European Parliament to debate new rules on litigation funding

The European Parliament's Legal Affairs Committee wants to create a set of rules regulating third party litigation funding (TPF) in the EU. On 15 June, it published a draft report (PDF/238 KB) with recommendations for the European Commission. The draft is currently being examined by the Economic Affairs Committee and will be discussed in the plenary session of the Parliament in November. It also includes a proposal for a directive on responsible private funding of litigation. Should the plenary adopt the draft report, it would be forwarded to the European Commission to prepare a proposal for a directive.

Draft highlights risks of litigation funding

The advantages of TPF include that it improves access to justice, for example by enabling consumers to enforce their rights without being exposed to the risk of high litigation costs. The draft report recognises this important and useful function of TPF.

TPF is a business model in which an investor assumes the legal costs of a party involved in a dispute. In most cases, a contingency fee is agreed in return, which the litigation funder receives if the party it finances wins or if a settlement is reached. However, litigation funders are not themselves parties to the court proceedings. They pursue an economic, but not a legal, interest in the proceedings they finance. The Committee on Legal Affairs said that the market for TPF was growing rapidly in the EU and bases this assessment on the findings of the European Parliamentary Research Service. The increasing popularity of collective actions in the EU is one of the reasons given for this growth.

The EU-level findings echo developments in recent years in the UK, where the TPF market has grown rapidly and is now well-established, playing an important part in the funding of a wide variety of commercial claims and collective actions.

However, the draft report expresses concern about litigation funders in the EU making a profit at the expense of litigants, such as consumers. The draft aims to "regulate third party litigation funding before it gains traction in all of our Member States". The draft describes TPF as a “profit-making enterprise, in which justice for the claimant may or may not be a by-product”. As an example of this, the draft points to Australian research indicating that litigation funders there often considered consumer product liability claims to be too risky and not profitable enough and therefore regularly charged excessive fees in such cases.

Proposals of the Committee on Legal Affairs

In the EU, in order to "safeguard the integrity of our justice system by effectively protecting European citizens from financial exploitation by litigation funders", the draft resolution therefore proposes to:

• establish a licensing system for litigation funders administered by national supervisory authorities;
• to impose requirements on their capital resources and on the bearing of costs incurred by the opposing party;
• introduce an obligation to disclose the TPF agreement;
• put in place strong safeguards against conflicts of interest;
• set a cap on fees; and
• prevent litigation funders from taking control of the proceedings.

The objectives set out in the Parliament's draft report are not new. The EU’s Directive on Representative Actions of December 2020 contains some rules regulating litigation funding in collective actions to which it applies: according to these, member states must ensure, when implementing the directive, that conflicts of interest are avoided and that funding by third parties that have an economic interest in the bringing or the outcome of the action does not divert the action away from the protection of the collective interests of consumers. For example, courts must have the power to require the qualified entity that brought the representative action to refuse or make changes to the funding in question and, if necessary, to reject the legal standing of the qualified entity in a specific representative action.

These objectives in many respects reflect principles by which major litigation funders in the UK operate. Although there is no mandatory regulation of TPF in the UK, the industry is self-regulated on a voluntary basis by the Association of Litigation Funders, which has a Code of Conduct to which many established litigation funders have committed. The Code of Conduct contains requirements about capital adequacy; requires funders to behave reasonably and sets out the specific, limited circumstances in which they may withdraw from a case; and prevents funders from taking control of litigation or settlement negotiations. In addition, some litigation funders are also regulated by the Financial Conduct Authority (FCA), and many have lawyers working within them who are regulated by the Solicitors Regulation Authority (SRA). A number of UK funders have also joined the recently-formed International Legal Finance Association (ILFA), whose stated goals are to be the voice of the global commercial funding industry on regulation, legislation, public awareness and best practices. This framework has helped to embed TPF in the UK legal industry.

Assessment of the German Federal Bar

In August, the German Federal Bar (BRAK) commented on the draft report and welcomed it. It shares the concerns regarding the financing of legal disputes by private companies and supports the introduction of minimum standards by way of an EU directive.

The BRAK identifies the risk that litigation funders could influence proceedings in order to achieve an outcome that is as profitable as possible for them - for example, through an early settlement instead of a long lasting litigation. In addition, the BRAK expects that the importance of litigation financing in Germany will increase, especially in the consumer area, and refers to the recent ruling of the German Federal Court of Justice on collective debt collection, to the new German Legal Tech Act adopted in June, as well as to the EU Directive on Representative Actions for the Protection of the Collective Interests of Consumers adopted at the end of 2020.

The BRAK makes some suggestions to improve the proposed directive: among others, it advises to extend the planned rules to out-of-court proceedings. So far, the draft only covers funding of court proceedings or of proceedings before an administrative authority.

In addition, the BRAK recommends covering companies that offer litigation financing only as an ancillary service, as legal tech companies or insurance companies sometimes do. BRAK also suggests limiting the contingency fee to a maximum of 30% of the recovered proceeds. The draft of the Committee on Legal Affairs, on the other hand, provides for a fee of up to 40%.

Increase in collective actions and mass litigation

It is clear from the draft resolution that collective redress, which benefits significantly from litigation funding, is and has to be on top of the agenda of the EU but also of each Member State. Class actions and mass proceedings have kept the German courts very busy for some years now, and the number of proceedings filed is still increasing. The Regional Court of Stuttgart, for example, has been confronted with a steadily rising wave of lawsuits for the past four years. The legislator is trying to remedy this situation, but so far without resounding success.

Mass actions and collective redress are similarly on the rise in the UK, and TPF is a key enabler in many of these claims. In particular, a rise in collective actions in the competition (antitrust) space – in which there is a bespoke ‘opt-out’ mass actions procedure in the Competition Appeal Tribunal (CAT) – is predicted following the recent decision in Merricks v Mastercard, in which the CAT certified collective proceedings, on an opt-out basis, for follow-on damages in respect of excessive ‘interchange fees’ imposed by Mastercard on the use of debit and credit cards. Mass claims in relation to data protection are also very active at present, although no similar bespoke procedure exists for these claims.

An interesting feature of the CAT’s decision in the Merricks case is the scrutiny to which the tribunal subjected the claimant’s litigation funding arrangements when deciding whether to allow the action to go forward as collective proceedings. The CAT considered whether arrangements with the funder were sufficient to finance the ongoing proceedings and cover potential adverse costs orders, as well as whether they contained appropriate safeguards to avoid potential conflicts of interest between the funder’s commercial incentives and the class members in the event of a potential settlement or termination of the funding agreement. This demonstrates a further way in which, in appropriate circumstances, some of the perceived risks and problems associated with TPF can be controlled and managed.