Recalibration of funding commissions to better link risk and reward

With the rise of common fund orders and competing class actions, the recent decision of Lee J in Lenthall v Westpac Life Insurance Services Limited [2018] FCA 1422 (Lenthall) will be of interest to plaintiff firms and funders, and in particular those involved in a “beauty parade” of competing funding proposals in duplicative proceedings.

Lee J made a common fund order which provided that the funder’s commission would be the lesser of three times the total spend on legal costs (including disbursements and adverse costs), or 25% of the net recoveries which, in his Honour’s view, better reflected the real and demonstrable proportionality between risk and reward. 

However, higher commission rates are likely to be allowed for cases which raise novel and complex claims compared with the lower risk “common form” or “orthodox” securities class actions which typically settle before trial.[1]  

Key takeaways

1. The funding terms proposed for common fund orders need to reflect the real and demonstrable proportionality between risk and reward in the bespoke circumstances of the proceeding.

    

2. Each case needs to be looked at on its merits because all class actions do not evolve in the same way and different commercial imperatives may arise. A “cookie cutter” approach will not be appropriate.  More innovative and competing funding proposals are being seen in recent class actions.  This an important development towards increasing access to justice including for prospective class members in more risky and difficult cases.

3. The increasing willingness of Courts to make common fund orders appears to have reduced wasted costs on “book building”.  However, the rise of common fund orders seems to have contributed to the filing of duplicate open class proceedings with inherent issues seen in GetSwift.  Such issues include circumstances where competing cases have been stayed, and common fund orders are made requiring applicants in stayed cases to pay towards the commission of the winning funder, despite those applicants having signed funding agreements with other funders.

Background

The applicants in Lenthall represent persons who were given advice by Westpac Banking Corporation (through its financial advisers in Westpac Financial Planning) on life (and related) insurance and the premiums payable, and who obtained insurance policies by reason of that advice. The applicants allege that the financial planners breached their fiduciary duties and statutory best interests and no conflict obligations because they did not advise the applicants or group members about more favourable insurance policies offered by third party insurers.  Lee J noted that there were aspects of the claims that were novel and that it was common ground that this case raised legal and factual issues of some complexity.

The Lenthall applicants initially applied for a common fund order including:

• the payment of a commission (to be fixed at a later stage by the Court) of no more than 30% (or 35% on appeal) of gross recoveries; and
• payment of the applicants’ solicitors’ unpaid costs.  These unpaid costs would amount to 20% of the total costs incurred[2] and a 25% uplift fee.

The applicants subsequently revised their proposal to seek a funding rate of the lesser of three times the total spend on legal costs (including disbursements and adverse costs), or 25% of the gross recovery in any resolution.  This revised proposal substantially mirrored the form of the funding terms of the common fund order that Lee J had indicated was appropriate in GetSwift.[3]  Whilst the multiples and percentage rates were higher than those in GetSwift, Lee J indicated that “if the percentage rate was struck by reference to net recoveries, the proposal is within range of reasonable funding commissions (and, to the extent relevant, lower than commissions approved in settlement approval hearings of roughly comparable cases)[4]” (Added emphasis).

Lee J distinguished the circumstances between GetSwift and Lenthall and recognised that higher rates could be justified by the potentially riskier claims involved in non-orthodox securities class actions that raise novel and complex claims. Also relevant was the fact that only one funder had indicated a willingness to fund the action and had already expended significant resources.  

In deciding it appropriate to make a common fund order (refined to refer to net rather than gross recoveries), Lee J explained the preference for common fund orders which propose funding commission rates struck by the lesser of a multiple of costs or net recoveries:

• calculating funding commissions based on a multiple of costs, among other things, recognises the real and demonstrable proportionality between risk and reward which is not directly reflected in “headline” funding percentages; and
• calculating funding commissions based on net recovery amounts allows for more ready comparison with earlier common fund orders, and reflects the reality that what is fair, reasonable and in the interests of group members is an evaluation of what they will actually receive in hand following any settlement or determination.[5]

The existence of the “uplift” arrangement with the applicants’ solicitors further justified a common fund order based on net recoveries as this would most appropriately reflect the fact that the funder is not accepting all the risks of an unfavourable outcome. Net recoveries (after costs) would also incentivise funders to exercise a greater degree of control over costs expended.

Brief analysis

Westpac opposed the making of a common fund order on a number of grounds. Curiously, one of these grounds was that the Court has no power to make an order creating new legal rights for the benefit of an entity that is not a party to the proceeding. As Lee J noted, this amounted to a submission that the Full Court’s decision in Money Max was wrongly decided.[6]  This appears to raise the possibility that Westpac may be considering a High Court appeal to obtain certainty as to whether or not the power exists. Interestingly, the power of the NSW Supreme Court to make common fund orders under section 183 of the Civil Procedure Act may be the subject of an appeal by BMW Australia.[7]

Westpac also argued that if s33ZF of the Federal Court of Australia Act 1976 (Cth) (FCA Act) was engaged, then the express limitation on the scope of the power conferred by that provision meant that the Court should not exercise the power to grant a common fund order “unless it affirmatively forms the view that there would be some injustice in this particular proceeding that could not be avoided unless the Funding terms were approved”.[8]

Westpac sought to distinguish the circumstances in Money Max and Lenthall and submitted that a “key point of difference” was the absence in Lenthall of a so-called “floor condition” to the effect that the making of the common fund order should not leave group members any worse off than if the order was not made.[9]  However, this submission did not have due regard to one of the key benefits of a common fund order, namely, it avoids the wasted costs of the funder of “book building”.

