Competition litigation funding doesn’t grow on trees – unintended consequences of the UKSC’s PACCAR decision

Background
Since 2015 the UK Competition Act (“CA”) permits opt-out collective actions whereby a representative can bring a claim on behalf of groups of injured consumers or businesses without the need for the group members to explicitly opt-in. After a slow start, the opt-out action regime has become increasingly attractive as demonstrated by the rising number of applications in the Competition Appeal Tribunal (“CAT” or “Tribunal”). As part of section 47B CA, an applicant seeking to bring an opt-out collective action must secure a collective proceedings order (“CPO”) from the CAT. The CAT will grant a CPO if the claims are eligible for inclusion in collective proceedings and the Tribunal can authorise the proposed class representative. A material part of the authorisation test is that applicants need to show that they have adequate funding arrangements in place to meet their own costs and any adverse costs order made against them. While funding is not explicitly mentioned as a prerequisite of opt-out actions in sections 47B ff., bringing collective actions invariably involves third-party litigation funding whereby a funder provides the means to the class representative to pursue the action. In a nutshell, without litigation funding, there is no CPO and, consequently, no opt-out collective action.
Funders support litigation because they expect a return on their investment in the form of a success fee. The litigation funding agreement (“LFA”) between funder and representative provides the funder’s investment terms and the terms of their return on the investment. The idiosyncratic aspect of the UK opt-out action regime is that the funders’ payment was virtually ignored in the debates leading to the enactment of section 47B ff. CA. Only section 47C(6) CA and CAT Rule 93(4), added as afterthoughts, mention that undistributed damages, i.e. damages left over after attempts were made to distribute them to the class, can be used to cover costs and expenses, if the CAT makes an appropriate order. As we have shown in a recent paper, this provision is incorrectly interpreted as meaning that this is the only way for funders to be paid. In other words, funders ought to wait until after the class members have received compensation before they can claim their costs and success fee. If the class is paid first, there is an obvious risk that the funder, who will have made a substantial investment in the case, receives little payment when distribution is good, or zero payment when distribution is perfect and/or the class is small. There is also the further risk that the CAT might decline to exercise its discretion to order a payment in favour of the funder. Indeed, there is a real possibility that a funder on a successful case could lose money and, consequently, will refrain from funding a ‘good’ case in the first place.

PACCAR on funders’ fee recovery
The recent Supreme Court decision in PACCAR has caused reverberations in the funding market by finding that LFAs, where the funder receives a percentage of damages, are damages-based agreements (“DBA”) and therefore unenforceable. LFAs, where the funder’s success fee is set as a multiple of their investment, continue to be enforceable. The Supreme Court, with a 4:1 majority, found that third-party funders were in fact, on a natural reading of the wording, providing ‘claims management services’ under section 4(3) of the Compensation Act 2006, since funding included the ‘provision of financial…assistance’.

More relevant for this blog post is the statement provided in paragraph 98. The Supreme Court accepted the appellants’ assertion that funders are paid after damages are distributed to the class subject to the CAT making an appropriate order. Lord Sales argued that: “…according to the procedural rules in the Tribunal and by virtue of the Competition Act 1998 the funder of opt-out proceedings always takes the risk that all of the damages recovered will be distributed to members of the class with the result that there will be nothing left to pay its fee and also takes the risk that the Tribunal might decline to exercise its discretion to order a payment in favour of the funder.”

The Court seemed to imply that this is the only avenue for funders to recover their fees. We respectfully disagree with Lord Sales. The view expressed by the Court is not supported by the drafting materials of the CA and ignores a competing opinion expressed in the Court of Appeal in BT Group Plc v Le Patourel (“Le Patourel”) without further explanation.
Why pre-distribution recovery makes sense

The widespread, albeit incorrect, belief that the CAT’s procedural rules and the CA state that funders are only paid after the class has been paid is not supported by the legislative record, as we have shown, and undermines the incentives to fund actions and defeats the compensation objective of private competition actions.

As analysed at length in our recent publication, the focus on post-distribution recovery is not supported by the travaux preparatois of the Consumer Rights Act 2015, which created the collective action regime. CAT Rule 93(4) was intended to deal with pro bono representation and to address the new, to English law, phenomena of unclaimed damages. The drafters did not express any complete views concerning litigation funding, their focus was on the orderly distribution of any left-over funds. Our analysis also shows that funders of litigants who settle may receive their fee before distribution. This creates an obvious conflict with funders of collective actions where there is no settlement. Why funders should be paid differently depending on whether the class settles or not, is not clear.

