Ruling twist for third-party funders

OPINION: Third-party litigation funders might see their stranglehold on the lucrative class-action market start to weaken after a recent ruling by the Federal Court.

In a case known as Richards v Macquarie Bank Limited (No 4), the court approved a 35 per cent uplift in recovery for class members who self-financed the cost of prosecuting their action, over those who did not.

The uplift was designed to reward the self-financiers in a manner akin to the return an external funder would have taken.

A group of about 1050 members, who on advice from Storm Financial Limited (now in liquidation) borrowed money in the form of margin loans from Macquarie Bank, and then used that money to invest in one or more of nine managed investment schemes, sued Macquarie for their losses.

Macquarie paid $82.5 million (30.57 per cent of losses claimed) to settle the class action, which required court approval.

As part of the court approval, the applicant sought a "funder's premium" of 35 per cent for those group members who co-funded the litigation.

This meant group members who contributed to the legal costs and disbursements involved in running the class action recovered 42 per cent of their losses while those who did not recovered only 17.6 per cent of their losses.

The percentage used was determined by reference to the range of premiums that one sees afforded to third-party litigation funders in respect of class actions.

Due to the novel nature of the "funder's premium", the Australian Securities & Investments Commissioned intervened in the proceedings.

Despite ASIC's concerns about the size of the "funder's premium" and whether adequate notice had been given to group members of the uplift, Justice John Logan found the "funder's premium" to be fair and reasonable.

He relied on those cases that rewarded creditors who chose to contribute to litigation undertaken by a liquidator, so as to recover monies owed to a company in liquidation in the course of the winding up of that company.

The group members had taken on the risk that they would throw good money after bad in seeking a recovery from Macquarie - the "funder's premium" was allowed in recognition of that risk.

The approval of a premium for group members who fund their own class action is likely to reshape the litigation funding market and provide another way to fund class actions.

Group members now have a way to fund their own proceedings so that they, and not a third-party litigation funder, recover a premium for taking on the risk of litigation.

Indeed, there may be an incentive for some types of litigants, such as institutional investors, to pool their resources and sue without a funder.

It may also mean smaller class actions that do not interest third-party litigation funders are now more viable.

However, there are key differences between third-party litigation funding and the premium approved in the Storm class action.

The group members in the Storm class action were not at risk of an adverse cost order (that is, paying an opponent's costs if the case fails), only the applicant was, due to the operation of the class-actions legislation.

Third-party funders usually indemnify an applicant against an adverse costs order, which means the applicant is protected and the funder has funds at risk.

The greater risk means the funder has an incentive to undertake due diligence and even perform a management role to assist in the case being successful.

Under the Storm class-action model, due diligence and management falls to the lawyer for the applicant and funding group members.

Significantly, though, the lawyer does not have funds at risk. The lawyer gets paid regardless of whether the case succeeds.

Consequently, the Storm class-action model also differs from the traditional lawyer-funded approach to legal proceedings of no win, no fee.

It may be that this dispersion of risk could prompt the pursuit of cases with lower prospects of success, which will increase the frequency of class actions.

While respondents usually have little interest in how claimants' recoveries in a specific case are divided up once a settlement is reached, the Storm class-action model suggests there is a need to consider how various funding models might affect the volume of class actions at a more macro level.

Michael Legg is an Associate Professor of Law at UNSW. John Emmerig is a litigator at Jones Day.

This opinion piece was first published in The Australian.