Precedent (Australian Lawyers Alliance)
THE ROLE OF LITIGATION FUNDERS IN CLASS ACTIONS
By Wayne Attrill
The importance of litigation funding to facilitate access to the civil justice system in Australia is now widely accepted. The funding of class actions, in particular, enables individuals and companies without the means to bring a claim on their own (either because they lack funds, or the claims individually are too small compared with the cost of prosecuting them) to collectively seek compensation and justice for losses or damage caused to them by others’ misconduct.
The Law Council of Australia and the Federal Court of Australia, in their Case Management Handbook (July 2014), have candidly observed:
‘In many senses, litigation funding has proven to be the lifeblood of much of Australia’s representative proceeding litigation at federal and state level. Not all cases are funded by third-party litigation funders but a sufficiently large number of class actions have been funded in this manner that it has had a major impact on the sorts of cases being conducted. Representative proceedings funded by group members are rarely heard of, and actions funded by law firms on a conditional fee basis are the exception rather than the rule. This is a consequence of the time, cost and complexity of most representative proceedings and the risk burden, carried by the representative applicant, of an adverse costs order.’
It is almost 10 years since the seminal decision of the High Court in the Fostif case, in which the majority effectively gave the green light to litigation funding of proceedings in Australia (outside of the insolvency area in which funding first arose). More recently, government policy and legislation have supported both class actions and funders who provide the means for those actions to be brought.
Many lawyers are still unaware or uncertain of how litigation funding works, what to look for when seeking funding, or of its benefits to them and their clients. This article explains the funding process and the assistance that a funder can bring to funded proceedings to the benefit of clients and lawyers alike. It also explains some of the criteria that funders consider when assessing a potential class action for funding, as well as identifying limitations on the use of funding.
WHAT IS LITIGATION FUNDING?
Litigation funding involves a third-party commercial funder agreeing to pay some or all of the claimant’s legal costs and disbursements (which can include adverse costs and security for costs) in return for a share of any damages or settlement recovered by the claimant.
The funder’s share usually comprises reimbursement of its outlays and a share of the recoveries, typically a percentage in the range of 25 per cent to 45 per cent (the median figure is around a third), depending on the time taken to resolve the case and the costs and risks involved in funding it. In some cases, the funder’s share will be calculated as a multiple of its outlays or at an interest rate on the sum invested. If the case is unsuccessful, the funder recovers nothing and may be liable to pay the other side’s costs incurred during the term of the funding agreement.
Within these broad parameters, funders can accommodate a range of funding options which may be tailored to the specific needs of the funded parties, their lawyers and the nature of the dispute. A funding package can include ‘after the event insurance’ by which the claimant (or the funder) obtains insurance to cover specified risks (such as the risk of paying adverse costs) on payment of a premium, which can itself be deferred to the conclusion of the litigation and/or made contingent on its success. A disadvantage with insurance, however, is that cover is often capped, whereas a funder may agree to pay all adverse costs orders incurred during the term of the funding agreement.
WHAT A LITIGATION FUNDER CAN PROVIDE
Class actions are notoriously expensive and risky. As noted above, class actions funded by claimants themselves are rare, and few law firms have the financial capacity to conduct a large and lengthy class action on a ‘no win, no fee’ basis.
Litigation funding can provide essential financial resources for claimants with little or no means, or for class action lawyers with cash flow constraints, allowing them to pursue the litigation with vigour. It can also allow better-resourced clients, who may nevertheless have an aversion to the risks associated with litigation, to transfer those risks (and the burden of managing the litigation) to the funder. Most importantly, funders can assume the risk of the representative applicant in a class action having to pay an adverse costs order – a risk which is otherwise prohibitive for all but the most indigent, courageous or wealthy of claimants.
Litigation funders offer more than financial support. Importantly in relation to large-scale class actions, they may be involved in identifying, contacting and organising the claimants and informing them of their right to join the class action. The claimants may otherwise be ignorant of this important right or it may not be not feasible for them to organise themselves. The funder may assist in the management of group member data and communications, which can be a significant task when the group is very large. The fact that a claim is funded may improve the prospects of it settling. The respondent will appreciate that an experienced, independent and objective commercial entity considers the claim to be of sufficient strength to merit funding it and that the claimants cannot be ‘outspent’ or worn down in a lengthy war of attrition.
