Is a 25% funding rate on the gross settlement fair and reasonable in the present case?
37 Litigation is inherently risky, as is the funding of it. Even more so when the funded case is a large, complex, commercial class action in which it is difficult to accurately assess the liability and quantum risks at the stage when the funding commitment is made. One way a well-run litigation funder will address the inherent uncertainties in such a business is by having a portfolio of cases so as to spread the risk. IMF's 2019 Annual Report shows that it funds many different types of cases, in a variety of jurisdictions both in Australia and overseas, and using different funding models. The cases that it funds carry different levels of risk for IMF and deliver different rates of return. Even in a particular category of cases, such as shareholder class actions in Australia, tab 64 shows that there is a great deal of variability in the rates of return it achieved in different shareholder or investor class actions, with some high returns, some modest returns, and some low returns, although no losses. A competent commercial litigation funder operating in a competitive market will price the risk it takes on in a particular case having regard to the knowledge that returns are variable between cases, with good, intermediate and bad results, including outright losses, to be expected over time.
38 In a settlement approval application the Court must focus on whether the funding commission in that case is fair and reasonable, so as to avoid the funder making excessive or disproportionate profits at the expense of class members. Thus the Court may consider the funder's rate of return in that case. But while it is the interests of class members in that case which are relevant, at least in relation to commercial litigation funders, the Court may also take into account the funder's rate of return over time as that may assist in understanding the range of fair and reasonable funding rates. Having regard to its confidentiality I will not disclose the average rate of return which IMF has achieved in shareholder and investor class actions over time, but it is not in my view manifestly excessive or unreasonable.
39 IMF's FY19 Annual Report shows that:
(a) in the period between IMF's public listing in 2001 and 30 June 2019, IMF has commenced and completed the funding of 192 cases;
(b) of those cases, 171 were won or settled, and 21 resulted in unsuccessful court verdicts;
(c) the successful cases generated total recoveries of $2.39 billion;
(d) of the $2.39 billion recovered, $1.49 billion was remitted to the funded party or parties (being 62.34% of the total amount recovered), with the balance of $897 million going to IMF;
(e) the average duration of completed cases was 2.6 years;
(f) IMF had an 89% success rate in relation to completed cases; and
(g) IMF's average return on invested capital is 1.3 times.
40 I doubt that anybody would argue that a rate of return of 1.3 times or 130% is excessive in a risky, illiquid and essentially unsecured investment class like litigation funding. But the 1.3 times return is IMF's general rate of return on its entire portfolio of cases both in and outside of Australia. Tab 64 shows that, while the rates of return achieved by IMF in funded shareholder class actions in Australia are quite variable, it has achieved a significantly better average rate of return in such cases compared with its average rate of return across its entire portfolio.
41 IMF does not assert confidentiality in relation to its estimated returns in the present case. The updated version of tab 64 shows the return that will be achieved in the present case calculated by reference to different funding rates, as follows:
(a) 32.1% (as initially sought) means that IMF's return would be 6.32 times, or 632%;
(b) 28% (as IMF later offered) means that IMF's return would be 5.62 times, or 562%; and
(c) 25% (which is now the rate for consideration) means that IMF's return would be 5.02 times or 502%.
The return of 5.02 times achieved on 25% funding rate is almost four times more than IMF's average return on investment across its entire portfolio in and outside of Australia, and is also in excess of IMF's average rate of return on funded shareholder or investor class actions in Australia.
42 In Endeavour River No 1 at [25]-[31] I set out the reasons for my preliminary view that a funding rate of 32.1% of the gross settlement was excessive and that 25% of the gross settlement may be fair and reasonable in the particular circumstances of the case. I said the following (at [31):
The circumstances in the present case include that:
(a) IMF agreed to fund the proceeding only after being provided with the detailed funding proposal which disclosed a high level of case preparation (for that early stage), a well-grounded case theory, and high levels of interest from unit holders. Each of those matters is relevant to the level of risk that IMF took on by agreeing to fund the case;
(b) IMF agreed to fund the proceeding relatively late in the day. Prior to commencement of the proceeding:
(i) the Webster proceeding raising the same or similar allegations was already on foot against MG from May 2016;
(ii) on 15 December 2017 MG was ordered to pay a penalty of $650,000 in an ASIC prosecution for a contravention of the continuous disclosure regime. The Court made a declaration in the following terms:
The defendant contravened section 674(2) of the Corporations Act 2001 (Cth) ("the Act") on and from 22 March 2016 continuing until 8:48 am on 27 April 2016 by failing to notify the Australian Securities Exchange ("the ASX") that circumstances had arisen a consequence of which was that Murray Goulburn Co-operate Co. Limited was unlikely to achieve the forecast Available Weighted Average Southern Region Farmgate Milk Price for the financial year ending 30 June 2016 ("FY16") of $5.60 per kilogram of milk solids and full-year net profit after tax for FY16 of appropriately $63 million as stated by MG and MGRE in their ASX announcements dated 29 February 2016 titled "Murray Goulburn - Half Year Financial Results News Release" and "Murray Goulburn - Half Year Financial Results Presentation".
