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This is Part Two of our four-part series on the impact of the findings and recommendations of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
Last week’s double decisions of the Full Court of the Federal Court and the New South Wales Court of Appeal confirm the Courts’ powers to make common fund orders. The decisions will give litigation funders additional certainty over the recovery of their commissions and permit third-party funding to continue to be one of the drivers of the active class actions landscape in Australia. However, the NSW Court of Appeal left open the possibility of future challenges to common fund orders on different grounds and has suggested a cap on the fees that litigation funders can recover from class actions in the NSW Supreme Court.
On March 1, 2019, in two decisions released on the same day, the Full Court of the Federal Court of Australia (Full Court) and the NSW Court of Appeal confirmed the legality and constitutionality of common fund orders (CFOs) in third-party funded class actions.
The decisions arise out of applications for CFOs made in two separate class actions: Lenthall v Westpac Life Insurance Services Limited (the Lenthall proceeding), filed in the Federal Court, and Brewster v BMW Australia Ltd (the Brewster proceeding), filed in the NSW Supreme Court.
A CFO is a court order which obliges all group members in a class action to pay their proportionate share of a litigation funder’s commission out of the proceeds of a judgment or settlement, whether or not the group members have entered into a funding agreement directly with the funder. A CFO is usually sought by a representative plaintiff to provide the funder with the certainty, at an early stage of proceedings, that all members of the class will be liable to pay the funder its commission should any proceeds be recovered in the litigation or as a result of settlement.
The concept of a CFO arose out of the common fund doctrine, established in the 1880s in the United States. The common fund doctrine entitles a lawyer who recovers a common fund for the benefit of persons other than his client to a reasonable fee from that fund. The underlying rationale for the doctrine is that a person who obtains the benefit of the lawsuit without contributing to court costs are unjustly enriched at the successful litigant’s expense.
In Australia, the Federal Court first held that it had the power to grant a CFO under section 33ZF of the Federal Court of Australia Act 1976 (Cth) (the Act) in 2016, in the case of Money Max Int Pty Ltd (Trustee) v QBE Insurance Group Limited  FCAFC 148. Since then, applications for CFOs have become a matter of course in third-party funded open class actions. To date, 85 CFOs have been made in Australia. There had been no direct challenge to the legality or constitutionality of common fund orders until the Lenthall and Brewster proceedings.
The Lenthall proceeding was commenced in the Federal Court in October 2017. The plaintiffs entered into a litigation funding agreement with JustKapital Litigation Pty Limited. In September 2018, Lee J made the common fund order requested by the plaintiffs. The defendant appealed that decision.
The Brewster proceeding was commenced in May 2018. The plaintiff entered into a litigation funding agreement with Regency Funding Pty Ltd. In August 2018, the plaintiff applied for a CFO. The defendant challenged the NSW Supreme Court’s power to make that CFO. The Supreme Court referred the question of whether the Court had the power to make the CFO to the NSW Court of Appeal.
The Chief Justice of the Federal Court, the Chief Justice of New South Wales and the President of the Court of Appeal of New South Wales agreed to hear the appeal in the Lenthall proceeding and the question before the Court of Appeal in the Brewster proceeding at the same time in the same courtroom. Such a joint hearing had never occurred before. As the Full Court explained:
The issues in the two matters overlapped considerably; and, given the importance of the questions, in particular of the Constitutional questions, it was thought convenient for the administration of justice that both Courts have the advantage of written and oral argument of counsel on the same occasion.
The Courts agreed not to discuss the substance of the arguments or their views on the questions at issue with the judges from the other Court or exchange draft judgments with one another. However, both Courts made it clear in their decisions that they did not consider such communications inappropriate.
The defendants made three primary arguments in challenging the Courts’ power to make CFOs.
First, each submitted that on their proper construction the applicable legislative provisions (s 33ZF of the Act and s 183 of the Civil Procedure Act 2005 (NSW)) did not authorise the Courts to make a CFO, either at all, or prior to settlement of or judgment in the proceeding. The Full Court referred to this as the “construction argument”.
Second, they argued that the making of a CFO was not an exercise of judicial power for three reasons:
This was referred to as the “judicial power argument”.
Third, if the making of a CFO was found to be an exercise of judicial power authorised by applicable legislation, the challengers argued that such legislation is to that extent a law with respect to the acquisition of property for purposes of s 51(xxxi) of the Constitution which does not provide “just terms” as required by the Constitution. This was referred to as the “acquisition argument”.
