31 Jan 2018

Litigation funding: an industry due to go under review


4 min

Does the margin of financial gain make it worth the action?

As liquidators, we must often decide whether to commence or to continue litigation for insolvent companies.

The potential financial return is of course attractive, but the risks of losing the case and having to pay the other side’s legal costs is a suitable deterrent, particularly in the instances where such costs must be paid from liquidators’ personal funds.

Financial hurdles—a lack of funds or our unwillingness to risk them—can sometimes be overcome, or partly overcome when creditors fund the litigation, or when solicitors agree to carry their fees during the actions. But getting such support is not always easy, nor always appropriate.

Litigation is also risky when we rely on directors to cooperate, when many just want to move on with their lives, particularly in contentious litigations. Our decision not to start or continue litigation can expose us to strident criticism from directors; they can seek to blame someone else.

In the instances where the liquidator is unwilling to fund the litigation personally and funding cannot be obtained through the creditors or the solicitors are unable to hold their fees, the liquidator is left with two options: abandon the legal action, or seek litigation funding.

Commonly, a ‘funder’ is given all the relevant information on the legal action, and often requires a legal opinion on the likely success of the litigation. A litigation funder will then assess the case’s merits and if they form the view that the action is strong they may well fund the action.

A typical funding model is funds covers the legal action fees and costs, often providing for any adverse costs order should the legal action prove to be unsuccessful. If successful, the funder becomes entitled to be reimbursed for any costs incurred in the legal action and additionally a fee is calculated on a percentage of the recoveries made. These percentage figures can be anywhere between 20 percent and 50 percent. The balance of these funds is passed onto the liquidator.

Obviously, any funds recovered will be significantly lower than if the liquidator funded the action. However, where litigation funding is used it is often the case that the only other option was to abandon the action, so while the recoveries may be lower, it is better than the converse position of zero recoveries.

But litigation funding is not limited to liquidators. Frequently, parties involved in a class action do not have the resources to fund any action themselves and therefore seek funding from litigation funders. In this class action arena, some concerns about litigation funding have been raised. In particular, the former Attorney General, George Brandis, recently directed the Australian Law Reform Commission to “inquire into class action proceedings and third-party litigation funders”. His view was that there was need to regulate litigation funders when class members face “exorbitant and unjustifiable” fees.

Some views appear to be that that instead of affordable and efficient justice being available to those who have suffered loss, class actions now prosper the commercial industry with large fees, commissions, and management fees. These substantial profits are evident in share prices and dividends of the publicly-listed litigation funders and in solicitor fees in acting for class members.

Given the potential return on a litigation loan, funders are invested in the action’s success, which is a shared motivator with the class action applicants, but often their role can dominate the direction and decisions made in the action.

Another point of disparity that reform could rectify is the fees being disclosed in advance, as a solicitor is compelled to do. Litigation funders disclose their fees and charges as being subject to court approval in class actions, however, the net effect of its fees plus the share in litigation proceeds could mean a very marginal financial gain.

We can see the dilemma that face litigation funders, it is often the case that they bear all the risk associated with the action and as such should be remunerated appropriately, but at the same time, ensuring that any remuneration should be fair and equitable to ensure that the vulnerable are not taken advantage of.

At Worrells, we’ll be curious to see where the Australian Law Reform Commission takes its inquiry.

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