Litigation Funding under Inquiry

Inquiry into Litigation Funding

The outgoing Attorney General’s announcement on 15 December that the third party funding industry is to be subject to an inquiry by the Australian Law Reform Commission (ALRC) has caught many by surprise, at least in terms of timing.

Commissions, Royal Commissions and Inquiries seem to be a feature of modern day life, although generally the announcements tend to follow a high profile trigger event which leads to a chorus demanding change.  Funding is neither particularly high profile nor have there been any obvious trigger events in recent months.  The AG’s Terms of Reference refer to the “increased prevalence of class action proceedings”, but as Federal Court Justice Murphy has highlighted in a recent speech:

There is no evidence in Australia of any practice of commencing unmeritorious cases in an attempt to blackmail the defendant into a nuisance value settlement, nor any coupon settlements. Justice Jonathan Beach recently said there has been no “Americanisation” of the Australian class action system, and very few spurious or unmeritorious claims.  Experience shows that the great majority of cases are brought in relation to alleged serious civil wrongs claiming substantial damages, and the claims appear to have merit.”

Instead the announcement seems best understood in a wider context.  The funding industry in Australia is essentially unregulated, falling as it does midway between the legal sector (regulated by State professional bodies) and the finance sector (regulated by ASIC, with help from APRA and the ACCC). The Victorian Law Reform Commission is currently conducting a review and in 2014, the Productivity Commission conducted a nation-wide review of access to justice arrangements.  The 2014 report concluded:

1.   Arguments that litigation funding facilitates unmeritorious claims and was exploitative of plaintiffs were rejected; the Commission found no evidence of current or likely future problems, or that the courts would not be able to address problems if they emerge.

2.   Concerns around the size of funding fees were also considered, but the Commission concluded “current commissions charged by funders appear commensurate to the services offered”.

3.   The Courts played an active role in overseeing litigation funding and are well equipped to deal with potential risks, such that new regulation was not generally required.

4.   However, there was a risk that certain funders might not hold adequate capital relative to their financial obligations, and the Commission recommended that funders be required to meet minimum capital adequacy standards as a condition of holding a financial services licence.

This final recommendation was not acted on, despite being supported by IMF, amongst others.

In any event, IMF welcomes the announcement and intends, of course, to fully support the ALRC’s work. The litigation funding industry will only continue to grow if it achieves public and professional acceptance, which in turn results from years of bringing meritorious cases, helping clients to achieve just outcomes, supporting the integrity of the court process, and doing so in an ethical, fair and transparent manner.  By these yardsticks, one could argue the funding industry in 2017/8 has come a long way since even the 2014 review – an example being the increasing use of funding by solvent corporates as a tool of risk management.  However, if the Inquiry identifies that some industry participants are not meeting basic prudential standards, then appropriate regulations should be introduced, and requiring funders to hold a minimum level of capital on their balance sheets (an approach recently adopted by Singapore) seems a sensible if overdue measure.

A more difficult issue for the Inquiry to deal with is “the desirability of statutory caps on the proportion of settlements or damages awards”. Australian class action jurisprudence has already produced a solution to this issue, in the form of “common fund orders” whereby the court can determine a fair and reasonable division of proceeds.  However, the difficulty of mandatory, state-imposed price caps is that funders, like insurers, set their commission rates on a portfolio basis and not solely by reference to the risk of the particular case being funded. In other words, a major international funder like IMF needs to ensure that the revenue from the successful cases in its portfolio is sufficient to meet the costs of its unsuccessful cases, and of course its general operating costs.  That is a highly complex commercial exercise.

One final comment: for the Inquiry to be fair and balanced, it must consider the costs of litigation (for both plaintiffs and defendants) in light of the root causes of disputes.  Litigation funding would not exist without breaches of the law. If laws cannot be effectively enforced, then the level of wrongdoing will only increase.  The history of litigation funding in Australia demonstrates that the enforcement of civil justice has been materially improved by the involvement of litigation funders; to give one example, 92% of funded class actions settle, compared to 49% of unfunded. Cutting down on the effectiveness of that involvement, at a time when legal aid has been slashed, may perversely cause far more damage than the perceived risks the ALRC is being asked to address.