29 Aug 2013

Attacking the straw man: security for costs in class action proceedings

by Ross McInnes, Kristen Zornada

The Full Federal Court's decision to order security for costs should give respondents in representative proceedings some comfort.

Class action proceedings are unique in many ways. One of the characteristics peculiar to class actions is that a successful respondent can only recover costs against the lead applicant, as group members are immune from having costs orders awarded against them.

This immunity is underpinned by important policy considerations, including affordable access to justice, as class actions allow group members to bring actions in circumstances where they individually could not afford to do so. However, it means that respondents will often be forced to defend an action at considerable costs with no ability to recover those costs if they are successful. That dynamic can impact many aspects of the proceedings including settlement negotiations. It shifts the balance of power in favour of applicants, who know that there will likely be an element of "wasted cost" even if a proceeding is successfully defended.

Usually in litigation, where a respondent does not expect to be able recover costs from a plaintiff, it has an option to make an application for a security for costs. A security for costs order restores the balance, as having to put up money upfront to potentially cover the respondent's costs forces an applicant to consider whether there is merit in pursuing the action, and avoids frivolous litigation.

While security for costs applications are not without their difficulties, they have had a chequered history in class action litigation. The recent Full Federal Court decision of Madgwick v Kelly [2013] FCAFC 61 has made it clear that security for costs applications are not prohibited in representative proceedings. The decision may open the way for more security for costs applications in class actions.

What was the case about?

Madgwick v Kelly concerned a suite of litigation commenced by the applicant and group members, who were all investors in a forestry plantation scheme that failed. The cases were being pursued against Wilmott Forests Ltd and Bioforest Ltd, as the responsible entities for the schemes, and also included lenders who financed some of the investors in the scheme.

Are security for costs orders inconsistent with class action proceedings?

At first instance, the respondents sought an order for security for costs. The application was refused. They sought to appeal the decision.

In allowing the appeal, Chief Justice Allsop and Justice Middleton considered the dichotomy between:

  • section 43(1A) of the Federal Court of Australia Act 1976 (Cth), which provides that a Court or judge cannot award costs against a group member in a class action; and
  • section 33ZG(c)(v) of the Act, which provides that nothing in Part IVA affects the operation of any law regarding security for costs.

They found that the primary judge had failed to follow the decision in Bray v Hoffman-La Roche (2003) 130 FCR 317, which made it clear that “an order for security did not affect the immunity of s43(1A) and there was no overlap between ss43(1A) and 33ZG(c)(v), which operate independently”.

A balancing exercise – but the position of group members and litigation funding is relevant

Having overcome that hurdle, the Court then considered whether security should have been awarded. The Court recognised that it must undertake a balancing exercise between the policy underlying representative proceedings and the risk of injustice to a respondent in having no real capacity to recover costs if it successfully defends the litigation.

The Full Court's decision recognised some important features of the kind of class actions that are now being pursued in Australia – namely, group members making active choices to participate in litigation, and litigation funders standing behind class action proceedings. A range of factors must be taken into account, including:

  • whether granting an application for security for costs is likely to stifle the applicant and group members' pursuit of their claims;
  • the financial circumstances of the group members, for which the applicant bears the onus of proof;
  • the unwillingness of group members to contribute for security for costs, and the reasonableness of requiring group members to do so; and
  • the availability of litigation funding.

The Full Court determined that security for costs should have been awarded, noting that:

"the applicants and group members entered commercial transactions for their own reasons… [i]t seems entirely fair that those standing to benefit from such litigation make a real, but not oppressive, contribution to a fund to secure the costs of the respondents".

No win, no fee?

A well-known feature of plaintiff firms is the "no win, no fee" retainer its solicitors often enter into with group members in a class action, who otherwise could not afford to fund the litigation. The flip side to this arrangement is that in the result of a win, the retainer agreement often contains provision for the payment of an "uplift" fee, in addition to professional costs.

The Full Court considered whether the solicitors for the applicants and group members were effectively "standing behind the litigation" or "standing to benefit" from the litigation and therefore be subject to a security for costs order. The Court emphatically rejected that suggestion:

"There are principled reasons to distinguish between a commercial litigation funder and solicitors … under these agreements. The former take a percentage of the judgment; the latter earn professional fees. … Solicitors are entitled to charge professional fees for undertaking the professional responsibilities of running the case, as officers of the Court, with all the attendant responsibilities (including duties to the Court) that that entails. No one, the solicitors included, should ever lose sight of those responsibilities. The expected or contingent receipt of proper professional fees … is not a basis for requiring an officer of the Court to contribute to a fund for the costs of the other side of the litigation."

Recognition of the class action industry

The decision should provide some comfort to respondents in representative proceedings. Security for costs applications are likely to be on the radar in future class actions.

Perhaps most importantly, the decision reflects an important recognition of some of the key features of Australian class action industry – litigation funders and active group members – which the Full Court took into account in reaching its decision.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.