Question (8): If the court has power to make a CFO of the kind sought, should it make such an order in its discretion in these circumstances?
192 If I am wrong about the power question, I would not make a CFO order of the type or in the amount sought as a matter of discretion, in any event, for the following reasons.
193 The funder submitted that it "funded large legal costs and disbursements, provided security for costs, and was exposed to significant risks including the risk of substantial adverse costs orders. The proceedings were complex, and could not have been brought without Galactic's funding. That funding has permitted the parties to reach a conditional settlement of $98 million, and will result in the establishment of a fund for the benefit of the representative applicants and group members". So much may be accepted, and was not disputed by the contradictor.
194 The funder further submitted that an order that it be paid an amount equal to 25% of the settlement sum, being $24.5 million (25% of $98 million) should be made in the exercise of the court's discretion, first and principally because "the amount of remuneration sought … has been held to be towards the 'middle of the range of rates offered or accepted by funders for class actions in Australia'" (citing Asirifi at [25]). The submission continued:
The empirical studies conducted by Professor Vince Morabito [Professor Vince Morabito, "An Evidence-Based Approach to Class Action Reform in Australia: Common Fund Orders, Funding Fees and Reimbursement Payment" (January 2019); Professor Vince Morabito, "Remuneration to Litigation Funders in the Post-Money Max Era (14 October 2020)] an independent expert in the area, show that there is a generally consistent pattern of common fund orders being made at around this level of remuneration. There is no suggestion that matters have changed since Professor Morabito's studies, and there no reason to depart from that analysis. Common fund orders made in recent proceedings are consistent with this level of remuneration. For example:
(a) in Kuterba v Sirtex Medical Limited (No 3) [2019] FCA 1374, the funder's remuneration was 25% of the gross settlement sum;
(b) in Clime Capital Limited v UGL Pty Limited [2020] FCA 66, the funder's remuneration was 22.5% of the gross settlement sum;
(c) in Webster (Trustee) v Murray Goulburn Co-Operative Co Limited (No 4) [2020] FCA 1053, the funder's remuneration was 23% of the gross settlement sum;
(d) in Uren v RMBL Investments Limited (No 2) [2020] FCA 647, the funder's remuneration was 25% of the gross settlement sum;
(e) in Court v Spotless Group Holdings Limited [2020] FCA 1730, the funder's remuneration was 22.5% of the settlement sum (net of costs); and
(f) in Asirifi, the funder's remuneration was 25% of the gross settlement sum.
The percentage sought also represents a discount from the rate initially agreed between Galactic and the solicitors for the applicants. The initial agreement (for group members who entered into a litigation funding agreement with Galactic) was for Galactic to charge a 35% funders premium [citing Mr Schulman's first affidavit sworn 21 October 2021 at [11]].
195 I do not accept the funder's submission that a funding commission should be determined principally by reference to a fixed or "benchmark" percentage of a settlement sum.
196 It is no doubt the case that funding commissions should avoid hindsight bias, and should be approved at levels that are commercially realistic, and which properly reflect the costs and risks taken by the funder. See, eg, Money Max Int Pty Ltd v QBE Insurance Group Ltd (2016) 245 FCR 191 at 210 [82] (Murphy, Gleeson and Beach JJ).
197 Here, however, the funder did not adduce any sufficient evidence as to how it assessed its risk at the time it made its investment and committed to fund the proceedings.
198 The funder relied on the evidence given by Mr Imlay at [87]-[132] of his 13 October 2021 affidavit that group members had been provided with information as to the existing funding arrangements (for those who had entered into litigation funding agreements) and with notice about a possible application for a common fund order by Galactic. The funder relied in particular on Mr Imlay's evidence that:
(a) from time to time, the solicitors for the applicants caused bulletins to be issued to franchisees who had retained them and published on their website, which explained that the funder's premium would be 35%, and the intention to seek a common fund order;
(b) between December 2017 and 2019, the solicitors for the applicants received inquiries from current and former 7-Eleven franchisees concerning the proceedings and typically provided the iteration of the funding agreement then in use and explained the effect of the funding agreement and the intention to seek a common fund order at the conclusion of the proceedings;
(c) between about 5 December 2017 and 25 December 2019, the various iterations of the funding agreement included a clause to the effect that the lead applicants would, if instructed, apply to the court to seek a common fund order; and
(d) at a series of meetings on 22 March 2018, Mr Imlay explained that Galactic would seek a common fund order. Similar statements were made by Mr Levitt at a "Town Hall" meeting held in Brisbane on 8 May 2018, and at meetings with franchisees in Melbourne.