In the recent Le Patourel decision the Court of Appeal supported our conclusion that funders can be paid before damages distribution:
“…It would defeat the purpose of opt-out proceedings, which might routinely require third party funding, if costs orders could not be made in any case where an account credit was the chosen means of achieving distribution. As to this the CAT has a wide discretion to make any case management order it sees fit and it is within its power to ensure that funders and representatives are paid. […] The Tribunal could for instance make a sequential order that: (i) there be an award of damages; (ii) costs be defrayed from the award (before or after the damages are paid to the representative or authorised third party); and (iii) the residue is then to be distributed according to whatever method is considered by the CAT to be most appropriate be that a fixed sum, an account credit or by some other sensible means…”

In Le Patourel, the obiter comment suggests that third party funders can be paid pre-distribution of damages. Lord Sales’ statement in PACCAR argues the opposite to the effect that funders’ returns are limited to post-distribution.
Obviously, neither view has benefitted from the parties’ in-depth argument. However, it is worth pointing out that, according to the drafting materials, the prohibition of DBAs in opt-out actions was supposed to encourage lawyers to bring small and medium-sized group claims. Enforcing that prohibition in LFAs while, at the same time, stating that fees can only recovered post-distribution invites an obvious policy conflict. Limiting funders to recover their fees post-distribution discourages the bringing of smaller group claims where the prospect of distribution is good and little is left for the funder.

Consequences for funders

Third party funding is essential in opt-out collective actions given the litigation costs and need for cover against adverse costs orders. The CAT places great emphasis on the funding arrangements before granting a CPO. No opt-out cases have seen a class representative use their own funds so far, and it is unfortunate that the Court has not yet clarified this really important point. The obiter statements have the potential to cause great confusion in the market, and to reinforce the incorrect view that funders receive their success fee after the class has been paid.
A concern for virtually all CAT collective actions is that their LFAs, likely worded in similar terms to those relied upon in PACAAR will also be unenforceable. As a result, most applicants in opt-out class action cases are amending their LFAs such that the funder’s return is calculated by a multiplier to their investment, which are not DBAs. It is hoped and expected that the CAT will be reasonable in this regard, given most, if not all, collective action cases will likely require the same process.

There remains uncertainty as to the status of pre-distribution recovery of funders’ returns. There are now arguably conflicting judgments, Le Patourel and PACCAR containing contradicting obiter statements, which will ultimately need to be addressed. The success of the swathe of LFAs which are currently going through amendments and submissions to the CAT will yet to be seen, though it is hoped that the CAT will be flexible given the scale of the amendments across the entire market.

Conclusions

It is striking that neither the Court of Appeal nor the Supreme Court have paid more attention to the incentives of funders in collective actions. Given that neither the CA nor the CAT Rules make specific provision for the payment of third-party funders, there is considerable uncertainty as to the recovery of fees. This uncertainty clearly affects the incentives to fund actions where third-party funders do not expect much damages to be left over after distribution. Section 47B(6) and CAT Rule 93(4) were meant to be rules dealing with pro bono costs and left-over damages rather than cost and fee recovery rules. The legislative materials reveal no clear intention that general cost and fee recovery rules were meant to be changed in collective actions. However, the Supreme Court’s non-binding statement to the contrary fuels uncertainty as to fee recovery, deterring funders from supporting medium-sized claims with a good prospect of distribution. In other words, the statement makes it more likely that good cases are considered as ‘too good to fund’ given the chance that funders may not recover their investment and lose money. There is a further risk that the removal of DBAs from the range of funding instruments available to class actions will create difficulties in attracting funding in what is already a challenging aspect of gaining class certification.

What the statement of the Supreme Court fails to acknowledge is that litigation funding has become essential to opt-out collective actions. No CPO application can succeed without external funding in place. To argue that funders’ only opportunity to get paid is after damages distribution, ignores the pivotal role funders play and the impact that this decision has on funders’ incentive to support claims where the prospect of distribution is good and the compensation objective is achieved. Ultimately, it is clear there is an urgent need for review of funding and distribution rules and the legislation governing opt-out collective actions, and a need for pragmatism on part of the CAT.