Protecting or creating a stumbling block for future class members: proposed reforms to litigation funding payouts

Introduction

Increased regulation of class action litigation funding is one step closer, with the introduction of the Corporations Amendment (Improving Outcomes for Litigation Funding Participants) Bill 2021 into Parliament on 27 October 2021.

If passed, the Bill will fundamentally change the Australian litigation funding environment. Indeed, the tabled bill contains changes from the exposure draft which mean that its consequences will be more acute for participants in the class action industry.

Some of the consequences are, in fact, stated aims of the Bill. The Bill's focus is "improving outcomes for litigation funding participants" (per the Bill's title), by increasing regulatory oversight of litigation funders and class action promoters. As the Explanatory Memorandum states, the Bill's recognised impacts include that litigation funders:

• will experience greater barriers to charging unfair and disproportionate fees and commissions in class actions, such that windfall profits will be less available;
• may be incentivised to undertake greater book building to inform their decision to support a class action and may experience a reduced funding appetite in respect of some types of cases;
• may experience greater uncertainty about the enforceability of some litigation funding agreements and their returns; however, they will gain clarity about the court's power to intervene in these agreements and how the court will assess proposed distribution of claim proceeds; and
• may be subject to additional administrative and compliance costs.

There is no doubt that, if passed, the Bill will result in increased regulatory and Court oversight of litigation funders and give class action participants signing up to funding agreements comfort that their share of the return takes centre stage in the court's consideration of settlements. However, the continuing uncertainty over common fund orders coupled with the introduction of the "rebuttable presumption" and requirement that only "signed-up" claimants can be required to contribute to the funder's fee or commission, will likely mean that (at least initially) funders are less willing and less able to provide financial support to 'open' class actions. This itself risks access to justice and may also lead to more innovative 'book-building' exercises.

Overview and key aspects of the Bill

Class action procedure and the role of litigation funders has been the subject of much scrutiny in recent years, including the Australian Law Reform Commission's inquiry into Class Action Proceedings and Third-Party Litigation Funders (ALRC Report, published January 2019) and the Parliamentary Joint Committee on Corporations and Financial Services' report on litigation funding and the regulation of the class action industry (PJCCFS Report, published December 2020). The PJCCFS Report highlighted the "virtually unanimous agreement" in submissions that current regulatory arrangements for class actions and litigation funding are "too light touch" and "greater oversight" of the industry is required.

The Bill seeks to answer those concerns by introducing a new class of managed investment scheme to the Corporations Act 2001 (Cth) and to provide both front-end (amendments to relevant funding scheme constitutions) and back-end (court approval) restraints on litigation funders. The Bill seeks to implement the Government's response to recommendations 7, 11, 12, 13, 16, 18 and 20 of the PJCCFS Report (see analysis in the Annexure to this paper).

The terms of the Bill itself and language supporting its introduction focus heavily on the intention of the Parliament to ensure that the distribution of proceeds in class action proceedings involving a litigation funder are "fair and reasonable" (see e.g. the joint media release by the Hon Josh Frydenberg MP and the Hon Michaelia Cash MP and the Explanatory Memorandum for the Bill). The recent Victorian Supreme Court decision of Bolitho v Banksia Securities Ltd (No 18) (remitter) [2021] VSC 666, which found that a litigation funder and five lawyers engaged in "egregious" conduct in connection with a fraudulent scheme, adds some urgency to the need for increased regulation.

Key features of the proposed new scheme are set out below, and we make further comment in the balance of this paper:

Background to the Bill

Before providing further critique of the Bill, it is worth revisiting some of the assumed knowledge when talking about class action proceedings. Most superior Australian Courts now have a class action procedure modelled closely on Part IVA of the Federal Court of Australia Act 1976 (Cth), which came into effect in 1992.

Class action procedure was designed to achieve two purposes:

• To provide access to justice in situations where many people are affected but each person’s loss is small and not economically viable to recover in individual actions; and
• To more efficiently deal with situations where the damages sought by each claimant are large enough to justify individual actions and a large number of persons wish to sue the respondent.

