10 Jun 2021

Reforming Australia's litigation funding and class actions 07: proportionality

By Greg Williams, Blair McEwan and Mitchell Donohue

Reform to the class action system is needed to avoid scenarios where plaintiff lawyers and funders vigorously pursue claims with questionable merit but which they perceive to be likely to return healthy profits.

Over the past six months we have been unpacking the recommendations made by the Parliamentary Joint Committee on Corporations and Financial Services in its report on Litigation funding and the regulation of the class action industry.

In the seventh and final instalment in the series, we take a closer look at the recommendations directed at ensuring that the Australian class action regime operates in the interests of class members (and not litigation funders). 

These recommendations include:

  • investigating legislation promoting proportionality in class actions by balancing the potential costs and drawbacks against the potential benefits, not only for parties to litigation, but also the impact on court resources and the public interest (Recommendation 1); and
  • consideration of a statutory minimum gross return for class members (Recommendation 20);
  • appointment by the Court of a "litigation funding fees assessor" , being a professional with market capital or finance expertise (as opposed to legal) (Recommendations 13 and 14).

Ensuring the costs of class actions are proportionate  

Class actions can be efficient vehicles for the determination of multiple claims with common issues of law or fact. However, they also tend to be more complex and lengthy than other forms of litigation, meaning that they can cost more.  It is important that the time and expense of a class action is proportionate to the potential benefits to the parties and group members.     

The Committee observed that there are significant challenges in implementing reforms to address procedural proportionality concerns. This is because it is difficult to make these kind of changes in a way which balances the risks and benefits for both plaintiffs and defendants. The Committee had difficulty in identifying such reform and proposed further investigation into the issue. However, the Committee was of the view that procedures to identify, at an early stage, the likely quantum of the claims and an estimate of the legal costs to be expended, would assist the Federal Court in assessing procedural proportionality. 

Legislating a minimum gross return for class members?

The Australian Law Reform Commission says that when a litigation funder is involved in a class action, the average return to class members was 51% of the total amount paid by the defendants, compared to 85 per cent when a funder was not involved. In this context, the Committee observed that the involvement of a litigation funder in a class action has a significant impact on the percentage of the settlement which ends up being returned to class members. 

Relying on "averages" in an area as complex and varied as class actions is problematic because they do not take into account factors such as the strength of the group members' claims, settlement amount (per group member), timing of settlement, and number of class members. However, the level of returns to class members, particularly when compared to the quantum taken up in fees and commissions, was obviously a key concern of the Committee.

In real terms litigation funder involvement can look like:

  • Clarke v Sandhurst Trustees Limited (No 2) [2018] FCA 511: Settlement of $16.85 million with $5 million (30%) for legal costs and another $5.06 million (30%) for the litigation funder leaving 40% for class members.
  • Money Max Int Pty Ltd v QBE Insurance Group Ltd [2018] FCA 1030: Settlement of $132.5 million settlement with $21.8 million (16.5%) deducted for legal costs and $30.75 million (23.2%) for the litigation funder leaving 60.3% for class members.
  • Caason Investments Pty Limited v Cao (No 2) [2018] FCA 527: Settlement of $19.25 million with 43% for legal costs, 30% to litigation funders (through a common fund order) leaving 27% for class members.

Recent example: Appco Unpaid Wages Settlement

The proceeding was brought on behalf of a closed class comprising 1,172 former staff members of Appco Group Australia Pty Ltd. All class members had signed funding agreements with a litigation funder (Harbour) which entitled Harbour to a 50% commission on the successful resolution of the proceeding.

In the early stages of the proceeding, lawyers for the class had estimated the claims of class members to total $65 million and considered the case to have good liability prospects. The parties reached in-principle settlement in August 2020 for $1.9 million.

The primary rationale cited for this low figure was the solvency of Appco. There were genuine concerns that Appco would be unable to meet an award for greater than this amount. A potential further source of funds was noted by the parties, but investigation into it was stymied by the funder being unwilling to expend further resources.