Funders can also offer their expertise and experience in managing complex litigation, as they are repeat participants in the civil justice system itself. A number of funders in Australia have funded class actions. Many firms offering litigation funding are run by highly experienced former dispute lawyers who are focused on the timely, efficient and successful resolution of funded claims for the maximum achievable value. It has been said that that ‘litigation can be made more efficient through the “commercial objectivity” of the funder’.
An experienced funder will be able to assist the lawyers and claimants in the due diligence or investigations phase of a case, as well as during the course of the litigation itself; for example, offering views on the choice of counsel and experts and (subject to conflicts management measures discussed below) in the giving of day-to-day instructions to the lawyers. Many funders have long-standing relationships with barristers who are experts in class action litigation. Funders also frequently play an active role in the settlement of claims, as their interests in maximising the value of the claims, while minimising the risks of losing the action, are closely aligned with those of the claimants.
HOW TO CHOOSE A FUNDER
Lawyers who wish to advise their clients about whether or not to use litigation funding need to know what to look for in a litigation funder and should undertake careful due diligence on any funders they approach. Important factors to investigate include:
• The funder’s reputation and track record (how many claims has it funded, for how much and how long and what have been the results?) and the skills, experience and competence of its staff.
• The funder's financial capacity. Litigation funders make promises which extend over many years and which, if broken, will cause financial distress to their clients. It is particularly important for the lawyer to be satisfied that the funder has sufficient financial resources (including any insurance) to meet all of its liabilities over the expected timeframe of the litigation. How is the funder itself funded? Does it have adequate assets in Australia, or if it is based overseas, assets that are readily accessible by funded parties in Australia, to meet its obligations?
• The funder’s business structure. Litigation funders provide funding through a wide range of structures, including public and private companies, partnerships, trusts, hedge funds and other private funds, and they may seek to co-fund the litigation with other entities. The source of the funds may be domestic or foreign, open to public scrutiny (for example, funds raised on the ASX) or subject to disclosure on a confidential basis (if at all). The lawyer and client may find themselves dealing with an adviser or fund manager, rather than the actual source of the funds themselves. Lawyers and their clients need to be comfortable that the funder has been completely transparent with them when disclosing its structure, as well as its financial capacity.
• The terms of the proposed litigation funding agreement (LFA). What precisely is the funder undertaking to fund? What management services is the funder offering to provide? What risks will the funder underwrite and for how much? Are the terms of the LFA and the funder’s policies adequate to manage any conflict of interest that might arise? Who makes decisions on behalf of the funder? And on what terms will the funder engage with the lawyers?
HOW TO APPLY FOR FUNDING
The process of applying for funding is straightforward. Usually a claimant or the claimant’s lawyer contacts a funder by phone, email or in person. The funder will enter into a confidentiality agreement with the claimant (and their lawyers) and will ask for information on the nature and, if known, potential size of the claim, the identity of the defendant, the amount and nature of funding sought and, if the claimant makes the approach, the identity of the claimant’s lawyers. In some cases, the funder may have independently identified a potential class action before being approached by lawyers seeking funding for that action, and so may have a head start in considering that application.
If the claim meets the funder’s threshold criteria (which generally relate to the nature and value of the claim, its prospects of success and the defendant’s capacity to pay a judgment), the funder will undertake an extensive and detailed due diligence on the proposed class action (discussed further below). Funders bring a highly commercial and objective perspective to the assessment of any claim. The success of their business depends on them only backing strong claims.
The decision to fund a class action is often made by an investment committee, comprised of senior executives within the funder. The claims must meet the funder’s rigorous investment criteria if they are to be funded. If the committee agrees to fund, a LFA is discussed with the lawyers and is sent to the representative applicant and prospective group members, who may negotiate changes to it. In some cases, the parties may agree to allocate risk to other entities, such as co-funders or insurers.
