Fostif Case

A recent majority decision by the High Court upheld the legitimacy of the litigation funding model. According to S Stuart Clark and Michael Legg, in doing so it effectively endorsed the use of US style contingency fee agreements in Australia.

In 1992 the Australian Federal Government introduced a package of reforms that included the introduction of Australia’s first class action procedure and a number of other measures that were expressly intended to increase the level of litigation. One of those other measures was the introduction of a limited form of conditional fee agreements.

Australian lawyers have always been prohibited from entering into contingency fee agreements of the type used in the US. A contingency fee agreement involves a client agreeing to pay their lawyer a specified percentage of any verdict or settlement. If the case is lost the lawyer usually gets nothing. In the US the lawyer often takes around forty per cent of the verdict or settlement as compensation for running the case.

While US style contingency fee agreements have always been prohibited in Australia some plaintiffs’ lawyers were willing to conduct litigation on a ‘no win – no pay’ basis. That is, if the plaintiff’s case failed, they received nothing while, if the plaintiff succeeded, the lawyer received his or her normal fee – generally calculated by reference to the lawyer’s normal hourly rate. Australia follows the so called ‘loser pays’ rule whereby the party that succeeds in litigation is entitled to recover the costs of running the case from the party that loses. Thus, where the plaintiff was successful, the defendant was the person who effectively paid the plaintiff’s lawyer’s fees.

The 1992 reforms allowed the lawyer to charge a premium or uplift of up to 25 per cent of their normal fee as the reward for the risk of receiving nothing if the case failed. This uplift or premium was applied at the fixed rate regardless of the amount recovered by the plaintiff. As a consequence there are comparatively few Australian lawyers who are willing to invest in complex or large scale, class action, litigation on a conditional fee basis. Frankly, the risks are significant and the potential rewards limited.

The rise of litigation funding

However, while lawyers were prohibited from entering into true contingency fee agreements, it was recognised that the prohibition did not extend beyond the legal profession. As a consequence, a number of entrepreneurs developed a business model that involved identifying potential claims and then entering into agreements with the plaintiff or plaintiffs under which the entrepreneur agreed to engage and pay for a lawyer to conduct the case on behalf of the plaintiffs – in exchange for a percentage of any verdict or settlement. These agreements also usually involved the plaintiff agreeing to assign the benefit of any costs order to the person providing the funding. Thus, if the case went to trial and the plaintiff was successful, the funder received the agreed percentage of the verdict and was able to recover most of their costs of running the case from the defendant.

While many of the cases that have been funded have taken the form of class actions, others have involved individual plaintiffs. For example, a number of cases have involved claims by liquidators in circumstances where the insolvent company lacked the resources to allow the liquidator to bring what was otherwise a meritorious case.

The percentage taken by the funder has varied depending upon a range of factors. Percentages of between 30 and 40 per cent of the verdict or settlement are common although there have been instances of the agreement providing for the funder to receive up to 75 per cent.

The early success of a number of these cases demonstrated the potential for the litigation funding model and a range of competing funds were established. In at least one instance, IMF (Australia) Ltd, the funder is a publicly listed company.

Defendants who found themselves facing litigation, promoted and funded by litigation funders, were quick to counter attack. They moved to have the proceedings struck out arguing that the arrangements offended against the old rules against maintenance (encouraging litigation) and champerty (funding another person’s litigation for profit), or were otherwise an abuse of process or not in the public interest. While some of these challenges were successful, others failed and it quickly became clear that the issue would have to be finally decided in the country’s ultimate appellate court, the High Court of Australia.

High Court decision legitimises litigation funding

The chance for the High Court to decide the issue ‘once and for all’ came in Campbells Cash and Carry Pty Limited v Fostif Pty Ltd [2006] HCA 41 – better known as Fostif’s Case. The proceedings concerned claims for the recovery of amounts paid by tobacco retailers to tobacco wholesalers, allegedly for the purposes of the wholesalers paying a licence fee, later found to be unconstitutional. The proceedings were instigated by a litigation funder who was prepared to underwrite the litigation in exchange for one-third of any amounts recovered, plus the benefit of any costs order.

