A cautionary tale

Andrew Morrison and Yudi New examine the outcome of a recent court case that could have great significance for the future of entrepreneurial class actions.

In April this year the Productivity Commission published a range of draft recommendations concerning access to justice, including the funding of Australian civil litigation by third parties and by lawyers.

Among the commission’s recommendations were proposals to lift the present ban on contingency fees and to require third party litigation funders to hold modified financial services licences and be subject to prudential regulation. This dual approach is notionally intended to create a playing field for managed competition to provide litigants with access to monetary awards (characterised as civil justice) in return for a contingent share of their potential success.

These recommendations have been influenced by the rising tide of representative proceedings in federal and state courts. Product and catastrophic event related actions aside, litigation funding is now a key driver in securities class actions, targeting the acts or omissions of publicly listed companies and others. To date, such cases are likely to settle and, if approved by the court, deliver a relatively quick and healthy return to the third party funder. That is why they are selected in the first place. In response, a small number of Australian plaintiff law firms have moved to set up their own captive funding companies. Other firms have devised different approaches. It is a small but burgeoning capital market, although one where lines are beginning to blur.

Interests of justice paramount

Courts administering class action regimes are increasingly being called upon to address the entrepreneurial models that underpin such actions.

The recent first instance decision of the Victorian Supreme Court in Melbourne City Investments (MCI) v Leighton Holdings and MCI v Treasury Wine Estates (TWE) serves as an ominous warning that some models are neither serving the interests of justice nor the claimants who they are supposed to benefit.

The MCI model

MCI is a Victorian investment company managed and controlled by Mark Elliott, a Melbourne‑based solicitor.  MCI holds a small parcel of shares in each of TWE and Leighton Holdings, having acquired each parcel for under $700.

MCI initiated separate securities class actions in the Victorian Supreme Court against TWE, Leighton and WorleyParsons Limited. Elliott is the solicitor for MCI in each of the proceedings.  He is also the solicitor in similar actions where MCI is not the claimant. Against each of the defendants, MCI alleges breaches of the Corporations Act 2001, principally, failures to disclose, and misleading and deceptive conduct. It does so on its own behalf and on behalf of security holders. However, the most that MCI could recover in each action would be less than $700.

An abuse of process?

TWE and Leighton each sought orders to effectively bring the actions to a halt. Their common argument was that the proceedings were an abuse of process because MCI commenced the actions for the collateral purpose of generating legal fees for Elliott.

Honourable Justice Anne Ferguson dealt with both applications together and published a single judgment. While Justice Ferguson was not satisfied that the proceedings are either an abuse of process or contrary to public policy, she was satisfied that “unless Mr Elliott ceases to act for MCI in the proceedings or MCI is replaced as the representative plaintiff, Mr Elliott should be restrained from acting as the solicitor for MCI and the proceedings should not be permitted to continue as group proceedings.”

A strike against the MCI model

The decision demonstrates a judicial willingness to police the proper separation between the interests of class action claimants and the lawyers representing and, in some instances, funding them.  On the evidence, the court was prepared to draw inferences that:

(a) MCI was created by Mr Elliott as a vehicle for bringing representative proceedings against listed companies alleging breaches of continuous disclosure obligations.

(b) MCI would be the representative plaintiff in such proceedings.

(c) Mr Elliott would act as its solicitor, with Mr Elliott earning fees from doing so.

The court was all the more willing to do so because, “although Mr Elliott was in court instructing during the hearing, he did not (in his capacity as a director of MCI) give any evidence, in circumstances where the facts called out for explanation by him. No evidence was given as to why he did not do so, nor was any submission made (let alone evidence given) that what he might say was protected by client legal privilege.”

The court concluded that MCI was probably created to launch proceedings to enable its sole director and shareholder to earn legal fees from acting as the solicitor for MCI. Possible compensation of $700 was hardly an explanation and, as Justice Ferguson said “another possible, but far less probable, inference would be that MCI is motivated by some general desire to assist shareholders to recover compensation from publicly listed companies which breach the law, or that MCI has some general desire to ensure that publicly listed companies comply with the law.”

