Call to put interests of litigation funders’ clients before shareholders

LITIGATION funders could have to give priority to the interests of their clients rather than their shareholders.

LITIGATION funders would have to give priority to the interests of their clients rather than their shareholders under plans for a regulatory overhaul that have been presented to the federal ­government.

If enacted, the scheme would bring the ethical obligations of funders closer to those of solicitors while introducing changes that would prevent funders controlling the conduct of court cases.

They would be banned from issuing instructions to solicitors in funded cases, would be required to accept the appointment of a court-approved claimants’ representative and would need to tell their clients about any contractual or other relationship with the lawyers running funded cases.

Litigation funders and instructing law firms would be banned from having an ownership stake in each other, or from having any other joint economic interest in the outcome of litigation.

These changes are part of an options paper prepared by the US Chamber Institute for Legal ­Reform that calls for a special licensing regime for litigation funders that would be enforced by the Australian Securities & Investments Commission.

The ILR, which is affiliated with the US Chamber of Commerce, believes litigation funders in this country are operating with minimal regulatory oversight and this means there is scope for “fly-by-night” operators to finance class actions against the business community.

The ILR’s proposals, prepared by partners at Clayton Utz, have been provided to the office of ­Attorney-General George Brandis and are expected to be considered as part of a crackdown on litigation funders and what Senator Brandis has called “opportunistic class actions”.

This comes as figures compiled by King & Wood Mallesons show five foreign litigation funding companies are active in Australia along with six Australian funders.

Mallesons’ figures show that Australian companies have paid out $1113.1 million to settle securities class actions in the 22 years in which this form of litigation has been available.

Insurers say the growing legal risk to business in the past decade has led some companies to double their annual claims limits under policies that cover payouts from class actions. The risk of litigation is also behind the campaign by the Australian Institute of Company Directors to insert a new defence in the Corporations Act to protect “honest and reasonable directors”.

Senator Brandis is expected to appoint an expert panel to assess the ILR’s proposals along with other recommendations on the regulation of litigation funders that were handed to the government last Friday by the ­Productivity Commission. Those recommendations, which have not yet been made public, are in the Productivity Commission’s final report on ­Access to Justice.

The ILR’s plan for a licensing regime is broadly in line with the commission’s draft report but the ILR’s scheme goes further.

As well as seeking to end the control litigation funders have over court cases, it would require funders to meet minimum ­standards of disclosure in the funding agreements with their ­clients.

“Litigation funders exert a significant degree of control over strategic decisions concerning the litigation process and any settlement,” the ILR’s paper says.

“This results in the claimants’ interests being relegated to ­secondary status behind the litigation funder’s profit objective, weakens the role of legal counsel and calls into question who the lawyer’s ‘client’ is.

“As the claimant’s lawyer ­accedes to the control asserted by litigation funders, no one remains to protect the claimant’s interests,” the ILR’s paper says.

The conditions the ILR believes should be included in the licensing regime include:

Prudential supervision to ensure funders have sufficient capital to satisfy their financial obligations, including potential liabilities associated with an unsuccessful case.

Each funder would be required to maintain liquid capital reserves equal to at least twice the amount of its investments in litigation.

ASIC would conduct annual audits to ensure each licensed funder is capable of paying legal fees, disbursements and any adverse costs order.

Funders would need to report breaches and potential breaches of licence conditions to ASIC within 10 days.

The ILR’s options paper says litigation funding has been growing ever since the High Court’s 2006 ruling in Campbells Cash and Carry v Fostif ­endorsed third-party investments in litigation and third-party control of litigation.

“The principal area of growth has been the prosecution of complex torts or business disputes and class actions,” the options paper says.

“Despite this shift in the litigation landscape, the Australian government has taken a largely hands-off approach to the regulation of the (litigation funding) industry.”

The options paper says litigation funders have been ­exempted from the requirement to hold a financial services ­licence, and they are not bound by the professional rules that govern lawyers in their dealings with the courts.