Litigation funding

The recent Allco Finance case saw litigation funders suffer a setback, but only a temporary one, writes Ruth Overington.

The financial interests of litigation funders were recently considered in the context of a novel application made in the Allco Finance class action. In Blairgowrie Trading Ltd v Allco Finance Group Ltd (Receivers & Managers Appointed) (In Liq) [2015] FCA 811 (Allco Finance case) the Federal Court of Australia was asked to make orders, the effect of which would have been to “[135]ensure the commercial viability of the proceeding from the perspective of the litigation funder.” Although the court declined to accede to the application, it did foreshadow that this issue is potentially an area worthy of legislative reform.

To fund or not to fund?

Litigation funding involves a business investment decision. The question of whether to invest (fund an action) will depend upon the commercial viability of that investment. Is the cost and risk of the investment worth the anticipated return?

Among other things, the anticipated return component of the equation will depend upon the number of group members who have entered into a funding agreement with the litigation funder. The return is realised by the payment to the funder by group members of a percentage of any monies they may receive as a result of a settlement or damages award. The greater the number of funded group members, the greater the potential return for the funder. The greater the potential return, the more likely a funder is to agree to fund a class action.

It is not surprising then to learn that a critical pre-commencement step undertaken by funders is the entry into funding agreements with as many potential group members as possible. The commercial viability of the funding investment is then calculated by reference to the potential returns of the funded group members. Where the numbers “add up”, an action is commonly commenced as a “closed class” class action, meaning that the proceeding is commenced on behalf only of those persons who have signed a litigation funding agreement.

The Allco experience

Investigations into a possible class action against Allco Finance commenced in 2008 and by late 2008 approximately 1,400 persons had entered into litigation funding agreements with IMF (Australia). However, no proceeding was commenced. One reason for the failure to commence a class action was that: “[34] the combined value of the claims of those who had entered into the funding agreements was not large. The proposed proceeding was apparently considered to be not ‘economically worthwhile from IMF’s perspective’.” IMF ultimately terminated these funding agreements in early 2012. In 2013, the Applicants and the funder commenced a class action using a different approach. The proceeding commenced as an “open class” class action, meaning that it was pursued on behalf of all persons who satisfied the class criteria described in the claim. Importantly, the criteria did not include a requirement that group members had signed a litigation funding agreement. In fact, none of the group members were asked to sign a litigation funding agreement.

Instead the Applicants had entered into a litigation funding agreement with a difference. Under the terms of the funding contract, they agreed to pay from the monies, which may ultimately be received by all group members:

a. An amount to reimburse the funder for legal costs paid to fund the class action.

b. A percentage/commission of any settlement monies or damages awarded.

That is, the Applicants agreed to pay to the litigation funder a certain proportion of group member monies. The Applicants entered into this agreement without the express consent of group members. “[47] In the absence of any order by the Court, it is not money that the Applicants can pay away, or agree to pay away, as they see fit. …[yet] that is exactly what the Applicants purport to do in clause 9.1.”

By seeking court approval of the terms of the funding agreement, the Applicants and the funder sought to achieve the same financial certainty which would otherwise have required the entry into a funding agreement by each and every group member. This approval was sought at an early stage in the proceeding, when the likely amount of legal costs was unknown and the amount, and in turn the reasonableness, of any commission ultimately payable to the funder unknowable.

“Common fund” doctrine

The Applicants’ characterised the order they sought as a “common fund” order. At its simplest, the common fund doctrine is one where the beneficiaries of a common fund are required to reimburse from the fund, the costs and expenses incurred by the persons responsible for recovering the fund. In the Allco Finance case, the Applicants sought to draw an analogy with the position of a liquidator and relied upon the principle identified In re Universal Distributing Ltd (in liq) (1933) 48 CLR 171 (Universal Distributing). In response, Justice Wigney observed that:“[118] [121] The principle in Universal Distributing, in simple terms, is that where a liquidator has realised property subject to security out of which the secured creditor can take payment, the liquidator’s remuneration and expenses incurred in realizing the property can rank in priority to the rights of the secured creditor...there is no real analogy between the position of a liquidator and the position of a representative party.”

Similarly, attempts by the Applicants to draw parallels with the “common fund” doctrine applied in US class actions were also rejected. The Court observed that there were significant differences between the Australian class action regimes and those in force in the US. His honour also observed that litigation funding appears not to be as significant in the US due to the availability of contingency fees.

Ultimately the Court considered that the order proposed by the Applicants in the Allco Finance case went beyond the extent to which the common fund doctrine is applied in US class actions. In particular, the order proposed in the Allco Finance case would effectively have approved the amounts payable to the funder as reasonable, not merely as a framework for future consideration of the amount which may be payable.

Ultimately Justice Wigney was not persuaded that an order of the kind sought by the Applicants was appropriate or necessary to ensure that justice is done in the proceeding. The court considered that such an order was premature, particularly in circumstances where the likely legal costs and the potential value of the commission proposed to be paid to the funder were not known or capable of being reliably estimated.

Where to from here?

Although refused in this instance, the court observed that: “[227]There is something to be said for the proposition that some form of common fund approach, similar to the common fund doctrine in the United States, should be adopted in Australia to deal with the reality of commercial litigation funding in representative proceedings. It would, however, perhaps be preferable for that to occur as a result of legislative reform, rather than by way of the piecemeal utilisation by judges of general discretionary powers such as ss23 and 33ZF of the [Federal Court of Australia Act].”

Whether the legislature agrees remains to be seen. If funders are permitted to obtain the benefit of recovery from persons with whom they do not have a contract, it follows that more potential class actions will become “commercially viable”, and in turn, more class actions are likely to be commenced.