Reforming Australia's litigation funding and class actions 02: increased regulation of litigation funding

In our second deep dive into the 31 recommendations of the Parliamentary Joint Committee on Corporations and Financial Services' report on Litigation funding and the regulation of the class action industry, we examine those dealing with the regulation of litigation funding fees by the Federal Court. What effect will these have on litigation funders' business models and class actions?

Background: what is litigation funding? What are the concerns?

Litigation funding involves a third-party funding the costs of litigation in return for a portion of the proceeds if the action is successful.

Historically, rules against the maintenance of litigation by a third party severely limited the role of litigation funding in Australia. However, the prohibition was relaxed throughout the 1990s and early 2000s and litigation funding was legitimised by the High Court of Australia in 2006 in Campbells Cash and Carry Pty Ltd v Fostif Pty Ltd. Over the years that followed, the number of litigation funders operating in Australia gradually increased, as did the number of funded class actions filed in the Federal, and State and Territory courts.

Litigation funding plays an important role in assisting lead plaintiffs and class members to meet the costs of running class actions. It is both reasonable and necessary that litigation funders receive a return on their investment, both on account of the risk undertaken and to ensure continued viability of the market. However, it is also the case that:

• litigation funded class actions are often complex schemes run on behalf of unsophisticated consumers;
• a majority of litigation funders operating in Australia are foreign owned or based overseas;
• there is currently no oversight mechanism to regulate or assess the fees charged, and return on investment earned, by litigation funders other than the courts' general powers to supervise litigation;
• at present, some litigation funders appear to be making windfall profits from class actions in Australia, at the expense of both group members and defendants;
• there is uncertainty as to the Federal Court's power to intervene in funding arrangements as well as their ability to assess the appropriateness of some aspects of funding arrangements (for example, whether a funder's return is reasonable).

As a result, there is a concern that the current regulatory arrangements for litigation funders are too light touch and greater oversight of the industry is required to ensure that the interests of lead plaintiffs and class members are suitably protected.

Regulation of litigation funding fees

The Committee observed that the regulation of litigation funding in class actions at the federal level has been primarily performed by the Federal Court. This regulation is achieved through the Federal Court's supervisory role in approving class action settlements and other case management processes. That role is limited, and dependent on individual judicial interpretation. There has been little legislative intervention to expand or clarify the Federal Court's role.

A number of submissions to the Committee identified frustration with the lack of active regulation of litigation funding agreements by the Federal Court. The Committee identified that a primary cause of the Federal Court's reluctance to intervene in this area is:

• first, uncertainty regarding the scope of the Federal Court's power to adjudicate on funding arrangements; and
• second, judicial reticence to intervene in arm's length contractual relationships.

In relation to the first issue, the Committee proposed that litigation funding agreements be subject to Federal Court approval to be enforceable, including a power to amend those agreements as necessary. In making this recommendation, the Committee recognised that providing the Federal Court with this power was just one piece of the puzzle in ensuring proportionate and fair costs in litigation funded class actions.

For this reason, the Committee also recommended further consultation on:

• the best way to guarantee a statutory minimum return of the gross proceeds of a class action (including settlements);
• whether a minimum gross return of 70% to class members, as endorsed by some class action law firms and litigation funders, is appropriate; and
• whether a graduated approach, taking into consideration the risk, complexity, length and likely proceeds of the case is appropriate to ensure even higher returns are guaranteed for class members in more straightforward cases.

In relation to the second issue, the Committee though that the Federal Court could better assess whether fees in class actions are reasonable, proportionate and fair if it had assistance from financial experts.

Accordingly, it recommended that the Federal Court have the power to appoint a litigation funding fees assessor, being a person with market capital or finance expertise. The Committee also recommended that the Federal Court’s Class Actions Practice Note state that the Federal Court may order the assessor's costs be paid by the litigation funder if appropriate in the circumstances.

The Committee also considered how these new powers should be enforced against foreign litigation funders and recommended that the Federal Court only approve a litigation funding agreement if the litigation funder submits irrevocably to the jurisdiction of the Federal Court.

In making these recommendations the Committee was cognisant that the Federal Court could not, and ought not, perform the role of a litigation funding regulator. Its function is inherently limited to adjudication of issues in the proceeding before the court. Issues of good governance and financial probity are properly addressed by other regulators, and will be discussed in further article.

Are these recommendations allowing the Federal Court to intervene in litigation funding agreements sound?

The Committee has approached the Federal Court's role by (as above) proposing a power to amend litigation funding agreements tied to a power to appoint qualified financial experts to assess funding agreements.

In our view this proposal is unlikely to resolve the historic reluctance of the Federal Court to intervene in the "fairness" of litigation funding agreements. First, the concern raised by the Full Court in Money Max International Pty Ltd v QBE Insurance Group Limited [2016] FCAFC 148 remains:

"there are questions as to the court’s power to interfere with the terms of arms-length commercial agreements between the funder and funded class members, and also as to whether it would be appropriate to do so." [emphasis added]

Second, it is unlikely that representative plaintiff will object to the terms of a funding agreement, and provide the impetus for appointment of an assessor. Group members and funders are not alike in sophistication.

Finally, consider a scenario in which an assessor recommends "reasonable fees". Absent clear statutory guidance as to what constitutes an "unfair bargain" the Federal Court is unlikely to re-write litigation funding agreements. Fortunately, as this recommendation is hardly novel, our speculation does not amount to mere crystal ball gazing. Justice Lee in considering a similar recommendation made by the Australian Law Reform Commission in Liverpool City Council v McGraw-Hill Financial, Inc (now known as S&P Global Inc) [2018] FCA 1289 had this to say:

"if I was to interfere with the funding agreements and the amount paid to the funder, in the absence of identified statutory criteria, I would be left adrift searching for a lodestar…. What I regard as a 'fair' return may be quite different from somebody else sitting in my position, and without some statutory guideposts and detailed economic evidence, it presents real challenges."

The Committee's proposal addresses the second request by Justice Lee, but does not resolve the first issue.

In conclusion, if implemented these recommendations will help improve the playing field for group members and defendants in achieving fair and proportionate litigation funding agreements. However, there is still work to be done in preventing windfall profits by litigation funders in Australian class actions.

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• Reforming Australia's litigation funding and class actions 01: multiple and competing class actions
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