A key feature of our class action procedure in Australia is the opt-out system. If a person falls within the group member definition (which must be included in the pleading) they are part of the class whose claims are being brought before the court and will be bound by the outcome of the class action unless they "opt out". In "open" class actions, there may be many (perhaps thousands) of potential group members – described but not known to the court or the parties. Group members may not themselves be aware that they are part of a class action.

Following the decision in Campbells Cash & Carry v Fostif in 2006, where the High Court found it was not automatically an abuse of process for non-lawyers to fund commercial litigation, litigation funding fast became an important feature of Australia's class action landscape. Litigation funding involves a third party funding the costs of litigation in return for a proportion of the proceeds if the action is successful (whether by settlement or after judgment).

Litigation funding arrangements have traditionally involved a tripartite contractual arrangement between funder, group member and lawyer and therefore depend upon the enforceability of those contracts for their effect. However, in 2016 the Federal Court made Australia's first "common fund order" (Money Max Int Pty Ltd v QBE [2016] FCAFC 148), an order which permits a litigation funder to recover a percentage of the proceeds of a class action settlement, in effect, requiring all group members participating in the settlement to pay a commission to the funder. Common fund orders released litigation funders from the burden of having to recruit and retain clients.

In 2019, the High Court cast doubt on the power of Australian Courts to make common fund orders (BMW v Brewster [2019] HCA 45), an uncertainty which remains unresolved.

Common fund orders and group members covered by funding arrangements

The proposed amendments introduce a new class of a managed investment scheme, and fold in the membership of such a scheme to the general definition of "member" in the Corporations Act (proposed amendments to section 9 "member", together with new proposed section 9AAA(1)(a)).

One of the critical amendments proposed by the legislation is to require members' written consent before they can be required to contribute to a litigation funder's remuneration. The Bill makes this a criterion of scheme membership (unlike the Exposure Draft, which required this to be a provision of the constitution of an enforceable class action litigation funding scheme). The Explanatory Memorandum describes this as necessary to ensure that class action members cannot be co-opted into a litigation funding scheme without their active consent. Further, the Bill provides that the claim proceeds of a litigation funding scheme may only be paid to persons who are members of the scheme or party to a funding agreement (i.e. the funder) (proposed new 601GA(5)(iii)).

By potentially limiting the ability of a litigation funding arrangement to facilitate payments to group members who have not signed a litigation funding agreement, the Bill seems likely to encourage litigation funders to commence closed class actions following intensive recruitment of group members. There is a tension between these requirements and the default "opt out" setting for Australian class actions described above.

One answer to this may be common fund orders. The Bill expressly acknowledges the possibility of a common fund order and provides that its process for enforcing a litigation funding agreement will not apply in proceedings where a common fund order is made. Presumably this is because when a common fund order is made the litigation funder no longer needs to enforce litigation funding agreements. Their right to remuneration arises under the common fund order, rather than under contract.

However, until the uncertainties about the power to make common fund orders created by BMW v Brewster [2019] HCA 45 are resolved, it is risky for a litigation funder to commence litigation on the assumption that a common fund order will be available. Nothing in the draft legislation clarifies the courts' powers in this regard. In fact, the Bill expressly states that nothing in new proposed s 601LF (including the definition for "common fund orders") is to be interpreted as endorsement that the court has the power to make such orders (proposed new section 601LF(7)).

To further add to the confusion, there is another kind of order which has been commonly made by courts in class actions, the "funding adjustment order" or "funding equalisation order" (also addressed in the Explanatory Memorandum). This is an order which spreads the liability for the commission which group members who have signed a funding agreement are required to pay across all group members who receive a remedy from a class action. The definition of "common fund order" in the draft legislation will cover a "funding adjustment order".

This potential lack of clarity, together with the requirement for consent to be given before claimants can be bound by funding arrangements, suggest it is likely that (if enacted) more class actions will necessarily be commenced as "closed" classes, with defined and known claimants (where being a signatory to a litigation funding agreement is a necessary precursor to group membership).

