By Jing Yang*
Since the first involvement of a third-party litigation financier in a class action in Australia in 2001, Third-Party Litigation Financing (“TPLF”) has enjoyed significant growth in Australia, and is becoming one of the “biggest and most influential trends in civil justice.” TPLF is where a third-party financier finances the lawsuit in return for a profit. The funder could be a bank, hedge fund, insurance company, or some other entity or individual. For plaintiffs, the transaction works as a non-recourse loan: if the plaintiff wins, the financier gets a percentage of the settlement or remedies; if the plaintiff loses the lawsuit, the financier eats up the losses. At the same time, defendants who are constantly sued could pay a pre-determined “insurance premium” to the financiers to ward off future litigation.
TPLF has become a major source of financing in class action litigation in Australia, primarily because lawyers are not allowed to undertake litigation on a contingent fee basis, and the loser has to pay all the costs. In contrast, in the United States the contingent fee regime and the fact that each side pays its own costs makes TPLF less attractive in class action litigation. Nevertheless, TPLF is emerging in the U.S. and has stirred a lot of discussion.
People have mixed feelings towards the idea that a lawsuit is not only a means to justice, but also an investment project. Some think that TPLF helps level the playing field between small plaintiffs and powerful defendants and therefore facilitate access to justice, while others argue that TPLF is “a cancerous growth on our civil justice system” that encourages more lawsuits and “turns our courts into profit centers.”
Today in Australia, TPLF is largely a matter of private contract, and judicial intervention comes in only when there is an abuse of process. Although it is hard to tell what counts as “an abuse of process” absent court instruction, it is clear that the high transaction costs imposed upon class members (on average thirty-one percent of recoveries) has been regarded as fair and reasonable given the risks inherent to the non-recourse loan scheme.
This note looks into the practice of TPLF in Australia, discusses concerns around this industry from an empirical perspective, summarizes the recent development in regulation, and suggests that a qualified free-market system is likely the future landscape of this industry.
General Concerns and the Experience in Australia
There is consensus that TPLF removes the economic disincentive for individuals and lawyers to pursue meritorious claim, while opponents argue that this advantage comes with substantial price.
Lawsuit Abuse Argument
First is the lawsuit abuse argument. Opponents argue that TPLF encourages non-meritorious claims, and thus facilitates access to lawsuits instead of justice. This is deemed to be particularly troublesome in class action lawsuits because the defendant faces larger exposure and often is compelled to settle rather than seek adjudication on the merits. Also, there is a concern that because plaintiffs have to pay a financier out of the proceeds of the recovery, the amount of the financing sets the “floor” for acceptable settlement offers. In this situation, the plaintiff has the incentive to reject what might otherwise be a fair settlement offer and hold out for a larger sum of money, impeding the resolution of the case.
However, Australia’s experience with TPLF lends gains little support to this argument. Since third-party financiers entered the Australia class action litigation market in 2001, they have funded 116 out of 355 (thirty-tree percent) class actions. Among all the players, IMF Bentham Ltd Group has taken up more than one-third of the market in Australia. To be clear, TPLF did not spark a dramatic rise in class action litigation in Australia. From 1992 to 2000, a total of 125 class actions were filed. While from 2001 to 2009, 130 class actions were filed. As to the duration of the settled class actions, there is no particular trend either before or after 2001, and the average is 978 days.
Further, there is no evidence that the cases supported by third-party financiers have been frivolous. Indeed, the repeat players are sophisticated investors, and they are unlikely to invest in a lawsuit unless they see some likelihood of success. The financiers are engaged in due diligence before making an investment decision, and the legal experience, expertise, and risk aversion of these financiers can serve to prevent frivolous claims rather than facilitate them.
Agency Cost Issue
Second is the agency cost concern. When a third-party financier has conflicting interests with the plaintiffs, which can happen frequently, their desired control over the case can arguably create loyalty and confidentiality issues which damages the lawyers’ fiduciary duty to their client. This problem is exacerbated in class action lawsuits where lawyers other than the plaintiffs are driving the case, and the plaintiffs who have monetary interests at stake have no incentive to monitor the lawyers, leaving the lawyers’ actions unchecked.
In 2006, the High Court in Australia held by a majority that the fact that the third-party financier exercised a significant level of control over the litigation proceeding was neither contrary to public policy nor an abuse of process. The majority based its decision on the rationale that the crimes and torts of maintenance and champerty had been abolished, and the only question was whether the agreement was enforceable under contract law. Since then, the financiers have been exercising substantial strategic and advisory roles in the lawsuits. For instance, third-party litigation financiers in Australia generally reserve the right to withdraw funding unilaterally at any time, and they often advise the plaintiff on counsel selection. Also, they generally require that they be apprised of and consulted regarding settlement proposals, with some companies going so far as to require the plaintiff to obtain the funder’s consent before settling the case.
