Spotless – CFO judgment key take outs

Justice Murphy of the Federal Court of Australia has published reasons for judgement in Court v Spotless Group Holdings Limited [2020] FCA 1730 (Spotless).

His Honour’s judgment provides important clarification of the:

  • Powers of the Federal Court to make “Common Fund Orders” (CFO) at the settlement approval stage under section 33V of the Federal Court of Australia Act 1971 (Cth)[1] and confirms the Court’s position on the implications of the High Court judgment in Brewster[2] for CFOs at settlement;

  • Key factors the Court will take into account when considering making a CFO or ‘Expense Sharing Order’ at settlement of a class action; and

  • Factors the Court will consider when deciding whether costs expended by funders should be recovered from settlement in class actions and how, specifically ATE and related costs recovery.

On 9 September 2020 His Honour approved settlement in Spotless, including a CFO which included a funding commission of 22.5% of net recoveries ($19.5 million) payable to the joint Funders after recovery of legal and related costs they had funded.  See our earlier blog here: https://www.mackayla.com.au/news-articles/2020/9/10/mackay-secures-195m-for-spotless-funders.

Nine Key Factors for a CFO

His Honour identified nine key factors which in this case supported making a CFO or “Expense Sharing Order”[3]:

  1. The risks taken by the Funders due to the complexity or the case, costs already incurred (which were in excess of $7million), and the stage of the proceedings at which settlement occurred (immediately before trial) – all factors which supported an ‘Expense Sharing Order’ being made;

  2. The fact that case would not have proceeded without litigation funding, and the gross return to group members of approximately 70% being a “strong rate of return which compares favourably to the average returns in funded class actions”;

  3. The proceeding was commenced prior to Brewster at a time when the making of CFOs was common and their availability was relied upon by the Funders both in terms of how the proceeding was managed (in particular book building ceased at an early stage) and the Funders’ decision to fund the case ;

  4. In this case Murphy J considered that a percentage-based CFO was a more just, equitable and transparent than a Funding Equalisation Order (FEO);

  5. The Funders sought a CFO at a funding rate of 22.5%, materially below their respective contractual entitlements under their litigation funding agreements (LFAs) with registered group members;

  6. The funding rate of 22.5% of the net settlement was comfortably below comparable funding rates identified in recent empirical research;

  7. The Funders return on capital on a CFO at 22.5% was approximately 2.29 times their Project Costs, lower than the 3 times multiple often referred to as a benchmark desired rate of return in the funding industry.  Further, a return of 2.29 was not excessive given the risky, illiquid and essentially unsecured nature of the Funders’ investment;

  8. Group members had been on notice for a significant period of the Funders’ intentions to seek a CFO and no objections were made to this order; and

  9. While an FEO may have resulted in a better financial return for group members than the Expense Sharing Order at the rate of 22.5%, this factor alone was not determinative of whether granting an Expense Sharing Order was “just.”

ATE and related expenses

The Funders had sought to recover costs of ‘After the Event’ (ATE) insurance and costs associated with Deeds of Indemnity for security for costs as ‘Project Costs’ (as they were contractually entitled to under the LFAs) prior to deduction of their funding commission.

At the settlement approval hearing, Justice Murphy queried the appropriateness of this approach, and the Funders withdrew their application to recover these costs as Project Costs.

His Honour’s reasons address this issue.  Importantly, His Honour notes in assessing the risks that a Funder takes in funding a proceeding (and when considering whether to grant a CFO) the Funder’s ability to recover expenses associated with ATE insurance and security for costs is a relevant factor, as is the extent to which the Funder has laid-off their risk through such devices.  Seeking to recover the costs of managing the inherent risk of funding, which may justify a CFO, was potentially problematic. In His Honour’s words “the Funders should not be able to have it both ways.”

Key Take Outs

The key take outs from this decision for funders and practitioners include:

  • CFO-type orders can be made under section 33V (2) at settlement approval.  His Honour’s decision follows and further affirms the Court’s power to make these types of orders at settlement.[4]

  • Demonstrating the reasonableness of a funding rate will be reliant on several factors, including but not limited to the gross return to group members, the ‘risk’ taken on by the Funder and its return on capital.

  • Transparency of funding terms and returns to group members is key.

  • When seeking a CFO-type order, the relevance of the prospect of such an order to the decision to fund and how the action proceeds through bookbuilding is important.

  • Also important is the group members’ attitude to a proposed CFO, the adequacy and timing of notice of an intention to seek one, and the comparative risk, return to group members and the funder, and whether the action could have proceeded without the funding.

  • Such orders will be made or declined by the exercise of a discretion and consider a range of factors as discussed above.  The result will be inextricably linked to the particular case.

  • However, some uncertainty remains for funders who will have to wait for settlement to obtain a CFO under section 33V and rely upon a range of factors.

  • In order to demonstrate the appropriateness of a CFO-type order, Funders should assess the appropriateness, having regard to the factors identified by Murphy J, of seeking reimbursement of ATE or GST expenses where those expenses are either not transparent to Group Members or have been incurred to reduce the risk taken by the funder.

Dan Mackay and Charles Haszler

[1] And the analogous provisions of the Civil Procedure Act (2005) (NSW).

[2] BMW Australia Ltd v Brewster [2019] HCA 45.

[3] His Honour noted the various terms used including Common Fund Order, Equitable Remuneration Order and Expense Sharing Order, preferring the latter.

[4] At [78] His Honour expressly noted: the Federal Court judgments in Bellamy’s, Vocus, Uren, UGL Limited, Lenthall and Webster which concluded the Court had power to make a CFO at settlement under section 33V; and the judgments of the Full Court of the Federal Court in Davaria and the NSW Court of Appeal in Brewster (CA) which held that the High Court’s judgment in Brewster was not authority that there was no such power under section 33V.

Published by Michael Chapman