US-Style Securities Class Actions: Coming Soon to a Jurisdiction Near You?

01 June 2006

Sonya Leydecker, Herbert Smith LLP

Class actions are claims made by specialist law firms who find a client and sue on behalf of a larger group, taking a significant share of the damages awarded or settlement reached. There is a pattern to the litigation, which involves plaintiffs trying to bring defendants to the table to prevent the haemorrhage of huge costs bills and vast amounts of management time, when other issues may be more pressing. It is a no-win situation for defendants. With no costs penalty, and given the huge awards and settlements which can be achieved, the plaintiffs’ lawyers make their investment and wait for a settlement. It now seems that the securities class action culture may be invading Europe. In June 2005, an article in the Financial Times asked the question: “So could it now be the turn of the ‘class action’, the quintessential US legal device, to cross the Atlantic?” and, in September 2005, the Wall Street Journal reported that US lawyers are “encouraging European countries to revamp their legal codes and move toward US-style lawsuits”. Is this a real cause for concern for those outside the United States or is it simply scaremongering?

Current Procedural Position in Europe

The absence of court rules and procedures, tailored for class actions, may historically have contributed to the lack of securities class actions in Europe. At present, there is no direct procedural equivalent of the US-style class action in key European jurisdictions and the availability of some form of representative action in these jurisdictions varies. There is evidence, however, of some changes as set out below.

England

There is currently no direct equivalent in English law to the US class action. English law, however, has developed procedural means of dealing with group actions or multiparty claims, which permit multiple claims against a defendant to be grouped into a single action. There are two alternative forms of action, which can be used in a ‘class action’ type situation:

• ‘representative proceedings’, which allow legal persons to be represented in civil proceedings by other legal persons who have the ‘same interest’. Any judgment or order given in a representative claim will be binding on all persons represented in the claim. A judgment or order, however, may only be enforced by or against a person who is not a party to the claim if the court gives permission. This concerns the exercise of the court’s discretion.

• ‘Group Litigation Orders’, which may be made to assist in the case management of claims which give rise to common or related issues of fact or law. The present rules came into force in May 2000. Most US-style class actions in England will now be brought under this procedure as the test is wider than the requirement for the same interest in representative proceedings.

In February 2001, the UK government issued a consultation document on whether a generic procedure should be set up enabling unidentifiable individuals or a representative group, such as a consumers association which has not itself suffered loss, to bring a claim. It was decided that a generic procedure was not necessary, but possible representative claims would be taken into consideration when drafting new legislation.

The Company Law Reform Bill, published on 3 November 2005, proposes changes to derivative actions which would enable shareholders to bring actions against directors in respect of “an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director”. This will be a significant change and may encourage increased shareholder activism. In contrast with the current law, derivative actions would therefore be available in cases of negligence without any need to show ‘fraud on the minority’.

The number of group actions in England (although still a small number) has increased since the introduction of the specific rules to deal with group litigation. Group actions have been commenced in spheres such as tax litigation and the transfer of pension rights as well as the more obvious areas of product liability, personal injury and travel. The hopes of claimants in mis-selling-type cases, however, were dashed in March 2006 when the high court refused an application for a group litigation order to allow split-capital investors to bring class-action style misselling claims against their financial advisers on the basis that the mis-selling cases related to advice given to individuals and therefore should be assessed on their own specific facts and circumstances. The position in respect of costs remains as for all litigation: the normal order is that they follow the event. Claimants therefore run the risk of paying the defendants’ costs if they are unsuccessful.

France

In France, class actions contravene a 200- year-old procedural rule by which each litigant must be personally identified and must justify that he personally has standing to sue before starting legal action.

In 1992, however, a specific type of action only available to associations of consumers was created (a ‘joint representation lawsuit’, now codified in article L. 422- 1 of the Consumer Code). However, the joint representation lawsuit does not allow for compensation for a whole group of unnamed injured persons. Consequently, the class action, US-style, is in its strictest sense unknown in France. Furthermore, joint representation lawsuits are very rare. One of the reasons for this is that consumer associations, which usually provide free advice and support to their members, are reluctant to manage proceedings given the amount of work and the potential liability concerned.

In light of the poor success of the joint representation lawsuit, President Jacques Chirac asked the government on 4 January 2005 to prepare a law allowing class actions in a broader sense. Such class actions will, once again, only be available to consumers. A draft bill is expected shortly.

Germany

A new Law on Model Proceedings for Investment Suits came into force in Germany on 1 November 2005. The act applies to multiple claims by investors for damages as a result of allegedly wrong or misleading capital markets information.

This new statute requires the institutional or private investor to file an individual action at the regional court of the defendant’s registered office. The investor has the right, however, to apply for a model decision regarding questions of fact or law, which is decisive for the outcome of the dispute. If the regional court admits the application, an announcement is published in a federal register, which is publicly available via the internet. Notice is thereby given to other claimants who may wish to join the model proceedings. If at least nine additional claimants join the application for model proceedings, the regional court will seek a model decision of the higher regional court regarding the relevant question of fact or law. The higher regional court then designates one case as the lead case, and decides on the issues of fact or law with binding effect on all other pending cases. Once the higher regional court has given its decision, the regional court will subsequently deal with the other actions pending or on a case-bycase basis.

