Settling a class action – common fund orders and legal costs

On 30 July 2019, Justice Parker handed down a decision in the Supreme Court of NSW class action Tredrea v KPMG Financial Advisory Services (Australia) Pty Ltd (No 3) [2019] (Tredrea) refusing both to grant a Common Fund Order (sought by the funder at a rate of 30% of the gross settlement reached) or approve the Plaintiff’s legal costs.

His Honour emphasised the need to appoint an independent contradictor to represent the Settlement Group Members’ interests in both instances, and for the issues to otherwise be dealt with by negotiation or upon further application to the Court.

The evidence before His Honour did not compellingly demonstrate that quantum of the commission sought by the Funder (LCM) or the quantum of legal costs incurred was ‘objectively reasonable’, and raised potential arguments that could be put to qualify those claims[1].

Whilst his Honour emphasised that the Court had the necessary power to make a CFO, it would not do so automatically[2] and would not in this instance, provide the funder with a level of return on its investment which was ‘objectively reasonable’. Several criticisms of LCM’s funding agreement were made, and orders appointing Grant Thornton (the administrator of the Settlement Fund) as an independent ‘contradictor’ for the CFO and application for costs approval.

What is a CFO and why is it important?

A common fund order (CFO), is in essence, a commission fee to a litigation funder for their efforts in bringing and funding a class action, deducted from the common fund of proceeds obtained by the class as a whole from any settlement or court ordered judgment. Thus, even those who have not signed a funding agreement will have the funding commission deducted from their share of the settlement fund.

CFOs derive from the common fund doctrine, established in the 1880s in the United States. The underlying rationale is that a person who obtains the benefit of the lawsuit without contributing to costs of obtaining it is unjustly enriched at the successful litigant’s expense.

CFOs are therefore designed to stop “free rider” group members who have not signed funding agreements from benefiting from the fruits of the class action, without contributing to the funder’s costs (usually borne by group members who have signed funding agreements).

Federal and State Courts have made numerous common fund orders since it was first applied in 2016 in the case of Money Max Int Pty Ltd (Trustee) v QBE Insurance Group Limited [2016]. FCAFC 148.

CFOs are welcomed by litigation funders, as it reduces the need to “Book Build” the portfolio of signed group members, and offers litigation funders greater certainty of return for their investment from an early stage in the proceeding.

CFOs were further cemented in the Australian class action landscape after the Full Federal Court and New South Wales Court of Appeal both rejected there were any barriers, including constitutional barriers, to the making of such orders, in Westpac Banking Corporation v Lenthall [2019] FCAFC 34 and Brewster v BMW Australia Pty Ltd [2019] NSWCA 35 respectively.

CFO rejected

In respect of the CFO, Parker J was not persuaded by LCM’s evidence and submissions that the 30% commission rate sought was reasonable.

Whilst LCM presented some evidence about the risks it ran by funding the proceedings (legal costs, LCM’s insurance premium, 3 year period taken to run the claim from first proposal to resolution) the Court “did not know how much time LCM’s executives put into managing the claim, but putting a figure on that time (if it could be identified) is unlikely to alter the position much”[3]. Only 142 of 1300 group members had previously registered with LCM. In any event, due to lack of comparative evidence about the rate of return, his Honour deemed the 30% commission rate not to be commensurate with the funder’s three year investment, guessed to be “in the hundreds of percent…which seems enormous”[4].

His Honour was ‘troubled’ that LCM sought a 30% commission rate which was:

• calculated on the gross value of the settlement (before deduction of expenses), rather than the net value (after deduction of expenses), observing that:

“Virtually all the costs will be passed back to the Settlement Group Members [and] LCM seems to be trying to have things both ways”[5]; and

• was uncapped. His Honour ultimately followed the position set out by the Court of Appeal in Brewster v BWM[6] at 114 and by Lee J in Perera v Getswift Ltd [7] stating that any common fund order made “should be capped at an appropriate multiple of the costs funded by it”[8].

