Litigation funding agreements - the future's in the balance

By Andrew Dienhoff.

Key Points:
The next 18 months will be an interesting period for LFAs, and will have a profound influence on the litigation landscape.

Courts have recently embraced litigation funding arrangements ("LFAs") which would, traditionally, have been considered objectionable. This potentially makes their use, in a wider range of legal actions, much more likely.

However three (potential) appeals could have significant impacts on this trend.

The first is the Full Federal Court appeal from the recent decision in Sons of Gwalia Ltd v Margaretic [2005] FCA 1305 [1]; which permitted shareholders to be treated as creditors of a company in certain circumstances. The primary judge's decision, if upheld, raises the prospect of increasing numbers of shareholder class actions being brought using LFAs.

Secondly, the High Court has granted special leave to appeal the decision in Fostif Pty Limited v Campbells Cash 'N' Carry Pty Ltd [2005] FCAFC 75, which considers the acceptable limits of LFAs themselves.

Thirdly, there is the potential for an appeal from the Federal Court decision in Dorajay Pty Limited v Aristocrat Leisure Limited [2005] FCA 1483, which prevented a shareholder class action, funded under an LFA, from continuing as a representative proceeding under Part IVA of the Federal Court Rules.

The State Attorneys-General have also now agreed to regulate litigation funders.

Background

A LFA arises where a third party provides funding to a plaintiff to enable a legal action to be pursued. If the litigation is successful, the funder will then receive repayment of the funds it provides to the plaintiff, plus a percentage of the net litigation proceeds.

Until relatively recently LFAs were commonly used:

• by liquidators of insolvent companies, or trustees in bankruptcy;
• where a third party had a "genuine commercial interest" in the outcome of the litigation.

New developments

There have been a number of recent cases that have considered, and generally accepted, the use of LFAs in other areas. These included LFAs:

• in class actions, where a litigation funder enters into an arrangement with multiple plaintiffs to pursue litigation involving common legal and factual issues. [2]

In this scenario, the litigation funder is usually a business that identifies the potential litigation and then locates the plaintiffs to enable the action to be brought.

In the Sons of Gwalia case, for example, the funder is endeavouring to identify additional shareholders, so as to ask them to be part of the funded litigation;

• where ordinary commercial litigants, with the funds to pursue litigation themselves, enter into an LFA simply to rationalise the cost, and risk, of complex litigation; [3]
• in which the litigation is funded for the pursuit of the broader commercial objectives of the litigation funder. [4]

Emerging principles

Historically, the courts were likely to stay or dismiss legal actions brought with the aid of LFAs. In the past, they saw it as undesirable for third parties, with no direct financial interest in the outcome of litigation, to be allowed to interfere.

However, the courts are now increasingly mindful of access to justice considerations, and are concerned about the increasing costs of litigation. Hence LFAs are now viewed as a useful mechanism to enable plaintiffs, who do not have the means to pursue litigation themselves, to pursue "well resourced and deep pocketed defendants".

As a result of the recent decisions it appears that funded actions will not be stayed or dismissed by the courts even if:

• the litigation funder is "stirring up controversy" where none previously existed (ie. the plaintiffs had no prior interest in pursuing the litigation themselves);
• the funder's interest in the litigation is only to derive profit;
• the funder will control the day to day conduct of the plaintiffs' litigation;
• the profit that is likely to be derived by the litigation funder, if the action is successful, is disproportionate to the level of services provided by the funder.

Even if the action is stayed, the court will endeavour to eliminate those aspects of the LFA that are viewed by the court as objectionable, and then allow the litigation to continue.

The courts will also permit sophisticated corporate plaintiffs to use LFAs. They are likely to permit this even if the plaintiff could fund the action itself.

Implications

It remains likely that an increasing percentage of claims will be brought with the aid of litigation funding.

However, the outcome of the upcoming appeals in Sons of Gwalia, Fostif and Dorajay could hamper the continued funding of shareholder class actions, which is the most likely growth area.

Further, on 3 November 2005, the State Attorneys-General reached "in principle" agreement to regulate litigation funders. The NSW Attorney-General, Mr Debus has even suggested that the States consider establishing "not for profit" litigation funding organisations designed to compete with commercial litigation funders in relation to small claims, so as to place downward pressure on funding fees.

There will also be continuing debate about the appropriate use of LFAs, and in particular whether it is appropriate for the court to be used for the pursuit of litigation that would not have been brought, but for the initial involvement of the litigation funder.

The next 18 months will be an interesting period for LFAs, and will have a profound influence on the litigation landscape.

[1]See our Banking & Financial Services Insights which discusses the Sons of Gwalia decision in greater detail.

[2] Fostif Pty Limited v Campbells Cash 'N' Carry Pty Ltd [2005] FCAFC 75, Trendlen v Mobil [2005] NSWSC 741, Clairs Keeley (a firm) v Treacy & Ors [2005] WASCA 86, Dorajay Pty Limited v Aristocrat Leisure Limited [2005] FCA 1483

[3] QPSX Limited v Ericsson Australia Pty Ltd (No.3) [2005] FCA 933

[4] Project 28 Pty Ltd v Tim Barr Pty Ltd [2005] NSWCA 240, Volpes v Permanent Custodians Ltd [2005] NSWSC 827