199 The funder also relied on the fact that there were very few objections to the funding commission from group members, and that to the extent objections had been lodged (in the end, there were 8 in all), they could be disregarded. I was provided with a document entitled "Aide memoire of objections to funding commission". It was marked Exhibit MFI4. It is not necessary to set out the contents of it. I accept the funder's submission that, for the reasons it gave in that document, each of the objections may properly be disregarded because they are inconsequential.
200 The funder submitted, and I agree that the facts establish, that group members have been provided both with information about the existing funding commission arrangements (for those who have entered into litigation funding agreements) and the intention to apply for a common fund order, and that they had no substantive objection to the information or the intention to apply for a common fund order.
201 The contradictor accepted, and I agree, that prima facie the security for costs it furnished, the considerable litigation risks it assumed, its adverse costs exposure and the large legal costs it has expended in financing the group proceedings, are all considerations that warrant a substantial funding commission reward to Galactic. But as he also said, "[a]t the same time, the range of what is 'substantial' is broad and a funding payment to Galactic of $10 million (profit), as an example only, would still be apt to be characterised as a substantial and handsome reward for the risks it has assumed".
202 Mr Schulman gave evidence in a confidential affidavit dated 1 February 2022 the effect of which included that he believed, based on what Mr Levitt had told him, that courts in Australia regularly made common fund orders. It may be accepted that this evidence would be a factor that would weigh in favour of making a CFO if the court had power to make one. Compare Hall v Pitcher Partners (a firm) [2022] FCA 1524 at [9] (Beach J).
203 I now turn to the competing expert evidence.
204 The funder adduced evidence, in the form of an expert report dated 2 February 2022, from Mr Greg Houston, a founding Partner of the economic consulting firm HoustonKemp, with over 30 years' experience in "the economic analysis of markets". The contradictor called Mr Sean McGing, who operates the consulting firm McGing Advisory & Actuarial. He is an actuary and an expert in assessing financial rates of return. His expert report was dated 25 March 2022.
205 Mr Houston was asked to address three questions:
(1) What is the range of common fund orders that are made by the Courts in the Australian market?
(2) What is the range of return on investment for litigation funders?
(3) If the court does make a common fund order in the sum of 25%, what is the return on investment for Galactic?
206 Mr Houston's evidence was only referred to fleetingly by counsel for the funder in closing oral submissions, and it was not relied upon in support of any particular proposition. It was of no assistance to the task at hand, because, apart from anything else, Mr Houston had assumed the appropriateness of a common fund order of 25% of the settlement sum.
207 But in any event, Mr Houston's evidence was not expert evidence, and it was irrelevant. Evidence from Mr Houston along the same lines was adduced by the funder who had provided funding in Bolitho v Banksia Securities Ltd (No 18) (remitter) [2021] VSC 666. The learned judge who heard that settlement approval application (John Dixon J) explained in detail why Mr Houston's evidence in that case was inadmissible on both those grounds. Those reasons included that:
(1) He failed to reason from those assumptions to the opinion that he expressed so as to reveal his opinion to be based upon relevant specialised knowledge ([1926]);
(2) His reasoning was in places that of a lawyer, not an economist ([1926]);
(3) He failed to identify a path of reasoning from his training, qualifications and experience as an economist to a methodology that enabled an assessment of a fair and reasonable funding commission ([1930]);
(4) He did not demonstrate that he drew on properly based specialised knowledge when identifying a litigation funding market ([1930]);
(5) His reasoning seemed to adopt his instructing solicitor's self-serving assumption that settlement approval decisions in earlier court decisions were evidence of the market for funding commissions ([1935(a)]).
208 No effort was made before me by the funder in these proceedings to explain why the gist of that reasoning is not applicable here.
209 Further, and more substantively, as Mr McGing said, a reasonable return should not be determined as a percentage of settlement, including for the following reasons:
A percentage of settlement provided to the litigation funder does not explicitly consider what the litigation funder actually put in and when. This approach may not align the interests of litigation funder and plaintiff. There are no underlying financial principles in the determination of the percentage of settlement amount that splits the balance between the litigation funder and the plaintiff.
…
Targeting a percentage of settlement amount is inappropriate for determining a reasonable rate of return as it is inconsistent with investment and insurance principles of assessing risk vs return on capital invested and amount at risk, as the amount of return is unknown and not directly related to the capital required or at risk.
