Legal Outlook Speciality Finance Episode 1: A spanner in the works for litigation funding

Matt:
Hi all, and welcome to our first Specialty Finance Series podcast. My name is Matt Pentecost and I lead the specialty finance practice here at Ashurst. Today I'm excited to be joined by Anna Morfey, fellow partner here at Ashurst and an expert in the world of competition claims and litigation funding. I'm excited to explore a little bit more about what's going on in the disputes world at the moment.

Anna:
Hello. Hi, Matt.

Matt:
Hey. As a structured finance team, we are seeing a material increase in the interest in litigation funding as an asset class. And you and I have been on roadshows, talking to clients around how they might fund litigation funders or indeed law firms. And the asset class is generally seen as quite attractive. It's non-correlated, it generates healthy returns, but in the last couple of months we've seen something come into the market, which has presented a bit of an obstacle. Are you able to give us a little bit more colour and detail around what that is?

Anna:
Yeah, so the development that you are referring to, Matt, it's the Supreme Court's judgement in the PACCAR case, which was handed down at the end of July this year. And that judgement arose out of proceedings brought by two proposed class representatives using the collective actions regime in the Competition Appeal Tribunal, the CAT. And they were seeking damages on behalf of purchases of trucks, which followed a finding by the European Commission back in 2016 that the European trucks manufacturers had been in a cartel.

One aspect of the regime that applies to competition class actions in the CAT is that they rely on litigation funders to back their claims. And in PACCAR, the class representatives had fairly standard funding arrangements for this type of claim, in which the funder's return would be the greater of either a multiple return or a percentage of the damages. And one of the truck manufacturer defendants in that case challenged the lawfulness of those funding arrangements on the grounds that the percentage of damages element was a damages based agreement, a DBA, which under the regime applicable to those claims, was unlawful. And that challenge failed at first instance, so in the CAT, and also in the Court of Appeal. But earlier this year it was heard in the Supreme Court and they sided with the defendant, and found that the funding agreements contained a damages based return were DBAs.

And the upshot of that is twofold. First, because they're DBAs, they need to comply with the DBA regulations. And in the PACCAR case, it was actually common ground between the claimants and the defendants that they didn't comply with the DBA regulations. But second, and more importantly, certainly for the competition class action regime, DBAs aren't permitted to fund opt-out class actions, which the vast majority of class actions in the CAT are. So that was a bit of a spanner in the works, certainly for litigation funding quite broadly, but also specifically in the competition regime.

Matt:
That's really interesting. And just one point I want to pick up on there. For those who are less familiar, could you just give us a very quick snapshot on what the difference is between opt-out and opt-in?

Anna:
Yeah, so in the competition regime, you can bring either an opt-in or an opt-out class action. An opt-in class action, as the name suggests, is where you need to go around basically and book-build and sign up claimants. So a bit more like a GLO structure. It's got its own mechanism, but you need claimants to opt in to your claim.

The opt-out mechanism, which is the far more common one that's being used, and that was the novelty of this regime is the ability to bring opt-out, is that you have one class representative bringing a claim on behalf of potentially tens of millions of businesses or customers or consumers without the need to book-build, without the need for all of them to opt in. So if they fall within the class definition, they're automatically within the claim, unless they proactively opt out.

Matt:
I see. Going back to that point around the percentage of damages, does that mean that all those current agreements are unenforceable? And I suppose as a second part to that question, does this have wider application than just CAT claims?

Anna:
I mean, it certainly meant that many, if not all of the funding agreements that are currently in place to fund competition class actions, are having to be reworked. It's the damages based element that was challenged in PACCAR and those will be unenforceable in all opt-out competition class actions and as well in other cases, unless they comply with the requirements of the DBA regulations. So it certainly has specific resonance for the opt-out competition class action regime, but it does mean that outside of that regime, they will need to be DBA regulation compliant if they're going to be lawful.
The multiple base return element wasn't challenged. So PACCAR doesn't make that aspect of funding agreements unenforceable, although we are now in the competition context, starting to see defendants looking at challenging that aspect too. So I think there is more to see there in due course.