Another conflict of interest issue arises when the Australian courts converted the statutory “opt-out” scheme to a de facto “opt-in” scheme in order to prevent free-riding that would harm the financiers’ interests. Under this scheme, the person who suffers relevant damages and thus could have been entitled to compensation in the statutory “opt-out” class is now not entitled to shares in the class proceedings if the person has not entered into an agreement with the financier. This scheme, while at first glance would encourage class members to join in the class actions, ended up breaking down class parties and generating many satellite litigations and appeals. At the same time, the financiers who were supposed to be benefitting from the scheme now must expend more effort and costs to identify and sign-up eligible persons to join the class, all while they are facing competition from other financiers.
Regulatory and Judicial Response to TPLF
In general, Australia adopts a relatively liberal approach towards TPLF. The Australian Securities & Investments Commission (ASIC), which regulates financial and credit service providers, exerts minimal oversight over financiers. Currently, litigation financiers are exempted from licensing requirements for financial services and credit providers, and are not part of the “managed investment schemes.” The only requirement is to properly manage conflicts of interest. Indeed, the Australian regulator is highly dependent upon the ethics and expertise of the financiers and law firms, as well as judicial scrutiny. In 2013, ASIC issued a Regulatory Guide and identified several stages where conflicts can arise.
The first stage is where the financier and the law firm have a pre-existing commercial relationship even before a class representative is identified, and therefore the agreement between them would discriminate against the interests of the class. In Bolitho v Banksia Securities Limited (No 4), the court disqualified lawyers from representing the class based on the fact that the lawyers and their family members were major shareholders in the litigation financier that was underwriting the proceedings, and there were no adequate measures in place to address any conflicts that might arise. In practice, however, most litigation financing agreements are subject to review and informed consent by the class members, and therefore improper collusion between the financier and the law firm can be avoided to a certain extent.
The second point of tension is when the law firms and financiers reach out to and engage with potential class members to enter retainer and funding agreements under the de facto “opt-in” scheme. They are tempted to exaggerate the claims’ prospective relief or to play down the prospective fee. In Bonham v Iluka Resources Ltd, in order to recruit class members, the law firm issued a media release detailing the funding they had secured, and the court found that the alleged claim amounted to no more than mere speculation and the statements created false and misleading impressions. In Modtech Engineering Pty Ltd v GPT Management Holding Ltd, the court stepped in where the class law firm’s estimation of its professional fees in its initial retainer agreement was three times less than the actual fees presented to the court for approval at the time of settlement. ASIC recommends that the recruiting process be overseen by senior management to prevent misleading marketing in respect of significant features, risks, and returns. Specifically, prospective members must be supplied with information that will assist them to understand how the amount they might receive is subject to deduction of law firm’s fees and the financier’s success fee.
Third, the financier’s fee might become a source of conflict. Financier’s fees are generally approved by the court subject to an examination of “the nature of the proceedings, the risk (legal, factual, and commercial) of the specific litigation, competition between funders for the right to fund the litigation, negotiations with solicitors about the terms on which the funding will be advanced and the nature and composition of the overall business of the litigation funder.” Moreover, the fees are not subject to the control on usurious interest imposed by the National Consumer Credit Code.
Fourth, the financier’s control over the proceedings and settlement decisions. ASIC notes that to the extent that financiers and class members each want to minimize the legal costs, their interests align. However, in the event of conflicts over litigation strategy, the class members’ instructions shall prevail. Arguably, this rarely arises because class representatives will normally give deference to the expertise of the financiers, especially in those proceedings where the class representatives have minimal stakes in the lawsuits. When settlement is sought, it has to go through court approval, and the oversight by the court tends to mitigate the risk of cheap settlements that are the result of collusion between the financier and the law firm. The courts will not approve a proposed settlement if they think that the settlement involves an unfair compromise of some members’ claims for the benefit of others. On the other hand, the court will likely approve a settlement distribution scheme incorporating a methodology in which compensation for different categories of class members differ according to the harm suffered and the risks.
In the class action context, TPLF helps to fulfil the capital requirement for the collective redress of justice, and in return gets a valuable investment opportunity. Aside from the restrictions on contingent fees and “losers pay all” scheme, Australia’s liberal approach to TPLF has created an environment that has allowed litigation funding to flourish. Similar to contingent fee arrangements, TPLF has raised numerous concerns over lawsuit abuse and conflicts of interest issues. While there is no evidence that unmeritorious class actions are being pursued by financiers and law firms, and the free market system seems capable of ensuring fair and reasonable financing agreements, the potential conflicts of interest that can and have arisen during class action proceedings call for regulatory intervention and judicial supervision, potentially starting from an early stage of the litigation. At the very least, there should be some guidance as to what information is required to be disclosed and communicated among financiers, law firms, and the class members, and when in the proceedings it should be done.
