Developments in Common Fund Orders since QBE

On 31 March 2017 Justice Beach of the Federal Court granted a ‘common fund order’ during settlement approval of the Blairgowrie v Allco shareholder class action.

This decision is part of a suite of recent Federal Court judgments relating to common fund orders and litigation funder’s commissions in class actions.

Court’s power to set funding rates in class actions

A common fund order is a Court order that all group members in a class action pay a portion of their recoveries to a litigation funder as consideration for the funder’s funding of the class action. Historically, funders of class actions have relied on contractual arrangements with group members as the basis for the funder’s compensation. This meant many funded class actions, when commenced, were structured to exclude persons who did not enter into a funding agreement (the so-called “closed class”). Blairgowrie follows the Full Court’s decision in late 2016 to make a common fund order at the commencement of the Money Max v QBE class action. In Money Max, the Court made orders that all group members contribute to the costs of funding, but only if the funding commission is approved by the Court at the end of the action.

Money Max was followed by a decision of Justice Murphy, also of the Federal Court, approving settlement of the shareholder class action Earglow v Newcrest. In Earglow some group members were funded and others were not. As part of the settlement distribution scheme the Court was asked to approve a payment to the litigation funder under a ‘funding equalisation mechanism’. This payment was equal to the amount the funder was contractually entitled to under the funding agreements it had entered into with the funded group members. While Murphy J approved the settlement and the full payment to the funder, he concluded the Court had the power to reduce a payment to a funder if the Court considered the funding rate and other terms to be excessive or exorbitant. He said that if funders later sought to enforce their contracts with funded group members directly, the Court could move to require funders to undertake at the outset of proceedings to be bound by orders of the Court before the proceedings are permitted to continue.

In Blairgowrie Beach J said he was of the view that section 33V(2) of the Federal Court Act (Cth) gives the Court power to “modify any contractual bargain dealing with the funding commission payable out of any settlement proceeds” [at 101]. Section 33V(2) provides that the Court may make “orders as are just with respect to the distribution of any money paid under a settlement or paid into the Court”. His Honour said that an order under 33V is an exercise of statutory power that overrides any contractual entitlement.

Money Max, Earglow and Blairgowrie demonstrate how the Court is taking a more hands-on role in overseeing funding arrangements for class actions, even in ‘closed class’ class actions.

What is a reasonable funding commission?

Although each case is determined on its facts, the settlement and common fund approval in Blairgowrie provides additional guidance on how the Court is likely to approach the task of determining the reasonableness of a funder’s commission.

Beach J said that the funding rate should be set:

1. referable to individual circumstances of the case before the Judge;
2. in the context of or informed by actual or putative market rates for litigation funding, including in foreign jurisdictions; and
3. referable to the risks faced by litigation funders investing in litigation generally and their expected return on equity and equity beta.

The proposed settlement distribution scheme which the Court was asked to approve in Blairgowrie made a provision for the litigation funder to be paid 22% of the settlement sum (equal to 30% of the settlement sum less the legal costs, or the ‘net settlement sum’). The Court approved this 22% commission on the basis that it was reasonable in the circumstances. As a result, the $40m settlement sum was divided as follows:

Beach J said that if the settlement sum had been higher he would have “set a lower percentage so that the amount paid to the funder would have remained proportionate to the investment and risk undertaken by the funder” [at 160]. He indicated that applying a fee equal to 30% of the net settlement sum would be difficult to justify on a net settlement sum above $50m, but added that “valuable services such as that which a funder provides have a commercial cost and if [such a rate] can be justified, so be it” [at 160].  

The 22% funding rate should be viewed in the context of the Blairgowrie funding arrangements and the split of the work done and risk taken between the funder and the lawyers.

In Blairgowrie the funder was not liable to pay the lawyer’s professional fees (only disbursements, security for costs[1] and adverse costs) and the lawyers were ‘at risk’ for their professional fees should the case be lost. As disbursements were $2 million and applicant’s legal costs $10.5 million, the funder was not obliged to pay up to $8.5 million of the lawyers’ professional fees and avoided the risk of not recovering this amount should the case be lost. In most funded class actions the funder is usually required to pay between 70% and 100% of the lawyers’ professional fees in addition to paying disbursements, providing security for costs and meeting any adverse costs.

More broadly, one would expect the reasonableness of the funding fee to vary depending on the split of work and risk undertaken between the lawyers and the funder. For instance, in some class actions the more administrative functions of contacting prospective claimants, arranging for them to sign funding agreements, sending communications to them and managing data relating to their claim is performed by the funder (and not charged for separately). If this role is undertaken by the lawyers the time spent undertaking these tasks will contribute to the legal costs, rather than being incorporated into the funder’s commission. Lower funding commissions in circumstances where certain non-legal work is undertaken by the lawyers instead of the funder does not necessarily result in lower overall costs for group members (because the lawyers will charge for this work). 

The Court in Blairgowrie cautioned against the use of funding commissions calculated as a multiple of the funder’s investment. Given the applicant’s legal costs in this matter were greater than 25% of the settlement sum, a return to the funder based on a multiple of investment (often 2 or 3 times) would have significantly disadvantaged group members compared with the approved, or even original, percentage fee.

Clarifying the Money Max ‘no worse off rider’

The Money Max common fund order included a rider that group members could not be financially worse off than if the Court applied a funding equalisation mechanism. Under a funding equalisation mechanism, the funder receives an amount of money equal to the amount it is contractually entitled to receive from the funded group members. However, the amount is ‘paid’ on a pro rata basis by all group members. The mechanism was originally introduced to prevent unfunded group members ‘free-riding’ on the funding arrangements between the funder and the funded group members. It has been regularly used in funded shareholder class action settlements over the last 8 years.

This rider underpinned the Court’s reasoning that the common fund order in Money Max was in the interests of group members (because they might receive more money at the expense of the funder). However, the rider caused some to question how a common fund order (with this rider) differed from a funding equalisation mechanism if the funder’s return was limited to its contractual entitlements (as it is with a funding equalisation mechanism).  

Beach J in Blairgowrie said that the rider in Money Max should be considered in the context of Money Max, a case “where a substantial number of group members had signed up to funding agreements and the respondent had asserted that if a funding equalisation order was made, group members would be better off than if the common fund order proposed in that case was made” [at 105]. He indicated that in cases where a common fund order is sought close to the inception of the case and there is no bookbuild, a funding equalisation mechanism may not be the correct counterfactual in assessing what is in the interests of group members.

This commentary signposts that the Court may be prepared to make common fund orders without the Money Max rider, which in turn may encourage open classes, reduce or eliminate the utility of group members signing funding agreements, may accelerate the institution of proceedings and may increase the possibility of competing class actions.