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McInnes, Ross; Kennedy-Breit, Alexandra; Manon, Magali --- "The rise (and fall?) of litigation funding and entrepreneurial class actions" [2015] PrecedentAULA 52; (2015) 129 Precedent 44


THE RISE (AND FALL?) OF LITIGATION FUNDING AND ENTREPRENEURIAL CLASS ACTIONS

By Ross McInnes, Alexandra Kennedy-Breit and Magali Manon

When the class action regime was introduced in the Federal Court of Australia in 1992, few would have imagined the forces that now drive the pursuit of mass consumer claims. There has been rigorous debate in recent years about the rise of the new breed of legal entrepreneur – the litigation funder. But with the litigation funding business model now entrenched in Australia's class action psyche, the different forms of litigation vehicle used to pursue cases are throwing up new issues for the legal industry and the judiciary to grapple with. Those unique models are not limited to litigation funders. With the debate about lawyers charging contingency fees still unresolved, enterprising lawyers are looking for new ways of running (and funding) class action litigation. Jurisprudence in the class action industry is developing at a swift pace, begging the question: with the significant rise of entrepreneurial class actions in recent years, is the bubble about to burst?

LITIGATION FUNDING THE JUGGERNAUT CONTINUES WITH LIMITED REGULATION

In Australia, contingency costs agreements between lawyers and clients are not permitted by law. Non-lawyers are not similarly constrained. As a result, litigation funding companies have emerged. Endorsed by the High Court of Australia as a viable business to promote and fund class action litigation, the role and impact of funders on Australia's legal landscape cannot be understated.

There is, however, a glaring disparity between the regulatory oversight imposed on the two groups central to the class action industry – lawyers are subject to stringent regulation, yet third-party funders are simply required to have 'adequate arrangements’ in place for managing conflicts of interest.

In 2012, the government passed the Corporations Amendment Regulation 2012 (No. 6). Under the Regulation, a person providing financial services for, relevantly, litigation schemes is exempt from the requirements that would otherwise apply under Chapter 7 of the Corporations Act 2001 (Cth), provided that that person maintains adequate practices for managing any conflicts of interest that may arise.

ASIC's Regulatory Guide 248[1] puts some meat on those regulatory bones. It sets out ASIC's expectations for compliance with the obligation of litigation schemes to maintain adequate conflict procedures. The Guide warns:

‘While you must take responsibility for determining your own approach to managing interests that conflict, in our view, if your arrangements are not consistent with the guidance and expectations in this guide, you are less likely to be complying with the obligation and will be exposed to a greater risk of regulatory action.’ [RG 248.22]

Much remains unresolved in the debate about regulating litigation funders. While steps have been taken to manage any conflicts that arise, questions remain about what the regulations will do to ensure that conflicts don’t arise in the first place. What will regulators do when inevitable and unavoidable conflicts bubble to the surface and are not managed? Will enforcement action be taken? A related issue is that, to date, litigation funders remain free from prudential controls. While this may not be a concern for the large, well-established and experienced funders, there is an increasing number of smaller overseas players entering the Australian market.

Against this background of relatively limited regulation, litigation funders are starting to seek court orders that would revolutionise the class action industry – the ‘common fund’ application. If successful, and endorsed by the courts, the ‘common fund’ application threatens to be the next game-changer for the industry.

THE GAME-CHANGER – THE POTENTIAL IMPACT OF THE ‘COMMON FUND’ APPLICATION

Ordinarily, a litigation funder is permitted to ‘clip the ticket’ only of those group members who have entered into a litigation funding agreement. The agreement provides that the funder will take on the risk and expense of the proceedings in exchange for a percentage of any settlement or damages paid to the group member. A ‘common fund’ application seeks court approval at the commencement or (at least to date) after settlement of the case for all group members to pay, to the litigation funder, a portion of any damages or settlement received, even if they have not entered into a funding agreement. If such applications continue to be successful, they have the potential to revolutionise (and further commercialise) the class action industry.

To date, such applications have achieved mixed success. The Supreme Court of Victoria approved a settlement with a ‘common fund’ element in Pathway Investments v National Australia Bank Ltd [2012] VSC 625. The settlement operates as follows:

1. Class closure orders were made, which removed the limb of the group definition which required participants to have signed an agreement with the litigation funder and made orders for a further opt-out and registration process.

