Legal update - litigation funding: Containing the genie

27/08/2010

The role of private litigation funding has become a live issue, with collective redress systems being proposed throughout Europe. Robert Hammesfahr explains why fears of abuse and soaring costs may be unfounded.

More and more countries are introducing instruments of class and representative actions to their civil justice systems, often termed ‘collective redress’ in Europe. Italy and Poland have recently enacted new legislation, and a draft law on collective redress is on the table in Belgium. Similar projects are being considered by the European Commission.

In the wake of this development, the role of private litigation funding is a live issue. Private litigation funding means that litigation is financed by a commercial third party. Funding is based on an assessment of the outcome of the litigation and linked to a contractual share of the recovery from it.

This form of funding is an emerging global phenomenon that is applied in jurisdictions as diverse as the US, Canada, Australia, Ireland, Germany and the Netherlands. And a conference organised in May 2010 by Oxford University’s Centre for Socio-Legal Studies discussed recent insights from academic research and implications for companies and legislators.

Many legislators perceive private litigation funding to be a necessary corollary of the political goal of facilitating access to justice by means of instruments of collective redress. The enabling of such funding is further encouraged by the absence of public financing, given growing levels of state debts. As a result, litigation funding has emerged as a commercial phenomenon with a clear growth perspective.

In the US, it mainly occurs in the form of contingency fees â that is to say, payment of a larger element in the event of success, explicitly linked to the size of the recovery. The US experience suggests that private litigation funding could be the thin end of the wedge â leading towards higher tort costs, conflicts of interest and unmeritorious litigation in Europe too.

By contrast, a comparative analysis of litigation funding practices as discussed at the conference suggests that, outside the US, experiences so far are more benign and do not warrant an out-of-hand rejection of the approach. Indeed, if adequately regulated, litigation funding could serve to undermine arguments of US contingency fee lawyers seeking to expand US-style class action remedies in other jurisdictions.

Current funding landscape

In considering whether the ‘genie’ of litigation funding can indeed be contained, the following facts indicate that the lid has not yet come off the bottle outside of the US. First, there are various models for litigation funding with varying degrees of involvement by the provider, and there is no single funding product. None of these models has so far proven to be conducive to abuse or to create conflicts of interest.

Second, under current funding models, the threshold for a case being accepted by commercial litigation funders is relatively high â £100 000 or higher â which indicates that the product is primarily available for commercial cases involving corporate clients. Thus, litigation funding has increased access to justice, but only for SMEs and corporate clients.

This sits in contrast to the ‘target audience’ of the ongoing political debate and legislative effort, especially at EU level, which is to facilitate access to justice for general consumers and private parties that have suffered damage â for example, as a result of violation of competition laws. For the same reason, current litigation funding models do not present significant consumer protection concerns.

In addition, demand for commercial litigation funding in the US has been low because of the widespread use of contingency fee systems â which are banned almost throughout Europe and should remain so to prevent abuse.

Academic research so far suggests that the availability of litigation funding has contributed to expanding class actions in Australia and probably Canada â and, to some limited extent, individual actions but not class claims by SMEs in the UK. However, more systematic research will be needed to examine the impact of third party litigation financing within the EU.

Finally, from a safeguards point of view, analysis of current funding models shows that some have built-in safeguards â for example, the model used by litigation funders in the UK weeds out bad or frivolous cases as they are not commercially viable for the funder.

Insurance implications

From an insurance point of view, private litigation funding is interesting in the context of insurance for litigation costs and various providers already offer related products. Third-party financing could significantly change liability dynamics: as cases are pre-vetted and ‘bad’ cases discarded as commercially unviable â which could encourage the consequence of swift out-of-court settlement â those cases supported by commercial litigation funders will bear a mark of quality.

The broader introduction of instruments of collective redress in combination with the enabling of private litigation funding could, therefore, open new business perspectives for insurance. In the UK, Lord Justice Jackson’s December 2009 analysis of civil litigation costs in England and Wales has already recommended revisiting the issue of statutory regulation of third party funders and the introduction of a voluntary code for all litigation funders.

There is broad agreement among both the providers of funding and other stakeholders, such as consumer or business organisations, that adequate regulation of litigation funding is desirable to prevent abuse and conflicts of interest. For example, Lord Justice Jackson’s proposed package of reforms would, if implemented, give claimants a financial interest in the level of costs that are being incurred on their behalf, and would significantly reduce the costs payable to claimant solicitors by liability insurers.

From a legislative point of view, if properly regulated by the EU, private litigation funding has the potential to help promote the political goal of enhancing access to justice without hurting the broad consensus that abusive and unmeritorious claims must be prevented. For example, a cap on recoverable legal fees may effectively hedge against conflicts of interest between the claimant and their litigation funder.

Regulatory safeguards

In terms of safeguards for collective actions, the European consensus is that ‘opt-out’ rules carry an inherent risk of abuse and that an ‘opt-in’ approach to collective actions is, a priori, preferable. In this context, some litigation funders argue that they need to be able to carry out a risk assessment on whether to make a potential investment. This requires certainty over the number of members of a class from whom they can recover their costs and fees. The funders fear that without some certainty on the scope of claims included, there will be a risk of claims getting a free ride based upon the litigation that is financed.

The debate has been over abusive ‘opt-out’ US-style class actions â the Australian variation â which authorises a closed class of individuals that opt-in, settlement based upon minimum levels of opt-in claims, and other alternatives. For example, court-approved inclusive settlements agreed by all the defendants could provide businesses with the advantage of comprehensive settlements with finality. Judicial review could provide important safeguards to hedge against the problem of so-called claimants seeking a free ride remedy while meeting the legitimate concerns of the third party litigation funders.

What is clear is that the EU redress remedy is only now emerging. For this reason, insurers should monitor these regulatory challenges closely and participate actively in the ongoing dialogue in order to support governments and legislators in their efforts to introduce balanced instruments of collective redress, including adequate checks on litigation funding.

Robert Hammesfahr is managing director and executive claims expert at Swiss Re

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