Maintaining the current levels of competition in the market is key to ensuring the ongoing improvement in returns

As we approach the 30-year anniversary of the Australian federal class action regime, class actions are once again under the political spotlight. This time, the focus is on the litigation funders that make most class actions possible.

While much of the focus is on how much money litigation funders make, any concerns about excessive commercial returns or a proliferation of claims seem increasingly out of date.

Historical picture

Since the introduction of the federal class action regime in 1992, there have been just over 634 class actions filed. On average this equates to about 23 class actions per year. As reported by the Australian Law Reform Commission (ALRC), class actions constitute between 0.33 percent and 0.68 percent of all cases filed in the federal court each year.

Of the 634 class actions filed, there have been a total of 122 shareholder class actions. The successful shareholder class actions have returned almost over $900 million to over 94,000 shareholders. It is also estimated that product liability class actions have returned over $400 million to nearly 12,000 customers.

There are the important policy benefits of shareholder class actions that, through their various iterations, have operated to correct the information asymmetry between listed companies and the market. The potential of class action litigation has no doubt worked effectively in the background to create a greater impetus for company directors to carefully consider what information is material and when it ought to be released to the market.

Litigation funders have played a key role in delivering these policy outcomes as well as compensation to shareholders and other class members.

Working together with plaintiff law firms, litigation funders have delivered access to justice in circumstances where the financial risk of litigation would not have been borne by anyone else.

Current state of the market

The market has seen an increase in players over the years. There used to only be a single litigation funder in the Australian market, whereas now there are 33. Meanwhile, plaintiff law firms that conduct the majority of the class actions for plaintiffs have increased from two to almost 30, including a number of large commercial firms.

The growth in the number of players in the class action and litigation funding market in Australia has unsurprisingly had the welcome effect of generating real competition between litigation funders and thereby driving drive down the cost of litigation to group members.

This is a result of both greater competition and increased judicial intervention in funding agreements in the context of common fund applications, which allows judges to scrutinise the funder’s rate of return and risk taken in the proceeding before approving a funder’s commission in a class action settlement. The days when the small handful of funders took a 40 percent commission on gross recoveries are well and truly behind us. Commissions recently approved by the court have been no greater than 25 percent of net recoveries.

There is evidence of increasing innovation, such as in the Westpac shareholder class action launched by Phi Finney McDonald in 2019. In that case, group members are guaranteed to receive more than 90 percent of gross litigation proceeds. Terms like this were simply not available to group members even three years ago.

A case for reform?

In the last five years, a number of inquiries and reports into the class action regime commissioned by the federal and state governments have provided overwhelmingly positive conclusions about the effectiveness of the class action regime, including litigation funding.

In 2014, the Productivity Commission conducted an inquiry into access to justice arrangements in which in concluded that litigation funders performed an important role of funding claims by plaintiffs who would otherwise lack resources to proceed’ but also recommended that litigation funders be licensed to ensure they met capital adequacy requirements.

Since that report, a number of organic developments in the class action market have addressed some of the key risks associated with capital adequacy of funders, most notably including the increased uptake of after the event insurance by funders which provide defendants with a direct right to call on funds to cover the specific adverse costs liability in the case in the event of their success.

In 2018, the Australian Law Reform Commission (ALRC) conducted a full-scale review into the class action regime since 1992. Many of the recommendations contained in its final report delivered to the federal government in December 2019 went to formalising practical mechanisms already in use by parties and the courts to deal with specific aspects of class action procedure such as dealing with multiplicity, embedding the presumption that funders provide security for costs and giving the court increased powers to reject, vary or set terms of litigation funding agreements.

The ALRC closely considered and ultimately rejected the need for a mandated financial services licensing regime of litigation funders on the basis that the court would be better equipped to provide consumer protections and enforce capital adequacy requirements. This makes sense given the court’s ability to intervene on the specific terms of litigation funding agreements, rather than having a funder meet a set of generic requirements under a boilerplate licencing regime.

Australian financial services licences: square peg, round hole

Rather than delivering its response to the ALRC’s important recommendations, in May 2020, the federal government urgently tasked the Parliamentary Joint Committee on Corporations and Financial Services to conduct yet another Inquiry into litigation funding and the regulation of the class action industry. The inquiry is convened on what the current data suggests is an out-dated premise that the price of litigation funding is too high. Their report is due by 7 December 2020 but certain outcomes have already been determined, regardless of the committee’s findings.

On 22 August, the federal government brought into force regulations requiring litigation funders to hold an Australian Financial Services Licence (AFSL) as well as placing class actions into the managed investment scheme (MIS) framework.

While the need for greater regulation of litigation funding is well accepted from both sides of the debate, there is an abundance of doubt as to whether these regulations will deliver any net benefit to class members.

First, the AFSL regime is far from perfect. Under this regime, a significant number of financial advice scandals, such as Storm Financial and Opes Prime went undetected in the Australian regulatory regime and hundreds of millions of dollars were lost by retail investors. The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry in 2019 also found that banks and lenders had engaged in egregious misconduct despite operating under the AFSL regime.

Secondly, the AFSL and MIS regimes are ill-suited to litigation funding. Under the current proposal, a litigation funded class action will be treated as an MIS. Putting aside the associated and onerous documentation required to operate an MIS – it is unclear what the ‘scheme property’ would be and how it would operate in tandem with open class actions. It is unclear which entity would appropriately act as the responsible entity. Would it open up another layer of management fees payable by class members, as is often the case in these investment schemes?

It is highly unlikely that introducing this overlay of mismatched regulatory requirements will result in better consumer protections for class action participants.

What is clear is that in addition to having to deal with litigation funding agreements, solicitors’ costs agreements and disclosure statements, class members will also have to familiarise themselves with the Product Disclosure Statement for the case, the scheme’s constitution and make an application for investments in the scheme.

There is also the real risk that, given the red tape associated with the operation of AFSL and MIS schemes, including reporting requirements, the costs of litigation funding will have to increase to meet the added expenditure. This may force smaller litigation funders out of the Australian market. The resulting combination of increased costs and fewer players will likely have the ironic outcome of decreasing competition and increasing costs at the very time competition is placing downwards pressures on prices.

The better outcome would be to see the federal government engage with recommendations made by the ALRC following their in-depth review of the class action regime.

Those recommendations favour giving more powers to the court to intervene in litigation funding and legal cost arrangements as well as supporting the open class action regime.

The courts have a far better understanding of class action practice and also have a statutory role to supervise and protect the interests of group members.

In our view, the court is far better placed to deliver bespoke consumer protections to class members rather than a ‘one-size-fits-no-one’ regulatory regime. Regulation for regulations’ sake is the worst type of reform. As the facts show, class actions in Australia are working relatively well. Maintaining the current levels of competition in the market is key to ensuring the ongoing improvement in returns to class action participants.

This article appeared in the Asset Servicing Times.

September 15, 2020 // Press