In a potentially huge step forward for access to justice, the Law Reform Commission proposes a class action system for HK. The key issue is litigation funding. Rather than a government-sponsored gatekeeper fund, we need a free-market approach, with contingent legal fees and the abolition of archaic laws against champerty and maintenance, to allow self-funded lawyers and third party funders to bear the risks of loser-pays-costs. Take our opinion poll and tell them what you think!

Class actions for HK
17 March 2010

Poll: Class actions

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Poll closed: 18:00:00 9-Apr-2010

1. Should class actions be allowed in Hong Kong?

2. Should lawyers be allowed to charge fees on a contingent basis?

3. Should third parties be allowed to provide litigation funding?

4. Should the laws against champerty and maintenance be abolished?

On 5-Nov-2009, Hong Kong's Law Reform Commission published a consultation paper proposing the introduction of a mechanism for "multi-party litigation" in HK, or class actions. If implemented, this will be a huge step forward for facilitating access to justice and introducing a financial deterrent to wrong-doing. Much of our common law and statute provides theoretical remedies for cheated consumers or investors, but these remedies remain impractical so long as we lack two things: a legal right to represent plaintiffs with a common interest as a "class", and mechanisms for funding the litigation.

Without a class action system and a litigation funding system:

Court clearance

The paper proposes, correctly in our view, that an action can only become a class action if the court allows it. The key test should be whether the court can identify a claim which is substantially the same for all potential claimants.

Loser pays

Opponents of class actions like to scaremonger, saying that HK would end up like the USA with a lot of "nuisance" litigation. Our "loser-pays" system ensures that would not happen.  It deters frivolous, meritless or vexatious actions, but it does mean that any class action system will be useless without a mechanism for funding the downside risk of paying the defendants' costs. Nobody is going to take the risk of being the representative plaintiff in a class action unless his potential costs are covered by a funding mechanism. His upside might only be a few thousand dollars, but the downside could amount to millions.

Opt out

A key provision of any class action system is the mechanism for determining who participates in any result. The consultation in our view correctly proposes an "opt-out" rather than "opt-in" system. In an opt-out system, once a court agrees to hear a case as a class action, the case would be advertised, and any potential claimant would have a fixed amount of time to opt out (in order to preserve his rights), failing which, he would be bound by the outcome. Very few claimants would opt out, because each would have to believe that he had some claim which was worth bringing individually, despite the costs, or as a member of a different class action. A court will normally unify competing class actions if they represent substantially the same claims.

The opt-out system ensures two things:

However, we think the consultation is wrong to suggest that cases should default to "opt-in" if they involve parties from outside HK, particularly claimants. We are an international city serving global markets, both financial markets and those in real goods and services. Almost any shareholder action, and most consumer actions, would involve potential claimants from overseas. For example, even a defective product sold in HK can be bought by tourists. Any shareholder action involving a listed company would certainly include beneficial shareholders who are overseas. If these cases default to "opt in" for a large portion of the potential claimants, then it raises a significant barrier to the viability of the case. Put simply, if large parts of the claimant base have to opt in, then it becomes more of a joint action than a true class action system, and we already have a joint action system. It doesn't work.

So if there is a clear connection with HK, such as a defective product sold here, a service provided here (including to visitors), or a stock acquired on our stock exchange, then the members of that class, wherever they are, should have to opt out if they want to preserve separate rights of action here.

We should note that to be viable, class action rights must include any beneficial owner, not just registered nominee shareholders who have no economic interest in the case. This is an ongoing issue for shareholder litigation generally, not just class actions.

Funding

It is this crucial part of the proposal where the consultation paper goes wrong. It proposes fattening up and "expanding the scope" of an existing Consumer Legal Action Fund (CLAF), which sits under the Consumer Council and until now has been a bit of a joke. It was set up on 30-Nov-1994 with a grant of only HK$10m and by May-2005 it had spent HK$2.39m. The latest Consumer Council annual report shows that the CLAF had net assets of HK$14.4m at 31-Mar-09 and by then had considered 118 groups of cases (a "group" comprising applications with common background and interests) of which only 32 were funded, or about 2 per year. It is overseen by the Consumer Legal Action Fund Management Committee.

The consultation paper (para 8.156) says:

"Our general intention is to take a step by step approach, leading to the establishment of a general class actions fund in the long term."

This conjures up the image of a government-appointed gatekeeper committee which has the (possibly exclusive) right to decide which cases can be submitted to court, and then to fund them from a fund which is presumably established using taxpayers' money. Hong Kong's rule of law is often cited by Government as one of our competitive advantages. It can only be an advantage if there is affordable access to justice. We cannot afford to take a "step by step" approach to removing these barriers, imposing new ones (a gatekeeper committee) in their place. Even if it is not exclusive, and private sector entities are allowed to fund litigation, a government-run body would be interventionist and distort the market.

