The Directive (EU) 2020/1828 on class actions, litigation funding and the impacts on international arbitration

1.      Introduction

In Portugal’s legal scene, there’s a noticeable rise in class actions across different areas, to which third-party funders are contributing in a significant manner. Not surprisingly, this contribution has raised questions about the legitimacy of those class actions, including one distinguished scholar who went so far as to consider the phenomenon of third-party funding as “unconstitutional” in the class actions’ domain.

Coincidentally, the Portuguese Government enacted Law Decree nr. 114-A/2023 (of 5 December 2023), which implemented in Portugal the Directive (EU) 2020/1828 of the European Parliament and of the Council of 25 November 2020. This European Directive and the Portuguese legislation aim at regulating a number of aspects related to so called “representative actions” for the protection of the collective interests of consumers. In a word, it sets forth a regulation of “class actions” related to consumers’ protection.

One of the most interesting topics subject to this regulation is the regime related to the funding of these class actions by third parties (third-party litigation funding). The Portuguese legal regime established several requirements that are worth mentioning and questioning whether they will pave the way to apply in the international arbitration realm.

2.      Third-Party Funding under EU Directive 2020/1828 and its Implementation in Portugal

According to EU Directive 2020/1828, the funding of class actions is subject to the following requirements (Arts. 4 and 10):

–          Independence of the funded party towards the funding provider: Member States shall ensure that “conflicts of interests are prevented” in the sense that third-party funders holding an economic interest in the “bringing or outcome” of the “class action” do not divert such class action from the protection of the collective interests of consumers: In this regard, third-party funders may not “unduly influence” the decisions of the entity carrying out “class actions”, in particular those decisions related to the settlement, in a manner that would be detrimental to the collective interests of the consumers. In addition, the representative entities must have in place “procedures to prevent such influence as well as to prevent conflicts of interest between itself, its funding providers and the interests of consumers”.

–          Transparency and non-competition: The representative action is not brought against a defendant that is a competitor of the funding provider or against a defendant on which the funding provider is dependent.

–          Transparency and disclosure: The entities that are allowed to bring class actions are obliged to “disclose to the court or administrative authority a financial overview that lists sources of funds used to support the representative action”. To this end, the representative entities shall make available on their website “information about the sources of its funding in general”.

–          Intervention of courts and administrative authorities, which “are empowered to take appropriate measures, such as requiring the qualified entity to refuse or make changes in respect of the relevant funding”.

By contrast, Art. 10 of Law Decree nr. 114-A/2023 provides for a much broader reach, as can be seen by the following requirements:

–          Disclosure: the plaintiff shall present to the court a certified copy of the funding agreement, which must be drafted “clearly” and “understandably” in Portuguese language and must include a financial summary of the sources of funding and a list of costs and expenses that will be borne by the litigation funder.

–          Approval of amendments: any amendments to the funding agreement must be subject to the approval of the court judge.

–          Independence: the agreement must ensure the independence of the plaintiff and the absence of conflicts of interest. A plaintiff is considered to be “independent” if it is the sole responsible for making all the decisions regarding the lawsuit and is guided by the principle of defending the interests at stake. These decisions include the choice of the counsel, definition of the procedural strategy, and also those related to the initiation, pursuit, withdrawal, settlement, appeals and the taking of any procedural step. The funder is impeded from prevent, influence in any way the decisions of the plaintiff and is not allowed to have vetting influence (such as authorize or be consulted before making those decisions and may not impose any negative consequence for the plaintiff in making any of these decisions.

–          Remuneration: the funding agreement cannot provide for a remuneration to the funder which is beyond a fair and proportionate amount, assessed in light of the characteristics and risk factors of the lawsuit and of the market price of such funding.

–          Non-competition: the lawsuit brought by a plaintiff who has entered into a funding agreement is inadmissible when at least one of the defendants in the action is a competitor of the funder or is an entity on which the funder depends.

–          Intervention and supervision of the court: The court holds the power to impose that these conditions are inserted in the funding agreement and remove the plaintiff’s standing if the latter does not comply with those conditions.

3.      The scope of the existing regulations in Portugal

While the EU Directive emphasizes preventing conflicts of interest and ensuring transparency, the Portuguese law takes a broader approach, requiring disclosure of funding agreements and court approval for any amendments. Notably, it mandates independence for plaintiffs and “fair remuneration” for funders, with courts empowered to enforce compliance.

One of the most interesting points of the Portuguese law is the provision related to “fair remuneration” for funders, which refers to ensuring that the compensation received by third-party litigation funders is reasonable and proportionate in relation to the services provided and the risks assumed. This principle aims to strike a balance between incentivizing funders to invest in legal claims while also preventing excessive or disproportionate returns that could undermine the integrity of the legal process.

In the context of the Portuguese legislation, fair remuneration provisions seek to prevent funders from exploiting class actions for excessive financial gain. Funders should be compensated for the capital invested, the risk taken on, and the expertise provided in evaluating and managing litigation. However, remuneration should not be set at a level that is unreasonably high or disproportionate to the value contributed, the risks involved, and prevailing market standards.

4.      Possible impacts on international arbitration

There is a growing trend in investment tribunals to order claimants to disclose the existence of third-party funding and the identity of the funder. Some tribunals have also ordered the disclosure of the details of the funding agreement. This trend seems to have no significant echo in commercial arbitration.

But international tribunals (even commercial tribunals) may be called upon to analyze and decide on the funding agreements when allocating costs, particularly when deciding which portion of the funding roll-out should be compensated by the losing party.

In this context, many questions may be posed. The first that comes to mind is whether tribunals are entitled to use similar powers as to those that the Portuguese courts have?

More specifically, are tribunals empowered to deny a claim for compensation of the funding costs (including the uplift) for being “unfair”, “disproportionate,” and apart from market price conditions?

And what are the criteria to assess the “market price” of litigation funding? Which is the “market” where the price for funding should be assessed? When should it be considered as out of proportion or unreasonable?

5.      Conclusions

In conclusion, the regulatory landscape surrounding third-party funding in Portugal, particularly in the realm of class actions, is undergoing significant development with the implementation of EU Directive 2020/1828 and its corresponding national legislation. While the Directive emphasizes conflict prevention and transparency, Portuguese law takes a more comprehensive approach, incorporating stringent requirements such as court approval for funding agreements and ensuring independence and fair remuneration for plaintiffs and funders alike.

The concept of “fair remuneration” for funders introduced by Portuguese law is particularly noteworthy, aiming to prevent exploitation of class actions for excessive financial gain while incentivizing investment in legal claims. However, this principle raises questions about its potential implications on international arbitration, where tribunals may be tasked with scrutinizing funding agreements and determining their fairness and proportionality.

As international tribunals increasingly confront issues related to third-party funding, there arises a need for clarity on whether they possess similar powers to those of Portuguese courts in assessing funding agreements. Moreover, defining criteria for evaluating the “market price” of litigation funding and determining when it becomes unreasonable or disproportionate presents a complex challenge for tribunals.

Addressing these questions requires careful consideration of legal principles, market dynamics, and the overarching goals of ensuring access to justice while maintaining the integrity of dispute resolution mechanisms. As the legal landscape continues to evolve, collaborative efforts among stakeholders and international cooperation will be essential in navigating the complexities surrounding third-party funding in both domestic and international contexts.