Litigation funding regulation for consumers – not the big end of town

published Aug 26, 2013
Calls from the big end of town and their agents for regulation of litigation funding needs to be kept in perspective. They amount to a call not to enforce existing market protection laws, rather than any paternalistic sympathy for consumer protection. When litigation funders interact with prospective clients, who can retain independent, competent lawyers on the basis that the funders are able to fund the open-ended costs of both claimants and (if the case is lost) defendants, there is little room for concern. Nevertheless, regulation is needed in four key areas: capital adequacy and other issues addressed by the AFS licence regime; ensuring funders remain independent of lawyers, with claimants being owed unfettered fiduciary duties, disclosure and duties to the court; and disclosure and duties to claimants.

Calls from the big end of town and their agents for regulation of litigation funding needs to be kept in perspective. They amount to a call not to enforce existing market protection laws, rather than any paternalistic sympathy for consumer protection. 

In the eight years that IMF held an Australian Financial Services Licence under Chapter 7 of the Corporations Act (AFS licence), IMF received only one complaint from the hundreds of thousands of people and entities it funded, with that complaint being resolved in IMF’s favour by the Financial Ombudsman.

Put simply, when litigation funders interact with prospective clients, who can retain independent, competent lawyers on the basis that the funders are able to fund the open-ended costs of both claimants and (if the case is lost) defendants, there is little room for concern.  The interest in maximising the net return from the claim as efficiently as possible is an overarching interest that claimants and funders have in common.

Nevertheless, regulation is needed in four key areas: capital adequacy and other issues addressed by the AFS licence regime; ensuring funders remain independent of lawyers, with claimants being owed unfettered fiduciary duties, disclosure and duties to the court; and disclosure and duties to claimants.

Mandatory AFS licensing

IMF held an AFS licence for eight years until the High Court recently held that litigation funding was not a financial product.  In response, Corporations Amendment Regulations came into effect in July 2013 deeming litigation funding to be a financial product, but exempting litigation funding schemes from requiring an AFS licence provided the litigation funder has adequate practices in place to manage conflicts of interest. (For details of these regulations and IMF’s new policy on conflicts of interest, see New regulations on conflicts of interest).

The current regulations do not tackle other consumer protection issues that would be addressed by the licensing regime. These include prudential requirements supported by annual audits of litigation funders’ financials and ASIC’s supervisory role with powers to suspend or cancel licences and make banning orders.

AFS licensing provides a mechanism that is readily suited to dealing with the consumer protection issues raised by litigation funding, including capital adequacy and complaints handling. Moreover, requiring litigation funders to be licensed would be a simple process.

The balance of the issues not addressed by the existing conflicts management regulations and the proposed licensing regime relate to the need for retention of independent lawyers, to define funders’ overarching duties to the court and to funded claimants, and for disclosure obligations to ensure fulfilment of those duties can be enforced.

Independent lawyers

There are important policy considerations for requiring that the traditional fiduciary duties of lawyers to their clients are unfettered by any third party funding.  A primary consumer protection is that this fiduciary relationship is not tainted by commercial influences. For more on this issue, see Ensuring funders remain independent of lawyers.

Disclosure and duties to the court

Australian courts should consider the example set by the Supreme Court of Western Australia. Last year it amended its rules to compel parties to notify the court - and all other parties to the litigation - of the identity of any “interested non-party” who provides funding or other financial assistance, and who exercises control or influence over the conduct of the case. 

Insurers are included with litigation funders as “interested non-parties” when they exercise control or influence over the conduct of the case, such as by choosing the defence lawyers, providing instructions and paying for any adverse cost orders.

With knowledge of which funders and insurers may be influencing the conduct of proceedings before it, the WA Supreme Court requires funders and insurers:

  • Not to engage in misleading conduct.
     
  • To cooperate with the parties and the court on matters concerning the conduct of the case.
     
  • To use reasonable endeavours to ensure just, efficient, timely and cost-effective resolution of the real issues in dispute.

Making funders, including insurers, accountable for their involvement in the court process in the same way as the parties to the action is an obvious way to protect the interests of the courts, and those who use their services.  

Mandating disclosure of funding agreements and insurance policies would be another step in the right direction. 

This reform also has the benefit of precedent.  For 40 years, Federal Rules of Civil Procedure in the United States have mandated disclosure by defendants of any relevant insurance policy.

Cost orders directly against unsuccessful funders and insurers would add to this accountability.

Disclosure and duties to funded claimants

Requiring proper disclosure to funded claimants prior to a funding agreement being signed addresses consumer protection issues, and can be brought about by requiring funders to hold an AFS licence.

An AFS licence would require funders (prior to entering a funding agreement) to provide a Financial Services Guide and Product Disclosure Statement containing plain English explanations of the principal terms of the proposed funding, and what claimants need to know in order to assess the suitability of the funding for their needs.

Whilst litigation funding is an arm’s length contractual arrangement, funders do influence selection of the lawyers and the claims and have a role in settlements.  Accordingly, like insurers, the imposition of a duty of good faith upon litigation funders, and funded claimants alike, would provide a strong framework within which funders and funded claimants can address each other’s interests.  The regulation of insurers within a framework built on a duty of good faith has fostered that industry over centuries. It is a guiding influence that could similarly benefit both litigation funders and funded claimants.

Conclusion

Litigation funding has rightly been subjected to intense judicial and regulatory scrutiny over the past 15 years since it emerged as an important option for claimants seeking to finance their litigation.  It has gradually gained acceptance by the courts, the legal profession, policymakers, capital markets and consumers around the world.  The legal principles under which it operates have become clearer.

Viewed objectively, litigation funding is a positive development for the civil justice systems in which it operates.  It unarguably enhances access to justice; not for all perhaps but certainly for many with genuine claims who are currently excluded from the system.  It also improves the effective enforcement of the law, especially in the areas of competition and securities. Of course, these being the principal concern of the big end of town, lobbying by corporate interests to limit the scope of litigation funding should be accorded the weight it deserves.

There is always the risk, as in any industry, of rogue and unprincipled players seeking to exploit unwary litigants or undermine court process for commercial gain.  But considering the safeguards that currently exist and the proposals for appropriate regulation in certain key areas in the future (including funders’ capital adequacy and mandatory disclosure of their terms of trade), litigation funding poses little risk to the integrity of the justice system and the interests of consumers. Policymakers are right to encourage its continued development.

A version of this article was published in The Australian on 2 August 2013.