Finally, the Explanatory Memorandum now includes supplementary analysis of relevant elements of policy proposal, including in relation to the availability of common fund orders. It states that the Government's policy approach is that "it is desirable to ensure that the Federal Court is properly empowered to make sure that all beneficiaries of a judgment or settlement contribute to the costs of the class action (ie. to avoid the free-rider problem)".

It appears that the Government's view is that, whether through a common fund order, a litigation funding agreement or a funding equalisation order, group members ought not be able to extract a benefit from a class action without also contributing to the risk and cost of running such an action. However, it sheds no further light on the question of whether, and if so when, common fund orders can be made.

So what if there are more closed class actions?

The PJCCFS Report acknowledged the risk that separate and concurrent class actions which litigate the same legal claims, for the same or overlapping class members, against the same defendant, undermine the objectives of the class action regime. Multiple class actions against the same defendant/s in respect of the same event or factual underpinning, which may not have identity of group membership, may equally threaten to undermine the class action regime. The court must determine how the dispute should best proceed. There is currently no consensus among courts as to the best method to manage competing class actions. The methods adopted by courts to date have included: allowing multiple class actions to proceed subject to co-operation arrangements between the plaintiff law firms involved; conducting "beauty parades" to choose which class action should be allowed to proceed; and ordering the consolidation of multiple class actions into a single proceeding. The difficulties are increased if class actions about the same subject matter are commenced in different courts.

If litigation funders are, in effect, required to 'book-build' more effectively to secure return from their investment in class action proceedings, this may lead to delays in the commencement of class action litigation. 'Book-building' itself has its own difficulties, particularly where potential group members may not be readily identifiable (eg. by reference to a list of shareholders at a given point in time). Advertising class action litigation at large to audiences of potentially vulnerable people may carry further risks where litigation arises from (often contentious and highly sensitive) medical matters.

What is "fair and reasonable"?

As is said above, the Bill provides that a litigation funding agreement may only be enforced if a court has determined that the associated schemes distribution method is fair and reasonable when considering the interests of scheme members as a whole. A court may also vary the distribution method so as to make it fair and reasonable.

The concept of "fair and reasonable" is introduced in the first substantive paragraph of the PJCCFS Report. The purpose of a civil justice system, wrote the authors of that Report, is to ensure a reasonable society, and to ensure that when unlawful damage is inflicted on a person, they are restored to their previous state. On that, we can agree.

If enacted, the Bill will introduce into legislation specific factors to which the court must only have regard (proposed section 601LG(3)) when considering whether the proposed distribution of litigation proceeds, or any variation to that distribution, is fair and reasonable:

• in relation to the proceedings:
  • the amount, or expected amount, of claim proceeds for the scheme from the proceeding;
  • whether the proceedings have been managed in the best interests of the members to minimise the costs for the proceedings incurred by, or on behalf of, the members;
  • the complexity and duration of the proceedings;
  • the legal costs for the proceedings incurred by, or on behalf of, the members, and the extent to which those legal costs are reasonable;
  • the costs (other than legal costs) for the proceedings incurred by the funder for the scheme, and the extent to which those costs are reasonable;
  • the costs (other than legal costs) for the proceedings incurred by the parties to each of the funding agreements (other than the funder for the scheme), and the extent to which those costs are reasonable;
  • the extent of the commercial return to the funder for the scheme in comparison to the costs incurred by the funder in relation to the scheme;
• the costs for the scheme incurred by the responsible entity of the scheme, and the extent to which those costs are reasonable;
• the risks accepted by the parties to each of the funding agreements for the scheme by becoming parties to the funding agreement;
• any other compensation or remedies obtained by any of the scheme’s members in relation to the transactions or circumstances which are the subject of the proceeding;
• any amounts that the members have contributed towards paying the costs for the scheme incurred by the parties to any of the funding agreements for the scheme; and
• any other factors prescribed by regulations.

Regulations enacted in the future may amend this list to omit, modify or vary any of the above factors (proposed section 601LG(4)). The Explanatory Memorandum for that item (at [1.75]) states that this power is necessary to ensure the "fairness and reasonableness" test remains relevant and appropriate as a protection for class members into the future. The rebuttable presumption cannot be amended, removed or ignored in this way.

