The road to reform: ALRC discussion paper on class actions and litigation funders released

On 31 May 2018 the Australian Law Reform Commission (ALRC) released a discussion paper on its “Inquiry into Class Action Proceedings and Third-Party Litigation Funders” (Inquiry).  The Inquiry focuses on the impact that an increasing number of class actions and litigation funders has had on the class action regime introduced to the Federal Court of Australia 26 years ago.  As a result of that Inquiry, the ALRC has proposed several reforms to the federal class action regime in Australia.  Whilst the ALRC is not due to provide its final report to the Attorney-General until December 2018, we explore the current proposals in this article.

The full ALRC report is available here.

Shareholder class actions

There is an established network of plaintiff law firms and litigation funders in Australia which have a well-developed shareholder class action business model and new entrants are frequently emerging. The existence of Side C insurance cover, together with the current continuous disclosure regime in the Corporations Act 2001 (Cth) (the Corporations Act) and statutory provisions in relation to misleading or deceptive conduct, has been a key driver in the increased number of claims since 2006.

The impact that this is having on the availability of directors and officers liability insurance (D&O insurance) in Australia, where the current premium pool is considered to be inadequate to meet current and projected future securities class action claims, has been recognised in the ALRC's first proposal that the Australian government should commission a review of the legal and economic impact of the central causes of action in shareholder claims with regard to:

• the propensity of corporate entities to be the target of funded shareholder class actions;
• the value of the investments of shareholders of the corporate entity at the time when that entity is the target of the shareholder class action; and
• the availability and cost of D&O insurance within the Australian market.

The Corporations Act presently imposes an obligation on listed entities to notify the Australian Securities Exchange (ASX) of information required to be disclosed under ASX Listing Rule 3.1 where:

• that information is not generally available, and
• it is information that a reasonable person would expect, if it were generally available, to have a material effect on the price or value of the listed securities or interests of the entity.

The ALRC has recognised that this is a low statutory threshold.  It is an area ripe for reform, as compared with other jurisdictions, it is not necessary to prove any intent to defraud investors, or even negligence.   An inter-related issue is the role of third-party litigation funders in these types of claims as the majority of funded claims are securities class actions, with the ALRC reporting that 100% of shareholder claims filed in the Federal Court in the past 5 years received funding.   The prevalence of funding (which is in large part presently unregulated) has, amongst other challenges, driven competing class actions which has an adverse impact on D&O insurance.   These matters are the subject of further recommended reforms considered below.

Regulation of litigation funders

The ALRC has proposed a litigation funding licensing regime in Australia.  Specifically, the ALRC proposes that the Corporations Act be amended so that litigation funders are required to obtain and maintain a litigation funding licence to operate in Australia.  Under this proposed regime, the ALRC envisages that a litigation funder would be subject to obligations similar to those imposed under the current Australian Financial Services Licence (AFSL) regime.  In particular, a litigation funder would be required to:

• do all things necessary to ensure that their services are provided efficiently, honestly and fairly;
• ensure all communications with potential or actual class members are clear, honest and accurate;
• have adequate arrangements for managing conflicts of interest;
• have sufficient resources (including financial resources);
• have adequate risk management systems;
• have a compliant dispute resolution system; and
• be audited annually.

In terms of the minimum requirements that should apply for obtaining a litigation funding licence, the ALRC considered both the existing requirements for an AFSL and entry into the legal profession.  The ALRC left the issue open for submissions by relevant stakeholders but indicated (unsurprisingly) that at a minimum a licensee would need the financial skills to operate a funding business and the legal skills to understand civil litigation.

The ALRC also left open for submission the question of proposed minimum financial requirements for litigation funders but suggested that prudential regulation would be inappropriate given the size of the Australian market and that foreign funders should be exempt from Australian requirements provided they meet comparable requirements in their home jurisdiction.

Conflicts of interest

A considerable portion of the ALRC report is devoted to identifying the sources of possible conflicts of interest in class action proceedings and possible reform proposals.  It was noted that while most funding agreements make it clear that solicitors represent class members, the often intimate level of involvement from funders in these types of claims can give rise to conflicts of interest and/or the perception of such conflicts.  Concern was expressed that unmanaged conflicts can undermine the integrity of class actions and the civil justice system more broadly.

The ALRC has identified a number of proposals to address this issue, including:

• the development of specialist accreditation for solicitors in class action law and practice including ongoing education regarding conflicts of interest;
• prohibiting law firms from having any financial interests in a litigation funder that is funding the same matters in which law firm is acting;
• requiring disclosure of third-party funding in any dispute resolution proceedings; and
• requiring notices provided to potential class members to clearly describe the obligation of legal representatives and litigation funders to avoid and manage conflicts of interest.

If the proposals made by the ALRC with respect to licensing are not adopted, the ALRC also recommended that instead ASIC could be given responsibility (via annual reporting) of monitoring the management of conflicts pursuant to ASIC Regulatory Guide 248[1].

Competing class actions

There are many examples of competing class actions in Australia, particularly in the shareholder and product liability space.  The ALRC observes that this increases cost and delay for both prospective class members and defendants.