At an initial hearing in October 2020, the Federal Court refused to approve the settlement on the basis that, once fees and the contractual commission was deducted, class members would be left with $910,000 – aptly described by Justice Lee as "diddly squat". The Court took issue with what was seen to be an ultimatum by those backing the class action, that the settlement be approved on the in-principle terms or financing would be withdrawn. In the course of the hearing, the lawyers for the class indicated that they would undertake the afore-mentioned investigations and the matter was adjourned.

The Court ultimately, (if reluctantly) approved settlement for $2.05 million was two months later (Bywater v Appco Group Australia Pty Ltd [2020] FCA 1877) on the basis that:

  • the sum had been augmented slightly;
  • the funder had agreed to reduce its commission to 25%;
  • the administration process was to be simplified with capped costs;
  • the notice contained a number of explicit disclosures which explained to class members the practical difficulties which arose; and
  • the Court was satisfied that pursuit of further sources of funds would be "a case of throwing good money after bad".

While by no means ordinary typical case, the Appco settlement illustrates the important role that the Court plays in scrutinising potential settlements – and the way in which its approval power can be used to influence the terms even after the parties reach in-principle settlement. All parties to a proposed settlement of a class action must be careful to ensure it is one which is capable of approval by the Court.

The Appco settlement was approved just days before the release of the Report, and is just one in a series of recent class actions where the Federal Court has raised concerns over return to group members. The Committee recommended further consultation including, in particular, in relation to a statutory minimum return rate for proceeds obtained in a class action. 

Independent litigation funding fees assessors

The Federal Court has the power to refer matters to a referee at any point. While the Federal Court’s Practice Note was amended in 2019 to add a statement that a referee may be appointed to scrutinise the reasonableness of legal costs, it is silent on the use of referees to assess litigation funding fees. As a result, the Committee recommends amendment to the underlying legislation to give express powers in this regard.

The Committee pointed out that the professionals currently used by the Federal Court as referees to assess legal costs are commonly practitioners in legal costing services. The Committee considered that referees appointed to undertake an assessment of litigation funding fees should have capital market or finance expertise, with a proposal put forward to establishing a panel of competent and reputable experts in this field that could be called upon by the Court to assist, for example, in the context of an application for a common fund order.

Recommendations to strike a balance

The Report's recommendations aim to strike a fair balance between stakeholder interests and maintain the viability of the class action regime. However there is a clear intention to "right the ship" and avoid misuse of the class action system to generate profit for funders and plaintiff law firms.

Some of the strategies contemplated to address the proportion issue included:

  • using empirical analysis of past cases;
  • a cap on the percentage of the settlement available to litigation funders;
  • a sliding scale reducing the percentage cap as the size of the litigation increases; and
  • a statutory minimum percentage guaranteed for class action members.

These recommendations may not be able to be applied equally to all class actions. Relatively straight-forward class actions may result in higher percentage returns to class members, while complex cases may see a higher return to funders, given greater investment and risk. Recognising that there is no "one size fits all" approach, the report nevertheless considers 70% of returns for class members as an appropriate starting point for consideration.

Treasury Consultation – Submissions open

Since the release of the Report in December 2020, these recommendations have been actioned – most directly by the joint consultation by the Treasurer and Attorney General in relation to "Guaranteeing a minimum return of class action proceeds to class members" (which is open for submissions until 28 June 2021). The Consultation Paper released on 1 June refers to the "systemic and inappropriate" skewing of successful class action proceeds in favour of litigation funders, which were observed in the Report.

Its stated objective is "to consult on the best way to guarantee a statutory minimum return of gross proceeds of a class action to class members. In particular, views are sought on the potential design elements of a guaranteed minimum return, the appropriate rate and how the rate might be differentiated based on the risk, complexity, length and likely proceeds of a particular case."

Reforms needed to manage returns to funders and class members

The Committee’s approach to these two issues is consistent with there being a growing level of concern regarding litigation funders making windfall profits at the expense of class members. Australian Courts need a broader and more prescriptive range of tools to ensure that they are able to properly manage this risk.

Reform to the class action system is needed to avoid scenarios where plaintiff lawyers and funders vigorously pursue claims with questionable merit but which they perceive to be likely to return healthy profits. Knowing that most class actions resolve through settlement provides a degree of control for funders and plaintiff lawyers (who, unlike class members, are directly involved in these negotiations) to ensure that their bills will be met as part of any resolution.

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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.