THE GLOBALIZATION OF ENTREPRENEURIAL LITIGATION: LAW, CULTURE, AND INCENTIVES.

Author:Coffee, John C., Jr.
Position:Special Issue on Class Actions
 
FREE EXCERPT

INTRODUCTION 1896 I. THE EUROPEAN FRONT: BARRIERS OUTFLANKED 1900 A. The Fortis Litigation 1902 B. The Volkswagen Litigation 1908 II. ASIA: A SHIFT TOWARDS ENTREPRENEURIAL LITIGATION 1911 A. Japan 1912 B. South Korea 1914 C. China 1916 III. IMPLICATIONS AND ANALYSIS 1917 A. How Should We Understand This New Phenomenon? 1917 B. New Patterns and New Issues 1919 1. New Players 1919 2. The Third Party Funder: Superior or Inferior? 1920 3. Reverse Auctions 1920 4. Unequal Distribution? 1921 5. Will the American Entrepreneurs Fade Away? 1922 6. Counter-Reaction? 1922 7. Future Directions 1923 CONCLUSION 1923 INTRODUCTION

The fiftieth anniversary of Rule 23's adoption in 1966 provides an opportunity to consider how legal change occurs. Law, culture, and incentives all play a role. But which dominates? The adoption of Rule 23 preceded a significant surge in the use of the class action, (1) and some areas of litigation came to depend on Rule 23's availability (e.g., securities litigation, antitrust litigation, and, for a time, mass torts litigation). (2) Perhaps even more importantly, Rule 23 spurred the growth of the plaintiff's bar, enabling small firms with a handful of lawyers to develop into major institutional firms of one hundred or more attorneys. Where once plaintiff's firms handled mainly personal injury cases, they grew to the point that they could finance and sustain major class action litigation for years and incur millions of dollars in expenses in the hopes of receiving an ultimate, but contingent, class action fee award. (3) With this metamorphosis also came the full-scale appearance of "entrepreneurial litigation." For our purposes, "entrepreneurial litigation" can be defined as litigation in which the attorney acts as a risk-taking entrepreneur, both financing and managing the litigation for numerous clients, who necessarily have smaller stakes in the litigation than the attorney. (4) Put another way, the attorney acts less as an agent and more as a principal. In this world, it is truer to say that the attorney hires the client than that the client hires the attorney.

This style of litigation predated Rule 23's amendment in 1966, (5) and thus raises the obvious question: what really explains the explosion of class action litigation in the United States? Was it a legal change alone (i.e., Rule 23)? Or, is the U.S.'s unique level of aggregate litigation better explained by a preexisting legal culture that Rule 23 energized, thereby enabling private enforcement of law to increase exponentially? (6) This brief Article cannot fully resolve those issues, but it suggests that perspective and insight is gained into the relative impact of law, culture, and incentives by looking at how entrepreneurial litigation is now spreading globally. In contrast to the American experience, the global expansion of class action litigation pits economic incentives against local culture and thus provides a basis for testing ideas about causation.

Before beginning this tour, a word of caution is needed: we must recognize that entrepreneurial litigation was and remains highly controversial. Periodically, both Congress and the Supreme Court have attempted to curb it. (7) Unsurprisingly, major scandals erupted in the U.S. as the size and settlement value of class actions grew over recent decades. Symptomatically, the law firm that was (at least for a time) the leading practitioner of this style of litigation saw its principal name partners indicted and convicted in 2006 for their practice of using and compensating in-house clients. (8) Nonetheless, entrepreneurial litigation survives in the United States, even though it has had a history of cliff-hanging narrow escapes. (9)

Much of the rest of the world remains skeptical of American-style "entrepreneurial litigation," and only Australia, Canada, and Israel have developed systems that approximately parallel the U.S.'s "opt-out" class action. (10) Elsewhere, the trio of legal rules that support and sustain entrepreneurial litigation in the U.S.--the opt-out class action, the contingent fee, and the "American rule" under which each side bears its own legal expenses--remain conspicuous by their absence. (11) Instead, around most of the world, plaintiffs' attorneys may not receive contingent fees, a "loser pays" rule chills the incentive to litigate, and "opt-in" class actions prevail and limit class size. In addition, strict rules often limit who can serve as the representative plaintiff for the class. (12)

