26 June 2013

Fractured class – recent settlement decisions expose conflicts of interest as between group members

In May 2013, the Federal Court approved a settlement in the Storm Financial class action against Macquarie and refused to approve a settlement in the Vioxx class action against Merck. These two decisions reveal the complex issues which arise when the interests of group members diverge.


On 3 May 2013, Logan J approved a settlement in the class action against Macquarie arising from the collapse of Storm Financial (Richards v Macquarie Bank Ltd (No 4) [2013] FCA 438), finding it to be fair and reasonable notwithstanding the fact that the settlement sum will be distributed on a differential basis as between group members who entered into funding agreements with Mrs Richards’ lawyers and those who did not.

Just two weeks later, Jessup J declined to approve a settlement made by the representative applicant in the Vioxx litigation (Peterson v Merck Sharp & Dohme (Australia) Pty Ltd (No 6) [2013] FCA 447). One of the reasons for this decision was the failure of the settlement adequately to differentiate between the respective strengths of group member claims.

We outline the reasons for each decision briefly below, before turning to the broader issue of intra-class conflict.

The Storm settlement

Mrs Richards and Macquarie reached a settlement at a late stage of the Storm proceeding: the trial had been conducted, submissions had been made and judgment had been reserved. In the absence of a third party litigation funder, the settlement allocates 35% of the settlement sum as a “premium” to be distributed to the group members who funded the proceeding, with the result that the funding group members stand to recover about 42% of their underlying investments, while the non-funding group members will recover less than 18%. ASIC intervened in the approval hearing to raise concerns about the settlement, taking issue not with the concept of a premium, but rather with its amount and with the notice which had been given to the non-funding group members.

In determining whether the settlement was fair as between group members, Logan J had regard to the premiums afforded to litigation funders, and also to the preferential treatment of creditors who fund liquidators’ actions. His Honour concluded that the internal allocation was fair and reasonable, the premium giving “apt recognition” to the risk borne by the funding group members. ASIC has lodged an appeal from Logan J’s decision which will be heard by a Full Federal Court on 5 August 2013.

The Vioxx settlement

If the Storm settlement was reached at a late stage, the Vioxx settlement was reached at a very late stage indeed.

The initial trial of Mr Peterson’s claims and of common questions took place before Jessup J in 2009. His Honour’s judgment was handed down in 2010 and the appeal from that judgment handed down by the Full Federal Court in 2011. The upshot of the appeal was that Mr Peterson failed entirely in his personal claims, but Jessup J’s findings against Merck in relation to a number of common questions concerning the capacity of Vioxx to contribute to heart attacks were undisturbed.

Mr Peterson’s personal claims failed for two main reasons. First, he exhibited a number of risk factors and so could not show that Vioxx was the cause of his heart attack. Secondly, his claim based on a negligent failure to warn failed because the evidence was that a warning would not have made any difference in his case.

Notwithstanding that his personal claim had failed, Mr Peterson entered into a settlement with Merck, under which $2,000 would be paid to living group members and $1,500 to the estate of deceased group members providing they could establish that they suffered heart attacks (or sudden cardiac death) within a certain period of receiving Vioxx tablets. The total settlement sum was capped at $497,500 for live group members and $45,000 for the deceased, with payments to be ratcheted back if those amounts were exceeded. Not insignificantly, the settlement involved Merck waiving any entitlement to costs as against Mr Peterson.

In the course of the approval hearing, Jessup J expressed scepticism about its fairness: "I don't just consider myself to be a street sweeper". Having reserved his decision, his Honour declined to approve the settlement, not being satisfied that it was fair or reasonable as between group members, as it failed to differentiate between group members according to the strength of their claims. For those, like Mr Peterson, who exhibited risk factors for heart attacks, the settlement would represent a windfall taken at the expense of those with more deserving claims.

Intra-class conflict, adequacy of representation and the protective role of Courts

Both cases highlight the complex issues which emerge when the interests of the representative applicant diverge from those of some or all group members.