2. A notice of settlement was issued, which required group members to register their interests on or before 12 October 2012.

3. After the settlement approval, there was a ‘late registrant’ process. Essentially, any group member who registered after 2012 was required to provide a statutory declaration to the solicitors for the applicants stating why they did not return the form by 12 October 2013. The solicitors would then consider whether it was fair and reasonable to allow them to receive a distribution.

4. All persons who had successfully registered (whether on time or through a late registration that had been accepted) were required to return a participant declaration. They then became ‘participants’.

5. The solicitors for the applicants informed each participant of their estimated distributions.

6. The litigation funder notified the solicitors for the applicants of the amount that each participant is required to pay the funder.

7. The plaintiff's costs and disbursements, reimbursement payments and administration costs were deducted from the settlement fund.

8. The settlement fund was then distributed to the participants (with an appropriate portion being paid to the litigation funder out of each participant's payment).

However, in Modtech Engineering Pty Ltd v GPT Management Holdings Ltd [2013] FCA 626, the Federal Court refused to approve a settlement with a similar regime. As part of the settlement, it was proposed that a ‘funding commission’ be deducted from the individual entitlements of all group members and paid to CLF, the litigation funder, irrespective of whether the group members executed a funding agreement. The Court observed (at [57] - [61]):

‘CLF, as a litigation funder, made a commercial decision to fund these proceedings on the terms and conditions set out in the various LFAs [Litigation Funding Agreements]. Relevantly, it made a commercial decision to fund these proceedings by entering into a LFA with 92 per cent of group members. Not 100 per cent of the group members, just 92 per cent of the group members. The question which arises is why should CLF be entitled to receive between 25 per cent and 30 per cent of the amount recovered by those group members who chose, for whatever reason, not to enter into a LFA (defined, erroneously, in the Settlement Distribution Scheme as ‘Informally Funded Registered Group Members’)? The deduction of the funding commission was never part of a commercial bargain reached by CLF with these so-called Informally Funded Registered Group Members. In fact, for whatever reason, the Informally Funded Registered Group Members decided to do the direct opposite and not enter into a LFA. What has changed? I can identify no reason why the LFA should now be imposed on the Informally Funded Registered Group Members. They have not agreed to it.’

In a current Federal Court shareholder class action against Allco Finance Group,[2] an application was heard in December 2014 seeking orders for the appointment of International Litigation Funding Partners Pty Ltd as the funder of the class action on the terms usually included in a litigation funding agreement. The approach taken in this application is unique, as it has been made at the commencement of the proceedings rather than at settlement. If approved, it will result in all group members being liable to pay the funder’s costs and a percentage of any recovery without choosing to enter into the funding agreement. Judgment is presently reserved, but the decision is keenly anticipated as precedent develops in this space.

If common fund applications become more accepted by courts, particularly if the Allco application is successful, and such orders could be obtained at the start of an action, the commercial viability of class actions from a litigation funder's perspective changes dramatically. The funder will no longer need to worry about going through the phase of building a ‘book' of potential group members. All group members could be required to pay the litigation funder's commission, regardless of whether they have signed a funding agreement. One can only imagine the impact that will have on the commercial decision faced by funders when considering whether to commence a class action.

SECURITY FOR COSTS INVOLVING LITIGATION FUNDERS

However, it is not all smooth sailing for funders. The Courts, in recent decisions, have recognised the role that funders play in class action litigation. This is seen in the changing approach to applications for security for costs, which have a chequered history in class action litigation.

The Full Federal Court decision of Madgwick v Kelly [2013] FCAFC 61; (2013) 212 FCR 1 has made it clear that security for costs applications are not prohibited in representative proceedings, including where litigation funders are involved. This case concerned a suite of litigation commenced by group members who were investors in a forestry plantation scheme that failed. The claims were being pursued against Wilmott Forests Ltd and Bioforest Ltd, as the responsible entities for the schemes, and also included lenders who financed some of the investors in the scheme.