This exhaustive list contains another clue that this regime is likely to encourage closed class actions. The list does not include (and therefore a court is not permitted to consider) the interests of any group members who are not scheme members when considering the fairness and reasonableness of the distribution method.

A rebuttable presumption: 30% return to non-members

The Bill provides for a "rebuttable presumption" that the distribution method is not fair and reasonable if more than 30% of the claim proceeds is to be paid or distributed to entities who are not members of the scheme, considering those entities as a whole (s 601LG(5)). The scheme's constitution must also include words dealing with how any distribution to non-members is to be handled (s 601GA(5)(ii) and (iii)).

The Explanatory Memorandum for the Bill (states that the proposed new s 601LG(5) is intended to signal the Government's policy objective that class action claimants should receive a fair and reasonable return but the court will maintain its flexibility to adjust the distribution of class action proceeds to reflect the circumstances of the case (pp. 35-38). The reference to "entities who are not members of the scheme" is intended to mean the litigation funder/s. However, it could also capture claimants who are not group members. If so, it makes open class actions even more difficult under the new provisions (or there may be a rush to commence before the new provisions kick in).

In any event, and having regard to the intention that courts maintain the degree of flexibility, the nature of a "rebuttable presumption" surely means that this is the starting point from which the courts will depart in appropriate (potentially exceptional?) cases. Any cap on distribution to funders (particularly where it may also be construed as covering claimants who are not members of the scheme) will be an arbitrary measure which does not necessarily reflect the actual risk and reward of a particular class action. It also assumes that there is a correlation between the amount invested by the funder in the litigation and the entitlements of group members, which is not always the case.

Even if a funder were to receive 30% of the proceeds of a particular class action, this amount may still not justify their investment. Equally, there may be circumstances where the entitlements of group members are ultimately shown to be less than 70% of the proceeds of the litigation (for example, in a case where the group members' claims on liability prove to be strong, but their actual damages are determined to be much less than was thought at the beginning of the class action).

There may also be implications for settlement negotiations. As litigation funders are unable predict whether they will be adequately remunerated for their investment (both in terms of capital and the risks assumed) until the end of a proceeding, imposing a maximum return may have the unintended consequence of making the funder's contribution a baseline for settlement expectations and, in turn, settlement more difficult to achieve.

These considerations should be taken into account when assessing the proposed reforms determining the remuneration paid to litigation funders in the event of a settlement or successful outcome is commensurate with the investment and risk, and is not excessive.

Broader application

Because the draft legislation proposes changes to the Corporations Act relating to the regulation of litigation funding, there is a limit to what it can achieve in changing the regulation and oversight of class action litigation at large. For example, nothing in the draft legislation purports to (or could) enhance regulatory or court oversight of non-funded class actions (including distribution of funds to group members). If the federal Government wanted to make these kinds of changes, it could do so by seeking amendments to the Federal Court Act, which contains the procedure for class actions in the Federal Court.

However, and notwithstanding the clear intention for these amendments to apply to class actions and the use of the phrase "class actions" throughout the draft legislation, nothing in the draft actually limits their application to class action proceedings in the sense in which that term is commonly used (that is, representative proceedings commenced under the regimes existing in the Federal, New South Wales, Victorian, Queensland and Tasmanian courts).

On the contrary, "class action proceedings" are defined as court proceedings which pursue remedies for members of a scheme, whether or not remedies are sought on behalf of other persons who are not members of the scheme. Expressed more directly, "class action litigation funding scheme", in terms, includes where the dominant purpose of the scheme may be to seek remedies where seven or more persons have claims arising from different transactions or circumstances. It also covers where steps are taken to seek remedies for claimants include lawyers providing services in relation to making a demand for payment, lodging a proof of debt, investigating potential or actual claims, commencing or undertaking legal proceedings or negotiating or administering a settlement. The arrangements could therefore apply to arrangements which are, for example, established to fund test cases or on behalf of large groups of plaintiffs.

Annexure: Analysis of relevant PJCCFS Report recommendations against proposed legislative amendments