MIS where participants are required to take a positive step in order to be involved. This would mean, according to LCM’s chief executive, that MIS have particular features such the ‘operator’ of the scheme who holds and controls the ‘scheme property’. 

“This does not sit comfortably with the concept of a funded class action where members do not contribute any actual property, other than the pooling of their claim, and a funder does not control the claim, rather a class action is controlled by the representative plaintiff,” he said.

“It is not yet clear whether law firms seeking contingency fees will be required to hold an AFSL or whether class actions being run on the basis of contingency fees will be required to be registered as a managed investment scheme. There is a problem with this; lawyers are prohibited from promoting or operating managed investment schemes.”

According to Nemeth, most serious litigation funders will not find the requirements restrictive and will already have the capacity to comply with further requirements. 

“Law firms who seek contingency fee commissions or an uplift fee are already heavily regulated by professional body rules in the way they conduct themselves. Adding further licensing requirements will add to the cost of their compliance and may make them think twice about taking a matter on based on a contingency fee. 

“This is, however, still playing out in the market with legislation to lift the cap on what contingency fees can be charged, now having passed in the Victorian parliament,” she said.

IMPACT ON ECONOMY

Andrew Saker, chief executive of Omni Bridgeway (which also includes IMF Bentham following their merger in 2019), said opponents of the litigation funding often suggested there would be a negative impact on the economy without necessarily articulating the reasons why.

“There have been some suggestions that litigation funding and class actions require boards to focus more on disclosure obligations versus running the business, that is it is a drain on directors and insurers, discouraged some people from being directors, that the cost of directors and officers insurance has increased,” he said.

“The counter-position, which is our position, is that class actions and litigation funding improve the economy by acting as a private enforcement tool to complement public enforcement, which improves the quality of the information available to shareholders and reduces the cost of capital. 

“The focus on disclosure obligations is a positive, not a negative, the drain on insurers and directors does not reflect the cost and damage done to investors who have been misled and damage to the integrity to the market for those companies that do fulfil their obligations.”

With the committee’s final report expected in early December, Mathias said: “I hope certainly that by the end of the year after the committee reports, we will have a clear set of recommendations for parliament to intervene, and to put the required regulatory frameworks around litigation funding in this country.