One of the recommendations of the recently published ALRC Report into Class Actions Proceedings and Third Party Litigation Funders is that Part IVA of the Federal Court of Australia Act 1976 (Cth) should be amended to include a statutory presumption that third-party litigation funders who fund representative proceedings will provide security for costs in any such proceedings in a form that is enforceable in Australia.
This was a late development to the thinking of the ALRC and was not a topic which was canvassed as part of the Discussion Paper nor during the consultations which were conducted by the ALRC. This recommendation in relation to security for costs is part of a suite designed to improve the regulation of litigation funders who are funding class actions in the Federal Court. Although the ALRC was initially in favour of a licence for litigation funders similar to an Australian Financial Services Licence, this proposal was ultimately abandoned.
It is already the case that generally where a litigation funder is funding a class action, the involvement of that funder is a factor weighing in favour of security for costs being ordered. The more controversial part of this recommendation however is the requirement that such security for costs be provided in a form that is enforceable in Australia. The ALRC explained the reasoning behind this recommendation to be a concern “that the types of security being provided by funders are less secure than a bank guarantee and would put the respondent to considerable costs if they were to seek to call on the security”. That this concern has been assumed by the ALRC to exist is surprising given only two submissions (from Clayton Utz and Allens respectively) have been cited in support of it and there is no evidence of any security for costs being provided from an overseas jurisdiction not being honoured, or a respondent being put to “considerable costs” in order to call on it.
The “type of security” referred to here is generally a Deed of Indemnity issued directly to a defendant from an After the Event Insurer. It is true that this form of security is generally not enforceable in Australia simply for the reason that there is no insurer based in Australia currently issuing this type of Deed of Indemnity. Nevertheless, the courts have developed a well-reasoned jurisprudence in relation to the provision of Deeds of Indemnity as security for costs and has found that these Deeds (generally from London based insurers) are a valid form of security for costs. The general approach of the courts to the fact that the security can only be enforced off-shore is to require the funder to pay into court a cash sum representing the likely costs of enforcing an Australian judgment against the After the Event insurer in their jurisdiction (in addition to the Deed of Indemnity provided by the insurer). That process is very straightforward and the cost is minimal.
It is difficult to understand why this form of security should be considered to be “less secure” given that it is generally issued by an A rated insurer with a significant balance sheet and with a business model which would be seriously damaged in the event that it was to fail to meet the indemnity offered. Importantly, the suggestion that security must be in a form which is enforceable in Australia also ignores the common law test in relation to security for costs namely that security must be “adequate” and once it has been demonstrated to be adequate then the plaintiff is entitled to propose security in a form least disadvantageous to it.
As the ALRC notes, there are more than 30 litigation funders currently operating in Australia. Many of these litigation funders are not based in Australia and do not hold capital in Australia. This proposal will have a particular impact on those litigation funders who generally use Deeds of Indemnity from After the Event Insurers to satisfy orders for security for costs. Funders with sufficient capital in Australia (such as LCM) will be able to satisfy orders for security for costs by the provision of a Deed from the funder directly in favour of the defendants. This option however will not necessarily be open to overseas based or smaller funders.
If the proposal is implemented many litigation funders (and, ultimately, the class members) will have no choice but to pay cash security into court or provide a bank guarantee. It is important to consider that using either of these forms will drastically change the overall economics of the case to the detriment of class members as the funders will require a return on this additional capital and such return will be paid from the settlement pool. The requirement for such a return will have a direct impact on the funds ultimately payable to group members. Further, this development may also mean that the funding of smaller class actions becomes uneconomic and the recommendation if implemented may result in some funders withdrawing from the class actions market entirely. Both of these consequences are counter-productive to the policy considerations behind Australia’s Class Actions regime.
The proposal that security for costs be provided in a form enforceable in Australia also has the potential to limit the number of firms who may otherwise have been willing to charge a contingency fee in a class action should this recommendation become law. The recommendation of the ALRC is that solicitors who fund representative proceedings on the basis of percentage-based fee agreements should be subject to a statutory presumption that they will be required to provide security for costs in any such representative proceeding. The ALRC recognises that not many firms will have a sufficient balance sheet to allow them to satisfy such an order for security for costs by payment into court and has said that firms may “raise capital as they see fit” by having a litigation funder support them or by taking out After the Event Insurance. However, by requiring security for costs to be provided in a form which is enforceable in Australia, the ALRC’s recommendation if implemented will seriously restrict the types of capital available to these firms.
Throughout its report (and demonstrated by the recommendation in support of contingency fees), the ALRC appears to be in favour of the expansion of the funding market and different funding models in order to promote competition and to result in lower commission rates charged by litigation funders. Unfortunately this principle has not been applied in relation to security for costs where the requirement that security be provided in a form enforceable in Australia is likely to result in decreased returns to group members and, ultimately, a reduced group of funders and solicitors participating in class actions.
Senior Investment Manager