210 I therefore have no regard to Mr Houston's evidence.
211 Mr McGing expressed his opinion on the approach to determining a fair and reasonable return that a return should be "linked strongly to the level of funding it provides, together with the time horizon and level of risk undertaken". The "fundamental principle" underlying his opinion was that a fair and reasonable return for a funder should be driven by "inputs" specific to that funder. Mr McGing applied principles which are generally accepted in the investments and insurance environments, which he viewed as suitable in determining a return for a litigation funder.
212 In an investment environment, the core inputs that Mr McGing said drive the level of return an investor sees as fair and reasonable are: (i) the amounts of capital invested, held (notionally or physically) for amounts potentially at risk, and depleted to cover costs/expenses specifically attributable to the investment; (ii) the time horizon over which any capital is invested and/or subject to risk; and (iii) the risk undertaken over the time horizon. Mr McGing opined that the interaction of these elements determines the output for an investor - a fair and reasonable investment return, including return of the capital invested. Investors associate low levels of risk with low potential investment returns, and high levels of risk with high potential investment returns, and will make their assessment at the time of making a particular investment, although subsequent events will determine the actual investment returns. Mr McGing identified two measures of investment return - the internal rate of return, which he said was the most commonly used measure of investment performance in financial markets, and return on investment (or return on invested capital), which is a simpler measure than the internal rate of return but which does not consider time as part of measuring performance.
213 In an insurance environment, Mr McGing opined that the core inputs that drive the level of return that an insurer sees as fair and reasonable are the amounts of: (i) insurance/protection for the amount of loss at risk; (ii) risk undertaken; (iii) expected claims to be paid; and (iv) expenses. Again, it was the interaction of these elements that determine the output for an insurer - a fair and reasonable insurance premium, incorporating the profit and risk margin. And again, insurers associate low/high levels of risk with low/high levels of insurance premiums, and will form their views at the time of taking or not taking an insurance contract, although the actual payout will be determined by subsequent events. Mr McGing referred to the suitable return for an insurer as the "notional insurance premium", being the suitable amount for an insurer to receive to meet the risks it is taking on, is a premium that is based on the best estimate probability of the loss occurring, and allows for the uncertainty around that best estimate, reflecting the size of the entity, and a profit margin.
214 Mr McGing said that the application of these investment and insurance principles is a fundamentally sound approach to determine a fair and reasonable return for a litigation funder, and that the inputs for a funder are the funding, or promise of funding, it provides. The output will be the amount of the return, including a refund of capital at risk actually invested, minus any deductions. Mr McGing also identified a range of other "specific inputs applicable to litigation funding", including specialist "insurance-type risks" and "investment risks" undertaken by the funder which would affect the notional insurance premium and investment returns, as well as inputs relevant to determining the capital invested and the time that the capital is at risk.
215 Using the principles identified in his report, Mr McGing then calculated a notional insurance premium and required investment return, and calculated a fair and reasonable return for the funder as a percentage of capital at risk. These calculations were made in relation to four separate categories of capital invested: (i) legal fees incurred before settlement; (ii) legal fees incurred after settlement; (iii) adverse costs and related security; and (iv) the funder's expenses for running the case. Relevantly, a "central reasonable key assumption" upon which those central estimates were based was that the probability of losing any invested capital committed before the date of settlement was 15 per cent (with a "reasonable range" being 10 to 20 per cent).
216 As I have said, Mr McGing also expressed the view that a reasonable return should not be determined as a percentage figure of the total settlement sum, as this does not take account of the range of inputs relevant to a particular proceedings.
217 The funder did not call any evidence about its return on invested capital or the rate of return on equity that a funder might reasonably expect given the level of risk it has assumed. As the contradictor correctly observed "[t]he inputs that drove Galactic's initial investment decision to finance the proceedings are left unexplained and opaque".
218 The funder primarily relied on Mr Schulman's testimony in his second affidavit sworn 1 February 2022 at [35] that in deciding to fund the proceeding, he took into account various opinions of counsel as to prospects of success. Those opinions were in evidence. They were confidential. It is not, however, to breach that confidentiality to say that, in general terms, counsel said that the proposed causes of action had reasonable prospects of success and the like. The only other evidence adduced by the funder in relation to this investment decision was in Mr Schulman's first affidavit sworn 21 October 2021, in which he described the factors which he considered in arriving at the 35% funder's premium and said that he agreed to fund the proceedings "on this basis". However, while this evidence explains some of the factors that Mr Schulman (and the funder) considered when deciding to fund the proceedings, it is only in relation to the funder's premium to be included in the funding agreements, rather than the return on investment.