Westpac further argued that the size of the commission potentially available to the present funder if a common fund order was made cannot be justified, or alternatively, that the applicants had failed to put material before the Court to justify the size. Emphasis was placed on four matters:

• First, the lack of approaches to other funders. Despite it being open for other funders to make proposals on different terms when the proceeding was commenced, Lee J observed no one was “beating down the Registry doors” to commence a duplicative proceeding.  Lee J did not consider that a proposal more favourable for group members would have resulted, even if the applicants’ lawyers had entered into detailed commercial discussions with more than one funder.  Lee J also emphasised the importance of (1) considering each common fund order proposal on its merits rather than by reference to fixed rules, and (2) the applicants ensuring they act appropriately given their representative role.  This includes careful consideration of the terms of any funding agreement they enter into, and whether that agreement prevents them from exploring the market to obtain an optimum result for group members.
• Secondly, the lack of evidence as to competitiveness of funding terms. No evidence was filed justifying the reasonableness of the funder’s proposed return by way of detailed economic analysis.  Instead, evidence was filed identifying “market” rates for litigation funding. Lee J noted this evidence had obvious limitations given the increasing number of funders entering the market, and the apparent downward pressure on funding rates.  The usefulness of comparative analysis of funding rates between class actions is further limited given the differing risks between actions.  However, Lee J indicated a clear preference for funding rates to be struck by net, rather than gross, recoveries as this would increase the utility of comparative exercises (and incentivise the funder to exercise some control over legal costs).
• Thirdly, the uncertainty as to funder’s ability to fund. A number of disclosures by the funder to the ASX about exiting its litigation funding business were put before the Court. Westpac submitted that the funder was apparently not committed to seeing the proceeding through to the end and that if the funder was likely to change, any common fund application should be deferred.  Lee J did not consider there to be any real substance in this submission and noted that the funder will be required to give undertakings to comply with the funding terms and to provide security for costs.  Accordingly, there was no reason to think the funder will not adequately fund the action or that Westpac will be at risk in relation to recovery of adverse costs (provided adequate security is ordered). 
• Fourthly, the proposal for a costs referee for future costs only. Significant legal costs (of $1.2 million) had already been incurred.  Lee J indicated that an independent costs referee would be engaged to scrutinise the costs incurred before the making of the common fund order and future costs.[10]

The applicants also filed evidence which suggested that if the Court did not make the proposed common fund order, but instead set its own terms, the funder may elect not to fund the proceeding, leading to a potential permanent stay of the proceeding.  Lee J placed little weight on this and described such a possibility as a “minatory suggestion” which would distract from the Court’s task.

Outcome

Lee J decided (including by consideration of the seven findings in Money Max[11] of relevance to Lenthall) that it was appropriate to make a common fund order on the basis that his Honour was satisfied that: first the funder will likely meet its funding obligations; secondly the funding rate is reasonable in all the circumstances and there was no evidence another funder would propose more favourable terms; thirdly no conflict issues arise, fourthly the applicants’ solicitors have acted responsibly notwithstanding they only had detailed discussions with one funder; fifthly the common fund order proposed is conscious of the duties of the applicants and their solicitors to group members; sixthly legal costs are likely to be very considerable and without litigation funding the proceeding would likely not advance to resolution at a mediation or on its merits; seventhly the making of the proposed order, and thus allowing an open class, is consistent with the policy objectives of Part IVA of the FCA Act, namely to secure a single decision on issues common to all and to reduce the cost of determining all related issues arising from the wrongdoing.[12]

Lee J made the common fund order in the terms approved on 28 September 2018, subject to an undertaking by the funder, the applicants and the applicants’ solicitors to each other and to the Court that they will comply with their obligations under the Funding Terms.[13]

The players in the class action space will be keenly awaiting the report and legislative reform, if any, following the Inquiry into Class Action Proceedings and Third-Party Litigation Funders by the Australian Law Reform Commission to determine whether any reform will stabilise the current climate, or lead to another round of what Lee J aptly describes as the “whack-a-mole” game of new issues arising upon the resolution of existing issues.

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[1] In this regard, see Liverpool City Council v McGraw-Hill Financial, Inc (now known as S&P Global Inc) [2018] FCA 1289 where Lee J approved a $92 million payment to the funder from the gross settlement sum of $215 million.

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