At first instance, the respondents sought an order for security for costs. The application was refused and the respondents then sought to appeal the decision. In allowing the appeal, Chief Justice Allsop and Justice Middleton considered the dichotomy between:

1. s43(1A) of the Federal Court of Australia Act 1976 (Cth), which provides that a court or judge cannot award costs against a group member in a class action; and

2. s33ZG(c)(v) of the Federal Court of Australia Act 1976 (Cth), which provides that nothing in Part IVA affects the operation of any law regarding security for costs.

The Court found that the primary judge had failed to follow the decision in Bray v Hoffman-La Roche [2003] FCAFC 153; (2003) 130 FCR 317, which made it clear that ‘an order for security did not affect the immunity of s43(1A) and there was no overlap between ss43(1A) and 33ZG(c)(v), which operate independently [of each other]’.

Having overcome that hurdle, the Court then considered whether security should have been awarded. The Court recognised that it must undertake a balancing exercise between the policy underlying representative proceedings and the risk of injustice to a respondent in having no real capacity to recover costs if it successfully defends the litigation.

After acknowledging some important features of the kind of class actions that are now being pursued in Australia – namely, group members making active choices to participate in litigation, and litigation funders standing behind class action proceedings – the Full Court determined that security for costs should have been awarded, noting that:

‘the applicants and group members entered commercial transactions for their own reasons... [i]t seems entirely fair that those standing to benefit from such litigation make a real, but not oppressive, contribution to a fund to secure the costs of the respondents’.

Some of the successful security for costs applications have had very large security amounts ordered. In the Pathway Investments class action against National Australia Bank Limited (NAB),[3] NAB obtained an order for security for costs which the plaintiffs described as ‘extraordinary in size and unprecedented in Australian history[4] and which serves as a warning to funders of class actions. In 2009, Maurice Blackburn issued media announcements that it would bring a class action on behalf of certain shareholders (backed by a litigation funder) alleging that NAB had failed to disclose its exposure to a portfolio of collateralised debt obligations. The plaintiffs agreed that NAB was entitled to security for costs; however, they disagreed with the amount being sought and queried whether there was an entitlement to pre-commencement costs.

In the NAB case, Justice Davies found that the fact it took the plaintiffs 18 months to commence proceedings after putting NAB on notice could not be the fault of NAB, and that necessary and proper legal costs incurred for work undertaken in reasonable anticipation of litigation are allowable. However, the pre-commencement costs were reduced to take into account the uncertainty of whether those costs would be recovered on a party/party basis at a final costs assessment.[5] The total security for costs ordered of $6,212,962 was only half the amount sought by NAB's application; however, it is still large enough to caution litigation funders that substantial security for costs orders may be made in class actions, and that threatened proceedings ought to be commenced without delay.

ENTREPRENEURIAL LAWYERS AND PROPOSALS FOR REFORM & CONTINGENCY FEES

With litigation funders benefitting financially from the pursuit of litigation, it seems that there is a movement towards levelling the regulatory playing field by granting lawyers a similar ability to take a share of any damages.

The Productivity Commission's Access to Justice report[6] recommended lifting the ban on lawyers charging contingency fees[7] as long as protections are put in place, including requirements to disclose certain matters at the outset of the agreement (for example, the percentage of damages to be paid as the fee and where liability will fall in relation to disbursements and adverse costs orders).[8] It was also recommended that relevant court rules be amended to ensure that both the discretionary power to award costs against non-parties in the interests of justice and the obligations to disclose funding agreements apply equally to both lawyers charging damages-based fees and litigation funders.[9]

There can be little doubt that the introduction of contingency fees will stimulate an increase in the overall level of litigation and, in all probability, an increase in the number of speculative or even unmeritorious claims. The one thing that may put a break on this is a further recommendation that courts be given the power to make costs orders against non-parties ‘in the interest of justice’. The Commission's report suggests that courts should have the power to make both costs orders and security for costs orders against lawyers who enter into contingency fee agreements.

While proposals for reform continue to be formulated, lawyers have been looking at other ways to become involved in litigation funding without falling foul of the restriction on contingency fees.

