The Class Action Debate in Europe: Lessons from the U.S. experience
U.S. Chamber of Commerce CEO Tom Donohue recently wrote about the importance of the transatlantic partnership—referring to it as “the backbone of global commerce.” In the face of the current economic crisis, it has become even more apparent how closely tied the well-being of our nations has become. There is one aspect of this transatlantic partnership, however, that the U.S. business community does not seek to develop and which we fear will hinder our collective economic recovery—the spread of U.S.-style litigation. Indeed, the export of U.S.-style litigation has the potential to break the back of global commerce through the spread of the U.S.-style “compensation culture.”
As a number of European governments and the EU itself are looking to adopt new litigation mechanisms that closely resemble U.S.-style class and mass action lawsuits, we in the U.S. business community are concerned about the creation of a transatlantic market for the type of abusive, lawyer-driven class action lawsuits that have plagued the U.S. for decades. European policy-makers seek to reassure the business community that they do not intend to import the problems of the U.S. legal system in adopting class action mechanisms. Our experience in the U.S. with the entrepreneurial plaintiffs’ bar leads us to believe that it may be impossible to import the benefits of U.S.-style class actions while avoiding abuses and economic burdens. For that reason, in this article, we seek to share the lessons of the U.S. class action experience. It is, above all, a tale of unintended consequences.
The Genesis of the U.S. Litigation Crisis
As originally envisioned by its authors, the U.S. class action device was intended to enhance judicial efficiency in adjudicating claims involving large numbers of people and was intended to grant access to compensation for individuals whose claims, when taken individually, would not be sufficiently profitable to persuade a lawyer to take their case.
What the authors did not foresee was the incredible financial incentive to bring class actions – the potential for plaintiffs’ lawyers to generate substantial attorneys’ fees by amassing hundreds or thousands of claims in a single legal proceeding. The abuses that have arisen in the U.S. with mass and class actions have been largely driven by the potential payoff offered by contingency fee financing of suits in which the winning plaintiffs’ lawyers are entitled to roughly a third or more of the award or settlement. The more plaintiffs a lawyer can recruit, the greater the potential payoff. Thus, class actions in the U.S. are largely lawyer-driven exercises in which the idea to bring a suit comes not from an injured consumer or investor, but rather from an entrepreneurial lawyer who sees an opportunity for profit.
The Cost to Businesses of U.S.-Style Litigation
The explosion of U.S. class actions over the past four decades has imposed a substantial cost on American business. Not only are U.S. companies forced to allocate billions of dollars to legal fees and litigation costs every year, but the overall litigation climate in the United States deters significant foreign investment in U.S. businesses and impedes research and development in important product areas, such as medical technology and pharmaceuticals.
U.S.-style litigation imposes crippling costs on the national economy. It is no secret that the U.S. litigation system has had a tremendous economic impact. A study by the research firm Tillinghast Towers-Perrin estimates that the tort litigation system in the U.S. costs $252 billion annually, or $835 per every American. These costs amount to 1.83% of U.S. GDP compared with .5% to .7% in other OECD countries. Both the overall cost and the percentage of GDP have actually dropped due to legal reforms—it had been at $261 billion or 2.2% of U.S. GDP in 2005.
The cost of litigation is borne largely by American business, including companies of all sizes. We can’t precisely quantify what portion of this cost is attributable to class actions, but certainly the ability to aggregate claims into class actions and mass actions is one of the features of our system, along with contingency fee arrangements, broad discovery capabilities and the threat of punitive damages, that encourages litigation and drives up costs.
Litigation run amok dulls America’s competitive edge. Notwithstanding recent improvements, there is growing concern that tort litigation costs undermine America’s ability to compete in the global economy. A recent paper issued by the U.S. Department of Commerce describes the chilling effect that the U.S. litigation culture has on foreign direct investment. In an examination of the specific areas of concern cited by foreign investors, class action lawsuits are listed as one of four categories (in addition to punitive damages, forum shopping and litigation culture) meriting further examination for their impact on investment.
A number of other recent studies provide confirmation of the Commerce Department’s findings. A survey of Chief Executive Officers of non-U.S.-based companies conducted by the Organization for International Investment found class action lawsuits to be the top concern with the U.S. legal system among foreign investors. In the same vein, the McKinsey and Company Global Capital Markets Survey found securities class actions to be a major concern affecting the health of the U.S. capital markets.
