Litigation funders by another name

Jason Betts and Guy Narburgh compare the checks and balances on litigation funders with those against D&O insurers to explain why they need comparable regulation.

Shareholder class actions are now a well-established feature of the Australian litigation landscape. One of the key factors in the growth of the class-action “industry” was the endorsement by the High Court of the funding of class actions in the 2006 Fostif decision. Litigation funders, domestic and foreign, now play a major role in class-action and other litigation in Australia. However, despite the large influence litigation funders have on starting and conducting major litigation, and in turn on the Australian economy, their regulation remains largely voluntary.

In November 2013, the Australian Institute of Company Directors provided a submission to the Productivity Commission’s inquiry into Access to Justice that outlined reasons why litigation funders should be the subject of appropriate regulation in Australia. Here, we focus on some of the key issues underlying that submission and draw a comparison between the treatment of litigation funders and another party frequently interested in the outcome of shareholder class actions, Directors’ & Officers’ (D&O) insurers. The contrast between the two provides further evidence that some form of comparable regulation should be introduced.

Why regulate?

As Company Directors points out in its submission, there is entirely valid access to justice considerations that support the existence and role of litigation funders. However, in the currently unregulated environment, there is no sense that competing interests, such as the ability of Australian companies to carry on their day-to-day business effectively, have been considered. Company Directors suggests regulation which includes, at a minimum:

1. Appropriate and consistent levels of protection for group members who enter into funding agreements, which is now commonly a requirement of participating in a funded class action.
2. A requirement on domestic and foreign funders to maintain sufficient assets in Australia to pay the defendant’s legal costs should the claimant be unsuccessful.
3. A prohibition on law firms (which should act in the best interests of its clients) establishing a related funding entity (which may be concerned with obtaining an early settlement to extract its profit).

The other litigation funders

Where a shareholder class action is started, it is common for a D&O liability insurer to have some exposure to that claim. This can be through claims against individual directors, but far more frequently the exposure arises from “Side C” or “securities claim” coverage provided either under a D&O policy or a stand-alone policy.

Where this occurs, D&O insurers are, in essence, litigation funders by another name – albeit funding the defence of the claim. Yet, as Figure 1 demonstrates, despite the increased risk profile of an insurer compared with a litigation funder, the checks and balances on insurers, legal and regulatory, are substantial compared with funders. The contrast between these two types of litigation funders is stark in terms of the relationships with their clients and the level of regulation that currently applies.

The way forward

The previous government declined the opportunity to regulate the litigation-funding industry following the full Federal Court’s decision, in Brookfield Multiplex Limited v International Litigation Funding Partners Pte Ltd (2009) 260 ALR 643, that a funded class action litigation was a managed investment scheme (MIS) subject to the licensing requirements of Chapter 7 of the Corporations Act 2001.

With a change in government and the deepening of the litigation-funding industry, it is the perfect time to reconsider the regulatory approach to litigation funding. While elements of insurance regulation could inform the regulation of litigation funders, other aspects would not be appropriate. Nevertheless, some form of tailored regulatory regime is needed to ensure there are safeguards in place to protect group members and defendants.

As Company Directors notes in its submission, this could be most effectively achieved by establishing a separate category of licence in the Corporations Act applicable to litigation funders that adequately addresses the concerns to promote certainty, avoid conflicts of interest and ensure minimum asset levels to meet adverse costs orders. Alternatively, funders could be required to obtain an Australian Financial Services Licence under the existing regime in Chapter 7 of the Corporations Act.

The bottom line

In light of increasing concerns in the business community about the effects of shareholder class actions, it would be disappointing if some form of regulation of litigation funders did not eventuate during this term of government.

However, what form that regulation takes is likely to be heavily informed by the submissions to the Productivity Commission.

Notably, in addition to the one from Company Directors, submissions have been made by Maurice Blackburn and Slater & Gordon, which between them account for around 90 per cent of all significant class-action litigation started in Australia.

Initial submissions closed on 4 November 2013. However, there will be opportunity for further comment after the release of a draft report, which is expected in April 2014. The final report to the Government is due in September 2014.

*The assistance of Cherissa Zhou in preparing this article is gratefully acknowledged.