The Netherlands

There is no direct equivalent in Dutch law to the US class action for the recovery of damages. Dutch law, however, has developed two other procedural means of dealing with group actions, the combined result of which resembles the US class action practice: (i) the collective action and (ii) the collective settlement of mass damage claims.

Since July 1994, the Dutch Civil Code has provided for ‘collective actions’, brought on behalf of a class of persons with a common interest by a special purpose vehicle (SPV) in a prescribed form.

A summons in a collective action is limited to a petition for a ‘declaration of law’, for example, that the defendant has breached its duty of care or has acted tortiously towards the members of the group, on whose behalf the action is brought. Each member of the group must subsequently try to recover his own damages in separate proceedings against the defendant. There can, however, be an assignment of claims by the group members to the SPV or they can give an instruction to the SPV to collect the claim without a formal assignment. In either case, the SPV can claim damages suffered by each group member in its own name, but can be required to disclose the names of its assignors or principals so that causation defences can be raised on a case-by-case basis.

On 27 July 2005, the Act on the collective settlement of mass damage claims came into force in the Netherlands. The act applies after settlement has been reached in principle between one or more SPVs and one or more defendants regarding ‘mass damages’. The settlement is submitted by all parties to the Amsterdam court of appeals which determines whether or not the settlement is reasonable.

Other Reasons for European Reluctance to Embrace Class Action Litigation

In addition to the procedural issues described above, there are significant legal and cultural differences which act as a deterrent against US-style securities class actions in Europe.

Culturally, there are concerns about the perceived abuses to which the US model has led. Also, at least in England, large institutional shareholders have traditionally preferred to rely on informal pressure exerted on companies and their directors, rather than resorting to public pressure and litigation.

Another major issue relates to cost. For example, in England, the incentive for claimants’ lawyers is significantly more limited than in the United States. In England, under a conditional fee agreement, an uplift fee may be applied if the claim is successful. This is, however, subject to a maximum cap of 100 per cent of the solicitors’ normal fees and to any argument by the paying party that the uplift is disproportionately high to the risk that the claim would not succeed. Furthermore, judges have recognised that class actions are heavily lawyer-driven and are inclined to control legal costs by making costs capping orders. By contrast, in the US, contingency fees permit class action plaintiff lawyers to take a very sizeable percentage of damages awards (typically 33 per cent to 40 per cent). In France, no win, no fee arrangements are prohibited.

Moreover, exemplary damages are rarely awarded, whereas awards of high levels of punitive damages seem relatively commonplace in the US, thereby incentivising the plaintiff bar.

Often in the US, the jury wants to send a message to a large corporate as to its behaviour. Class actions are perceived as being for the public good in that they operate as a check on big businesses.

The absence in Europe of jury trials is said to account for the lack of securities class actions. It is thought that juries are more likely to be sympathetic to claimants and less rigorous than a judge in the approach to issues such as causation and reliance.

Conclusion

Are class actions coming to Europe? I think not. Modest moves are being made to provide a mechanism for claimants in mass tort to obtain swifter and cheaper access to damages for their losses. Many of the features which allow class actions to thrive in the US are still absent in Europe: direct investment in quoted securities on a large scale and a litigation culture with litigation used as a self-help remedy.

Particularly in England, the costs regime does not favour the development of specialist plaintiff law firms geared to take advantage of every corporate failing. So long as claimants are at risk on costs and the limit on the uplift on fees for conditional fee agreements remains at 100 per cent, with no other share in the damages, this is unlikely to change.

The UK government is flirting with the idea of allowing a version of US-style contingency fees. This may be partly in response to the recent dramatic decline in litigation commenced, as a result of the combined effect of the Woolf procedural reforms and the unavailability of legal aid for the vast majority of civil claims. Instinctively, English lawyers are appalled at the prospect: the obvious conflict of interest that contingency fees would cause when advising clients on whether or not to settle, and the lack of deterrent to unmeritorious claimants. But is this overcautious?

Contingency fees leading to class actions can be advantageous where a defendant has engaged in a pattern of wrongdoing, and can provide an effective remedy for a group of claimants without incurring the costs of thousands of separate lawsuits and risking inconsistent court decisions. They would also potentially give a remedy to claimants in the case of serious management failures in financial services companies where no one is prepared to accept responsibility, whether the company, its directors, the government or the regulators. Our different cultural approach to litigation might mean the worst excesses of the US system are not replicated here.

However, the English system is still criticised for its failure to grip the issue of the escalating costs of litigation. Any removal of the loser-pays-the-costs rule would have a significant and negative effect on the tactics and practice of litigation and would require much more active case management than the Woolf reforms have managed to produce.

A number of European jurisdictions are moving to provide procedural mechanisms for group or representative litigation and we already have them in England. With its emphasis on asserting consumer rights and furthering access to the courts, particularly in cross-border disputes, the European Commission is also expected to encourage developments in this direction at a pan- European level.

On balance, in England, I think the mechanisms we have for allowing redress for victims of torts and of securities irregularities should be simplified and the costs risks reduced, perhaps by more public funding, rather than opening the Pandora’s box of unbridled mass tort action claims.

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