Germany passes reform of lawyers' fees and litigation funding

The German parliament has adopted a new law to promote consumer legal services, the so-called Legal-Tech Act. It provides for lawyers to agree on contingency fees to a greater extent than before or to bear the costs of legal proceedings. The new law is to come into force on 1 October 2021.

The reform is intended to put lawyers on an equal footing with debt collection service providers in the area of out-of-court debt collection:  In Germany, this area is currently dominated by legal tech companies, which are registered as debt collection companies and therefore do not fall under the laws regulating lawyers.

In the so-called assignment model, individuals assign legal claims to collection service providers. The collection service providers assert the claims out of court and in court - sometimes bundling similar claims together. In most cases, the collection service providers take over the financing of legal costs and receive a success fee in return. They use technology to process cases of the same or similar nature in a bundled and thus time- and cost-efficient manner, for example when it comes to compensation for rail or air passengers or the rights of tenants. This approach is considered to be particularly attractive to consumers if the damage to the individual is so small that they shy away from the costs of individual proceedings.

Lawyers will be able to agree a contingency fee with their clients in cases valued up to €2,000 as well as for out of court debt collection services. Until now lawyers were only allowed to do this in very limited cases. According to the new laws, they may also assume the legal costs of their clients, which is currently prohibited. The new contingency fees are only possible for assignments that relate to claims that are subject to distraint.

Lawyers can take on the costs of proceedings in certain cases. They will in future be allowed to conclude agreements with their clients according to which they will bear the court costs, administrative costs or costs of other parties involved. However, this will only be possible for out of court debt collection services and judicial dunning, a German court procedure to simplify enforcement of monetary claims. Originally, it was planned to allow litigation funding for all types of monetary claims up to €2,000.

The law provides for new duties of disclosure in order to strengthen the transparency and clarity of the new business models. When agreeing on a contingency fee, debt collection companies must inform their clients of other options for enforcing their claims. In future, they must also inform customers about the cost risks and why the contract is lucrative for the collection agency. Additionally, debt collection agencies are to be subject to stricter controls. At the time of their registration, authorities will check whether their business model is compatible with the legal rules for debt collection service providers.

According to the German government the new law will strengthen consumer protection by making it safer and more transparent for consumers to exercise their rights in relation to mass claims where they are represented by lawyers and legal service providers.

In the past, courts have repeatedly dismissed class actions conducted under the assignment model with the argument that the assignment agreements of the collection service providers were void. The German Federal Supreme Court (BGH) later recognised the general legality of the business model of legal tech companies in a landmark decision in November 2019, but also said that a case by case analysis of the respective business model is required. Experts criticised that legal uncertainty remained.

Johanna Weißbach, litigation expert at Pinsent Masons, the law firm behind Out-Law, said: "The intention of the legislature is to cast the standards of the Federal Supreme Court from its two landmark judgments on debt collection service providers from November 2019 and April 2020 into legal form and thus finally ensure legal certainty. However, the legislature does not go as far as the Federal Court of Justice."

The German parliament does not consider the reform of the professional law for debt collection service providers and lawyers to be completed. There was a need to "continue to observe the practice and to include the outstanding decisions of the Federal Supreme Court on legal services law in the further considerations", it said in its resolution.

"We anticipate that there will be a variety of further legal innovations in this area in the coming years, which will have a significant impact on court proceedings and, in particular, the initiation of new mass proceedings," said Sibylle Schumacher, litigation expert at Pinsent Masons. "It remains to be seen whether this development will be followed by the - urgently needed - increase in staff and technology in courts."

The parliament called on the German government to examine whether further adjustments to the professional law are necessary. Among others, after only three years, the government shall examine whether the possibilities for lawyers to agree on contingency fees and to assume the costs of proceedings in the form now envisaged are expedient.

By 30 June 2022, the federal government is also to present a draft law to transfer the supervision of the new rules to a central body, possibly the Federal Office of Justice.