FUNDING CRITERIA FOR CLASS ACTIONS
A litigation funder will carefully and thoroughly analyse all aspects of a potential class action that bear on the financial risks it is being asked to assume. These factors include:
• crucially, the prospects of success of the claims themselves;
• the estimated quantum of the claims following a book-build, compared with the likely costs and risks of pursuing the claims. The funder will wish to ensure that the costs and risks of the class action are not disproportionate to the likely recovery;
• whether there are any potential counterclaims;
• how many respondents will need to be sued and whether any third parties are likely to be joined to the proceedings – that is, how complex the litigation is likely to become and the estimated amount of any adverse costs orders if the class action is lost;
• any risks associated with the class action procedure. For example, the court ruling that there are no, or insufficient, common issues of law or fact to meet the threshold requirements for a class action, or the prospects of a competing class action being brought (this can arise because the funded class action will only encompass claimants who have signed a LFA with the funder – there may be other claimants who have not done so who may join a further class action);
• the likely time to complete the trial of the representative applicant’s case, which will determine the common issues; and
• any risks associated with the enforcement of a judgment.
The due diligence process is rigorous and is scrupulously applied to all potential funded litigation.
MANAGING CONFLICTS OF INTEREST
Lawyers and their clients who may wish to use litigation funding may be concerned with the possibility that conflicts of interest could arise between the funder, the lawyers and the claimants. This concern is principally dealt with in two ways.
First, specific regulations applying to litigation funders in Australia require funders to put in place written procedures for managing any conflict of interest that may arise in the funded litigation. This requirement is backed by criminal sanctions for non-compliance and the Australian Securities and Investments Commission (ASIC) has published detailed guidance on how it expects funders to comply with the regulations. ASIC stipulates that the procedures should include how the funder will:
• manage situations in which interests may conflict;
• protect the interests of funded claimants in the event of such conflicts;
• deal with situations in which a lawyer acts for both the funder and the claimant (although in practice the lawyers typically act solely for the claimants); and
• address any pre-existing relationships between the funder, the lawyers and any claimant.
Disclosure (by funders to funded claimants) forms a key component of ASIC’s guidance. The purpose of disclosure is to provide claimants with sufficient information about the situations in which conflicts may possibly arise. Claimants need to understand the different interests of the funder, the lawyers and themselves. Disclosure will also inform them of the procedures (including dispute resolution procedures) the funder makes available to manage any conflicts so as to adequately protect their interests. Lawyers should therefore ask to see the funder's written conflicts management policy and disclosure document before advising their clients on whether to accept an offer of funding.
The second way in which conflicts are addressed is in the LFA itself. Reputable funders have, for many years, included provisions in their LFAs aimed at ensuring that the professional and ethical obligations owed by lawyers to their clients take precedence over any obligations the lawyers may owe to the funder. This is a most important protection for the claimants. Settlement of claims is an area in which a conflict might arise. For instance, the funder may want to settle the claims while the claimants may be inclined to fight on. Again, the LFA should address this possibility by providing that if the funder and the claimants are unable to agree on whether the claims should be settled, or on the terms of any settlement, that dispute will be resolved independently by the binding decision of Senior Counsel.
The ASIC guidance acknowledges the importance of many of these contractual protections, and identifies the measures ASIC expects all funders to include in their LFAs. The ASIC guide sets out a list of criteria that Senior Counsel should take into account when deciding whether a proposed settlement is fair and reasonable in the interests of all group members. These include the likelihood of the representative obtaining judgment for an amount significantly in excess of the proposed settlement; whether the settlement falls within a realistic range of likely outcomes; and the attitude of the group members to the settlement.
Using a commercial litigation funder ensures that the boundaries between the lawyers handling the litigation, the claimants in whose interests the litigation is being conducted, and the party funding the litigation, are kept clear and distinct. This arrangement facilitates the management of any conflicts in the interests of all parties to the funding arrangement.
In particular, third-party funding avoids the risk of potentially difficult conflicts arising should the lawyers seek to both act for the claimants in the class action and provide litigation funding to them through a third-party entity related to the lawyers. Litigation funding by an independent third party ensures that the claimants are legally represented by lawyers who are duty bound to protect their interests over the interests of the funder, while the lawyers can be sure of their costs being met by the funder. The funder, operating at arm’s length to the lawyers, has an interest in achieving a cost-effective outcome to the litigation, which interest is aligned with that of the claimants, and can expertly monitor the litigation and the performance of the lawyers to the advantage of the claimants.