Now comes the surprise: despite the apparent hostility of other jurisdictions to entrepreneurial litigation, that system has leaped the national boundaries of the United States and recently moved to both Europe and Asia. (13) Moreover, this has happened without any legislative or judicial changes to welcome it. One focus of this brief article will be on how this has happened and the forces that have driven it. In overview, this article will argue that a demand arose for legal services in which someone other than the client assumed the costs and downside risks of the litigation in return for a contingent fee. If lawyers could not receive a contingent fee, others could. Entrepreneurs, mainly from the U.S., have found ways to design around the legal barriers in at least some jurisdictions, and clients are now taking their cases to those jurisdictions. The result is not a perfect substitute for the U.S. system--indeed, the same legal services seem to be provided at much higher cost--but plaintiffs do obtain what they want most: a forum in which their claims can be asserted on an aggregate basis and without liability for costs if they lose.

To be sure, there could yet be a counter-reaction, but creative lawyering has seemingly developed substitute relationships that achieve a functionally similar form of entrepreneurial litigation in which (1) the risk capital is provided by hedge funds and other "third party funders," and (2) the problem of "loser pays" fee-shifting is dealt with through insurance. All this will be examined in more detail later, but the point to be made at the outset is that the role of legal rules can be overstated. This article will survey recent developments in both Europe and Asia in order to show that, when both clients and entrepreneurs want to shift risks away from the client, means can be found to accommodate that desire. Then, looking to Asia, it will find that the authorization of the class action does not necessarily cause a significant increase in the volume of litigation in a jurisdiction. Conversely, even when authorization of collective redress is lacking, entrepreneurial litigation can still develop if the local culture is tolerant.

As with many legal innovations, the spread of entrepreneurial litigation abroad was a response to a crisis. When the U.S. Supreme Court ruled in 2010 in Morrison v. National Australia Bank Ltd. (14) that U.S. courts could not hear the securities fraud claims of plaintiffs who had purchased their securities outside the United States, this presented extraterritorial plaintiffs with a crisis. They had come to rely on a U.S. forum and on U.S. plaintiffs' attorneys willing to take their cases on a contingent fee basis. The result was a search, led by U.S. plaintiffs' attorneys, for an alternative forum in which claims could be broadly aggregated, contingent fees could be charged, and the risks of adverse fee shifting under a "loser pays" rule could be mitigated. All this took some creative legal engineering, as described below.

  1. THE EUROPEAN FRONT: BARRIERS OUTFLANKED

    For some time, the European Union has recognized the need for an aggregate litigation remedy. The key rationale for such a remedy is the existence of "negative value" claims. That is, claims where the costs of litigation would exceed the recovery, even if victory were certain. Take a hypothetical consumer product: a defective toaster that costs $50. No individual can afford the likely legal costs of establishing the toaster's defects--assuming that the defendant would not concede them. The answer to this problem is broad claim aggregation: if 1,000 plaintiffs could combine to litigate in a single case, they could afford the costs of the litigation. This does not necessarily require the

    American "opt-out" class action. An "opt-in" class in which class members expressly opt to join in the litigation could also work, but then it would be necessary for someone to play the role of "claim aggregator"--soliciting persons who may have been injured to join the action. This is costly and there may be ethical restrictions in some jurisdictions on attorneys soliciting business. The point here is that the "opt-out" class action may be the lowest-cost mechanism for aggregating claims, but it is not the only mechanism.

    Desiring a mechanism for "collective redress," but apprehensive of a system of entrepreneurial litigation that resembled that of the United States, the European Union in June 2013 published a "recommendation" (the "E.U. Recommendation"), setting forth the principles that E.U. member states should adopt in order to create collective redress mechanisms. (15) As is customary, the E.U. Recommendation was non-binding, but it could not have been more emphatic in rejecting most of the key elements of the U.S. system. Specifically, the E.U. Recommendation insisted on:

    (1) An "opt-in" principle requiring the "express consent" of all claimants to be represented in the class; (16) (2) The close regulation of contingent fees (in the "Member States that exceptionally allow" such fees at all); (17) (3) A "loser pays" rule under which the winning party is paid its legal costs by the losing party; (18) (4) A prohibition on punitive damages; (19) (5) Mandatory use of non-profit entities to lead the class action (in order to minimize the danger of lawyer-controlled classes); (20) and (6) Close regulation of litigation funding by third parties (with a special...

To continue reading

FREE SIGN UP