Varying Funding Agreements and Freedom of Contract: Some Observations
IMF Bentham Class Actions Research Initiative with UNSW Law:
Resolving Class Actions Effectively and Fairly
Court intervention in funding agreements is a matter of current controversy in class actios circles – in one sense it could be described as a “hot topic”, at least to those who have a real interest in class action developments – no doubt there are many lawyers who would consider the topic to be somewhat arcane.
In making these observations I will (I hope) be scrupulous in not expressing definitive personal views; even less so should what follows be interpreted as me making observations which, in any way, reflect thinking within the Court.
I speak as someone who is a new judge but as someone who has acted in very many class actions of all types, including most of the large securities class actions over the last decade. I am also someone who has had an involvement in many of the cases that have developed both the procedural and substantive law in relation to class actions, and my purpose today is both simple and modest: to identify the issue and to raise some thoughts that may cause some reflection by persons interested.
Over 11 years ago I received a brief to draw the documents necessary to commence proceedings against Multiplex Limited. The proceedings arose out of substantial costs overruns in delays in the construction of Wembley Stadium by a subsidiary of Multiplex.
As was to become familiar in securities class actions, the substance of the cause of action was that Multiplex had breached its duty of continuous disclosure under section 674 of the Corporations Act 2001 (Cth) and engaged in contravening conduct contrary to a number of other statutory norms.
What I found immediately curious upon being briefed, was that instead of being asked to draft an application and statement of claim in the Federal Court to commence a representative proceeding under Part IVA of the Federal Court of Australia Act 1976 (Cth) (Act), I was asked to prepare a summons and commercial list statement in the Supreme Court of New South Wales.
What was doubly surprising to me was that the intention was to commence a proceeding under the old Chancery representative proceeding rules in the Supreme Court, rather than making use of Part IVA. This was, of course, long before the enactment, in 2011, of Part 10 of the Civil Procedure Act 2005 (NSW).
Upon enquiry, I was informed that the proposed commencement in the Supreme Court was as a consequence of the decision of Stone J in Dorajay Pty Limited v Aristocrat Leisure Limited (2005) 147 FCR 394. That decision had been followed shortly thereafter by decisions in the Supreme Court of Victoria (see, e.g. Rod Investments (Vic) Pty Limited v Clark [2005] VSC 449) and a further decision of Young CJ in Eq in New South Wales (Jameson v Professional Investment Services Pty Limited (2007) 215 FLR 377; [2007] NSWSC 1437).
In short, the substance of those decisions was that a criterion of group membership which sought to restrict the group to a particular firm of solicitors or a certain litigation funder was said to be inconsistent with the policy of Part IVA and, in particular, the deliberate legislative choice by the Commonwealth Parliament to adopt an “opt out” rather than a “opt in” model for representative proceedings.
One of the benefits of ignorance (or at least, coming to an area of legal discourse without preconceived notions) is looking at problems from first principles. The more I thought about it, the less I considered the rationale for commencing the proposed proceedings in the Supreme Court had merit.
It seemed to me clear from the text of section 33C(1) of the Act that a proceeding was able to be commenced by an applicant “representing some or all” of the persons who had a claim which was in respect of, or arose out of, the same, similar or related circumstances; and where the claims of all those persons give rise to a substantial common issue of law or fact.
What was (and is) often lost when considering group composition is the simplicity of the scheme created by the “gateway” provisions to commencement of class actions. They are deliberately non-demanding: the “control” mechanism is section 33N which allows a representative proceeding, which passes through these “gateway” provisions, to be declassed if certain circumstances exist and it is in the interests of justice to do so.
Properly analysed, it is important to remember that a group definition is nothing more than a list of persons (often described by reference to characteristics) who share similar or related claims against a proposed respondent and on whose behalf a proceeding is commenced. Subject to there being a group definition that is somehow against public policy (for example, if it was formulated expressly by reference to racialist or other discriminatory grounds), any definition which describes the group, seemed to me to be acceptable.
It followed that the cases I looked at which declassed a proceeding on the basis that there was a funding criterion were, I thought, paying insufficient attention to the text of the statute and using section 33N (the declassing provision) as a quasi legislative rule excluding representative proceedings defined by reference to either solicitors or litigation funders.
As a consequence, I boldly recommended that the Multiplex proceeding be commenced in the Federal Court and that the three decisions, which suggested a funding criterion was heterodox, were plainly wrong. Mercifully for my future career, my solicitors had already independently reached the same view, and a funder was willing to take on the fight notwithstanding the inevitability of group definition being challenged. The consequence was Multiplex Funds Management Limited v P Dawson Nominees Pty Limited (2007) 164 FCR 275 where Justices French, Lindgren and Jacobson opened the way for representative proceedings to be commenced with group definitions which included a funding criterion. The rest, as they say, is history.
