Debate over litigation funding heats up

ADLS - by Rod Vaughn | 5 June 2020

https://adls.org.nz/Story?Action=View&Story_id=127


Last week’s crackdown on litigation funders across the Tasman has turned the torch on New Zealand where pressure is mounting on the government to regulate the industry sooner rather than later.


The New Zealand Law Commission is conducting a review of the law relating to class actions and litigation funding, and it’s expected to recommend some sort of a regulatory regime. But its findings will not be delivered to government until the end of next year.


Bell Gully partner Jenny Stevens, who specialises in commercial litigation and competition law, told LawNews it might be desirable for the review to be accelerated should there be a wave of funded class actions in New Zealand as a result of Covid-19 issues.


“It is reasonable to assume funders are likely to become more active in insolvency contexts arising from Covid-19,” she says. “Ideally, we would not be caught off-guard if we see sudden growth in this area. It is work that should continue to be prioritised. It is important for us to get the policy settings right for our country.”


In Australia, where Covid-19-related litigation is becoming a major issue, litigation funders will be forced to operate under tough new oversight rules and reporting requirements in a bid to stem the flow of costly shareholder class actions.


In the past decade there has been a threefold increase in class action cases in Australia, with litigation funders receiving revenues of more than A$140 million last year and recording average profit margins of nearly 35%.


Responding to a call from industry groups to protect local companies and jobs during the Covid-19 economic crisis, Treasurer Josh Frydenberg said it had never been more important to keep companies in business.


“We want Australian businesses staying in business and focused on keeping people in jobs rather than fending off class actions by unregulated and unaccountable parties,” Frydenberg told The Australian.


“There is no reasonable basis for litigation funders to continue to be exempt from the same regulation that applies to the entities they seek to litigate against.”


The Australian revealed last year that an “explosion” in class actions funded by overseas litigation backers was threatening jobs and investment in Australia, with more than A$10 billion in claims lodged against businesses in 2018-19.


Despite shared concerns about the economic impact of Covid-19, Stevens says the development of class actions in Australia is on a very different trajectory to New Zealand and has been for several years.


“Australia has become very much like the US in its approach to class actions and the sheer volume of cases seen across a range of sectors. Undoubtedly the volume …. has, in turn, spurred on a vigorous and active litigation funding industry,” she says.


“The growth in that industry then fuels new class actions, and so it goes around. The more people you have involved in any industry, the more risk you have of some of those involved being opportunistic or unscrupulous.”


Because of the relatively recent onset of class actions in New Zealand, we may not have been exposed to “the worst of what can happen when a third party is seeking a financial return in a litigation context”.


“There is undoubtedly a risk of harm both to claimants and to those defending class actions if excessive practices take hold. There are some horror stories in Australia of multiple class actions coming out of single events, with defendants caught in the middle,” Stevens says.


“Especially at present, as widespread efforts are underway to mitigate some of the effects of Covid-19 on businesses, there is a real question as to whether you want businesses fighting class actions – or being focused on getting back up and running. New Zealand does have the opportunity to learn from what has been seen in other jurisdictions and to set good rules for funders before poor and excessive practices emerge here.”


Stevens says she fully supports the Law Commission’s review of litigation funding and class actions.


“The Law Commission’s current terms of reference are broad and should give ample opportunity for interested parties to consider the extent to which we want to regulate litigation funders, the form that regulation should take and whether we should follow Australia or go our own way.


“I agree that the regulation of funders is an area that should be carefully examined: there are no formal rules governing funding arrangements or funders themselves at present. In the context of class actions, particularly those brought on behalf of consumers, transparency around the funding arrangements is critical.”


Stevens says the presence of a funder introduces a different dynamic to both the overall conduct of the claim and, importantly, to a potential settlement. “The funder’s interest is purely in making a financial return from its investment. That will usually be at the expense of the claimant class as the funder takes a cut of what the claimant would otherwise receive.


“Of course, without the funder the claim may never have been advanced in the first place. Perhaps that ‘price’ for access to justice might be deemed acceptable to society, although that’s likely to depend on the percentage taken by the funder.”


However, Stevens points out that having a funder driving the settlement discussion means it is only about the money.


“Some claimants’ interest in a legal claim may not only be about a financial return. They may be interested in changing practices in an industry moving forward.


“They might be interested in obtaining recognition of a wrong – maybe they actually want an apology. Money is not always the only way to solve a claim but with a funder it becomes the only way. So long as all parties sitting around a table understand this, there may not be a fundamental public concern.”


Stevens says the Law Commission’s review is not about stopping funded class actions or even, necessarily, about enabling more actions. “It is about whether we need rules in place that give greater certainty around how such claims are conducted.”


