Access to Justice or Justice Not Accessed: Is There a Case for Public Funding of Derivative Suits?

Abstract

The purpose of this Paper is to highlight and analyze an interesting recent development, whereby public funding may be provided in specific cases to fund derivative claims. An amendment made to the Israeli Companies Law of 1999 in May 2011 (“Amendment 16”) permits the Israeli Securities Authority (“ISA”) to fund derivative claims in cases it is convinced there is a public interest. This has the potential to be an important development for several reasons. First, it extends the discussion on how to address the funding problem in derivative action procedures beyond the common solutions (i.e. those involving various fee arrangements such as costs orders, rewarding the plaintiff, or contingency fees) and its “usual suspects” (i.e. plaintiff shareholders or attorneys) to an entirely novel domain — that of a public regulator — and public funding for these private actions. Second, and directly related to the previous point, providing public funding for private actions cuts across the traditional public/private dichotomy. It shows that the choice lies not solely between private and public enforcement, but also between a private enforcement aided by a public body (i.e. privately initiated and pursued litigation which are publicly funded). Finally, the Israeli solution may offer a new strategy to address a major concern in the literature on the theory of litigation, namely, the basic problem that private incentives to litigate may diverge from what is socially desirable and that strategies may be employed to tackle this.

In this Paper, I will discuss the problem of funding of derivative actions in a different taxonomy. Despite the various fee mechanisms and fee-favoring rules available under Israeli law before the introduction of Amendment 16, the fact that parties would still not pursue these claims demonstrates the underproduction of positive externalities. Thus if we are to motivate private actions by aggrieved parties, access to funding must be considered. Put simply, the policy underlying Amendment 16 reveals a new truth: where lawsuits would produce collateral social benefits, individuals are given financial support by a public body to litigate their claims. The new mechanism of a public body internalizing the cost (ISA) and thus enabling the lawsuits to be brought, helps produce these social benefits.

The Paper is structured as follows. Section A will briefly explicate the economics of derivative claim litigation. Section B will then outline the derivative action procedure under Israeli Companies Law of 1999, looking in particular at the various costs and fees arrangements under its regime. It will also briefly look at the time, cost, and number of procedures usually expected to resolve a commercial dispute through the Israeli courts. Section C will examine the details of Amendment 16, from which derivative actions may be underwritten through public funds. It will also look into the rationales behind the law. Subsequently, this Paper will in-quire into the advantages (both theoretical and practical) of public funding of such claims as well as highlight the shortcomings of such an approach. As part of this consideration, class actions currently funded by ISA will be analyzed. Finally, the implications of the preceding discussion will be examined and assessed in Section D with a view toward determining whether public funding provides a way forward for the funding problem, and whether it could be extended to other jurisdictions.

Keywords: derivative actions, derivative suits, derivative claims, comparative corporate governance, shareholder, incentives, Costs, Indemnity Costs Order, Funding, Conditional Fee Agreements, Contingency Fees, Incentives to Litigate

JEL Classification: C80, G34, K22, K40, N20, N40, P50