What this development allowed was express sanction to a form of representative proceeding that was friendly to a funder and seemed to solve, together with some parallel developments which I do not have time to detail, the perceived problem of “free riders” – persons who take the benefit a class action without defraying the risk of adverse costs or contributing to the enormous cost of most large-scale representative proceedings.
Relevantly for present purposes, this led to the growth of large-scale class actions with group members defined, in part, by execution of a funding agreement, which creates a series of bilateral obligations and benefits between the funder and individual group members.
In a case where I had confidently predicted the opposite result, the Full Court in Brookfield Multiplex Limited v International Litigation Funding Partners Pte Ltd (2009) 180 FCR 11, by majority, found these bilateral (or, with the solicitors, trilateral) arrangements pursuant to which a funded representative action was conducted was a managed investment scheme that should have been registered for the purposes of the Corporations Act 2001 (Cth).
The Full Court explained that the class action (or, more particularly, the scheme constituted by the agreements which allowed the class action to be funded and maintained) had the following characteristics:
- The promises given by the class action members and the funder were 'money's worth' contributed for the purposes of the litigation funding arrangement made in return for their acquiring rights to share in any judgment sum, and the benefit of the funder's promises to meet legal costs.
- The opportunity to prosecute a claim, with virtually no exposure to any costs or outgoings in the event of failure, was a benefit accruing to class members produced as a result of all parties carrying out their obligations under the scheme. A successful prosecution of those claims would yield financial benefits to members, the funder and, indirectly, the solicitors.
- The pooling of contributions was effected by the class action members making their individual promises available for the purposes of the scheme and the benefit of scheme members and, ultimately, for the funder's benefit.
- The litigation funding arrangement was a common enterprise. The Court considered that there was a shared purpose of pursuing class action members' claims successfully that would then benefit the class action members, the funder and the solicitors.
- Further, the Court held that the scheme was clearly an enterprise. It was economic in nature and, indeed, could be considered to be commercial from, at least, the viewpoint of the funder and the solicitors.
As we all know, arrangements exempting representative proceedings and proof of debt arrangements from the definition of managed investment scheme (as long as there are appropriate arrangements in place to manage conflicts of interest) were made, but an appropriate point of departure, when considering the Court’s power to interfere with funding arrangements, is what current authority says about the way those arrangements are to be properly characterised – that is, a common enterprise which, subject to exemption, has the characteristics of a managed investment scheme.
Against this background, I come to the focus of my remarks: the three recent judgments (by judges highly experienced in class actions) which have considered the Court’s power to interfere with the amounts that would be payable to group members pursuant to funding agreements. They are, in chronological order, the decisions of: Murphy J in Earglow Pty Ltd v Newcrest Mining Ltd [2016] FCA 1433;Beach J in Blairgowrie Trading Ltd v Allco Finance Group Ltd (Receivers & Managers Appointed) (in liq) (No 3) [2017] FCA 330; and by Middleton J in Mitic v OZ Minerals Limited (No 2) [2017] FCA 409.
Having been in all three cases (at some stage) I can say something about four common threads in the cases and an important difference.
First, they were all securities non-disclosure cases.
Secondly, they were all highly complex and hard fought, and each case was settled very late – one shortly before the hearing, one the day before, and one at 10:10 am on day one of the hearing. I imagine you can feel sympathy for the frustration felt by someone who has prepared intently to open a case and cross-examine, only for a case to settle moments before it starts. There is, however, a compensation for such frustration – which leads to the next similarity.
Thirdly, each case was funded and the funder had paid out huge amounts to get the case to the stage when it was settled and was at risk for even vaster sums by way of adverse costs.
Fourthly, at the time of settlement each had groups which comprised members who had (and some who had not) signed funding agreements.
I now come to the important difference: two were traditional “closed class” proceedings which were opened for a short period prior to a mediation and thereafter closed; the other was an open class which initially had been the subject of the first (and unsuccessful) attempt to seek that the Court impose a “common fund” arrangement shortly after commencement. As most of you would know, this involves the Court addressing the “free rider” problem not by making “funding equalisation orders” (which redistribute the additional amounts received “in hand” by unfunded class members pro rata across the class as a whole), but rather provides a solution whereby the funder is recompensed from the common fund of proceeds obtained by the class as a whole in any settlement or judgment. Upon the failure of that application – and over the vigorous opposition of the respondents – the Allco case remained an “open class” until it was settled.
