Litigation funders watching for certainty on common fund orders in class actions

Diverging judicial opinions on whether the Federal Court has the power to make a common fund order (CFO) in a class action proceeding might seem a classic lawyer's problem, of little relevance to the wider world. It goes, however, to the heart of the profitability of litigation funders' business model, and consequently impacts access to justice; a principle that underpins Australia's class action regimes. To appreciate the divergence of the Federal Court that has recently been emphasised by Davaria Pty Ltd v 7-Eleven stores Pty Ltd (No 13) [2023] FCA 84 and what it means, it is first necessary to explore how class actions are funded.

What is litigation funding?

Litigation funding involves a third-party, who is not otherwise involved with the class action, funding the proceeding in return for a share of any judgment or settlement. If the class action is unsuccessful, the funder does not receive any return on its investment and may be exposed to adverse cost orders or other fees.

Given practical difficulties identifying potential group members at an early stage of a proceeding, funders often only enter agreements with some group members. Under those agreements, group members are required to pay the funder a commission if the class action is successful. However, the group members who have not entered any agreement with the funder will receive the benefit of any settlement or judgment without any obligation to contribute towards the costs of the litigation. It is generally accepted that this is unfair and that all class members should contribute towards this cost if the class action is successful.

Over the years, courts have taken different approaches to resolving this problem, including through mechanisms commonly described as funding equalisation orders (FEO) and common fund orders (CFO).

What is a funding equalisation order?

An FEO requires unfunded group members to contribute to the total commission payable by the funded group members under their funding agreements. This means all group members (both funded and unfunded) contribute equally to the commission.

There are two important points about an FEO. First, no funded group member pays the full commission rate specified in the funding agreements. Rather, the burden of the commission payable by funded group members is shared equally across all group members by sourcing funds from unfunded group members. Second, even with the benefit of an FEO, the litigation funder still receives the same commission as if they had fully recovered under the funder's agreements with only funded group members.

What is a common fund order?

A CFO is an order which requires all group members to pay the litigation funder a commission from the proceeds of their share of any settlement or judgment, regardless of whether each group member has entered into a funding agreement with the litigation funder. Generally, the CFO contemplates a commission in the form of a percentage of the total settlement sum or judgment amount.

In the past, a funded class action lead plaintiff or representative party would typically apply for a CFO at an early stage in the proceeding. If the court granted the application, it would provisionally make a CFO that would then be implemented at settlement or judgment. However, the court would reserve the right to review the commission percentage at that later time.

In practice this meant that the court was giving the litigation funder an assurance that a CFO would be implemented at a later stage in the proceeding. This gave the litigation funder comfort that they would receive a return on their investment in the litigation if it was successful.

So how does that differ from a FEO? In short, the return to the funder is tied to the total amount of the settlement or judgment and not then limited by what is stipulated in the original funding agreement. Under a CFO, the litigation funder can, and would likely, receive more money and the group members as a whole are likely to receive less compensation than under an FEO.

A short history of common fund orders

The first CFO was made by the Court in Money Max Int Pty Ltd v QBE Insurance Group Ltd in 2016. It then became commonplace for litigation funded plaintiffs to apply for a CFO at an early stage of a class action.

However, in 2019 in BMW Australia Ltd v Brewster, the High Court of Australia determined that the Court does not have the power under section 33ZF of the Federal Court of Australia Act 1976 (Cth) to make a CFO at a relatively early stage in the proceeding. But the High Court did not go further to clarify whether the Court does have the power to make a CFO under another provision of Part IVA at some later stage (i.e. at settlement pursuant to section 33V or following judgment).

Making a common fund order when approving a settlement

Since Brewster, the Court has been asked several times to consider whether a CFO could be made under section 33V when approving settlement. Until recently, it appeared that a consensus view was emerging, at least amongst Federal Court judges, that the Court does have the power to make such orders.

On 14 February 2023, in Davaria Pty Ltd v 7-Eleven stores Pty Ltd (No 13), a single justice of the Court concluded that the Court does not have the power under section 33V to make a CFO.

In Davaria, Justice O'Callaghan was asked to make a CFO in the amount of $24.5 million (25% of the $98 million settlement sum, which had already been approved). He held that the correct interpretation of Brewster means that the Court does not have power to make such orders at settlement or at any stage of a proceeding.

Instead, Justice O'Callaghan was persuaded by the applicants and the contradictor to make an FEO. The funder did not support the making of an FEO, remarking that – if no CFO was made – it was content to recover its commission from the funded members alone. In determining that an FEO was appropriate, Justice O'Callaghan observed that such an order was intended to ensure that the funded group members were not solely burdened with the costs of funding the proceeding

Under the FEO, the litigation funder received a payment of about $12 million, as opposed to the $24.5 million it would have received under the proposed CFO. The figure ordered by the Court reflects just over 12% of settlement sum, which Justice O'Callaghan determined to be a fair and reasonable distribution between the group members.

As the amount recoverable under an FEO is directly proportionate to the number of group members who have entered into a funding agreement with the funder, the amount recovered is contingent on the success of the book-building exercise, that is, the number of group members the funder signs up to its funding agreements. As noted above, in most cases, the amount recovered pursuant to an FEO will be materially less than under a CFO.

The funder in Davaria indicated it intends to appeal the decision to deny it a CFO.