Matt:
And I suppose one of the things that's worth noting at this point is that whilst there is ... We're talking about these CAT claims in the Competition Appeal Tribunal, in some instances there's a sense that it's not ... The claims that end up in that forum are possibly wider than pure competition claims. Is that accurate?

Anna:
Yeah. I mean, it's certainly the case that we're seeing claims that are not naturally thought of as competition claims being brought in the Competition Appeal Tribunal, exactly so that claimants and claimant law firms can use the opt-out regime in a broader number of cases. So we've seen cases that might be more naturally thought of as consumer cases or data protection type cases being packaged as competition claims to use that regime.

Matt:
That's really interesting, particularly from my perspective where we are looking at funding a portfolio of claims. How's the market generally responding to this obstacle that's been thrown their way?

Anna:
I think what we're seeing is where the damages based element of the funding agreement severable, that might be one solution. So to renegotiate on the multiple based return element of the funder's fee and possibly other terms to ensure the claims are still attractive to the funder, but to sever the damages based agreement part. Where the damages based element is less easily severable, the problems might be more significant. And I think either way, the CAT is now, I believe, dealing with a loss of the fallouts of this because pretty much every funding agreement, even if it's accepted by the defendant and the defendant and the claimants manage to agree some amendments between them, they still need to be approved by the CAT. And so I think there's an element of clearing a backlog of those.

Defendants were also looking at whether the multiple base return element can be challenged, as I mentioned. And we've seen this already raised in the CAT in one case where the defendant, Sony, in a proposed class action that was filed and it's awaiting certification broadly, I think the argument has been that because the pot of money from which the funder's fee can be paid is itself limited by the amount of damages onboarded, even a multiple based return is linked to the level of damages and so ultimately amounts to a DBA. That's perhaps a rather too concise summary of the argument to do it justice, but that's the nub of it, and we don't yet know if the courts are going to endorse that sort of argument.

Matt:
Yeah. I mean, there's a degree of further uncertainty here, and I guess this all kind of knocks into my world as a structured finance lawyer because the documents that fund those law firms or litigation funders will have strict parameters around those contracts that are eligible for the purposes of those funding. And one of course will be that they are legal, valid and binding. And so how this all gets worked through remains a topic of some contention. And clearly this causes uncertainty in current transactions, but it's also going to be an important consideration on new money transactions.
And I suppose the question that everybody will be asking is whether we can expect any developments to help calm these nerves, whether there's going to be something that's going to come in that will give us some clarity as to what people should be doing.

Anna:
I mean, we've heard rumours in the market that there's some expectation that the PACCAR judgment's going to be addressed by legislative changes in the spring, so it's possible that this will be addressed by way of legislation. We haven't seen anything concrete on that yet, or any proposed drafting. It's certainly one to keep an eye on.

I think in the meantime, the funding agreements and so on, certainly the ones that we are more familiar with, are being redrafted so as to ensure any damages based element of them is severable if the law is not changed. And so funders I think are trying to work out ways of structuring these deals such that they'll obviously be compliant and be enforceable.

Matt:
That's really interesting. Yeah, so definitely something to be alive to on current deals, but also as the legislative changes that may come through over the next few months. I think we'll all welcome certainty, but if anyone listening would like to be kept abreast of those developments, please do get in touch with any one of us, whether that be in relation to the CAT judgments, the underlying litigation funding agreements, all the kind of structured finance solutions to some of the liquidity constraints, we'd love to hear from you.

As a note, we're also lead sponsor of the DealCatalyst Specialist Lending Conference in London on 16th of November, which will be packed with informative panels in all aspects of specialist finance, including litigation funding. So we'd love to see you there. Again, do get in touch if you'd like any details of that conference.

So that was a short, sharp, first podcast, and we'll be back again soon with another one on another topic in the specialty finance space. And lastly, thank you very much to Anna for joining me.

Anna:
Thank you.