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Asia-Pacific Litigation Update – October 2021

Shifting Sands’: Adopting Contingency Fees in Australian Class Actions

Introduction

Unlike the United States, Australia has historically prohibited (and for the most part, continues to prohibit) contingency fees in any type of litigation. This includes Australian class actions. The consequence has been that litigation funders have adopted a direct funding structure, whereby a percentage of the amount awarded for that proceeding can be claimed by the litigation funder as a “commission”. The viability of these funding structures has come under recent threat due to legislative and judicial intervention in the litigation funding of class actions. At the same time, at least one Australian State (and perhaps the Federal Court of Australia) have rolled back the prohibition on contigency fees in class actions. This note considers how this position has been arrived at and its implications for the funding of class action litigation in Australia. 

 

The Historical Opposition to Contingency Fees

Contingency fees have long been considered anathema to Australian litigation. Section 183 of the Legal Profession Uniform Law (NSW) (Uniform Law) stipulates that a law firm may not enter into an agreement where its fees are calculated by reference to the actual amount recovered in the proceedings. Contravening that provision has stern penalties that sound in substantial fines and can lead to a finding of unsatisfactory professional conduct or professional misconduct for the legal practitioners involved. 

Equivalent provisions exist in every State and Territory of Australia.

The perceived problem with contingency fees in Australia is that it puts attorneys in a potentially conflicted position with respect to their duties to the court and their clients—it is said that by holding what can be a (significant) personal stake in the litigation, their judgement may be clouded by the financial incentives before them. It might, for example, impede their ability to give full and frank advice to their client on the prospects of success of the case. That is a particular concern for Australian practitioners where, unlike the United States, unsuccessful parties are usually ordered to pay the costs of the successful party. 

Of course, if financial incentives based on success are the reason for the opposition to contingency fees, the argument unravels quickly. Attorneys are, under the existing rules, entitled to charge at least a 25% uplift on the fees that they incur on a conditional basis in Australian litigation. If we are prepared to allow attorneys to carry some financial risk in a litigation, then the danger that purportedly justified the prohibition of contingency fees has already been realized. All that is left is a the question of the scale of that investment—and even then, some “no-win no-fee” class actions have had fees awarded in the order of $40 million: see, eg, Cantor v Audi Australia Pty Ltd (No 5) [2020] FCA 637.

With the above in mind, this paper describes how the model for litigation funding of class actions in Australia has rapidly evolved over the past 3 years, and how contingency fees will likely play in increasing role in the future, as a new mechanism for a claimant’s access to justice in light of the judicial excision of the “Common Fund Order” (CFO) that had, until recently, supported funding of Australian class actions.  

 

Recent Flux in Funding Orders

Historically, there have been two basic ways class actions are funded in Australia (other than by the claimants themselves): firstly, a firm of attorneys can run the matter in a speculative “no win no fee” manner (that is their fees and perhaps disbursements would only be payable out of any successful outcome) and they would then be entitled to at most a 25% uplift on their deferred fees at the end of the case; secondly, since the High Court’s decision in Campbell’s Cash and Carry Pty Limited v Fostif Pty Ltd (2006) 229 CLR 386, a litigation funder can enter into an agreement with the lead plaintiff to meet the costs of the representative proceedings. 

Prior to 2016, remuneration for the appointed attorneys and any litigation funder were dealt with by way of standard contractual principles—i.e., the attorneys and/or funders would enter into individual agreements with as many of the group members as they could. By that contract, the Court (which is obliged to approve any settlement of a class action, including as to the fees and funding charges) could approve the settlement and therefore the fees and funding charges as between those parties. However, this approach to funding created a “free rider problem”, whereby group members who did not sign-up to the funding agreement would—in theory—be entitled to their share of the proceeds of the action but without the need to pay their proportionate share of the costs incurred to receive it. 

The first solution was to create a “funding equalization order”. This meant that the amount that would have to be paid by the contracting parties to the lawyers and litigation funder (including any commission of the litigation funder) would be set by reference to those contracts, but then each of the group members would be obliged to contribute their share of that amount: see, e.g., Money Max Int Pty Ltd (Trustee) v QBE Insurance Group Limited (2016) 338 ALR 188 (Money Max). This however left open the risk that if insufficient group members sign the funding agreements, the economic return for the litigation funder could be disproportionate to what they would have expected to receive had every group member signed up.