THE MELBOURNE CITY INVESTMENTS 'BUSINESS MODEL' PUSHING ENTREPRENEURSHIP TO THE LIMITS

An example of the versatility of entrepreneurial litigation funding is the Melbourne City Investments Pty Ltd (MCI) business model. MCI is an investment company managed and controlled by solicitor Mark Elliot. Established in November 2012, it purchased small shares of around $700 to $800 in over 150 publicly listed companies with the objective of commencing class actions against those companies for breaches of continuous disclosure obligations. Mark Elliot has attempted to act as both the solicitor on record and the litigation funder (by his company MCI) in a number of matters, raising questions about conflicts of interest.

One of MCI's first forays into class action litigation came in late 2013 when MCI commenced separate class actions against Treasury Wine Estates Limited, Leighton Holdings Limited and WorleyParsons Limited alleging breaches of continuous disclosure obligations on behalf of certain classes of shareholders. Mr Elliot acted for MCI in each proceeding.

In the WorleyParsons claim, MCI did not itself make a claim for compensation (despite seeking to be the lead plaintiff) as it purchased its shares before the alleged conduct occurred. WorleyParsons opposed an application by MCI to file a further amended statement of claim on grounds including that MCI did not have standing to bring the proceedings. MCI argued that it had a real interest in the proceedings, as the relief sought had foreseeable consequences associated with a reduction in the value of its shares, a desire to prevent further decreases in share value and both personal and public interests in deterring WorleyParsons from engaging in contravening conduct. Justice Ferguson rejected those arguments, finding that MCI did not have standing to bring a representative action against WorleyParsons, as it had no real interest in the prosecution of the proceedings, and there would be no foreseeable consequences for it in the event that the matter was heard.[10] MCI has since reformulated the claim.

In the Treasury Wine Estates and Leighton Holdings proceedings, the MCI model came under attack again. A joint application was heard by Justice Ferguson in which the defendants sought orders that:[11]

1. the proceedings against them be stayed as an abuse of process;

2. Mr Elliot be restrained from acting in the proceeding while MCI was the representative plaintiff; or

3. the proceeding not continue as a class action while MCI was the representative plaintiff and Mr Elliot acted for MCI.

The facts underpinning the applications were not in dispute. MCI was incorporated on 1 November 2012 and on that day bought just under $700 of shares in each of the defendants. Mark Elliot was the sole shareholder and director of MCI and acts for MCI in each proceeding. Justice Ferguson considered whether the proceedings should be stayed as an abuse of process on the basis that MCI initiated the proceedings for the predominant improper purpose of earning legal fees for the solicitor.[12] Having regard to the public interest in access to justice through class actions articulated in Campbells Cash and Carry Pty Ltd v Fostif Pty Ltd,[13] and the high threshold required to stay proceedings, Justice Ferguson held that MCI's 'ultimate purpose' did not render the proceedings an abuse of process, since MCI also had an 'immediate purpose' of obtaining compensation for group members. Justice Ferguson observed:

‘I have formed the view that MCI commenced the proceeding for the purpose of generating legal fees for Mr Elliott. I agree with the defendants that that purpose is not a purpose of earning legal fees as a desired by-product of the litigation. It is the predominant purpose.’

However, obtaining an order for the payment of legal costs, she said, was not a collateral advantage. That is because in order to get an order for costs, MCI had to win the substantive issue, which was compensation for the class members. As this was its immediate purpose in commencing proceedings, there was thus no abuse of process.

Justice Ferguson then considered whether Mark Elliot should be restrained from acting for MCI while it was the representative plaintiff in the class action. Her Honour found that the 'hypothetical fair-minded independent observer' would see that Mr Elliot had a personal interest in the proceeding beyond that of a normal class action lawyer, and there was a real risk that he could not give detached, independent advice to his clients and that ‘that self-interest will dominate over the interests of group members’.[14] Justice Ferguson concluded that Mr Elliot should be prevented from acting while MCI remained the representative plaintiff, but the proceedings could continue as class actions. The issue was summarised as follows:

‘... 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 trail. Mr Elliott is simply not in a position to give detached advice to MCI.’[15]

Her Honour 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’.