The settlement of each case called for an approval application to be made pursuant to section 33V of the Act. For reasons I will come to, the principles that inform the exercise of the section 33V discretion repay close attention.
Of course, the fundamental question that arises on an application under section 33V of the Act is whether the settlement is “a fair and reasonable compromise of the claims made on behalf of the Group Members”. This formulation derives from the judgment of Finkelstein J in Lopez v Star World Enterprises (1999) ATPR 41-678; [1999] FCA 104 at [15] and what has recently been described by Beach J (in Foley v Gay [2016] FCA 273 at [7]) as the “foundational analysis” of Goldberg J in Williams v FAI Home Security Pty Ltd (No 4) (2000) 180 ALR 459.
In giving content to this broad evaluative task, there have been a number of observations made where the protective role of the Court pursuant to section 33V has been emphasised. For example:
(a) In Tasfast Air Freight Pty Ltd v Mobil Oil Australia Ltd [2002] VSC 457 at [4], Bongiorno J explained:
The principles upon which section 33V is based might be said to be those of the protective jurisdiction of the Court, not unlike the principles which lead the Court to require compromises on behalf of infants or persons under a disability to be approved. In a group proceeding, ex hypothesi, there may be persons, in the community who can be affected by such settlement but know nothing of it ...
(b) In Australian Securities and Investments Commission v Richards [2013] FCAFC 89 at [8], the Full Court (Jacobson, Middleton and Gordon JJ) said:
The role of the court is important and onerous … It is protective. It assumes a role akin to that of a guardian, not unlike the role a court assumes when approving infant compromises.
(c) In Hodges v Waters (No 7) (2015) 232 FCR 97 at [70], Perram J said:
Insofar as s 33V is concerned, the authorities are clear. Approval will be granted to a settlement where it is just to do so and that will be so where the settlement is fair and reasonable having regard to the claims made by the group members who are bound by it. In carrying out the assessment called for by s 33V the court’s function is protective, recognising, as it must, that the interests of the parties before it and those of the class members as a whole may not wholly coincide: see Australian Securities and Investments Commission v Richards [2013] FCAFC 89 at [7]–[8]. As Richards itself demonstrates, some care must be taken to ensure that the settlement is not only fair as between the parties but also as between individual class members.
Importantly, in my view, while bearing in mind this special role, the task of the Court is not to speculate as to the content or the terms of alternative settlements, which may also be regarded as “fair” and “reasonable”, but to reach a view on the proposed settlement that has been struck.
Applying these principles, the Court came to a consideration of the settlements proposed in Earglow, Allco and Oz Minerals and, in particular, whether, as part of its protective and supervisory role, it would possess the power to consider and appropriately vary the funding commission payable pursuant to the bargain struck in the funding agreement.
In Earglow at [148] and following, the following was said:
148. Earglow did not argue that if the Court considered the legal costs charged to be excessive the Court only had power to refuse to approve the settlement, and it accepted that the Court has power to approve the proposed settlement but reduce the legal costs to be deducted. Earglow’s acceptance of the Court’s power in that regard is discordant with its contention that the Court has no power to approve settlement but reduce the funding commission to be deducted.
149. If a proposed settlement is fair and reasonable except that the Court considers the claimed legal costs to be excessive, it is difficult to see why it would be appropriate (or fair and reasonable in the interest of class members) for the Court to make orders refusing settlement approval …
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150. The same can be said where a proposed settlement is fair and reasonable in the interests of class members except that the Court considers the funding commission to be excessive. In such circumstances it is quicker, cheaper and more efficient (and just and appropriate in the interests of class members) to approve the settlement and reduce the funding commission. There are, of course, specific legislative provisions which empower Court supervision of the reasonableness of legal costs (e.g. the Legal Profession Uniform Law) but there is no reason in principle for treating litigation funding costs incurred to achieve a settlement differently from legal costs incurred to achieve the settlement”: Money Max (at [71]).
151. I can see little merit in Earglow’s contention that the scope of the Court’s power under ss 33ZF(1) and 33Z is confined to making orders in respect of the matters in issue between the parties to the proceeding …
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155. Earglow’s contention that, even if the Court considered that a funding agreement is misleading or unlawful, that that would be a controversy falling outside the scope of ensuring that justice is done “in the proceeding”, is impossible to accept. If class members were misled as to the requirement to pay a funding commission I would have no difficulty in concluding that a settlement that proposed the deduction of that commission from class members’ settlement amounts was not fair or reasonable in their interests.
