EU Litigation Update - February 2023

EU to regulate third-party litigation funding. The EU is considering a revision of the present regulatory framework applicable to third-party litigation funding. The objective is to bolster the existing rules on private investors’ ability to generate profits through third-party litigation funding. This proposal was made by the European Parliament’s Legal Affairs Committee and adopted by a majority of the Members of the EU Parliament in the so-called “Resolution with recommendations to the Commission on Responsible private funding of litigation” on September 13, 2022. It is now for the EU Commission to decide whether to adopt the proposed directive contained in the recommendation.

Background. The concept of commercial third-party litigation funding was born almost a quarter of a century ago. It is a business model where investors cover the litigation costs of a party involved in a dispute.  In return, should the case have a positive financial outcome, the investors receive a portion of the awarded money. In contrast to traditional before-the-event (BTE) legal expense insurance, third-party litigation funders insure legal actions relating to events that have already happened, i.e., after-the-event (ATE). Litigation funders are not themselves parties to the court proceedings and thus have an economic, but not a legal, interest. Although captured by some financial regulations, third-party litigation funding has not up until now been subject to any specific EU regulatory framework.

Concerns and proposal of the EU Parliament. The lack of EU regulation might change as a result of the proposal made by the EU Parliament’s Legal Affairs Committee. Referring to allegedly negative experiences overseas, the Legal Affairs Committee regards the growing number of litigation funders acting on “legal markets” of the EU Member States as a “threat to the administration of justice in Europe” and a “profit-driven activity in which justice for the claimant can be seen as a by-product”. They claim that the funders regularly request an excessively high share of the awarded money. Therefore, in order to “preserve the integrity of the EU judicial system” and “effectively protect EU citizens from financial exploitation by litigation funders”, the draft resolution inter alia proposes to:

• establish a system of accreditation for litigation funders administered by national supervisory authorities (requiring a registered office in an EU Member State);
• implement an obligation for litigation funders to have adequate financial resources to pre-fund the particular case and a possibility for the supervisory authority to verify their solvency;
• where the litigation funder later becomes insolvent,  protect claimants that engaged a third-party funded litigation in good faith by setting up an insurance fund to cover outstanding costs;
• establish a complaints procedure that allows any natural or legal person to raise any concerns/complaints about the compliance of a litigation funder with its obligations under the directive and the applicable national law before a supervisory authority;
• establish specific requirements for the admissible content of third-party funding agreements;
• deem invalid any clause in third-party funding agreements granting a litigation funder the power to take or influence decisions in relation to proceedings;
• set a cap on the funders’ profits, requiring claimants to receive at least 60% of the total settlement or compensation amount; and
• introduce an obligation to disclose the third-party funding agreement and to strictly avoid any conflicts of interest (e.g., with lawyers or other interested parties).

EU Directive on representative actions. Although the provisions proposed in the EU Parliament’s draft resolution may seem radical, they are not entirely novel. The EU Directive on representative actions already contains a number of provisions restricting third-party litigation funding: According to the Directive, Member States must ensure that conflicts of interest are avoided in third-party funded proceedings and that consumers’ collective interests remain protected. Courts must, for example, have the power to force the third-party funded claimant to refuse or amend the funding and, if necessary, to withdraw the claimant’s standing to bring a particular action. The Directive on representative actions entered into force at the end of 2020. It must be transposed into national law by December 25, 2022, and most importantly – applied from June 25, 2023. So far, only the Netherlands and Denmark appear to have implemented the Directive – quite contrary to Germany, where the governing political parties currently cannot agree on fundamental aspects of the Directive’s implementation into national law (in particular regarding timing of the Opt-In, legal standing of qualified entities and tolling of time-barring) and, therefore, will certainly fail to comply with the transposition deadline set by the Directive.

Opinion of the Council of Bars and Law Societies of Europe (CCBE): The CCBE welcomes the initiative of the EU Parliament. Further, the CCBE argues that although third-party litigation funding could offer a remedy to the imbalance between parties, the intervention of a litigation funder may result in a breach of the ethical obligations of lawyers such as the duty of independence. In this regard, the CCBE requests that “[t]he lawyer should be free to act in the best interests of his or her client, without being bound by a funding agreement”. Therefore, the CCBE calls for a tightening of some of the regulations: “Any clause from a funding agreement which may influence the task of the lawyer and prevent him to act in his or her client’s best interests should be prohibited”. The legal framework should also clarify that it “does not only cover providers offering litigation funding as a main activity but also those carrying out such activities as an ancillary service”. Finally, the CCBE considers a maximum percentage of 25-30% as a reward for the litigation funder as sufficient.

Joint Statement supporting the proposed regulation: In their joint statement, the organizations Airlines for Europe, AmCham EU, BUSINESSEUROPE, DIGITALEUROPE, DOT Europe, EFPIA, Eurochambres, EuroCommerce, European Banking Federation, European Justice Forum, InsuranceEurope, MedTech Europe, and U.S. Chamber Institute for Legal Reform also express their support of the EU Parliament’s initiative. The organizations argue that “[w]ith no obligation to see cases through to the end and no responsibility for adverse costs” litigation funders could pursue “opportunistic claims for a high reward with low risk”.

Statement of the Legal Tech Association. The German Legal Tech Association, however, raises concerns on the planned regulations on third-party litigation funding and expressly rejected them. They argue that there were no known cases in Germany or Europe of abuse of litigation funding, nor are there any gaps in the legal system from which consumers must be protected. Litigation funders were often the first to ensure equality of arms in legal disputes – “especially where the damaging party is financially superior to the injured party and where legal disputes are particularly time-consuming and expensive”. According to the Association, the best examples are cases of antitrust damages and, in particular, the diesel case. The Association observes a “convergence of interests” between litigation funders and claimants in the recent case law of the German Federal Court of Justice (“Bundesgerichtshof”). According to the statement, the planned regulations ignore the developments on a national level and are unsuitable, disproportionate, and unworldly.

Opinion of the German Federal Bar Association. Contrary to the Legal-Tech Association, the German Federal Bar Association (“Bundesrechtsanwaltskammer”) welcomes the draft and calls for a tightening of the proposed regulations: It suggests an extension to the extrajudicial sector, as the current draft resolution only covers third-party litigation funding in court proceedings or in proceedings before an administrative authority. In addition, the Association proposes to also include companies that offer litigation funding only as an ancillary service, as some legal tech companies or insurance companies do. Furthermore, litigation funders should only be allowed to conclude agreements with the disputing party directly. This excludes any agreements with lawyers or other intermediary parties. Finally, litigation funders should not be allowed to influence settlement negotiations and should receive a maximum of a 30% share of the outcome.

Outlook. Although the EU Commission is not forced to present a legislative proposal, it must react to the resolution of the EU Parliament. There are further developments to be expected as the topic is high up on the agenda. It is clear from the draft resolution and the comments discussed above that there are conflicting views on the best way forward.