The matter went on appeal, and the decision in Treasury Wine Estates Ltd v Melbourne City Investments Pty Ltd [2014] VSCA 351 resulted in significant criticism of the MCI funding model and the resulting litigation. A majority in the Victorian Court of Appeal (President Maxwell and Justice Nettle (since appointed to the High Court) disagreed with Justice Ferguson's original conclusion. The Court found that the litigation amounted to an abuse of process, and ordered that the proceedings be permanently stayed, as MCI’s purpose of ‘generating legal fees for Mr Elliott’ could not be a legitimate one, as it would not vindicate legal rights or immunities. As they observed:

‘...its sole purpose has only ever been to create for itself — in this case, by acquiring a small parcel of shares — a cause of action of sufficient merit to induce the defendant company to pay Mr Elliott’s fees. It seems to us that this is a clear example of an abuse of process. The processes of the court do not exist — and are not to be used — merely to enable income to be generated for solicitors. On the contrary, they exist to enable legal rights and immunities to be asserted and defended.’

Justice Kyrou dissented and agreed with Justice Ferguson: an order of costs can only be made once the plaintiff has won. Even if a costs order is the predominant purpose for bringing the proceedings, it cannot be made as primary relief. It is only a consequence of victory on the substantive point.

The High Court has since refused MCI special leave to appeal.[16]

WHAT COMES UP MUST COME DOWN IS THE FALL OF ENTREPRENEURIAL CLASS ACTIONS INEVITABLE?

Jurisprudence in the class action industry is developing at a rapid pace, and changes to regulation of funders and lawyers will have a significant impact on not only the kind of class action pursued in coming years, but also the vehicles through which those claims are advanced.

Recent judgments have recognised the increased commercialisation of the class action environment and the role that funders and entrepreneurs are having, and have had, in that change. An ability to recognise and respond to those developments in a nimble and flexible fashion is essential if access to justice and the integrity of the regime is to be preserved.

The authors would like to acknowledge the contribution of Robert Bianchini in preparing this article.

Ross McInnes is a partner at Clayton Utz in Sydney, and a commercial litigator specialising in class actions. His experience traverses a range of industries and practice areas including financial services, pharmaceuticals, medical devices, anti-trust claims and shareholder class actions. PHONE (02) 9353 4371 EMAIL rmcinnes@claytonutz.com.

Alexandra Kennedy-Breit is a senior lawyer at Clayton Utz in Sydney PHONE (02) 9353 5291 EMAIL akennedybreit@claytonutz.com.

Magali Manon is a lawyer at Clayton Utz in Sydney PHONE (02) 9353 4706 EMAIL mmanon@claytonutz.com.


[1] ASIC's Regulatory Guide 248: Litigation schemes and proof of debt schemes: Managing conflicts of interest (April 2013).

[2] Blairgowrie Trading Limited & Ors v Allco Finance Group Limited (Receivers and Managers Appointed) (In Liquidation) & Ors (NSD 1609 of 2013).

[3] Pathway Investments Pty Ltd and Ors v National Australia Bank Limited [2012] VSC 97.

[4] Ibid at [1], referring to the Plaintiffs’ Outline of Submissions at [10].

[5] Ibid at [52].

[6] Productivity Commission Inquiry Report Overview: Access to Justice Arrangements No. 72, 5 September 2014. See, in particular, chapter 18 - Private funding for litigation.

[7] Apart from in criminal and family law matters.

[8] Productivity Commission, above note 6, Recommendation 18.1.

[9] Ibid, Recommendation 18.3.

[10] Melbourne City Investments Pty Ltd v WorleyParsons Ltd [2014] VSC 303.

[11] Melbourne City Investments Pty Ltd v Treasury Wine Estates Limited (No. 3) [2014] VSC 340. The judgment was a single judgment with both matters appearing in the heading.

[12] Ibid at [7] to [9], [29] and [49].

[13] Campbells Cash and Carry Pty Ltd v Fostif Pty Ltd [2006] HCA 41; (2006) 229 CLR 386.

[14] Melbourne City Investments Pty Ltd, above note 11 at [63].

[15] Ibid.

[16] Melbourne City Investments Pty Ltd v Treasury Wine Estates Limited [2015] HCATrans 116 (15 May 2015).


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