Inappropriate vested interests

To test whether this was an instance where the solicitor/plaintiff ought to be restrained, the court considered the position of a hypothetical fair-minded independent observer. Such an observer would be reasonably informed of the matters noted above concerning MCI, its shareholder and the basis for the proceedings. Further, that if MCI is unsuccessful in any of the proceedings, it will likely be exposed to an adverse costs order, which would be substantial and that such liability would likely reduce the value of Elliott’s shareholding in MCI.

The court held that: “The Observer would conclude that Mr Elliott is the decision-maker in the conduct of the proceedings, both from the point of view of what is in MCI’s commercial interests as plaintiff and also as its solicitor. In this regard, the Observer would reasonably conclude that Mr Elliott, through MCI, is in the business of purchasing small shareholdings in listed companies with the objective of subsequently commencing group proceedings against some of them for alleged breaches of their continuous disclosure obligations.”

As to Elliott’s position, Justice Ferguson was clear: “In addition, the Observer would consider that Mr Elliott is compromised in his role as a solicitor such that there would be a real risk that he could not give detached, independent and impartial advice taking into account not only the interests of MCI (and its potential exposure to an adverse costs order), but also the interests of group members.”

This is critically important in the context of class actions because: “The group members do not have control over the action, yet unless they opt out, they are bound by judgment in the group proceedings.  In the context of group proceedings affecting group members, the Observer would consider it important that the solicitor who is acting for the plaintiff is independent, so that forthright and strident advice is given, untainted by the personal interest of the lawyer beyond their normal interest. If justice is to be seen to be done, the Observer would expect that MCI would be represented by a person without the vested interests that Mr Elliott has in the proceedings.”

For these reasons the court held that the proper administration of justice warranted that Elliott be prevented from acting for MCI while the proceedings remain as group proceedings with MCI as the representative plaintiff. Further, the actions should not continue as class actions for so long as Elliott was acting for MCI or, if Elliott continued to represent MCI, for as long as MCI remained the representative plaintiff.

Justice Ferguson offered a cautionary comment directed not at class actions per se but as to their conduct: “Whether it is good or bad, the reality is that group proceedings are lawyer-driven. They will not, for that reason, be brought to a halt. Nevertheless, it does seem to me that the risks associated with entrepreneurial lawyers acting in group proceedings…are exacerbated here where the plaintiff and the solicitor are not independent of one another…. Ordinarily, lead plaintiffs have the benefit of independent advice about what they should or should not do taking into account the interests of group members. Ordinarily, the solicitor is not facing any possibility of adverse costs orders that will affect them if the plaintiff fails in expensive interlocutory disputes or does not succeed at trial. Mr Elliott is simply not in a position to give detached advice to MCI.”

Entrepreneurial class actions

The court did not find that Elliott had inappropriately sought to derive fees from his clients. The court simply found that he could not in this case act for the plaintiff and also be its driving mind.

Likewise, the decision does not actually concern the conduct of a third party litigation funder standing arms-length to the claimants and their lawyers.  However, in light of the commission’s recommendations, it serves as useful guidance for those presently considering reform of litigation funding.  

The MCI decision highlights that, in the absence of regulation, there is a justifiable concern about the proper separation between claimant, lawyer and funder. The courts charged with administering class actions are plainly alive to the challenges that the entrepreneurial class action industry presents.  If that line is pushed too hard, courts, both federal and state, will intervene and may well decide that such issues ought to be examined at a very early stage.   Indeed, for defendants it is important that those boundaries are assessed at the outset rather than allowing class actions to proceed to trial or a court approved settlement before the concern is tackled.

As to reform, the decision offers a mixed message. The need for such intervention adds to the concerns expressed by the commission that the regulation of third party litigation funding is warranted. However, it offers very little, if any, support for the notion that the time for contingency fees by lawyers has arrived.  A playing field that is not in the interests of justice or the parties is not a competitive solution and cannot afford genuine access to justice.