219 Mr Finch did not dispute the relevance of Mr McGing's evidence, or his general methodology. His main point was that a 10-20% risk factor was not an appropriate number for him to assume, because that would mean that at the top end of the range (that is, there is a 20% risk of losing the invested capital) one would be assuming that the proceeding the subject of the funding or proposed funding had prospects of success of 80%, which it was submitted in this case at least (and generally) would be an unreasonable critical assumption to make in assessing a reasonable rate of return and thus an appropriate rate of commission.
220 Mr Houston and Mr McGing filed a joint statement (Exhibit F5) with a series of agreed tables which set out the implied fair and reasonable litigation funding commission adopting the methodology proposed by Mr McGing, but altering the instructed assumption as to the risk of loss during the pre‐settlement period of 15 per cent to show the implied fair and reasonable litigation funding commission if this risk is assumed to be 20, 25, 30, 35 and 40 per cent (while holding all other assumptions constant). That produced so-called "implied funding commissions" of $18.7 million, $20.3 million, $22 million, $24.1 million, $26.4 million and $29.1 million, respectively.
221 The funder's submissions about what factors are relevant to a court in determining the amount of a settlement CFO were put at in a broad brush way. As Mr Finch put it in the course of his oral submissions:
As a reality check, let's look at Mr McGing's approach, rather than a top down approach which is roughly what's wrong with percentages on outcome, and do a bottom up approach, which is, again, roughly what Mr McGing is doing. And my point about that is, as I've said before, if one does that and inserts a more reasonable integer for the risk, acknowledging the different type of investment that this is, then one gets a reality check of, well, that gives a roughly similar amount or sometimes more than the number I first thought of. That is a legitimate, with respect, perfectly proper exercise. And that's the exercise, in short, that I'm going to ask your Honour to do.
…
Now, again … with respect, I think exactly the sort of thing that your Honour was talking about earlier, which is, you have to look at the dollars in question. If the settlement is $10, it's a very different consideration than if the settlement is $100 billion. And percentages, whilst they might be the door through which one walks to get to the debate, are not the answer to the debate. They're simply how you get to the numbers being debated. And one then applies your Honour's discretion to the number which is thrown up by the various analyses.
And - as I say, I keep using the shorthand expression - the easy expression, "reality check", but I - we mean what we say when we say that. That's shorthand for your Honour's discretionary exercise in saying, well, that's how you got there. That's - they were promised something like a 25 per cent return. In fact, most people who signed up - I think everybody who signed up to funding agreements, signed up to 35 per cent. Is 25 per cent a fair return when you do the numbers? Well, let's look at the gross numbers. It's 24.5 million in a settlement of 98. Measure that against the amount of costs paid. Well, they're almost $20 million. They're the costs actually paid so far. So it's only a little bit above what the costs actually paid are.
222 Mr Finch continued:
Secondly, we say that no reasoned criticism can be made or has been made of the actual dollar amount, $24.5 million. Nobody has stood up to say that, in the context of this matter, a $98 million matter, where our costs actually paid approached 20 million on our own side and our cost risk must have been exactly - at least double that, or more - that the return of 24.5 [million] is self-evidently not reasonable, where that - as I say, that return is less than the potential adverse exposure that they might have had if they had lost, and, indeed, perhaps half of the exposure they might have had, and one doesn't need to do any particularly arcane playing with numbers.
If we assume in round figures that our costs which we have paid approach 20 million - and let's assume that the other side's bill was going to be as much again as that - then one comes quickly to a potential exposure of our own loss, the other side's costs, 40 million plus.
…
Secondly, 25 per cent, assuming that we're not talking about a billion dollar settlement, seems to be a reasonable rate of return which is very often rewarded to funders in the Federal Court. That's a relevant factor as well, because, as Mr McGing conceded, it is relevant to take into account, even using his bottom-up approach, the legitimate expectations of the investor.
223 As to Exhibit F5, Mr Finch submitted:
[W]hen your Honour comes to write a judgment, in the event, and to the extent, that it is of utility to refer to it at all, exhibit F5 was a document I asked the two experts in their hot tub to create. If one left Mr McGing's approach effectively as it was - and I will shorthand that as a bottom-up approach, in a way that your Honour understands me, I think - but altering the risk from a 15 per cent chance of loss to chances higher than that. And being the sort of very conservative person I am, I asked him to stop at a 40 per cent chance of loss. One can imagine the figure might well be higher, but at that level, using his own approach, the implied funding commission ended up at $29 million.