In representative proceedings, the Courts have an important protective role in ensuring that the absent group members are adequately represented and that their interests are not prejudiced by the conduct of proceedings on their behalf. Ordinarily, a Court can rely “on the congruence of [group members’] interests with those of the representatives as the incentive for effective representation” because “the self-interest of the representative… drives the active party”. However, where the representative applicant no longer has a personal interest in the proceeding (as with Mr Peterson) or where the personal interests of the representative applicant may conflict with some or all of the group members (as with Mrs Richards), issues concerning the adequate representation of group members become acute.

Jessup J’s rejection of the Vioxx settlement reveals some sensitivity to these issues, expressing concern both as to Mr Peterson’s personal interest in escaping costs liability and as to the divergent interests of group members with stronger and weaker claims. It could well be asked why Mr Peterson continued to be representative applicant at all. While a representative applicant may theoretically continue to represent the group once their individual claim is resolved, it will usually not be appropriate that they do so as they do not have any personal interest in the further conduct of the proceeding. It was this consideration which led the Australian Law Reform Commission to recommend that the conclusion of a representative applicant’s proceeding “should prevent him or her from continuing to conduct group members’ proceedings.” That recommendation was not adopted in Part IVA, but the issue of whether an applicant without a personal interest should continue to represent the group remains significant (all the more in the case of Mr Peterson given that he has now purported to compromise group member claims on a basis which could not be shown to be fair or reasonable).

As for the potential conflict between group members with stronger and weaker claims, Jessup J acknowledged that an undifferentiated settlement will not always be inappropriate, noting that a settlement in which everyone gets something might be understandable at an earlier stage of proceedings, where it was uncertain that any common questions would be determined in group members’ favour. This sort of “averaging” of a settlement sum may also be appropriate in circumstances where expected damages for individual group members are low, and the administration costs of a differential settlement would substantially erode any settlement sum. However, this was not shown to be such a case. Distribution mechanisms are frequently devised to address such issues. Interestingly, the settlement agreement approved in the Canadian Vioxx litigation includes a complex formula for the weighting of claims based on various elements including the presence or absence of several risk factors.

The Storm settlement also gave rise to issues of intra-class conflict. Every dollar allocated to the funding group members by way of premium came at the expense of the non-funding group members. More remarkably, the solicitor for Mrs Robinson has now made public comments pejorative of those group members who “decided to take overseas holidays, buy cars, and say they were too poor to contribute”, the very same group members Mrs Robinson undertook to represent. If a representative applicant does not wish to represent the interests of those who take overseas holidays rather than enter funding agreements, he or she need not do so. It is open to a representative applicant to restrict a class to those who have entered into funding agreements by defining the class in that fashion. ASIC has indicated that one of the issues it will raise on appeal is the question of notice (express notice of the prospect of a premium being awarded to funding group members not having been given to non-funding group members until after the opportunity to opt out of the proceeding had passed).

The comparison of third party litigation funders with funding group members can only be taken so far.  A third party litigation funder does not undertake a personal responsibility to represent the interests of all group members (as does a representative applicant).  Nor does a litigation funder bear the significant legal powers reposed in a representative applicant, who has the ability to conduct proceedings on behalf of absent parties potentially to the prejudice of their legal rights.  Further, the premium afforded to a third party litigation funder is not strictly imposed on non-funding group members. While several settlements have been approved in which the burden of a third party litigation funder’s premium has effectively been reallocated so that it is shared by all group members and not just those who have entered into agreements with the litigation funder, the rationale of such “equalisation” payments is that they ensure that non-funding group members do not profit at the expense of the funding group members and are, in that way, akin to the reimbursement of the funding group members’ expenses. The Storm settlement appears to be the first instance where funding group members have directly profited at non-funding group members’ expense.

ASIC acknowledged that its intervention in the Storm approval hearing was unusual. Absent that intervention, it seems that no voice would have been heard in opposition to the settlement. It remains to be seen whether the issue discussed above (namely the adequacy of group member representation in circumstances of intra-class conflict) will be considered on appeal.

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