The ALRC discussion paper considers the competing views expressed about the merits of closed and open class actions.  This dovetailed into a discussion about more recent judicial developments, including the Money Max[2] decision, where the courts have been prepared to make common fund orders allowing litigation funders to charge a funding commission to an entire class, not just those who had signed the funding agreement.  The ALRC further observed that there is some evidence that the Money Max decision has encouraged greater use of open class proceedings.[3]  It is anticipated that this will reduce the prospect of competing class actions, though there is at this stage no conclusive evidence that this has occurred.

The ALRC observes that unlike the United States and Canada where detailed certification processes have been adopted, there is no mechanism under the Federal Court of Australia Act 1976 (Cth) (FCA Act) to deal with competing class actions.  Notwithstanding, the courts have been prepared to apply more general provisions to address competing class actions, as evidenced by the decision of his Honour Justice Lee in GetSwift[4], delivered in late May 2018, where a determination was made to allow one class action to proceed whilst two competing class actions were stayed.

In order to address the issue of competing class actions, the ALRC proposes that Part IVA of the FCA Act is amended to ensure that:

• all class actions are initiated as open class actions; and
• the courts only allow one action to progress with competing class actions to be stayed other than in exceptional circumstances.

It is also proposed that the Class Actions Practice Note (GPN-CA) is amended to provide a further case management procedure for competing class actions, to ensure that issues surrounding competing classes are front-loaded and resolved quickly to enable a single class action proceeding can progress.

Commission rates and legal fees

Access to justice is not just the perpetual war cry of the plaintiff firm and litigation funder. It remains a cornerstone principle for class actions in Australia.  However, the ALRC has placed considerable focus in its Inquiry on what access to justice means in practice, with particular focus on solicitor fee arrangements and funder commission rates.  In many respects that is unsurprising given the significant time spent on these issues of late by the judiciary.

The ALRC considers that one of the key limitations of the current class action system is the gap in services available for mid-sized class actions.  It is contended that this gap could be filled, in part, by permitting solicitors to enter into contingency fee arrangements, perhaps subject to statutory caps, and subject to the Court being given express power to reject, set or amend contingency fees.  One of the rationales behind this proposal is to promote competition between the plaintiff bar and litigation funders so as to create a "more level playing field".  The ALRC observed that the current prohibition on contingency fees has stifled competition, making Australia a very attractive jurisdiction for litigation funding.

Recent judicial experience shows that group members often receive less than 50% of any final settlement sum.  It is considered that the introduction of contingency fees would better align the interests of the solicitors and group members because there would be a common interest in obtaining an early return.  The counter-argument, acknowledged by the Inquiry, is that contingency fees could foster unmeritorious claims.  Having weighed these competing views, the ALRC has ultimately proposed that solicitors acting for the representative plaintiff in class actions should be permitted to enter into contingency fee agreements, subject to certain limitations including that the solicitors must indemnify the representative class members against adverse costs order, and the action must not also have a litigation funder charging on a contingent basis. 

In addition, the ALRC proposes that the courts be given broad and express power to reject, set and vary contingency fee arrangements and commission rates.  Whilst there is a view that this power is already vested in the courts, through more general provisions such as s 33V(2) of the FCA Act, there remains a tension between this apparent source of authority and upholding the contractual bargains entered into by interested parties from the plaintiff camp.  The proposed express powers would avoid that tension.

Settlement approval and distribution

The question of settlement approval and distribution has also been considered by the Inquiry, with particular attention given to the assessment of solicitors' costs, establishing criteria to assess proposed settlements or discontinuances and whether settlements should be permitted to remain confidential.

The ALRC considers there is sufficient judicial guidance such that it is unnecessary to prescribe, through legislation, the criteria that a court must have regard to when approving class action settlements.  However, the ALRC also observed that there remain difficulties in how the developed principles should be applied.  In that regard, it was noted that interested parties and judges might subconsciously view other cases as an "anchor" to justify a particular outcome as reasonable, particularly in relation to funder commissions and legal fees, when in fact each case does turn on its own facts. The courts have noted that care must particularly be taken where the amounts recoverable in complex litigation are comparatively low, as this could raise the prospect of a settlement being in the interests of the funder and solicitors, but not necessarily the class members.  It follows that the ALRC's views on commission rates and legal fees may have a direct impact on the factors that will be considered in approving class action settlements in the future.

Whilst it has provided some discussion on the questions of how settlement sums should be distributed, and whether class action settlements should remain confidential, the ALRC has not formed a definitive view on these topics at this stage.

Road to reform?

The claims activity witnessed by corporate Australia and D&O insurers provides clear impetus for reform, with several recommendations made by the ALRC likely to be welcomed by many – particularly in respect of shareholder class actions.

Intervention by the legislature is likely to be particularly favourably received in relation to some matters which, left to judicial discretion, can lead to inconsistent and anomalous outcomes (for example, in how competing class actions are treated, or how commission rates of third party funders are set in court approval of settlements). 

Of course, the ALRC's report is but one step along the way to reform.  It remains to be seen how long it will take for the proposals to be adopted (if at all) following the further consultation process (submissions now open until 30 July 2018) and the issue of the ALRC's final report which is expected in late December 2018.

[1] This requires funders to have in place and follow procedures to address actual or perceived conflicts of interest.

[2] Money Max Int Pty Ltd (Trustee) v QBE Insurance Group Limited [2016] FCAFC 148.

[3] ALRC Discussion Paper 85 at [6.18].

[4] Perera v GetSwift Limited [2018] FCA 732.