156. I do not accept Earglow’s submissions as to the “element of necessity” required for an order under s 33ZF. The requirement that an order to disallow or to reduce the funding commission can only be made if the Court thinks it “appropriate or necessary to ensure that justice is done in the proceeding” does not mean that the Court must consider that justice is certain (in the sense of “ensured”) if the proposed order is made or that injustice is certain if the order is not made. It requires only that the proposed order be reasonably adapted to the purpose of seeking or obtaining justice in the proceeding: Money Max at [165].
157. I conclude that, if in a settlement approval application the Court considers the proposed settlement is fair and reasonable except that the funding commission is excessive or exorbitant, the Court has power to approve the settlement and reduce the funding commission to be deducted pursuant to the terms of the settlement. Having regard to ss 33V, 33ZF(1), 33Z(1)(g) and 23 I do not accept that the Court’s powers are limited to a binary choice between approving or rejecting the proposed settlement. In such circumstances it may be “just”, “appropriate”, or “appropriate or necessary to ensure that justice is done in the proceeding” that the Court make orders approving the settlement but reducing the funding commission to be deducted under the settlement.
In Blairgowrie at [101], Beach J noted [101]):
… I consider that as part of any approval order under s 33V, I have power in effect to modify any contractual bargain dealing with the funding commission payable out of any settlement proceeds. It may not be a power to expressly vary a funding agreement as such. Rather, it is an exercise of power under s 33V(2); for present purposes it is not necessary to invoke s 33ZF. I am empowered to make “such orders as are just with respect to the distribution of any money paid under a settlement”. If I make an order that out of monies paid by a respondent, a lesser percentage than that set out in a funding agreement is to be paid to a funder, that is an exercise of statutory power which overrides the otherwise contractual entitlement. That is not an unusual scenario in many and varying contexts. It might also be said that the funding agreement itself contains an implied term reflecting this override in any event; the parties would be contracting in the known setting that the funder’s percentage commission entitlement would only operate on a settlement sum if the necessary condition of Court approval had first been given.
Finally, Middleton J agreeing with Beach J’s observation said in Oz Minerals at [27]:
27. However, I make one observation as to the power of the Court to effectively vary the commission paid to a litigation funder.
28. Sections 33Z and 33ZF(1) of the Act, whilst expressed in broad terms, as is s 23, are not specifically directed to settlement approvals, but relate generally to the power of the Court in representative proceedings and proceedings generally. Once the Court is dealing with a settlement approval application, the focus is upon s 33V. A power to effectively vary the contractual rights of a litigation funder in the course of a settlement approval is to be found in s 33V, specifically subs (2). I would not readily adopt the view that the very general broad powers found in ss 23, 33Z(1)(g) and 33ZF(1), which are not specifically directed to settlement approvals, would provide the power to vary or effectively vary the funding agreement, or otherwise interfere with the contractual rights and obligations of a litigation funder and class members.
29. Nevertheless, by having recourse to the power of the Court under s 33V(2) of the Act, the Court may still take into account the fee or commission of a litigation funder and make orders accordingly. Oversight by the Court of litigation funding fees or commissions so as to protect class members’ interests is required. Of course, s 33V(2) refers to orders that are “just” – this includes taking into account the fact that litigation funders assume the substantial costs and risks of a representative proceeding and should be allowed a commercially realistic return.
In the wake of these three cases, the position remains unresolved as to the source of any power to vary funding agreements and (assuming power exists) the principles that should guide the exercise of discretion. No doubt the issue as to the existence, source, and exercise of such a power will be further debated. My purpose is to raise a few interconnected issues which might form part of that debate.
First, as I have pointed out, the starting point is that, according to the Full Court in Brookfield Multiplex, the promises given by funded group members were part of a pooling of contributions and the provision of their individual promises for the purposes of an integrated scheme and the benefit of scheme members and, ultimately, for funder's benefit. If the litigation funding arrangement is seen as a common enterprise with a shared economic purpose, any interference or tinkering with funding arrangements can arguably be characterised as a readjustment of the scheme to the benefit of one scheme participant and to the detriment of another. It might be argued that any analogy with the power of the Court to supervise costs may not be a perfect analogue in this respect.
Secondly, no doubt regard must be had to the foundational and elementary matter well expressed in Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165 at 182-3, where Gleeson CJ, Gummow, Hayne, Callinan and Heydon JJ said:
… where a man signs a document knowing that it is a legal document relating to an interest in property, he is in general bound by the act of signature. Legal instruments of various kinds take their efficacy from signature or execution. Such instruments are often signed by people who have not read and understood all their terms, but who are nevertheless committed to those terms by the act of signature or execution. It is that commitment which enables third parties to assume the legal efficacy of the instrument. To undermine that assumption would cause serious mischief.