PRODUCTIVITY COMMISSION REPORT ON ACCESS TO JUSTICE AND THE REGULATION OF FUNDERS
In December 2014, the Productivity Commission published a report on access to justice arrangements in Australia’s civil justice system. The report includes a review of private funding of litigation. One of the Commission’s key recommendations is that litigation funding companies should have to hold a financial services licence so as to ensure that they have adequate capital to meet their financial obligations.
IMF Bentham has long supported a mandatory licensing regime and regulation of litigation funders to ensure the protection of clients and that the funding industry is not tainted by undercapitalised operators. There are currently no restrictions on a funder setting up in Australia, agreeing to fund litigation here but being unwilling or unable to meet its financial commitments when they fall due. Security for costs orders provide some protection for respondents, but are no substitute for a full licensing regime and the prudential supervision of funders.
There has been no decision yet from the government as to whether the Commission’s recommendation will be implemented. It has been reported that the federal Attorney-General is in favour of regulation and is to convene an advisory panel to examine the litigation funding industry. The industry awaits developments with interest.
LIMITATIONS ON THE USE OF FUNDING
By its nature, commercial litigation funding suits only certain types of class actions. In particular, the relief sought generally must be monetary (ruling out class actions seeking only non-monetary relief, such as injunctions or declarations) and any likely settlement or judgment sum must be large enough to make funding the litigation commercially viable, bearing in mind the likely cost of the class action (including all potential adverse costs orders).
In Australia, funded class actions are comprised of identified group members who have signed a LFA with the funder before the litigation commenced, rather than an ‘open class’ of unidentified claimants who potentially comprise all who may have a claim against the respondent. Currently under Australian law, funders cannot obtain recompense for the costs and risks they have incurred in funding the class action from group members who have not signed a LFA (the ‘free rider’ problem), so as to ensure that the benefits and burdens of the class action are fairly shared among all group members. This is likely to remain the position unless and until a ‘common fund’ approach is mandated by the courts (under a common fund, all group members in an open class who have not opted out of the class action are required to pay their pro rata share of the funder’s costs, and a commission to the funder, whether they have signed a LFA or not, in recognition of the funder’s role in achieving the settlement or judgment). The absence of a common fund approach is a significant constraint on the ability to fully utilise the class action procedure to achieve access to justice and avoid competing class actions.
Continued growth in the litigation funding industry in Australia, together with broad judicial and government support, has led to litigation funding becoming a more mainstream service. The high cost of litigation (especially class actions) and the risk of adverse costs orders deter many individuals and small to medium companies from commencing litigation, even where they have a strong case. While commercial funding does not solve all access to justice concerns, the funding of class actions provides an important means of obtaining compensation for mass wrongs.
Wayne Attrill is Investment Manager, IMF Bentham Limited, Sydney. PHONE (02) 8223 3567 WEBSITE: https://www.imf.com.au.
The author thanks Kate Hurford, Simon Weeks and Clive Bowman for their invaluable assistance in preparing this article.
 For example, the Productivity Commission’s final report on access to justice arrangements (http://www.pc.gov.au/inquiries/completed/access-justice/report), which was released on 3 December 2014, provides broad support for litigation funding. The report states at p607: ‘Litigation funding can promote access to justice by providing finance for the prosecution of genuine claims by claimants who would otherwise lack the resources to proceed.’
 The term ‘class action’ used in this article broadly refers to representative proceedings under Part IVA of the Federal Court of Australia Act 1976 (Cth) (Part IVA); proceedings under provisions equivalent to Part IVA found in the Rules of the Supreme Courts of Victoria and New South Wales; and also to other multi-party proceedings such as multi-plaintiff or group claims (see, for example, Part 9 of the Federal Court Rules 2011, Order 6, Rule 19 of the Uniform Civil Procedure Rules 2005(NSW) and Rule 9.02 of the Supreme Court (General Civil Procedure) Rules 2005 (Vic)).