The High Court held, by a five to two majority, that litigation funding was neither an abuse of process nor contrary to public policy. That is to say the High Court upheld the legitimacy of litigation funding. Ironically, however, while the concept of litigation funding was upheld by the Court, the plaintiffs and thus the litigation funder, ultimately lost the case on a different ground – that the proceedings did not meet the requirements for a representative proceeding under the NSW Supreme Court rules.

Three of the Justices in the majority explained that, in those states and territories that had abolished maintenance and champerty as crimes and torts, there were no public policy questions beyond those that would be relevant when considering the enforceability of the agreement for maintenance of the proceedings as between the parties to the agreement. In other words, once you have abolished the crimes and the torts of maintenance, these concepts cannot be used to mount a challenge to proceedings which are being maintained. Their only relevance is in a dispute between plaintiff and funder about the enforceability of the agreement.

The Justices went on to say that, to the extent that concerns remain about the potential for litigation funders to subvert the judicial process, such conduct could be addressed by “existing doctrines of abuse of process and other procedural and substantive elements of the court’s processes”. There was accordingly no need for an overarching doctrine of abuse arising from maintenance. Nor was there any need for any special rule in relation to class actions.

The Court did not decide the question for those jurisdictions where legislation had not abolished maintenance and champerty as crimes and torts (Western Australia, Queensland, Northern Territory and Tasmania).

Implications for directors

The High Court’s decision has lifted a cloud of uncertainty surrounding litigation funding. It is now clear that, at least in those jurisdictions which have abolished the crimes and torts of maintenance and champerty, funded litigation of all types will proceed without the threat of a challenge from defendants based on the existence of the funding.

There can be little doubt that the resolution of this issue in favour of the litigation funding industry will lead to an increase in litigation, particularly class actions, promoted by litigation funders. Indeed, there are a number of class actions that have been ‘on hold’ awaiting the High Court’s decision. These cases will now proceed. A number of these additional cases will be of particular interest to company directors as some of the litigation funders have made it clear that they have a particular interest in pursuing claims against corporations on behalf of investors and liquidators. In some of these cases it is inevitable that directors will be joined as defendants or brought into the proceedings by way of a cross-claim.

A key question for directors relates to the impact this decision will have on the cost and availability of D&O insurance. For once the news on this front is not that bad. On the one hand there can be little doubt that the decision will lead to an increase in claims against directors in the longer term. However, given the current softness of the insurance market and the fact that the risk of litigation in itself is not new, the decision is unlikely to have any significant short term effect on either premiums or the availability of D&O insurance. Rather, it is an additional factor which will be likely to contribute to a future hardening of the market.

In addition, new participants who see the opportunity for a profitable investment in litigation will enter the litigation funding market. This in turn will have an impact on the number of cases that can be funded at any one time. The form of the emerging litigation funding industry and its overall effect on litigation will depend to a large extent on whether government regulation is adopted and in what form. The Standing Committee of Attorneys-General (SCAG) is currently examining the issue of litigation funding. Its report may well lead to:

• the repeal of laws against maintenance and champerty in those jurisdictions where the tort or crime continues to exist – so as to make the position consistent across Australia;
• the development of criteria for acceptable funding agreements; and
• the introduction of prudential regulation requirements for funders.

Lawyers are highly regulated and must comply with extensive disclosure requirements to ensure that consumers are made aware of the nature and effect of the retainer agreement that they have with their lawyer. Similarly, there is a well established regime for dealing with complaints and disciplining those lawyers who breach the rules. There can be no reason why consumers should not receive the same protection in relation to litigation funding agreements which, in reality, replace the traditional fee agreements between the plaintiff and the lawyer.

Finally, there will be renewed calls on the part of plaintiff’s lawyers for the legislation governing the legal profession to be amended so as to allow lawyers to enter into true contingency fee agreements with their clients. If there are no sound public policy reasons to prohibit litigation funders entering into contingency fee agreements it is hard to see why lawyers should be prevented from entering into the same arrangements.

S Stuart Clark is national managing partner - litigation and dispute resolution and the class actions team leader with Clayton Utz. Michael Legg is a senior associate with Clayton Utz who specialises in securities class actions.