In most common law jurisdictions, and throughout Australia, legislation has been enacted in recent years to confer on courts a capacity to ameliorate in individual cases hardship caused by the strict application of legal principle to contractual relations. As a result, there is no reason to depart from principle, and every reason to adhere to it, in cases where such legislation does not apply, or is not invoked.
Thirdly, connected to the last point, the amelioration in individual cases of hardship is, obviously enough, generally regarded as a quintessentially individual assessment by reference to a statutory or equitable requirement to have regard to all the circumstances of the case and is not usually regarded as a principled basis to rewrite bargains with a broad brush.
Fourthly, the decisions in Allco and Oz Minerals indicate a preference to basing any exercise of power by recourse to section 33V(2) of the Act, by making orders which are “just” to protect class members’ interests; needless to say, this involves the Court forming an assessment of what was described in Oz Minerals as a “commercially realistic return”. This in itself raises interesting questions: is this to be assessed on a micro level (the proceeding itself) or on a macro level, that is, across the whole of the funder’s business? What are the appropriate economic comparators? These are large questions.
Fifthly, unlike the US Constitution, there is no Contract Clause in our Constitution. As an interesting historical sidelight, the Contract Clause prohibits states (but not the federal government or the courts) from enacting any law that retrospectively impairs contract rights – this was done by the US Founding Fathers in response to the fear that states would continue a practice of granting relief to specified persons from their obligation to pay their debts. What we do have is Chapter III. Chapter III arguments (to the effect that “common fund orders” did not involve an exercise of judicial power or were not incidental to the exercise of judicial power) were decisively rejected in Money Max (Money Max Int Pty Ltd v QBE Insurance Group Ltd (2016) 245 FCR 191). It seems to me quite plain that a Court can make orders creating or modifying rights or liabilities in the exercise of discretionary power, provided the power is exercised according to legal principle and by reference to an objective standard. Having said this, the possibility that novel arguments may be made by one scheme participant (a funder) when its property rights have been the subject of acquisition to the benefit of another (funded group members) cannot be dismissed as fanciful.
Sixthly, where do the boundaries lie? When I was a young solicitor, there was an attempt by one retail bank in Sydney to get into the business of an embryonic form of litigation funding. Although primarily directed to family law difficulties and the inter partes commercial disputes of established customers, there were cases of which I am aware, where, if Part IVA had existed, the bank may have been prepared to provide an overdraft in order to fund the litigation on the basis that there was third party security and a charge was taken over the proceeds of any judgment or settlement. In return, the bank, from recollection, was charging customers a rate, which by today’s standards may seem extraordinary (around 22%) but by reference to then prevailing interest rates, represented an incremental margin of only 5% or 6% over prevailing overdraft rates. If a Part IVA case were conducted pursuant to such a facility, would the Court step in and upset these commercial arrangements, in the context of a section 33V application, if it considered them subjectively to be commercially “unjust”? If not, what is the discrimen used to sort out those types of arrangements and schemes, which are subject to interference and those (if any), which are not? This might be of significance in a potential growth area for funding – complex family law disputes. If the Federal Court regularly uses broad statutory powers in Part IVA cases to amend funding arrangements, does this mean that it would be regarded as sound, from a policy perspective, for the Family Court of Australia, which has a protective role in relation to children of a marriage, to take a similarly interventionist role in relation to funding arrangements entered into between a parent with primary care of the children and an external funder in a property dispute, in order to maximise an amount that might be ultimately be paid to, or preserved for, the children’s education?
I offer only matters to consider and I do not offer any solutions or definitive views. The topic is complex, raises interesting policy issues and will no doubt be thought through carefully and worked out in the cases.
There is, of course, nothing stopping a Court, if it is dissatisfied with an amount paid to group members, refusing approval and hence forcing the parties to make commercial choices which might include a readjustment of their rights inter se. I have seen this happen in a different way, when lawyers have refused to put up an application for approval unless there was a readjustment of rights which allowed for a greater amount to be paid to group members.
But here, instead of refusing approval, the notion is that approval be given but with a readjustment of rights imposed by the Court. In considering this prospect I will leave you with this thought: those of us in the room who are lawyers can probably remember that very early on in our studies we had cause to be introduced to the famous observations of Henry James Sumner Maine in his book Ancient Law where he explained that the movement to progressive modern societies has been uniform in one respect – and it has been a movement from status to contract. The right of a person of legal capacity to contract with whomever they choose and the right to hold another party to their bargain are bedrock to a modern society governed by the rule of law.
Anything which can be seen as a departure from the free exercise of those rights, in the absence of some form of catching bargain or other vitiating conduct, in the broad, and by reference to a highly subjective evaluative standard, raises interesting questions and issues that merit reflection.