A solution to this problem was crafted by the Full Court of the Federal Court in Money Max. The Court devised the CFO so that, instead of requiring each person to enter into a funding agreement with the litigation funder, the Court was empowered, under s 33ZF of the Federal Court of Australia Act 1976 (Cth) (which allows the Court to make any order it sees fit to ensure that justice is done in the proceeding), to order that each group member, irrespective of whether they have signed a funding contract with the litigation funder, would be obliged to pay the litigation funder the amount specified in a Court’s order. 

The impact of this order was immediate—it allowed litigation funders to invest in class actions without the need to conduct any real “bookbuild” exercise first. Naturally, this had the effect of drastically increasing the number of litigation funders (and capital available) in the Australian market.  

In 2018, BMW, one of the defendants in the Australian incarnation of the Takata class actions, applied for the determination of a separate question to the NSW Court of Appeal that an interlocutory CFO was either beyond the scope of the NSW equivalent of s 33ZF and/or was unconstitutional. That question was heard alongside an appeal to the Full Court of the Federal Court from the making of an  “interlocutory” CFO.  In an Australian first, three judges of the NSW Court of Appeal and three judges of the Full Court of the Federal Court sat together and then jointly held 6-0 that CFO were neither beyond power nor unconstitutional: Brewster v BMW Australia Ltd (2019) 366 ALR 171; Westpac Banking Corporation v Lenthall (2019) 265 FCR 21.

That judgment was then appealed to the High Court of Australia which—in a surprise decision—held 5-2 that interlocutory CFOs were beyond the scope of s 33ZF: BMW Australia Ltd v Brewster [2019] HCA 45 (BMW v Brewster). 

The rise and fall of CFOs in Australia occurred in a period of around three years. But despite BMW v Brewster, the saga of the CFO is not yet complete. Presently, the Federal Court at least, has begun making orders under the settlement approval power (s 33V(2)) to approve settlements that include arrangements in the nature of CFOs: e.g., Lee J implementing a “Settlement CFO” in Asirifi-Otchere v Swann Insurance (Aust) Pty Ltd (No 3) [2020] FCA 1885, and further Evans v Davantage Group Pty Ltd (No 3) [2021] FCA 70 at [49], where Beach J expressly stated that the decision in BMW v Brewster did not limit the Court’s power to make a CFO-like order under s 33V(2). Nonetheless, uncertainty has again begun to creep into the Australian funding market for class actions. 

Adding to this uncertainty, the conservative Australian Federal Government and corporate Australia has grown increasingly antagonistic towards the financing of class actions, and litigation funders in particular. Consequently, in the last 18 months there have been a number of reports and Parliamentary inquiries into class actions and the class action regime. In addition, in mid-2020, the Australian Federal Government actively sought to clamp down on class action litigation:

  • First, with respect to shareholder class actions, it introduced a temporary (and now permanent), amendment to a corporation’s continuous disclosure obligations under the Corporations Act 2001 (Cth). This changed the nature of the breach of the obligation to disclose from a mere failure to disclose material information sounding in breach to only those failures where “the entity knows or is reckless or negligent” as to the failure to disclose: ss 674A and 675A of the Corporations Act. The idea behind this move was to make it more difficult (ostensibly at first to assist companies to manage the risks posed by COVID-19) to commence shareholder class actions. 
  • Second, in August 2020, the Australian Federal Government amended the Corporations Regulations 2001 (Cth) to remove the exemption for litigation funders of class actions from having to comply with the requirements for managed investment schemes (MIS).  As a result,  for any class action commenced after August 22, 2020, the litigation funder would have to hold an Australian financial Services License (AFSL) and the litigation itself would have to comply with the rules relating to MIS, including the publication of a prospectus and abidance with the anti-hawker provisions. It is noteworthy that defendants to class actions have already sought to take advantage of these changes by challenging the funding arrangements of class actions, and has led at least one Federal Court judge to remark that the MIS regime “doesn’t work”.