So that is more than what is the return on the 25 per cent on gross. That's the effective utility of that report. It's only two pages long. In due course, your Honour can look at that. But that's the purpose for which it is relevant; that is, if we look, as a reality check, at the dollars produced by 25 per cent on gross another way, look at it bottom-up, adopt everything Mr McGing says, but recognising this is a different type of investment, recognising that that inflates the risk from 15 per cent as a reasonable chance of loss to something higher than that, then you only need to change it a few notches, and the amount quickly goes above what we're seeking anyway.
Now, there's no magic in that. But again, your Honour can say, well, all of those chances of loss are within the realms of possibility, given what I have seen both as to what he was looking forward to from the start, and to what counsel, looking back, thought. And without retrying the case or trying the case for the first time in my own mind, none of those numbers is outside the bounds of the sorts of numbers that the experts have plugged into Mr McGing's analysis, and the outcome of that analysis shows me that we are in the right ballpark in terms of outcome. That is, even if you do that analysis from an entirely different standpoint, we don't get numbers which are wildly different.
224 So much may be accepted, but in my view, however, the following important matters would weigh heavily in the balance against the making of a CFO in the sum of $24.5 million.
225 First, as Moshinsky J said in Fisher (trustee for the Tramik Super Fund Trust) v Vocus Group Ltd (No 2) [2020] FCA 579 at [73], the majority in Brewster "express[ed] strong reasons for favouring a funding equalisation order over a common fund order. When the observations of Gordon J are added to those of the plurality, a majority of the High Court have indicated strong reasons favouring the making of a funding equalisation order over a common fund order".
226 Secondly, even if the applicant's late filed evidence in Mr Imlay's 12 May 2022 affidavit were admitted into evidence (something I decline to agree to - see infra at [307]-[310]), and I accepted (which I do not) that the funder is entitled to total commission of $13.72 million under the funding agreements with the group members, a CFO order in the sum of $24.5 million would mean that the funder would be entitled to receive something approaching double what it would be entitled to under the funding agreements. It is not at all clear to me what rationale would justify the difference ($10.78 million) being paid to the funder, other than under some sort of "windfall gain" theory. (As Moshinsky J said in Vocus at [74], a differential of that order of magnitude goes further than is necessary to deal with the problem of "free riding").
227 And, again as in Vocus at [74], although it can readily be accepted in this case that the funder played an important role in funding the litigation, and thus exposed itself to litigation risk for the benefit of group members, the applicant's proposal for a FEO recognises that role and the risks it took.
228 Mr Levitt gave evidence about book building activities being conducted between mid-2018 and June 2021 in his confidential affidavit sworn on 14 October 2021. The gist of that evidence related to a belief that he held that 7-Eleven had at relevant times endeavoured in some fashion or another to "pressure" franchisees not to "sign up" to the class action, or to seek legal advice from Levitt Robinson, and that such supposed pressure made book building efforts more difficult than they otherwise would be.
229 But there was no evidence before me of that in fact occurring (as distinct from Mr Levitt's state of mind about the matter), so the point goes nowhere.
230 As the contradictor submitted, "the fact of the matter is that the funder and Levitt Robinson signed up as many franchisees as were willing to enter into funding agreements with Galactic. There were sustained efforts including after Brewster, which was 18 months prior to the settlement. So this is not a case where Galactic's contractual rights are insufficient by reason of the proceedings settling early, or it not having a sufficient opportunity to sign up as many group members as possible".
231 The contradictor also submitted, and I agree, that Levitt Robinson had "adequate opportunity over a considerable period of time to build and sign up", and despite the fact that "every effort was made … the best they could do was 38 per cent [of the number of stores operated by group members] … and that's simply no reason to depart from the prima facie contractual position".
232 The contradictor continued, and again I agree:
Now, the funder may not like that result, it may wish that more signed up, no doubt it would, but that's not a reason for making a CFO instead of a … FEO.
Now, so our overall submission, then, on the discretion issue, is that your Honour's squarely in the kind of territory of Moshinsky J in Vocus, informed by the strong remarks of the … majority of the High Court in Brewster, and that the appropriate order to make here is one pegged to the valid and binding contractual rights of the funder, as aggregated and then spread across the group through an FEO.