Class action law, Better Call Saul and the cost of bad incentives

Rethinking class action in Britain

Better Call Saul is rightly regarded as one of the greatest television series of the 21^st century. A prequel to the (almost equally excellent) AMC series Breaking Bad, it follows the career of the New Mexican lawyer, turned cartel fixer, turned fugitive, Jimmy McGill (alias Saul Goodman).

Between occasional shootouts and meth dealing the show is largely a well-researched, procedural legal drama.

One of the most compelling subplots, which unfolds over several seasons, involves a chain of care homes which has been systematically overcharging its elderly residents for basic items like plasters and syringes. This is uncovered by McGill who encourages the residents to bring a class action case against the care home to win compensation for their losses. In order to have a realistic chance of success they enlist the support of a large legal firm which takes on the case in exchange for a share of the proceeds, which the residents will almost certainly win given the strength of their case. This is where the problems emerge.

It is later revealed that the legal firm is pushing for the case to go to trial in the hopes of winning a slightly larger compensation package despite the fact that the care home has already offered to settle out of court for $20 million. McGill argues (admittedly for self-interested reasons) that the residents would be better served by accepting the offer as many will have died by the time the case comes to trial – and suggests that the legal firm is failing in its fiduciary duty to their clients in the pursuit of the financial gain.

While Better Call Saul is a work of fiction,¹ it does highlight the potential for misaligned incentives that can emerge in even in relatively simple class action cases involving small numbers of claimants.

Photo by Tingey Injury Law Firm on Unsplash

Back in Britain

Until recently British lawyers, economists and politicians have not had to give much consideration to such difficulties for the simple reason that, unlike in the US, class action cases were extremely rare.

While the earliest recorded class action case dates back to the 12^th century, shifts in company law and various court rulings meant that by the late 19^th century they had largely fell into disuse. Class action was, in the words of Stephen Yeazell – one of the leading scholars on the topic, treated as a ‘theoretically available’ option that in practice had become ‘an exotic offshoot of a happily abolished doctrine.’

This all changed with the Consumer Rights Act 2015. The Act for the first time allowed US style ‘opt-out’ class action cases to be brought before British courts. This meant that rather than claimants needing to actively choose to take part in a claim anyone who had (allegedly) been affected by a company accused of acting unlawfully could automatically be included in a suit without their consent or even knowledge.² The intentions behind this change were not malign; it was thought that requiring consumers to opt-in made class action suits unviable and that by lowering the bar firms would be discouraged from forming anticompetitive cartels.

That said, concerns about the new system soon emerged. There was an explosion in the number of class action claims funded by third-party financiers (often international hedge funds) in exchange for a share of any potential winnings.

This has created a number of issues: weak and speculative cases coming through, jamming up courts with lengthy cases, accusations of lawyers acting as rent seekers and claiming huge shares of compensation, third-party funders (who unlike lawyers have no fiduciary duty to the nominal claimants) coming into conflict with lawyers and the interests of claimants.

Third-party funders, are often willing to cover legal costs even in the cases where the likelihood of success is low. This is in part because the funder’s share of the payouts from a successful class action suit can cover the legal fees for several unsuccessful cases. Additionally even in the face of weak claims some defendants have been known to settle claims simply to avoid the uncertainty and expense of lengthy court proceedings.

Another major problem with the existing system is that third-party funders can actually benefit from drawn out cases as courts are known to award litigation financiers a greater share of compensation funds in cases that last longer. This at the very least, has the potential to create perverse incentives for financiers to avoid quick resolutions to cases that may be in the best interest of claimants. The notorious Merricks vs Mastercard case saw third-party funders take the lead lawyer on their own side before an arbitration panel for coming to a ‘premature agreement’ in accepting a £200 million pound settlement after nine-year legal battle. Just last month the CEO of the legal firm suing in the Fundao dam case was removed after he clashed with third-party funders in the £36 billion case. This is the UK’s biggest ever class action suit, despite the events occurring in Brazil and affecting Brazilians. These cases, and there are many more, highlight how the current system of class action law in the UK often creates clashing interests of claimants, lawyers and funders, often with messy results.

What is to be done?

One solution might be to require third-party funders to buyout the claims from the customers before the case reaches the tribunal stage, well before it reaches trial. This means funders would have to put their money where their mouth is by providing compensation up front to customers, which they are unlikely to do if the claim is weak. It also means funders have a strong incentive not to draw out the case and are more likely to come a settlement quickly, reducing the strain on courts.

Though this would be a radical shift in how class action works in the UK, this is not without precedent. A similar system currently works well in Germany, which could act as a model. Such a buyout system could also create a bidding market between different third-party funders for consumer claims which has the effect of providing vital information to investors on the likelihood of a successful suit.

We should all want a legal system that allows consumers to quickly gain redress when firms violate the law and engage in cartelism, but without creating new opportunities for rent seekers to harass law-abiding firms.

Unfortunately, the UK’s ten-year experiment with opt-out class action law has revealed a system which is poorly equipped to fulfil either of these objectives. The system is sluggish but also creates far too many opportunities for rent seeking and spurious cases to slip through, harming both investment and the economy more broadly.

A forthcoming IEA paper will examine the rise of the class action industry in the UK and what should be done to reform it in more detail. Class action, if properly used, can be an effective tool for preventing the deadweight losses to the economy that result from anti-competitive, monopolistic behaviour. But problems have emerged under the current system. The report will outline how we can learn from the mistakes of the last decade to build a system that is fair for consumers and firms. Let’s hope policymakers are willing to learn.

¹ The show’s class action case is ultimately resolved with the help doctored photographs, the impersonation of a judge and drugging a senior lawyer in a mediate session. All tactics I am reliably informed are a rarity in real class action cases, even in the US.

2 The number of claimants in opt-out cases can run to the tens of millions, meaning if you are reading this in the UK it is highly likely you are either currently or at least have been a claimant at some point in the last decade.