Companies are forced to pay for even meritless lawsuits. Class actions represent major revenues for plaintiffs’ lawyers, whose objective is to leverage a large settlement by building as large a potential risk to the company as possible. The more class members, the higher the stakes, and the greater the likelihood that defendants will settle rather than betting the company and risking a huge judgment against them, regardless of whether the facts are on their side. Settlement is the name of the game in U.S. litigation, and the availability of class actions gives plaintiffs lawyers the opportunity to set the stakes for defendants so high that companies are pressured by the economic risk to simply settle, even if a claim has little merit. In fact, these cases rarely get to a trial at all. In the U.S., less than 2 percent of federal cases get to trial, and 5 percent of state cases get to trial.
U.S.-style litigation diverts resources from more productive goals. Class actions force companies to expend their resources on legal and settlement costs instead of in more productive areas, such as research and development. Nowhere is this felt more than in the pharmaceutical industry. For example, between 1999 and 2004, one major U.S. drug maker spent $25 billion [USD] on legal costs and legal reserves to fight class action lawsuits, while devoting only $19 billion [USD] to research and development. Surely such a diversion of resources away from productive R&D is not desirable in any industry. In the pharmaceutical industry, it should be noted that this constitutes a diversion of resources away from the development of potentially life-saving products. We also note that it was later discovered in this particular pharmaceutical litigation that many of the claims involved were fraudulent and several of the claimants were ultimately indicted for forging fake prescriptions.
Frequent Abuses in the U.S. Class and Mass Action System
In addition to being extremely burdensome to the U.S. economy, class and mass actions fail to accomplish their original purpose: efficiently bringing justice to truly injured parties. Securities class actions and the mass action system are especially rife with abuse and fraud.
Economic Loss vs. Consumer Gain in Securities Class Actions. Securities class actions have been particularly problematic in the U.S. While plaintiffs’ lawyers are incentivized by profit to file these cases by the thousands, securities class actions return little or no money to those lawyers’ clients – the individual shareholders.
No other country permits claims that approach the size and scale of those that may be filed under U.S. law. Reversing a small downturn in 2005-2006, securities class action filings have begun growing again in recent years, increasing 58% between 2006 and 2007. And the most recent data from 2008 suggests that the number of filings may be significantly higher this year than in 2007.
Regardless of the number of securities suits filed, the amount companies spend to settle securities litigation continues to grow ever larger. The average settlement size has increased dramatically in recent years. The average settlement for the period 1996 to 2001 was $16.3 million, skyrocketed to $54.7 million for the 2002-2007 period, and, in 2008, for the first time ever, each of the top ten settlements totaled over $1 billion.
Securities class action lawsuits have a particularly corrosive effect on the economic competitiveness of the US. According to a study conducted for the Institute for Legal Reform by Professor Anjan Thakor of Washington University in St. Louis, the mere act of filing a securities class action lawsuit against a company causes its stock values to drop on average 3.5%.
Moreover, studies commissioned by the Institute for Legal Reform show that, fundamentally, class action lawsuits are the least efficient way of holding a firm accountable for any alleged wrongdoing. This system is based on one group of investors suing another group of investors. The lawyers win huge contingency fees while recovery to investors is generally only pennies on the dollar.
In our study of 755 cases over 10 years, just one plaintiffs’ firm, Milberg Weiss, served as lead or co-counsel in cases that generated $1.7 billion in legal fees – or 43 percent of all fees in these cases. Notably, this firm has become notorious not only for its success in stirring fear in Board rooms across America, but because four current and former Milberg Weiss partners have since pled guilty to criminal charges. The firm was paying huge sums of money to plaintiffs to bring cases – a clearly illegal practice in the U.S.
Fraud in Mass Actions. Another area that has been rife with fraud and abuse in the U.S. system is mass actions. In addition to class actions, U.S. law allows for another kind of collective action mechanism called a “mass action” where claimants are aggregated into one case. Asbestos and certain pharmaceutical lawsuits have been brought as mass actions.
In the asbestos arena, companies have paid out more than $70 billion, much of which has been based on claims that were largely fraudulent. More than 85 companies have been bankrupted by this litigation. On average, asbestos victims have collected 43 cents on the dollar paid out in settlements and verdicts, and reports indicate that a disproportionate amount of bankruptcy trust dollars have gone to the least injured claimants – many with no discernable asbestos-related impairment at all. Not only have mass actions been plagued with fraud and abuse, they are also remarkably inefficient in delivering compensation to the truly injured.