 Law Council of Australia/Federal Court of Australia, Case Management Handbook (July 2014), 13.12.
 Campbells Cash and Carry Pty Ltd v Fostif Pty Ltd  HCA 41 (High Court of Australia), in which a majority of the High Court held that the litigation funding arrangement in that case was neither contrary to public policy nor an abuse of the court’s process.
 The explanatory statement to the Corporations Amendment Regulation 2012 (No. 6) (http://www.comlaw.gov.au/Details/F2012L01549), enacted by the previous federal government, states that: ‘The government supports class actions and litigation funders as they can provide access to justice for a large number of consumers who may otherwise have difficulties in resolving disputes. The government’s main objective is therefore to ensure that consumers do not lose this important means of obtaining access to the justice system.’ (The regulations provide a broad exemption to litigation funders from various regulatory provisions of the Corporations Act 2001 (Cth) provided they maintain adequate procedures for managing conflicts of interest.)
 See the Productivity Commission’s final report (above note 1) at p607.
 Ibid. The final report states at p607: ‘Along with financial support, litigation funders bring expertise and experience. For example, funders can supervise the provision of legal services and ensure that costs are minimised, keeping the lawyer accountable on behalf of the client. The funder can also assist in developing the case by collecting information to assess the viability of the claim.’
 Ibid at p 610.
 The funding of a class action against the Commonwealth over an outbreak of equine influenza had to be restructured when allegations emerged that the ultimate source of funds utilised by a Channel Islands registered co-funder of the litigation was from an offshore Ponzi scheme: B Butler, ‘Ponzi scheme claims against litigation funder of equine class action’, Sydney Morning Herald, 22 February 2014 http://www.smh.com.au/business/ponzi-scheme-claims-against-litigation-funder-of-equine-class-action-20140221-337my.html accessed 1 May 2015.
 For example, IMF Bentham Limited (IMF) generally does not fund certain types of claims, including claims arising in the personal injury, defamation and criminal areas.
 For a more detailed discussion, see J Walker, S Khouri and W Attrill, ‘Funding Criteria for Class Actions’  UNSWLawJl 54; (2009) 32 UNSWLJ 1036.
 The process of identifying potential claimants, informing them of their rights to join a class action and, where the class action is funded, obtaining their agreement to the funding arrangements.
 For example, under s33C of the Federal Court of Australia Act 1976 (Cth).
 IMF has an Investment Protocol in relation to case selection and a rigorous due diligence process which ensures that only cases with very good chances of success are accepted for funding.
 This requirement was imposed by the Corporations Amendment Regulation 2012 (No. 6) (http://www.comlaw.gov.au/Details/F2012L01549).
 ASIC, Litigation Schemes and Proof of Debt Schemes: Managing Conflicts of Interest, Regulatory Guide 248 (April 2013).
 See Bolitho v Banksia Securities Limited (No. 4)  VSC 582: Court concludes that the solicitor and senior counsel should cease to continue to act for the representative applicant in a class action, due to the risk or appearance of a conflict between duties owed to the applicant and to the court, in circumstances where the class action was funded by a company of which the solicitor was a director and secretary, and the wife of senior counsel and the solicitor’s superannuation fund and another company he controlled were major shareholders, though no final order was made as the application was not brought against the solicitor and counsel.
 Above note 1.
 IMF made submissions to the Productivity Commission, which are available on IMF’s website at http://www.imf.com.au/docs/default-source/site-documents/bentham-imf-limited's-submission-to-the-productivity-commission-inquiry-into-access-to-justice-arrangements; http://www.imf.com.au/docs/default-source/site-documents/bentham-imf-limiteds-response-to-productivity-commissions-draft-report.
 A common fund was approved in consent orders made by the Supreme Court of Victoria in Pathway Investments Pty Ltd v National Australia Bank Limited (No. 3)  VSC 625, but has not been ordered on any contested application. A decision is awaited in litigation involving Allco Finance, where the issue of the court’s power to make a common fund order in the absence of the parties’ agreement is squarely before the court.