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Shareholder class actions

(An article from Equity Nov 2013 by Tracy Tran)

Shareholder class actions are now well established in Australia but controversy still reigns. Aggrieved shareholders are supportive but some companies remain highly critical and see Australia becoming a more litigious place to do business. 

Class actions were established in Australia after a long and careful gestation period during which law reform agencies, regulators, academics and others all had their say. As a result, there are marked differences between the operation of class actions in Australia and elsewhere to ensure a US-style culture of ‘entrepreneur litigation mania’ cannot develop.

The Aims and Operation of Class Actions

Access to Justice

The core purpose of a class action is to allow people with existing legal rights to band together in circumstances where the costs of pursing their rights individually would be prohibitive. The formation of a class action changes the economics of the situation, not the substantive merits of the case. By changing the economics, class actions effectively level the playing field between the plaintiff group and a well-resourced defendant. 

Corporate Governance and Integrity of the Market

Shareholder class actions operate as the second regulatory enforcement arm to deter corporate wrong doing. The other arm of deterrence in Australia encompasses ASIC, ACCC and ASX.

Anecdotal evidence suggests that the risk of a class action has had the salutary effect of encouraging Boards and Directors to take more seriously good corporate governance systems and practice. In turn, better corporate governance enhances and maintains the integrity of the market. 

Controls for the Conduct of Class Actions

Suing the Company

There is a view that it is counterproductive for shareholders to sue a company in which they have shares. This is unfounded. 

Firstly, it is possible for a shareholder to keep his/her shareholding and still be part of a class action to claim compensation from a company which has caused them harm. 

Secondly, the ongoing financial viability of a company is unaffected if, as often happens, the misconduct in question is covered at least in part by professional indemnity insurance. Professional indemnity insurance is simply a normal cost of doing business that predates the introduction of class actions in Australia. Moreover, in recent times, there has been an increase in ‘Entity Securities Coverage’ insurance (also known as Side-C insurance) which provides cover to publicly listed Australian companies for any liability arising out of shareholder claims.

Due Diligence 

In the US, as a general rule, the first law firm to file a class action usually provides exclusively to all damages claims. In Australia, there is no such rule or practice.

Australian class action law firms take considerable time to conduct due diligence and make a decision as to whether or not the class action is meritorious in law. Any litigation appetite must be commensurate with the risks involved. 

As an extra level of due diligence, if a third party litigation funder is involved, the funder will scrutinise the merits of the matter and, in practice, funding will not be provided unless the funder is independently satisfied that the prospective class action has strong merits. 

Greed -vs- Merits 

Contrary to the concerns about entrepreneur class actions, empirical evidence has demonstrated that hundreds of thousands of Australian shareholders have benefited in receiving compensation for alleged wrongs that they have suffered.

Importantly, in Australia unlike the US, the party that loses the litigation is ordered to pay the winning party’s costs. Adverse costs, and security for costs, will usually be provided by litigation funders, thereby removing the ‘straw-man plaintiff’ argument. Fundamentally in practice, the risk of having to pay these cost orders is an effective deterrent against unsound litigation that might have otherwise been considered by unscrupulous lawyers more interested in earning fees.

The result is a highly competent and specialised plaintiff’s bar who are skilled at assessing the prospects of succeeding in potential litigation, and whether it is economically viable for group members to pursue their claims. 

Professional Rules, Ethics and Judicial Oversight 

Professional regulation, legal ethics, and judicial oversight are further ways in which aspects of the conduct of class actions are controlled. 

In particular, no out of court class action settlement in Australia is binding unless it obtains court approval. The court must be satisfied the settlement is in the interests of all group members as well as being fair and reasonable in the circumstances. Critically, the court must be satisfied that the legal costs of the class action law firm are also fair and reasonable. 

The Reality

Empirical appraisal of the evolution and effect of class actions in Australia demonstrates that there has been no flood of class action litigation in Australia. The high profile nature of the relatively few shareholder class actions probably gives the misapprehension of proliferation. Overall, class actions have had and will continue to have a salutary effect in promoting better corporate governance and, most importantly from an investor’s point of view, market integrity.

Tracy Tran is an Associate in the Commercial and Project Litigation group at Slater & Gordon Lawyers. She has particular expertise in managing and running large-scale litigation including a number of landmark shareholder class actions in Australia involving Trade Practices, Corporations, Finance and Contract Law. She was admitted to practice in the Supreme Court of NSW and the High Court of Australia in 2008 and has been practicing at Slater & Gordon Lawyer in the last 5 years. 

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