It is not surprising therefore that traditional litigation funding models for class actions have become increasingly clouded and difficult to navigate. It also means that proceedings funded on a direct financing model and commenced post-August 2020 are far less flexible in their funding structures. This presents a particular problem for these models where competing class action proceedings are commenced. Due to the opt out structure of Australian class actions, lead plaintiffs can commence identical, overlapping proceedings that ostensibly seek the same damages as those already on foot. As defendants should not be “vexed” with multiple proceedings (see McKay Super Solutions Pty Ltd (Trustee) v Bellamy’s Australia Ltd [2017] FCA 947), and in the absence of any statutory procedure for selecting which lead plaintiff should proceed, the Courts have developed a “multi-factorial” process to assess which class action should proceed: Perera v GetSwift Limited [2018] FCA 732; Wigmans v AMP Ltd [2019] NSWSC 603. While ostensibly based on a number of factors (see Perera v GetSwift Limited [2018] FCA 732), the primary factor is the expected cost of the proceedings and the return to group members: see Wigmans v AMP Ltd [2019] NSWSC 603; CJMcG Pty Ltd as Trustee for the CJMcG Superannuation Fund v Boral Limited (No 2) [2021] FCA 350 (Boral). The High Court (in a 3-2 decision) has recently approved of this multifactorial analysis that places the expected costs at the heart of the decision of which proceeding should continue: Wigmans v AMP & Anor [2021] HCA 7 (Wigmans). Given that, superficially at least, it often appears that a funded model is more expensive than a no-win no-fee model (Boral at [66]), this leaves funded proceedings vulnerable to competing proceedings commenced on a no-win no-fee basis. 

This shift in the law begs the question: How can traditional litigation funding of class actions move forward? 

The answer is that it can only move forward by evolution and, in that respect, in an evolution towards a U.S. model of ‘portfolio financing’. The challenge of course is making that financially viable for both funders and lawyers where the only recovery (absent a direct funder who is entitled to charge a commission) can be the costs incurred in the proceedings plus an uplift on attorney fees—this naturally leads to a reconsideration of the legality of and role for contingency fees in class action proceedings.

Australian Contingency Arrangements 

There has been some notable progress towards the acceptance of contingency fees in Australia. On June 18, 2020, the Victorian Parliament (based on recommendations from the Victorian Law Reform Commission (VLRC)) passed legislation that appeared to have the effect of legalizing contingency fees (called “Group Costs Orders” (GCO)) for class actions where the Court is “satisfied that it is appropriate or necessary to ensure that justice is done in the proceeding”: s 33ZDA of the Supreme Court Act 1986 (Vic) (SCA). 

The first decision on the question of whether a GCO should be made was handed down on 14 September 2021: Fox v Westpac; Crawford v ANZ [2021] VSC 573 (Fox). The Court refused to make a GCO. In short, the Court found that a GCO was not necessary to ensure that justice is done in the proceeding because the lawyers for the plaintiff had entered into a binding retainer to conduct the proceeding on a no-win no-fee basis. That is, if the GCO were refused, the plaintiffs would not be forced to find litigation financing elsewhere. While Fox provides an important insight into the criteria necessary for establishing when a GCO might be ordered, the fact that the decision turns on the structure of the lawyer-client relationship means it is of less use in understanding how the Supreme Court of Victoria will approach the question of quantification of the GCO. It still remains to be seen whether the Supreme Court of Victoria will approve settlements and contingency fees that represent significant uplifts for law firms, or whether the amount to be awarded will reflect a lodestar to the fees that were (or would have been) incurred in the proceeding.

The movement in favor of contingency fees is gathering momentum even without a legislative imprimatur. In Boral, Lee J noted at [50] (and citing an earlier decision in Klemweb Nominees Pty Ltd (as trustee for the Klemweb Superannuation Fund) v BHP Group Ltd (2019) 369 ALR 583, that: 

“I do not consider it unlikely that a common fund order incorporating a contingency payment [to a firm of solicitors] could be made. When one has regard to the equitable roots and restitutionary basis of common fund orders, it is not apparent why a common fund order incorporating a contingency component is antithetical to doing justice in a [class action] in an appropriate case.”

In short, his Honor appears to consider that the Federal Court can achieve a similar outcome to the Victorian legislation by making orders permitting such an arrangement.   

What these developments suggest is that Australia is beginning a transition towards more flexible (albeit, presently, more uncertain) funding arrangements for class actions. There are risks and benefits to this approach, and scrutiny from the Court (as well as the development of consistent principle) will be essential. Nevertheless, contingency arrangements will (and in some cases already do) present an opportunity for class actions to be pursued with both transparent and Court-monitored funding arrangements. That, in turn, should give some confidence to litigants that they will be protected from unfair financial outcomes, and for litigation funders that there can be some certainty of a return on their investment.