02 August 2019

Common Fund Orders - When Is A Funder's Commission Too High?

This article was written by Moira Saville, Jack Power and Victoria James.

Tredrea v KPMG Financial Advisory Services (Australia) Pty Ltd (No 3) [2019] NSWSC 871: In a decision on Wednesday this week, Justice Parker of the NSW Supreme Court refused to approve both a common fund order and the quantum of the plaintiff’s solicitors’ costs. His Honour emphasised that although the Court had the power to make a common fund order, it would not do so mechanically and in this case the order would likely provide the funder, LCM Operations Pty Limited (Ltd) (LCM) with a level of return on its investment which he could not be satisfied was ‘objectively reasonable’. In reaching that position, Justice Parker voiced several criticisms of the terms of the funding agreement.

Justice Parker also made orders appointing Grant Thornton (already the administrator of the settlement fund) as ‘contradictor’ to the applications for a common fund order and approval of the quantum of legal costs. Those applications will then be contested before the Court should Grant Thornton and the other parties be unable to reach an agreement on appropriate orders with respect to the common fund and legal costs.

Common funds and their history

In Australia a common fund order was made by a court for the first time in Money Max Int Pty Ltd (Trustee) v QBE Insurance Group Limited [2016] FCAFC 148. This type of order allows a litigation funder to be recompensed from the common fund of proceeds obtained by the class as a whole in any settlement or judgment. In doing so, the order is intended to overcome the ‘free-rider’ problem (as it is commonly referred to) where those group members who did not sign a funding agreement obtain the benefits of the funder’s financial support without bearing any cost themselves.

Since then, the Federal and State Courts have made multiple common fund orders, although the power of the courts actually to make such an order is currently being considered by the High Court. The willingness of courts to make those orders has been welcomed by litigation funders as it largely avoids them having to engage in extensive ‘book building’ (that is signing up group members) and often enables the funder to obtain a greater share of any proceeds from the litigation.   

Justice Parker’s objections to the common fund order

Here LCM sought a common fund order which would provide the funder with 30% of the gross proceeds of settlement. However, only 142 of 1300 group members had previously registered with the funder. As a result, a common fund order would likely mean LCM would vastly increase its overall return.

Justice Parker cited multiple objections to making the order, including the following:

  1. His Honour was ‘troubled’ by the fact that the 30% commission LCM proposed was to be calculated on the ‘gross’ value of settlement (i.e. before costs had been deducted) rather than ‘net’ (i.e. after costs had been deducted). This meant that although LCM would recoup the legal costs it paid during the proceedings out of the settlement proceeds, its 30% commission would still be calculated by reference to the entire settlement amount. As such LCM would have its cake and eat it to.[1]

  2. His Honour also objected to there being no cap on LCM’s commission under the proposed common fund, noting that it would have been appropriate for the funder’s commission to be capped at a multiple of the costs funded by it.

Equally Justice Parker made little of LCM’s argument that it was desirable for the Court to prevent those group members who had not signed up with LCM (i.e. the ‘free-riders’) from benefiting at the expense of other group members, including because the ‘enforceability of the funding agreements in this case, or some of them, may (and I emphasise the word “may”) be questionable.’ As such, those group members that had registered with the funder might, in effect, be in the same position as those that had not. His Honour did not provide details about why the agreements might not be enforceable other than alluding to consumer protection legislation, including the Contracts Review Act 1980 (NSW).

Further, Justice Parker placed little weight on LCM’s argument that no class member had objected to the proposed common fund order since there was nothing to suggest that such persons would know what an appropriate rate of commission was.

The plaintiff’s solicitors' costs

Although the plaintiff had provided a report from a reputable costs assessor stating that the plaintiff’s solicitors' costs were reasonable, Justice Parker voiced a concern expressed by other judges when faced with approving the quantum of legal costs during the settlement process – the solicitor, acting for themselves, applies to the court to approve their own costs.  

Further, given how difficult it would be for a group member to reach an informed decision about whether to object to such costs with the information available to them, Justice Parker again placed little weight on the fact that no objections had been filed (as his Honour did in the case of the proposed common fund).

Justice Parker was also largely unpersuaded by the argument that LCM would have been motivated to keep the solicitors’ costs down, noting that any such motivation would have been small in this case given those costs were swamped by the potential returns. He also observed (without criticism) that plaintiff law firms and funders naturally develop close working relationships, making it less likely that LCM would have acted as a brake on the accumulation of costs.   

Where to from here

This case is likely to cause courts (particularly in NSW) to be even more cautious when being asked, in effect, to extend the application of a funding agreement to all group members through the making of a common fund order. In particular, courts are likely to cast a critical eye over any funding agreement and closely question the reasonableness of a funder obtaining such large returns on its investment.

The decision will also send a word of caution to plaintiff law firms that expect to recover all or the vast majority of their costs from a settlement. Plaintiff firms will re-evaluate their approach to obtaining a court’s approval – in particular favourable evidence from a costs assessor (particularly one who is not independent) is unlikely to be seen as the solution it might have been previously.

Historically the use of contradictors with respect to the settlement approval of class actions has been patchy (although somewhat more common in Victoria). The Court’s appointment of one here is likely to spark some renewed enthusiasm for this mechanism among lawyers, as it can be an effective way to address a court’s concern that the interests of unrepresented group members may not have been adequately addressed.  

[1] In Lenthall v Westpac Life Insurance Services Limited [2018] FCA 1422, Justice Lee of the Federal Court accepted the proposal for a funding rate of the lesser of three times the total spend on legal costs and disbursements and adverse cost orders, or 25% of the net recovery. In Petersen Superannuation Fund Pty Ltd v Bank of Queensland Limited (No3) [2018] FCA 1842, Justice Murphy of the Federal Court refused to make a common fund order for 25% of the gross settlement where the commission rate in the agreement was agreed as the greater of 25% of gross settlement or three times the legal costs. Instead Justice Murphy considered a funding rate of 13.7% of the net settlement to be appropriate, which equated to 8.3% of the gross settlement.

 

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