Equally, his Honour thought little of LCM’s submission that unfunded group members would catch a “free ride” at the expense of the funded group members. His Honour questioned the enforceability of the funding agreements, which ‘in this case may (emphasising the word “may”) be questionable’[9], putting those group members affected in the same shoes as unfunded group members. Whilst he did not critically examine enforceability of the funding agreements, Parker J referred to consumer protection legislation, including the Contracts Review Act 1980 (NSW).

His Honour also rejected LCM’s submission based on no group member objection to the CFO sought. His Honour deemed no group member (whether they were a lead plaintiff or an institutional investor) would be sufficiently equipped to know what an appropriate commission rate might be, and in any event, there would be marginal cost benefit from such group member objecting to the CFO sought[10].

Because there was no comparative evidence about LCM’s rate of return, his Honour concluded the ‘Court should limit any CFO to a share of the net recovery, rather than the gross, and the Court should impose a commission ceiling calculated by reference to a multiple of the costs incurred’. LCM’s commission rate sought (30%) in this instance was thus rejected.

Plaintiff’s legal costs rejected

Although the Plaintiff had provided a report from a reputable cost assessor, who had confirmed $3.2m of the $3.311m sought was reasonable and “well within the range” of the type of class action before the Court, Parker J regarded Piper Alderman (Plaintiff’s solicitors) and LCM as the real applicants for the Plaintiff’s costs.

His Honour again rejected the submission based on no group member objection to the costs sought, recognising there was little material before group members set out in the Notice to Group Members to enable them to make an informed decision.

His Honour suggested appointing a cost referee may be an alternative approach, or for costs to be assessed by ordinary assessment process, under the Legal Professional Uniform Law (NSW), Part 4.3 Division 7 (LPUL), or for the Court to appoint an independent legally qualified cost assessor for the Plaintiff throughout the proceeding. However, with the benefit of hindsight, his Honour agreed it would not be appropriate to adopt such additional processes in circumstances where funds had already been spent obtaining the costs report.

Finally, his Honour found the costs sought by the Plaintiff lacked the opinion of a ‘contradictor’, who would be best placed to independently and critically ask whether the costs, being paid from the perspective of a settlement group member, were justified. His Honour found the costs report obtained did not answer this discrepancy[11].

Parker J concluded “the Court may ultimately consider it is appropriate to reimburse [LCM’s] costs to the extent that they contributed to the ultimately successfully outcome”. This could suitably be done either by negotiation, or failing that, by the appointed ‘contradictor’, Grant Thornton, requiring an assessment[12].

Key lessons from Tredrea

Tredrea demonstrates that the Courts (particularly in NSW) are likely to be especially critical when being asked to:

1.  make a CFO, and will look critically at the funding agreement and the evidence filed to support the reasonableness of the commission sought, and assess the return on the funder’s investment represented by the commission; and
2. approve the plaintiff’s costs – plaintiff firms should consider the most appropriate way to ensure such costs are adequately assessed and justified. A report from an independent costs assessor obtained after the fact may not carry the weight it traditionally once did.

Using a ‘contradictor’ to represent the interests of group members, and particular sub groups within a class (ie. settlement group, as opposed to group members generally) is an effective way to overcome the Court’s concerns that such interests are not being adequately represented in applications for Settlement Approval of shareholder class actions.

[1] Tredreav KPMG Financial Advisory Services (Australia) Pty Ltd (No 3) [2019], per Parker J, at [10].

[2] Ibid, at [100].

[3] Ibid, at [85].

[4] Ibid, at [57].

[5] Ibid, at [88].

[6] [2019] NSWSCA 35, at [114]

[7] [2018] FCA 732 at 283

[8] Above No 1, at [93].

[9] Ibid, at [98].

[10] Above No 1, at [102]; referring to P Dawson Nominees Pty Ltd v Brookfield Multiplex (No 4) [2010] FCA 1029 at [23] per Finklestein J.

[11] Ibid, at [139].

[12] Ibid, at [160].

Authored by:

Glenn McGowan QC, Partner & Chief Counsel

Rebecca Di Rago, Associate