: see Australian Securities & Investments Commission, in the matter of MG Responsible Entity Limited v MG Responsible Entity Limited [2017] FCA 1531; and
(iii) MG publicly stated that it was putting aside $195 million to deal with potential costs from class action litigation.
(c) I have had the benefit of reading the funding proposal and Counsel's Opinion in relation to the risks associated with the litigation. It is important to avoid hindsight bias, but they allow some insight into the liability and quantum risks associated with the litigation at the time IMF agreed to provide funding, including any risk that IMF may be required to meet an adverse costs order;
(d) the legal costs and disbursements that IMF incurred in the proceeding are relatively low for litigation of this type and size. To the date of the approval application IMF paid $1.86 million in costs and disbursements (and except for an outstanding invoice, the balance is conditional on a successful outcome). The proposed funding commission is more than seven times that amount;
(e) nor was IMF out of pocket for a lengthy period for the monies it paid for costs. The proceeding was filed on 16 August 2018 and settled in-principle at a mediation on 30 May 2019. I estimate that IMF outlaid the costs over a period of approximately 12-14 months, and upon settlement approval it would be reimbursed those monies;
(f) the quantum of any exposure to adverse costs liability which IMF took on was reduced because the case was to be heard together with the Webster proceeding. If the case was unsuccessful at trial it is unlikely that IMF would have borne the burden of adverse costs by itself. Most likely it would only be liable for approximately half of any adverse costs order made because the other half would be paid by the unsuccessful applicant or funder of the Webster proceeding;
(g) IMF was not required to advance security for costs in cash, as it did so by way of a deed poll;
(h) this is a matter that requires further evidence, and it is appropriate to be cautious in comparing headline funding rates, but it appears that funding rates lower than 30% and 35% were available in 2018. In Re Banksia Securities Ltd (Rec & Mgr Apptd) (in liq) (No 2) [2018] VSC 47 at [90] Croft J reviewed the gross and net funding rates approved in six class actions in 2016 and 2017, which ranged from 17% to 27% of the gross settlement and 26% to 45% of the net settlement (excluding one idiosyncratic case which can be excluded for the purposes of comparison: see Blairgowrie at [156]). Perera v GetSwift Limited [2018] FCA 732; (2018) 263 FCR 1 at [68]-[73], handed down on 23 May 2018, records that three competing litigation funders offered to fund the proceeding at: (a) the lesser of 25% of net proceeds or 22.5% of gross proceeds; (b) 10% of gross proceeds before an early date, 20% of gross proceeds until 42 days prior to the initial trial and 30% thereafter; and (c) the lesser of 2.2 the costs of the proceeding (or 2.8 times depending upon when a successful resolution of the case occurs) and 20% of net proceeds.
43 The second Bowman affidavit responded to each of these matters, and I have taken those responses into account. It is unnecessary to detail Mr Bowman's responses, and in any event some of them are confidential. Overall, I consider the material provides no support for the funding rate of 32.1% that IMF initially claimed. That funding rate would have provided a return on investment of 632%, in a case in which the risks did not justify such a return, derived over an investment period of less than eighteen months.
44 A funding rate of 25% which provides a return of 502% may also be argued to be too high. The evidence however shows that the case faced risks on liability, and a risk that the quantum of any settlement or judgment would not be sufficient to justify the expense and risk of the proceeding and yet provide class members with a reasonable level of recovery. IMF took on the case with liability and quantum risks at a time when it was uncertain that the case would be successful, and if successful uncertain as to the quantum of any settlement or judgment, with budgeted legal costs of $6.26 million and an exposure to substantial adverse costs.
45 Ultimately the case settled very much in the upper end of the range, and with substantially lower expenditure on legal costs than IMF anticipated would be necessary. That drove the rate of return which, at a 25% funding rate, is above IMF's average rate of return for such cases. But hindsight bias must be avoided, and IMF took on the risks when the outcome on liability and quantum was uncertain. Further, over the period from post August 2001 to November 2019 while IMF achieved high rates of return in some shareholder class actions and lesser or poor rates of return in others, over time it achieved an average rate of return which I would not describe as excessive or unreasonable. That is, the good results for IMF were balanced by some poor results.
46 To reiterate what I said in Endeavour River No 1 at [29], in Money Max the Full Court said (at [82]) that it expected that the courts:
…will approve funding commission rates that avoid excessive or disproportionate charges to class members but which recognise the important role of litigation funding in providing access to justice, are commercially realistic and properly reflect the costs and risks taken by the funder, and which avoid hindsight bias.
The approval of funding commission rates should not become a "race to the bottom" and funding rates should provide an appropriate reward for the risk undertaken by a litigation funder: Kuterba v Sirtex Medical Limited (No 3) [2019] FCA 1374 at [12] (Beach J).
47 Having regard to the matters above, the relevant considerations set out in Money Max at [80]; the various matters I set out in Endeavour River No 1 at [31] and Mr Bowman's responses to those matters; the variability in IMF's rate of return in shareholder class actions; and its average rate of return in shareholder class actions over time, I consider a 25% funding rate is within the range of what is a fair and reasonable funding commission.. It provides IMF a funding commission of $10.5 million, which constitutes a reduction of almost $3 million on the funding commission it sought, and to which class members had agreed.