In the Lenthall proceeding, the defendant also argued that the primary judge erred in exercising its discretion to make the CFO in the circumstances of that case.
Both the Full Court and the NSW Court of Appeal rejected each of the arguments made by the defendants, finding that that the CFOs sought by the plaintiffs were permitted under applicable legislation and the Constitution.
With respect to the construction argument, both Courts noted the “width, amplitude and flexibility” and “utmost generality” of the statutory provisions that are the source of the Courts’ power to make CFOs. The Courts each viewed the provisions at issue as being wide enough to empower the Courts to make CFOs.
In response to the judicial power argument, the Courts held that the exercise of judicial power can involve the creation of rights and obligations, that a CFO is made by the Court on the basis of evidence (including as to actual and anticipated costs and risks), and that a CFO is not purely hypothetical as it would take effect immediately to bind group members to the funding agreement.
The Full Court rejected the acquisition argument because:
The Full Court regarded CFOs not as acquisitions of property but as adjustments of the competing rights of the group and the funder, and further held that even if it was an acquisition, it may be on just terms because it was possible that value of the funder’s service would be the pecuniary equivalent to each group members’ share of the commission.
The NSW Court of Appeal rejected the acquisition argument on the basis that the law at issue was not a law with respect to the acquisition of property, but rather a law which confers a general power upon a Court.
Lastly, the Full Court rejected arguments that the primary judge in the Lenthall proceeding made an error in exercising his discretion to make the CFO. Of particular note, the Full Court found that it was legitimate and relevant for the primary judge to take into account the risk to funding continuing, and so the action continuing, if he did not make the CFO.
Funding agreements typically calculate a litigation funder’s consideration for funding a class action as a percentage of a damages award or settlement amount (Resolution Sum), net of legal fees, disbursements and administration expenses (Funder Costs). However, recently it has become more common to see CFOs which set a funder’s consideration as the lesser of a percentage of the Resolution Sum and a multiple of the Funder Costs.
In Brewster, the NSW Court of Appeal expressed its view that the CFO sought by the plaintiff should limit the funder’s commission to a multiple of the Funder Costs:
There is also much to be said for imposing a further order capping the funder’s share of the proceeds of litigation to an amount based upon a multiple of the total amount paid by the funder (being the cost of the provision of security, and the costs and disbursements paid), so as to prevent the order from yielding a benefit which is out of all proportion to the capital deployed and the risk.
The Court noted that a pure percentage-based commission in a CFO could contingently entitle a funder “to a return which might be out of all proportion to the capital deployed and put at risk”. Such an order, the Court said, would not be an order that is appropriate or necessary to ensure that justice is done and thus would not be one the Court had the power to make under applicable legislation.
The Court of Appeal did not provide guidance on what multiples might be applied to ensure the benefit to the litigation funder is not out of all proportion to the capital deployed and the risk. One challenge the Courts will face in setting such a cap on fees is ensuring that the multiple does not act to disincentivise the early resolution of class actions at a time when the parties’ costs will be at their lowest and a funder’s recoveries might be constrained by such a cap. It will be important for CFOs to be made on terms that do not encourage litigation funders to settle later in a proceeding, only after material costs have been expended.
Although both Courts clearly decided that CFOs were legal and constitutional, the NSW Court of Appeal noted that no party had raised the argument that a CFO, by requiring all group members to be subject to the same regime, “undercut or was antithetical to the basic idea of open classes” underlying the class action statutory regimes in Australia. The Court appears to be suggesting that the very nature of a CFO, which binds groups members to certain obligations before the time for exercising their right to opt out had expired, may render CFOs inconsistent with the concept of open classes, and thus with applicable class action legislation as a whole.
The decisions of the Full Court and the NSW Court of Appeal in the Lenthall and Brewster proceedings will further entrench the position of litigation funding in class actions in Australia, as funders gain greater certainty over the recovery of commissions from the lawsuits they fund.
However, the NSW Court of Appeal has left the door open to a future challenge to the validity of CFOs as being inconsistent with the legislative regimes governing class actions. As a result, the decisions may not be sufficient to avoid legislative intervention to provide courts with the express power to make CFOs, as recommended by the Australian Law Reform Commission in its recent report on class action proceedings.
The NSW Court of Appeal has suggested that the funder’s fees be capped at a multiple of the funder’s costs. Given the complexity and risks with such a cap, this may see an increase in third-party funded class action plaintiffs commencing proceedings in the Federal Court, but it is unlikely the Federal and Supreme Courts will adopt a different approach to CFOs for long.