It would be rather like setting up a government body to decide which companies can get venture capital funding or which movies get funded. These are real-life examples of government intervention in HK's economy in the form of the Applied Research Council (and its successors) and the Film Development Council with its Film Development Fund. Then there's the Hong Kong Mortgage Corporation, which crowds out the mortgage insurance market, and the Urban Renewal Authority, which throws its weight around in the form of statutory compulsory purchase powers in the redevelopment market. We don't need another interventionist monster. We need a competitive, efficient, free-market solution.

There is no need for a public fund to finance class actions. The private sector should be allowed to assess cases on their merits and decide whether to finance them, covering the costs (including the defendant's costs on the downside) in return for an agreed share of any winnings. The courts should have discretion to require security from the plaintiff to cover the defendant's costs, which would be financed by whoever is funding the case.

And who should be allowed to fund a case? In our view, anyone, including the law firm, third parties, or a wealthy lead plaintiff, in each case for a share of the potential award. Large law firms may choose to self-finance a case from their own capital, or they may choose to outsource the risk to a litigation funding company (LFC), which in effect is "insuring" the downside of the case. If an LFC is funding a case, then they in turn will employ legal experts to assess the case, just as a fund manager employs experts to pick stocks. And if a wealthy plaintiff is willing to self-fund a case in return for a share of the class winnings, then he should be free to do so, for that is no different to him owning an LFC.

If a court faces applications from competing class actions with the same underlying claim, then all other things being equal (or ceteris paribus, as a judge would say), he should pick the one which offers the lowest share of any winnings to funders and the highest share to class members. In effect, a tender would be held for the right to conduct the litigation. This would help to keep down the costs.

There is no point in pretending that LFCs or other third parties are not already funding court actions here - it is an open secret in several cases, such as the now-settled case of Akai Holdings against Ernst & Young. Yet the consultation paper balks at the notion of a free market, and says (p224):

"if LFCs were to be allowed in Hong Kong , legislation would be necessary to recognise and regulate LFCs, as well as to clarify what activities are approved in commercial third party funding of litigation."

In our view, there is no obvious need to legislate for LFCs or other third parties who may fund cases, including self-funding law firms and wealthy plaintiffs. If the concern is about their credit worthiness, then that can be dealt with by a judge's discretion to require security for costs. Optionally, LFCs may be insurance companies, in which case their capital adequacy is regulated by the Commissioner of Insurance. Rather than create a regulatory framework for LFCs, with the implication that everyone else would be prohibited from funding a case, we need to legislate to remove barriers that stand in their way, which brings us neatly on to...

Champerty and maintenance

There are still archaic laws in HK against champerty (profiting from someone else's litigation) and maintenance (funding someone else's litigation). These laws were devised in medieval England to counter the risk of corruption of the courts - where a nobleman could lend their name to a case in return for a piece of the winnings and influence the judge (either by threat or incentive) in return. Even the word "champerty" derives from Middle French champart, meaning a feudal lord's share of his tenant's crop. Hong Kong is one of the last places where champerty and maintenance is still a crime. Those laws should be consigned to history. Our Judiciary is widely seen as independent and not corrupt. We pay judges well enough, and the penalties for corruption are high enough, to minimise that risk.

However, instead of making those laws history, HK has, for the first time since 1897, used them in prosecutions. The case involved a recovery agent and a solicitor, and a 25% share of the damages in a traffic injury. If there is a problem with fair disclosure or the practices used by "ambulance-chasing" recovery agents, then it should be dealt with by setting up an agent-licensing body and establishing standards rather than outlawing them. As far as we know, these were the only prosecutions after 21 people were arrested "throughout the territory" in a blitz on 3-Jul-2008 (you will note the fictitious spokesman in that press release telling us all about it).

It is a highly unlikely coincidence that only 5 days after the arrests, the Government launched a TV advertising campaign, at public expense, warning people that champerty and maintenance is a crime. It takes more than 5 days to script, cast and edit such commercials. At the very least, they prepared the commercial and then held it until the arrests, which to us smacks of an abuse of process. Watch the ad at the link. Now if the guy in the hospital bed had been a cheated shareholder in a potential class action case, would the agents and lawyers also be accused of champerty and maintenance?

Contingent legal fees

Those best placed to asses the merits of a case and whether to fund it are often the lawyers acting on it. Section 64 of the Legal Practitioners Ordinance (LPO) and paragraph 4.1.16 of the Hong Kong Solicitors' Guide to Professional Conduct respectively outlaw and prohibit contingent legal fees on contentious cases. These should be scrapped. They represent an artificial constraint on the terms of contract between a customer and a supplier of legal services. Customers and suppliers should be free to negotiate any fee basis in the free market.

