Australia: Is There Safety in Numbers?

Although we are only a quarter of the way into the year, it already seems that 2006 will be a jubilee year for class actions, particularly in the field of what are commonly termed "securities class actions".

In October 2005, Hugh McLernon, a director of Australia's largest litigation funder, IMF, said in an article in the Australian Financial Review[1] that there were currently six shareholders' class actions on foot in Australia: Sons of Gwalia, Aristocrat, Concept Sports, Ion, Village Life and Media World. Perhaps coincidentally, IMF is funding five of them. However, Mr McLernon could also have mentioned the Harris Scarfe class action on foot in the Federal Court in Adelaide[2] or the class action proceedings which are on foot against the NAB in the US, on behalf of Australian investors, over the NAB's losses flowing from its involvement in HomeSide Lending.

In his article Mr McLernon predicted that fears of an explosion of such litigation in Australia were scaremongering. However, in the few months since his article we have seen class actions commenced or contemplated in relation to, allegations that Telstra failed to fulfil its continuous disclosure obligations to the share market, the collapse of the Westpoint mezzanine finance schemes, and the Australian Wheat Board scandal. Australian lawyers are also investigating the possibility of a class action against Multiplex, again in relation to continuous disclosure obligations arising from the construction of Wembley stadium.

While it is true that the past year or so has disclosed a rich vein of alleged corporate misdeeds, such allegations are not new. What is unusual is the suggestion that they might give rise to a right on the part of shareholders to sue someone, whether it be the company itself, or its officers, advisers or (in the case of Westpoint) third party financial advisers. They also represent the emergence of a model for concerted and co-operative action on behalf of shareholders which, until recently, did not exist.

This firm has elsewhere written widely on the factors which are driving the emergence of securities class actions in Australia[3], including the growth of the litigation funding industry. That ground does not need to be covered again. Suffice it to note that the odds are firmly in favour of an increase in this type of litigation in the near future, whether that increase is explosive or not.

Part of this trend is the tendency to use class actions as the preferred vehicle to advance the interests of the wronged parties. While class actions seeking damages for financial loss are not new, until recently the most publicity about class actions has focussed on product liability litigation - injured consumers suing for compensation for their injuries. The increased attention on so-called securities class actions reflects a recognition that the public now see securities and other financial instruments - whether they be shares or the mezzanine lending arrangements made famous by Westpoint - as products, the purchasers of which are entitled to the same protections and entitlements which the law affords to purchasers of products which are capable of causing physical injury. The law to some extent reflects this, with the continually increasing emphasis on regulation and disclosure in the financial services industry.

A good example of this is the recent Full Federal Court decision in Sons of Gwalia Ltd v Margaretic [2006] FCAFC 17. In February of this year the Full Federal Court affirmed the decision of a single Federal Court judge which attracted considerable publicity when it was handed down in September 2005. The Full Federal Court has confirmed that that shareholders who allege that they were induced to purchase shares by a company's unlawful conduct are entitled to sue in their capacity as members of the public, not members of the company, and therefore have their claims rank alongside other unsecured creditors in any distribution of the company's assets.

Whatever your views about the merits of this decision, it is another indication of the shift from the concept of company shareholders as participants in a company's venture to consumers in the financial market.

What are the consequences of the growth in financial products class actions for a company, its officers and employees?

The first and, perhaps most obvious point, is the increasing risk that breach of a company's legal or listing obligations may give rise to not just regulatory action, but also significant, long term and potentially highly public litigation against a company or its officers or both. Many people have written at great length about the importance of keeping abreast of the ever-increasing obligations which are imposed on companies and their officers, regardless of whether they arise from the Trade Practices Act, the Corporations Act, listing rules, prudential requirements or any other source. This new risk from breach of such obligations should act as encouragement to greater diligence.

It should also be mentioned that under the model of financial products class actions emerging in Australia there will usually be a litigation funder involved underwriting and promoting the litigation. This month the High Court heard an important case about litigation funding (an appeal from the decision of the NSW Court of Appeal in Fostif v Campbells Cash and Carry (2005) 63 NSWLR 203). The High Court's decision is likely to provide important guidance on the lawfulness of litigation funding and the obligations which the law imposes on litigation funders. For the moment, however, litigation funders have been emboldened by the Court of Appeal's decision and most of the cases mentioned at the beginning of this article are being funded.

While the involvement of the funder may mean that a defendant in a financial product class action faces a well organised and resourced opponent, it can also have its advantages. Litigation funders are usually commercial operations and they exist for the same purpose as the defendants in the litigation they underwrite - to make a profit. This means that, while litigation funders owe important obligations to the claimants in a class action (which should be, and usually are, enshrined in the litigation funding agreement), they are not inclined to spend money unless there is a prospect of a return. There is no reason to believe that litigation funders' attitude to litigation will be anything but commercial, meaning they are likely to be amenable to negotiation and will consider any commercial proposal which is consistent with their legal advice about the strength of the claimants' cases.

The final point is that companies need not always see themselves as defendants in financial products litigation. Many Australian companies, particularly those in the financial sector, hold large portfolios of Australian and international shares either in their own interest or on behalf of others. While financial products class actions may be a relatively new phenomenon in Australia, they are a well established industry in the US. The total value of settlements in US federal securities class actions for 2004 was US$2.9 billion, with an average value per settlement of $6 million[4]. The total value of settlements for 2005 was a staggering US$9.7 billion, although a large proportion of this was the US$6.1 billion settlement of the WorldCom litigation, a new record for the value of a single settlement. The record may not stand for long because it has been reported that the settlement fund for Enron has grown to $7.1 billion.

To date the most participants in financial products litigation have been small shareholders. However, institutional shareholders play a much more significant role in the US. Since 1995 institutional shareholders have been the lead plaintiffs in about 35% of US securities class actions.

Some of these issues will obviously be of considerable strategic importance to companies. Decisions about whether to settle or fight litigation, particularly large scale public litigation, cannot be taken lightly. Decisions about whether it is open to an investor to become involved in a class action and, if so, whether it is a good idea to do so require equally serious consideration There will usually be cogent arguments both for and against such involvement. To give but one example, it may be important to consider the effect of the litigation on the value of any ongoing holding in the defendant company.

Such decisions obviously need to be taken after careful evaluation of the opportunities and risks that arise from such litigation. In this regard, many of the issues raised by class actions are unique. However, if the present cluster of such actions is a guide to the future they are issues that will become increasingly familiar to corporate Australia.