Litigation funding in Australia - a tangled web

John Emmerig and Michael Legg unravel the tangled web of litigation funding and forecast more development as the regulatory framework becomes clearer. 

Litigation funding is now embedded in the Australian litigation framework. Since the High Court endorsed the suitability of funding in 2006, it has played a critical role in facilitating the prosecution of major pieces of litigation in Australia, most frequently in the area of class actions.

Litigation funding is also now expressly recognised in the rules of court in key Australian jurisdictions such as New South Wales, Victoria and Western Australia.

For most of the period since its endorsement, litigation funding has avoided direct regulation. In response to concerns arising from a number of cases in recent years calling into issue whether litigation funding of class actions offended the Corporations Act 2001, the government established a "light touch" regime through the Corporations Amendment Regulation 2012 (No. 6), seeking to overcome the issue.

In effect, this has been done by excluding the funding of class actions from the requirements of an Australian Financial Services License and managed investment scheme provisions of the Corporation Act, and the introduction of requirements on funders to manage conflicts of interest. Consequently, litigation funding is a feature of litigation that directors need to understand and be able to grapple with when dealing with litigation.

Litigation funding has become entrenched, but this does not mean its form or its providers are not changing. To the contrary, the litigation funding market looks set to go through considerable development now that the regulatory framework has become more certain.

Foreign funders

Australia has had a number of domestic funders for some time due to funding originally arising in the context of Australian insolvency proceedings. The growth of class actions saw the emergence of two major foreign funders, one based in the US and one based in Singapore. However, a number of new funders, mainly from overseas, have entered the market and are looking to fund class actions in Australia. These have largely been from the UK, where litigation funding has been adopted in recent times but no class action procedure yet exists. In part, the stimulus of UK funder interest in the Australian market seems to be linked to UK reforms affecting the after-the-event insurance market that have caused insurers in this business to look further afield for litigation funding opportunities.

The trends suggest competition in the Australian funding market is likely to increase.

This may see the percentages charged by funders decline (currently they are in the 25-45 per cent range). But it is also likely to see an increase in the volume and novelty of litigation commenced as all funders seek to make a return on their capital.

Law firm-created funders

It also seems likely that there will be a number of more novel entrants into the market.

Maurice Blackburn, known for its class actions expertise, especially in the shareholder class actions area, has created its own funder, the Claims Funding Australia Trust, which has as its trustee Claims Funding Australia. The media has reported that two of the law firm’s senior principals are shareholders in the funder and a third is one of the funder’s three directors. In addition, all of Maurice Blackburn’s principals are beneficiaries of the discretionary trust. Due to the novel nature of a law firm creating a litigation funder, the trustee of the funder has sought approval to be able to fund the equine influenza (EI) class action against the Commonwealth government. The EI class action is being run by Maurice Blackburn.

The request for approval has been referred to the Full Federal Court to ensure the funding arrangement does not breach the ban on contingency fees that exists in all Australian states.

Whether the structure adopted for the litigation funder is sufficient to avoid a breach of the legislation outlawing contingency fees may in many ways be beside the point. If law firms are able to establish litigation funding entities they can direct clients to, and receive from, albeit indirectly, a proportion of the client’s recovery, then Australia will have contingency fees in substance. This then raises two further issues: Should lawyers creating and controlling funders be prevented to avoid the excesses of contingency fees seen in the US? And, if such arrangements are seen as a desirable, should Australian states amend their statutes governing the legal profession and allow lawyers to charge contingency fees directly?

Class action members self-funding

The ability of funders to take a share of claimants’ recoveries has also been met with group members in a class action seeking to fund the proceedings by contributing funds themselves.

In the Storm Financial class action, this was taken a step further with the group members who "self-financed" seeking a 35 per cent uplift in recovery compared with group members who did not finance the class action. The premium was sought on the basis that it was akin to a litigation funder being involved and recognised that the group members had taken on the risk that no recovery may be achieved. This funding arrangement was approved by the Federal Court when approving a settlement between group members and Macquarie Bank. The approval took place despite the Australian Securities and Investments Commission (ASIC) intervening because of its concerns about the size of the premium and whether adequate notice had been given to group members of the uplift. ASIC has subsequently appealed the settlement approval decision. As a result, the Full Federal Court will have the opportunity to consider this funding arrangement further.

While the arrangement was likened to a third-party litigation funding with the premium calculated by reference to what such a funder might demand, the arrangement differs in important respects. The group members in the Storm class action were not at risk of an adverse cost order (that is, paying an opponent’s costs if the case fails). Only the applicant was, due to the operation of the class actions legislation.

Third-party funders usually indemnify an applicant against an adverse costs order, meaning the applicant is protected and the funder has funds at risk. The greater risk means the funder has an incentive to undertake due diligence and even perform a management role to assist in the case being successful.

Under the Storm class action model, due diligence and management fall to the lawyer for the applicant and the funding group members. Significantly though, the lawyer does not have funds at risk the way it would under a traditional "no-win, no-fee" arrangement that was used to fund class actions before litigation funding. The lawyer gets paid regardless of whether the case succeeds.

US common fund doctrine

The other development mooted is the adoption of some form of common fund approach to determining the success fee claimed by litigation funders. The common fund approach refers to a US form of paying legal fees in the class action context.

In the US, the common fund doctrine allows lawyers to apply for a share of any fund, usually an award of damages, they create for the benefit of persons other than themselves or their client. The court, upon application by the lawyer, will award a reasonable attorney’s fee from the fund to compensate the lawyers for their time and effort in achieving the fund.

The amount of the fees awarded requires consideration of a number of factors, such as the time actually expended by the lawyers in running the case, the complexity of the litigation and the risk of the litigation. While the fee may be agreed before proceedings begin, the court has the last say on what the amount will be. The advantage of a common fund approach from the perspective of a litigation funder is that there is no need for a contractual relationship between it and group members. Instead, the court awards fees that are equally shared by all group members. This can reduce the costs funders incur in signing up claimants and may produce larger groups. It may also provide some form of oversight in relation to the fees charged by litigation funders so that those fees are commensurate with the risk of the proceedings.

Where the Australian approach differs from the US approach is that litigation funders appear to want the percentage determined at the start of proceedings rather than at their conclusion when the amount of any settlement or any judgment is known. Funders presumably prefer this approach because it reduces uncertainty and allows them to calculate the return they can achieve from the class action.

The problem with this is that the merits of the proceedings and the actual quantum the funder will be paid are difficult to determine at such an early stage. For example, 30 per cent of the recovery might be reasonable if a $1 million settlement is achieved but may be excessive if a $1 billion recovery is achieved. Payments to the funder mean less compensation for those who actually suffered loss.