The largest New Zealand-owned and operated litigation funder in this country, LPF Group, says it supports regulations that “facilitate better access to justice and ensure both funded plaintiffs and funded defendants are treated equally in the courts of New Zealand”. Chaired by former Supreme Court judge Bill Wilson QC, the company’s directors include Phil Newland, Bruce Sheppard and Michael Stiassny.


Since being formed in 2009 LPF has investigated more than 250 prospective claims and funded 26 cases in the past 10 years, only four of which have been class actions.


Executive director Jonathan Woodhams says access to litigation is an important right in any democracy, but it is uncertain, expensive and lengthy.


“As a result, it is out of reach for most ordinary New Zealanders who have suffered significant financial losses resulting from wrongdoing. These challenges mean that without litigation funding, many credible claims simply would not be able to proceed, and defendants would not be held accountable for their actions in causing losses,” he says.


“In our experience, defendants, and their insurers, are often prepared to spend significant amounts to defend their actions and will often take steps to introduce time and delay to increase costs of litigation to plaintiffs in the hope that litigation is either not pursued or settled cheaply.”

Woodhams says it’s not unusual for cases to take five years or more with costs running into many millions of dollars. As an example, he cites Mainzeal, which collapsed in 2013 owing unsecured creditors $110 million.


LPF Group financed the fight against the failed construction company’s insurers. “This case has been tested in the High Court, which found that the directors had allowed the company to trade insolvent for many years, using creditors’ funds to keep it afloat.


“The former directors were ordered to pay $36m in compensation by the High Court to the creditors for breaching their directors’ duties and allowing the company to trade recklessly. The case is now being appealed in the Court of Appeal.


“It has taken seven years to get to this point, and there is no immediate end in sight,” he says.


“Without third party funding, Mainzeal’s liquidators and unsecured creditors would not be able to afford the costs associated with the case, would not receive any compensation for their losses, and the directors would not have had their actions examined by the courts.


“We are now also seeing cases where plaintiffs have the resources available to fund their own case but would prefer to use LPF’s financial resources and experience in managing litigation.


They recognise that litigation is costly, involves risk and takes time.”


Tony Gavigan, a former Fay Richwhite executive who has driven the 12-year claim by out-of-pocket former Feltex shareholders against the company’s former directors, concurs.


Litigation funding, he says, is an access-to-justice issue and without it class actions would be all-but impossible. Giving mum and dad shareholders an avenue for legal redress provides a “compelling case” for class actions, he says.


The 3600 shareholders in Houghton v Saunders & others are claiming up to $200m for losses they say were sustained as a result of untrue statements in the offer document for Feltex’s initial public offering in 2004. The directors deny all wrongdoing; the claim, filed on 26 February 2008, is still before the courts.


Gavigan says he and his team have followed the developments in Australia with interest “and we are in no doubt there will be some appetite to follow the new regulations here”.


All about money?

Woodhams says LPF funds only claims with strong legal merit on a ‘no success, no fee’ basis.


“The inherent risks associated with litigation provide an absolute incentive to be responsible when making decisions over which cases to fund.


“It’s not about just achieving financial success. We are part of the New Zealand community. Our board and investors expect us to take on what they consider to be good cases. It cannot be about just making money.


“The last thing we want as a business is where the lawyers and the funder make money and the plaintiffs get nothing. It’s just not what we as a company and our investors believe in.”

Woodhams says about 60% of all proceeds delivered after legal fees from cases funded by LPF have gone back to plaintiffs.


He believes any regulation of litigation funding in New Zealand should have three objectives:

  • Ensuring New Zealand has a legal environment that is fair and equitable and doesn’t penalise a plaintiff because he or she is accessing justice using third party funding.

“Twice, LPF Group has been taken to the Supreme Court in challenges to its right to fund cases. This has added both time and significant cost to the deserving plaintiffs and a high degree of uncertainty around whether those who have done wrong will be held to account.


“Many of the defendants in the cases funded by LPF Group are in fact funded through liability insurance but do not face the same scrutiny, uncertainty, and legal challenges to their funding.


“There is no logic as to why litigation funding rules should not apply to both sides to facilitate access to justice and appropriate conduct of cases.”

  • Provide transparency for both plaintiffs and defendants about funding arrangements for litigation.

“There is currently a degree of uncertainty around the legal status of litigation funding in New Zealand which has resulted in third party funding becoming riskier and more expensive as funders factor in the additional risks, time, and cost in supporting a legal case.


“These additional costs act as a barrier to both funders and to plaintiffs wanting to access justice, as the threshold for funding meritorious cases is far higher than it should be.”

  • Greater clarity and enforcement around excluding lawyers from stepping into the role of funder through conditional fee or success fee type arrangements.

“It is imperative to preserve the integrity of legal advice and ensure those who want to pursue justice are not subject to conflicts of interest where lawyers have a material financial interest in a case in which they are also required to provide objective advice to plaintiffs.”