Some have raised the possible conflict of interest in acting on a contingent or "no win, no fee" basis. The argument goes that if a lawyer is contracted for a share of the winnings and liable for costs, then he might push his client to settle a case quickly, for a lower outcome than might be achieved if he pursues the case to completion. We would counter that with the argument that if a lawyer is on a fixed hourly rate, then he might push his client into prolonged litigation, resulting in higher fees for the lawyer and a lower net recovery for the client than if the case had been settled quickly. The truth is that neither fixed fee rates nor contingent legal fees can completely avoid conflicts of interest. It is inherent in any supplier-customer relationship that the supplier will seek to maximise his expected profit. However, that includes the prospect of repeat business or referral business versus loss of business and reputational damage, so this does tend to offset the incentive for the supplier to screw the customer.

Take doctors, for example - they could just charge you a fixed annual fee for "all you can eat", including drugs and tests, but then they would have an incentive to kick you out of their clinics as fast as possible. Alternatively, they could charge you for each and every procedure, and charge mark-ups on medical tests and drugs, in which case, they have an incentive to do more work and tests than necessary. Neither basis is devoid of conflict. The latter basis prevails in HK.

Barristers, with their age-old traditions and anti-competitive practices, are a conservative lot, and many of them are horrified by the prospect that they may be asked by solicitors and clients to act on anything other than an hourly or daily rate. On 6-Nov-2009 your editor went on local radio with the Chairman of the Bar Association and the President of the Law Society of HK to discuss this.

Barristers should get used to the real world, a world in which travel agents, estate agents, stockbrokers and shop assistants work on a partly or fully commissioned basis, for a percentage of any deal they complete. Barristers who win more cases than average should have nothing to fear from this, for they will be competitive against their peers. Change is coming to the bar, including the new rights of audience for experienced solicitors in the High Court and Court of Final Appeal. Get used to it. Nobody is going to force barristers or solicitors to work on a contingency basis, but it should not be illegal to charge that way.

In any event, the advent of class actions would certainly provide more business for both barristers and solicitors, because when united in classes, more cases will find viable access to justice than before. Class actions will support jobs in the legal sector, which is an important limb of our service-based economy.

HAMS

It is worth mentioning that the consultation paper devotes several pages (210-213) to a discussion of our 2001 proposals to establish HAMS (Hongkong Association of Minority Shareholders). In brief, the proposal was to legislate a 0.005% levy on stock-market transactions to fund a body to represent investors and catalyse reform. A board of non-executive governors would oversee it, half elected by individuals and half by institutions, with nominal membership fees to cover communication costs. It would be open to all, and accountable to the Legislative Council for the use of the levy. HAMS would have three divisions: a policy division, for advocacy and engagement in the legislative, regulatory and standards-setting process; a ratings division, for comprehensive corporate governance ratings and proxy voting recommendations; and an enforcement division, for quasi-class actions. As we said at the time, in the absence of a legal framework for real class actions, and with barriers to contingent legal fees, HAMS could synthesize class actions by acting for hundreds or thousands of members in joint actions, using part of its levy to finance the cases.

However, quasi-class actions were always our second-best option, the first-choice being a real class action system, which is now proposed by the Law Reform Commission. As we noted above, in a real class-action system, there is no need for a central funding body, whether funded by investor levies or government grants, because the free market will take care of it and finance viable cases if allowed to do so.

Class actions and competition

The HAMS proposal received widespread market endorsement, but was left on the shelf in Apr-2002 when the Government refused to contemplate a levy, alleging that HAMS would "lack accountability" - which is ironic coming from an unelected government. The real issue, and the likely source of opposition to the current class action proposals, is that the tycoons, who pull the strings of government, don't want to face meaningful empowerment of consumers and investors in the courts. It's the same reason why the Government is dragging its feet on a multitude of issues, including the introduction of a competition law. Just take a look at the LegCo database on competition policy - there has been no update on the proposed law since 30-Mar-2009, although in his 14-Oct-2009 policy address, the Chief Executive said that the Government hoped to introduce the bill in the 2009-10 legislative session. After all, it's only been 14 years since the Consumer Council first recommended one and the government said no, thanks.

Class actions would be a key tool for seeking compensation for anti-competitive behaviour such as price-fixing, if that were illegal. Take, for example, the class action settlement with British Airways and Virgin Atlantic, who allegedly conspired to fix prices for fuel surcharges between 2004 and 2006. Note that it only applies if you bought your ticket in the UK or US, even if you were flying to HK. Although both airlines fly to HK, price fixing is perfectly legal here, so customers who bought tickets in HK were not part of the claim.

What do you think?

Should consumers and investors have class action rights in HK courts? Should they be free to negotiate contingent fees with lawyers? Should third parties be allowed to finance and insure legal costs? Tell us your views in our class actions opinion poll. We will forward this paper as our (belated) submission on class actions, and follow up by submitting the poll results. Unlike the proposed class action system, you have to opt-in to count, so vote now!

What do you think? Take our Opinion Poll!

Your name will not be disclosed, but the aggregate results will be sent to the Law Reform Commission

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