The Legal Climate in Europe is Vulnerable to U.S.-Style Litigation Abuses
Needless to say, we have a growing interest in keeping our lawsuit culture away from the European Continent. Generally speaking, companies have enjoyed a fairly favorable legal environment in Europe, which is largely free of abusive and frivolous lawsuits and class action activities. Rules such as loser pays, prohibitions on contingency fees, limits on discovery, and prohibitions on punitive damages all protect Europe from the lawsuit abuse generated by over-zealous U.S. plaintiffs’ lawyers.
The plaintiffs’ bar in the U.S. nevertheless sees Europe as a target of opportunity. Despite these barriers to class action abuse, the opportunistic American plaintiffs’ bar is partnering with consumer rights advocates to promote American-style lawsuits in Europe. They are gaining strength in the media, public opinion, academic and political circles, including in conservative and generally pro-business political parties. The American plaintiffs’ bar seeks to take advantage of the changing legal climate in Europe. U.S. lawyers are beginning to put the infrastructure in place to expand their growth opportunities and markets. As one partner at New York’s Murray, Frank & Sailer explained: “All the fields have been plowed in the United States. If you want to enter new markets, you have to go outside the United States.”
A few quick examples: First, French consumer group UFC-Que Choisir has filed papers in a U.S. Federal Court in an antitrust class action case against Intel. The purpose of their representation is to use the U.S. class action rules in order to gain access to confidential documents that will help the firm bring group consumer damages actions against Intel in France. Their lawyers? U.S. class action plaintiffs’ firm Cohen Milstein. With this kind of opportunity on the horizon, Cohen Milstein opened a London office just last year.
Likewise, the U.S. plaintiffs’ bar quickly infiltrated the class settlement system adopted in the Netherlands in 2005. In 2007, Shell Oil settled a U.S.-style shareholder class action lawsuit for $352.6 million (USD), $47 million of which was paid in attorney’s fees to U.S. law firms.
U.S. companies are rightly concerned by these developments, because they know all too well what the abuses of the U.S. legal system are costing them, and they don’t want to reproduce the experience in Europe. Worse, they don’t want to see the creation of a transatlantic market for class action lawsuits.
Present safeguards may not protect against future class action abuse. The abuses of the American system are so well known that advocates for class actions in Europe claim that they will not adopt the American system by supporting the adoption of “collective redress,” which is just another word for “class actions,” by permitting only consumer organizations to sue, prohibiting the use of contingency fees, limiting discovery, and passing time limited or experimental class action laws. However, entrepreneurial lawyers are finding ways to work around each of these defensive measures. The rise of third party litigation funding, for example, is simply a substitute for contingency fees. Additionally, parties that cannot get discovery in Europe are intervening in parallel U.S. proceedings to get access to documents in U.S. courts for use before European tribunals. And temporary or experimental laws can easily become permanent.
The debate currently underway in Europe shares many of the same well-intended motives we had in the United States when we created class actions more than forty years ago. But at the end of the day, the path Europe is undertaking is a slippery slope that could ultimately lead to the same type of litigation abuses found in the United States.
What Advice Can We Offer?
European nations have historically been largely protected by the unavailability of contingency fee arrangements and the availability of “loser-pays” rules, which discourage the launching of speculative lawsuits. Furthermore, unlike in the U.S. where punitive or exemplary damages and pain and suffering damages are available, damage payments in Europe are generally more limited. However, efforts are underway to dilute these safeguards. Creative ways to work around the ban on contingency fees are springing up, such as third party financing of lawsuits. In addition, there is debate underway in some quarters in Europe, such as the UK Civil Justice Council, about adopting contingency fees in certain situations. Such erosion of these bulwarks against litigation abuse that have protected Europe for so long should be avoided at all costs.
In addition, alternative dispute resolution mechanisms, such as arbitration, mediation, and special compensation funds, can be more user-friendly and efficient than the courts.
Our advice can be summed up in one short phrase: follow the money. If European nations establish class action systems that provide financial incentives for lawyers to drive litigation for their own personal profit, then you will invite abuse just as your well-intended American friends did 40 years ago when we first went down this path. We urge you to proceed with utmost caution.
About the author
Lisa Rickard is the president of the U.S. Chamber Institute for Legal Reform (ILR), a position she has held since 2003. ILR seeks to promote civil justice reform through legislative, political, judicial, and educational activities at the national, state, and international levels. ILR is an affiliate of the U.S. Chamber of Commerce, the world’s largest business federation, which represents more than 3 million businesses and organizations of every size, sector, and region.