Contingency fees coming to Australia

Damian Grave and Maura McIntosh look at the Productivity Commission’s recent recommendation to lift the ban on contingency fees and consider the potential impact for major corporates in Australia.

In December last year, the Productivity Commission (the Commission) published its final report into access to justice arrangements. This included a controversial recommendation to introduce contingency fees, or damages-based billing, so that lawyers would be able to conduct litigation in return for an agreed share of any amount recovered by the client. If this recommendation is implemented, it will reverse a long-standing ban on such arrangements in Australia.

Under current regulations, lawyers are restricted to offering “conditional” billing where they charge no fee, or a lower fee, if the case is lost but can charge an uplift based on normal rates (rather than a share of damages) if the case is successful. This uplift is capped at 25 per cent of the normal fee.

Although lawyers cannot take a percentage of a client’s damages, there is no such restriction on third party funders who commonly fund litigation in return for a share of the proceeds, including large commercial claims as well as class actions where litigation funding has become increasingly important in allowing cases to get off the ground.

An increase in claims?

The Commission’s report addresses concerns raised that damages-based billing might promote unmeritorious claims, similar to the concerns that are sometimes expressed about litigation funding. The report concludes that there are strong incentives for both lawyers and litigation funders to bring only meritorious claims, given their financial exposure if a case is lost. Similarly, with damages-based billing at least, the report concludes that clients are discouraged from pursuing frivolous claims because they still pay disbursements and face the threat of paying the opposing party’s legal fees if they are unsuccessful.

If that analysis is correct, it may be that permitting lawyers to fund litigation through damages-based billing may have little impact on the overall number of claims brought.

A ban on hybrids

The idea of an explosion in claims funded by newly-permitted contingency fee arrangements may be less likely when one considers that the Commission’s recommendation to lift the current prohibition is subject to a number of significant restrictions. These include, importantly, a requirement that where a damages-based fee is charged it should be the sole form of billing. So it seems that there will be a ban on partial or “hybrid” arrangements, where a lawyer could receive, for example, a reduced hourly rate as the case proceeds plus a share of damages in the event of success.

We understand that hybrid arrangements of this sort are used by commercial claimants in US litigation. Such claimants will not normally agree a “traditional” contingency fee, where the lawyer is paid perhaps 30 per cent or 40 per cent of any recovery, but may agree a discounted hourly rate combined with a smaller contingency fee or uplift in the event of success. In contrast, under the Commission’s recommendation, it seems a damages-based fee can be charged only as part of a full “no win, no fee” arrangement.

The Commission’s report does not give any reason for this restriction other than to say that certain protections must be in place for consumers, highlighting the concern that retail consumers are vulnerable to being overcharged. To that same end, the report proposes a sliding scale cap on the percentages that can be charged by way of contingency fee for retail clients, but states that no such cap is needed for sophisticated clients. In contrast, the proposed prohibition on hybrid arrangements does not appear to be subject to a carve-out for sophisticated clients. It is not clear why that is the case.

UK parallels

It may be instructive to compare the UK experience. Contingency fees were introduced for litigation in England and Wales from April 2013 in the form of “damages-based agreements” (DBAs). This followed a recommendation made by Lord Justice Jackson, a senior judge, in his 2009 review of civil litigation costs. The drivers for that recommendation were two-fold:

(i) The desire to have as many funding methods as possible available to litigants, in order to promote access to justice.

(ii) The freedom of contract argument, i.e the notion that if the client wishes to enter into a contingency fee agreement with its lawyer, it should be free to do so.

In implementing the recommendation, the government introduced a number of regulatory restrictions on the terms of DBAs, including a 50 per cent cap on the level of fee for commercial cases (lower for personal injury and employment) and a prohibition on partial or “hybrid” DBAs.

To date the new regime has had very little take-up, with few firms willing to offer DBAs. This has been attributed, in large part, to the exclusion of hybrid DBAs, which came as a surprise to the profession when DBAs were introduced and which has been widely criticised, including by Lord Justice Jackson himself. The idea of conducting major litigation on a full “no win, no fee” DBA is unattractive to many firms, given the level of risk involved over what may be a significant timescale, though of course some may be willing to make an exception for the right case.

Hybrid arrangements

The Civil Justice Council has been reviewing the regulations governing DBAs, at the government’s request, to consider possible improvements. However, the Government has ruled out the introduction of hybrid arrangements as it considers they “could encourage litigation behaviour based on a low risk/high returns approach”. At the moment hybrid arrangements appear to be off the political agenda. So long as that is the case, they may remain off the agenda for many firms.

In light of the restrictive regulatory regime governing DBAs, a number of UK litigation funders have begun to offer their own so-called hybrid DBA arrangements, to fill the perceived gap. The idea is that although lawyers cannot offer a hybrid DBA directly, the same result can be achieved – from the law firm’s perspective at least – by partnering with a litigation funder to share both the risk and the reward.

Typically, such models involve the law firm entering into a DBA with the client and a parallel agreement with the litigation funder, under which the funder will pay some part of the law firm’s ongoing fees, generally calculated by reference to hourly rates and in return will take a share of the agreed contingency fee on success.

It is worth noting, however, that although a funder-backed hybrid arrangement of this sort achieves the same result as a hybrid contingency fee model from the law firm’s perspective, it is not the same from a client’s perspective. Under the current proposals, the client’s only option for a damages-based fee will still be a full “no win, no fee” deal.

Although it is not clear to what extent such arrangements are currently being used in the UK, they seem likely to increase in popularity as law firms seek a way of offering DBAs to their clients without taking on the full risks involved. A similar model may develop here, if the Commission’s recommendations are implemented.

Class actions

Unlike Australia, the UK does not currently have an “opt-out” class action regime; the main procedures for bringing collective damages claims require the identification of individual claimants. That is set to change for competition law claims, under proposals recently passed by parliament which are due to take effect in October 2015. Under the new procedure, the tribunal will be able to certify an action to be brought on an opt-out basis, so that damages can be awarded to a defined group without all individual claimants needing to be identified.

Interestingly, however, the use of DBAs will be specifically prohibited for competition law claims brought under the new procedure. This prohibition was introduced as an additional safeguard against the possibility of speculative litigation arising from the introduction of an opt-out regime. The Commission’s recommendation does not propose any such prohibition on the use of damages-based billing for class actions in Australia. There will be a limit on the amount lawyers can earn in high value claims as a result of the proposed sliding scale cap on contingency fees for retail clients, referred to above.

To the extent that class actions are brought on behalf of businesses rather than consumers, however, it appears there will be no such restriction.