*Jing Yang is a J.D. Candidate at Cornell Law School where she is an associate of the Cornell International Law Journal. Jing holds a Bachelor’s degree from Renmin University of China, and a Masters in Industrial and Labor Relations from Cornell University.
 Vince Morabito, An Empirical Study of Australia’s Class Action Regimes, Fifth Report 13–14 (July 2017).
 Jasminka Kalajdzic et al., Justice for Profit: A Comparative Analysis of Australian, Canadian and U.S. Third Party Litigation Funding, 61 Am. J. Comp. L. 93, 147 (2013).
 See Lisa Bench Nieuwveld & Victoria Shannon, Third-Party Funding In International Arbitration 4–11 (2012). There are other types of third-party financing, such as lawyer lending, assignment, or insurance covering legal expenses. This Note limits its discussion, however, to third-party financing provided on a non-recourse basis.
 Deborah Hensler, The Future of Mass Litigation, 79 Geo. Wash. L. Rev. 306, 322 (2011).
 See Kalajdzic, supra note 2, at 97.
 Lisa A. Rickard, This Is Casino Litigation, Where We All Lose, N.Y. Times (May 27, 2016), https://www.nytimes.com/roomfordebate/2016/05/27/the-ethics-of-investing-in-anothers-lawsuit/this-is-casino-litigation-where-we-all-lose.
 See Kalajdzic, supra note 2, at 109.
 See infra note 34, at 34.
 See Kalajdzic, supra note 2, at 100.
 John Beisner et al., Selling Lawsuits, Buying Trouble–Third Party Litigation Funding in the United States, U.S. Chamber Institute for Legal Reform (Oct. 2009).
 Id. at 4.
 Id. at 7.
 Morabito, supra note 1, at 22–24.
 Id. at 23.
 Id. at 34.
 Id. at 22.
 Id. at 31.
 See Kalajdzic, supra note 2, at 142.
 Morabito, supra note 1, at 7–9.
 Id. at 9.
 Campbells Cash & Carry Pty Ltd v Fostif Pty Ltd  229 CLR 386 (Austl).
 Kalajdzic, supra note 2, at 119.
 Vicki Waye, Conflicts of Interest between Claimholders, Lawyers and Litigation Entrepreneurs, 19 Bond L. Rev. 223 (2007).
 Vicki Waye & Vince Morabito, When Pragmatism Leads to Unintended Consequences: a Critique of Australia’s Unique Closed Class Regime, 18 Theoretical Inquiries in Law (forthcoming 2017).
 Id. at 4.
 See Kalajdzic, supra note 2, at 103.
 See Corporations Regulations 2001 (Cth), Regs 5C.11.01; 7.1.06 (2A); 7.1.06(2B); 7.6.01AB; 7.8.26; 7.9.98A.
 Vicki Waye & Vince Morabito, Financial Arrangements With Litigation Funders and Law Firms in Australian Class Actions, in Litigation, Costs, Funding, and Behaviour 155, 195 (Willem H. van Boom, 2017).
 ASIC, Regulatory Guide 248, Litigation Schemes and Proof of Debt Schemes: Managing Conflicts of Interest (2013) (hereinafter RG).
 See Corporations Regulations 2001 (Cth), Regs 5C.11.01; 7.1.06 (2A); 7.1.06(2B); 7.6.01AB; 7.8.26; 7.9.98A.
  VSC 582 (Austl.).
 See Waye & Morabito, supra note 39, at 176.
 See ASIC RG 248.14(a).
 Bonham v Iluka Resources Ltd  FCA 713 (Austl.).
 Modtech Engineering Pty Ltd v GPT Management Holding Ltd  FCA 626 (Austl.).
 RG 248.64–68.
 RG 248.54–55.
 See Waye & Morabito, supra note 39, at 180.
 ASIC v Richard  FCAFA 89 (Austl.).
 Corporations Regulations 2001 (Cth), Reg 7.1.06 (2A) & (2B).
 RG 248.71 (c).
 See Waye & Morabito, supra note 39, at 189.
 See, e.g., Australian Securities and Investments Commission v Richards  FCAFC 89 (Austl.).
 See, e.g., Collin v Aspen Pharmacare Australian Pty Ltd  FCA 1336 (Austl.).
 See Waye & Morabito, supra note 39, at 156.