Funder's fees put in context

By Clive Bowman

The Murray Goulburn class action, taken on behalf of aggrieved unit holders in the dairy business, has attracted more than its fair share of commentary. In particular, observers have been drawn to the returns generated by Omni Bridgeway, which funded the successful action.

To some, those returns were too high. To others – including the one person in the best position to judge – they were reasonable.

On 9 July 2020, Federal Court Justice Bernard Murphy gave his reasons for approving the settlement of the Murray Goulburn class action (Endeavour River Pty Ltd v MG Responsible Entity Limited (No 2) [2020] FCA 968). 

He found that the funding fee of 25 per cent was within the range of what is a fair and reasonable funding commission. That rate meant that Omni Bridgeway would receive a return of 5.02 times the money it had invested, although costs subsequently incurred to finalise the matter meant the ultimate figure was 3.43 times.

Critics, particularly those in whose interests it is to stifle litigation funding and impede the ability of people to seek legal redress through class actions, argue the fees were unreasonable. In doing so they overlook a number of critical factors, set out below.

Factor 1 – The people who paid the fee, the group members, did not object

There were ultimately 1230 group members in the action. They signed a funding agreement at the outset, and many were sophisticated institutions. A few negotiated the terms of the funding agreement, but none sought to negotiate the funding fee. 

Group members were provided with a disclosure statement by the funder at the outset, identifying potential conflicts, and a frequently asked questions document that specifically drew attention to the relevant clause in the funding agreement that dealt with the commission rates. They were given the opportunity to seek independent advice about the funding terms.  Group members were also given a chance to opt out of the case and only two ultimately did so.   

Before the settlement approval hearing in the Federal Court, group members were provided with a court approved notice that identified the total estimated legal costs, the total settlement amount of $42 million, the funder’s proposed commission of $13.5 million (which was ultimately reduced to $10.7 million including GST) and how much it was estimated that each group member would receive in the hand (after deduction of costs and commission) if the proposed settlement was approved by the court.  They were also notified of their right to object. 

Not one group member wrote to the court raising any objection. (Like most objection processes in this system, this is as simple as completing and returning a short form to the court, and does not require the claimant to be represented by a lawyer or even appear in person for their objection to be considered, although they may have appeared if they wished to do so.)  

Any suggestion that this group of institutions and individual investors lacked the sophistication to write to the court is ludicrous. The group members ultimately received 68 per cent of the settlement monies after costs and the funder’s fee.

Factor 2 – The fee needs to be looked at by taking into account returns to the funder across the portfolio

No one would consider it reasonable to isolate one investment in a portfolio and, from that investment, draw conclusions about the return across the whole portfolio. That is as illogical as pointing to a loss on one investment and using that as a proxy for the whole portfolio, but that’s exactly the reasoning critics of litigation funders are using. The returns across the spectrum of matters being funded need to be considered.

Justice Murphy took into account the “variability in [Omni Bridgeway’s] rate of return in shareholder class actions; and its average rate of return in shareholder class actions over time” in reaching his conclusion about the reasonableness of the commission. Why? A litigation funding business comprises a portfolio of litigation investments, which produce variable returns and incur overhead expenses to run, all of which are necessary to operate a business. Without that portfolio and those overheads, there would be no litigation funding business to provide capital to allow access to justice.

Justice Murphy concluded that the average rate of return that Omni Bridgeway has achieved in shareholder and investor class actions over time was not, in his view, manifestly excessive or unreasonable. He found that: “Further, over the period from post August 2001 to November 2019 while [Omni Bridgeway] achieved high rates of return in some shareholder class actions and lesser or poor rates of return in others, over time it achieved an average rate of return which I would not describe as excessive or unreasonable. That is, the good results for [Omni Bridgeway] were balanced by some poor results.”

Focussing on a return by reference to a multiple of the amount invested (i.e. a ROIC) in one matter alone tells you nothing very useful about how much the funder is making. What is relevant is to distil a return across the portfolio of cases over time, taking into account the costs of running the business.

On that basis Omni Bridgeway has generated an all-in ROIC, before tax, of about 21 per cent during the period from 2001 to 30 June 2019. Even that number does not paint a true picture. It does not take into account the “at risk” capital, namely that, in addition to the amounts invested in a case, there is a potential for a case to be lost and the funder required to pay the other side’s costs, amounting to a  further 70 per cent or more to be expended (although some of this potential downside is insured in some cases).

Of course, the returns need to be viewed through the lens of the risks being assumed, which is the next factor.

Factor 3 - The nature of the risks assumed are relevant to assessing the reasonableness of the fee

An assessment of the reasonableness of any investment return has to take into account the specific risks.   The required return by an investor in a government bond will be less than the required return by an investor in a start-up venture.

Justice Murphy said: “A funding rate of 25% which provides a return of 502% may also be argued to be too high. The evidence however shows that the case faced risks on liability, and a risk that the quantum of any settlement or judgment would not be sufficient to justify the expense and risk of the proceeding and yet provide class members with a reasonable level of recovery.

Ultimately the case settled very much in the upper end of the range, and with substantially lower expenditure on legal costs than [Omni Bridgeway] anticipated would be necessary. That drove the rate of return which, at a 25% funding rate, is above [Omni Bridgeway’s] average rate of return for such cases. But hindsight bias must be avoided, and [Omni Bridgeway] took on the risks when the outcome on liability and quantum was uncertain.”

The risks of investing in litigation are quite different to other investments. The funder assumes an uncapped exposure to costs (the plaintiff’s own costs and, if the case is lost, the other side’s legal costs), an unknown time to conclusion of the case, an uncertain outcome to the case and, in some instances, an unknown ability to recover even if the case is won.  It is an illiquid investment with recourse only to the recoveries in the case, if there are any. The returns cannot be viewed in isolation of the risks.

Factor 4 - The fee should not be viewed with the benefit of hindsight. 

The risks are assumed from the outset of funding. That is when the fee is set. As courts have recognised, that’s the point at which the reasonableness of the rate needs to be judged. At that time, Omni Bridgeway assumed a potential exposure of about $10 million to the applicant’s own costs and adverse costs through to conclusion of the trial. Ultimately, this was for a gross profit on this matter of $10.7 million inclusive of GST - that is, before accounting for Omni Bridgeway’s own overheads.

Just because this matter resolved before the full costs budget was spent and the risks of budget overruns and of losing the case did not materialise, is not a reason to discount the relevance of those risks in assessing the return.

Factor 5: The judge is best placed to assess the litigation risks.

You would not ask an economist to assess the risks of a building collapsing; you would ask an engineer. So too, when an assessment of the risks of litigation assumed by a litigation funder is required, the most appropriate person to perform that role is the judge. 

The judge is usually provided with confidential material about the risks specific to the case when assessing whether to approve a settlement. In the Murray Goulburn case, after assessing the evidence, the judge found that a 25 per cent fee was fair and reasonable.

Each case is different and needs to be assessed in light of its individual circumstances. There is no one-size-fits-all approach, and any prescribed cap on fees will not allow for the intrinsic risks of the individual piece of litigation to be properly taken into account.

Clive Bowman is Global Chief Investment Officer of Omni Bridgeway

A shorter version of this article was published by Lawyerly.