For his part, Roger Partridge, chairman and a cofounder of think-tank the New Zealand Initiative and the former chairman of Bell Gully, says he has seen no evidence that litigation funding is a problem in New Zealand that needs solving.


“Before considering further regulation of litigation funding, I would want to see a clearly articulated case that the costs to the overall welfare of New Zealanders of the status quo exceeds the benefits.


“In the absence of evidence to the contrary, there are good reasons for thinking litigation funding is a benefit to overall welfare. Litigation funding improves access to justice.”


Partridge says the cost of commercial litigation for individual litigants is a barrier to many pursuing their rights. “Litigation funding lowers that barrier by enabling litigants to finance the cost of proceedings by, in effect, mortgaging their potential recoveries in favour of the litigation funder.


“Rather than protection from litigation funders in the aftermath of Covid-19, businesses need protection from ill-considered regulation. Parliament should be addressing the root cause of the problem - regulations that are not fit for purpose - rather than regulating mechanisms used by aggrieved parties to lower the personal cost of accessing justice,” he says.


As far as BusinessNZ is concerned, there are positives and negatives associated with class actions.


Chief executive Kirk Hope says a class action allows individuals or small businesses to take action against a large entity and hold it to account.


“But class actions may also enable an interest group to pursue an agenda that is not necessarily in the interests of the national or community good. There are also positives and negatives associated with third-party funding.


“It gives ordinary individuals the ability to afford action against a large organisation that has the resources to engage expensive representation and draw out proceedings to burn off plaintiffs. But it could also be a way for wealthy interest groups to push a malign agenda.”


Given that New Zealand has less regulation of class actions and litigation funding than some other jurisdictions and because of the increase in class action lawsuits in recent years, it’s reasonable to consider developing a more detailed legislative regime, Hope says.


BusinessNZ considers such a regime should take into account principles including:

  • that the main justification for litigation funding should be in addressing the wider interests created by a given case, including pursuing justice for those to whom harm has been done;

  • that litigation funding should not be driven by the pursuit of gaining competitive advantage or by purely commercial interests;

  • that defendants have the right to know who is bringing the action against them; and

  • that any regulation of class actions and litigation funding should apply to the behaviour of both plaintiffs and defendants.

Stakeholder protection

Auckland Law School lecturer and class action researcher Nikki Chamberlain believes regulation is needed to “protect stakeholders and provide transparency and accountability”.


However, she says the extent of the regulatory requirements is up for debate.


“There are no barriers to entry into the market for litigation funders who wish to operate in New Zealand. Theoretically, without these barriers to entry, there could be more funders underwriting more claims here than in the counterfactual scenario, being a market with regulation.


“Defendants currently have certain protections available to them in relation to claims filed against them. For example, defendants can apply to strike out unmeritorious claims, seek security for costs and challenge litigation funders if there is an abuse of process.


“Of course, if corporate defendants do not have the provisioning or capital to defend litigation or meet settlement or damages awards, then it will impact on the viability of their business and, as a consequence, jobs,” Chamberlain says.


“Against this, the use of the class action device provides corporate accountability and a remedy for wrongs which may not otherwise be remedied. There is a balancing exercise to be done in weighing the competing interests at play.”


Chamberlain believes it’s unlikely the government will make regulation a top priority because of the modest volume of class actions here, compared to Australia.


Australia is planning to introduce a robust regime under which all litigation funders will have to hold a financial services licence (FSL) pursuant to the Corporations Act 2001.


This means litigation funders will have to comply with the same regulatory requirements as other financial service and product providers in Australia. Funders will have to register and will be monitored by the Australian Securities and Investment Commission.


Broadly speaking, the FSL will require litigation funders to (a) act efficiently, honestly and fairly, (b) have adequate resources available to provide their services (including financial), (c) have an appropriate level of competence and (d) have adequate risk management systems in place.


If they are classified as a ‘registered managed investment scheme’, they will also (a) need to be solvent and have positive net assets, (b) have sufficient cash resources to cover three months of expenses, (c) have significant net tangible assets, and (d) comply with the Australian Securities and Investment Commission’s audit requirements.


Chamberlain believes the FSL requirements are likely to provide a barrier to entry for small players wanting to funding class actions.


“However, there are a number of well-resourced litigation funders who will be able to meet the financial requirements to hold a FSL and, as a result, it is unclear whether the number of funded class actions will reduce in practice,” she says.


“Regardless, the requirements will mean that there is greater transparency and accountability in relation to the funders who do hold a FSL for the benefit of all other stakeholders.”


In the meantime, Justice Minister Andrew Little told LawNews he has “no predetermined outcome” for the Law Commission’s review and awaits the findings with interest.


“This is a fast-moving area and there is a lot that has changed over the last 20 years,” he says.


“There is a balance to be struck between allowing a means of access to justice and ensuring cases do not simply become a commercial proposition.”


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