Flip Out Thornton Pty Ltd v Flip Out - Trampoline Arena Franchises Pty Ltd

JUDGMENT

1. The plaintiffs were franchisees, and related individuals, of the "Flip Out" franchise system. They set up trampoline centres at Thornton and Orange using this system.
2. The first to fourth defendants, who I will call "the Franchisor Defendants", were the franchisor and related entities.
3. The fifth and seventh defendants were, in substances, recruiters for the Flip Out franchise system. I will refer to them as "the Recruitment Defendants".
4. The plaintiffs commenced these proceedings on 31 October 2019 alleging, as against the Franchisor Defendants, various breaches of contract and the making of representations said to be misleading or deceptive for the purpose of s 18 of the Australian Consumer Law. [1] As against the Recruitment Defendants, the plaintiffs allege the making of various allegedly misleading or deceptive representations.
5. The proceedings are well advanced. All lay and expert evidence has been served. The expert evidence relates to the question of whether the trampolines provided by the Franchisor Defendants comply with relevant Australian standards. There is also expert accounting evidence. The next step in the proceedings is discovery.
6. The defendants seek further security for their costs from the corporate plaintiffs. [2] The Franchisor Defendants seek $520,520. The Recruitment Defendants seek $420,000.
7. The plaintiffs do not dispute that the threshold test for the making of an order for security has been met, namely, that there is reason to believe that they will be unable to meet an adverse costs order. Mr Byrne, who appeared for the plaintiffs accepted, and indeed actively submitted, that the plaintiffs have no assets or access to funds. That is, of course, always a strong factor in favour of ordering security, although not the end of the enquiry.
8. The defendants have made two earlier applications for security. On 21 February 2020, Hammerschlag J [3] ordered that the corporate plaintiffs provide $50,000 security for each of the Franchisor Defendants and the Recruitment Defendants. A further application for security by the Franchisor Defendants and the Recruitment Defendants was compromised when, on 2 May 2022, Ball J, by consent, ordered that the plaintiffs provide further security of $100,000 in relation to the Franchisor Defendants and $66,000 in relation to the Recruitment Defendants.
9. Thus, the total amount of security provided to date is $266,000.
10. All of the security was provided by a litigation funder, Galactic Sports Litigation LLC ("the Funder"). I return to the position of the Funder below.

The plaintiffs' prospects of success

1. A factor to be taken into account on an application for security for costs is the likely strength of the plaintiffs' case.
2. Mr Lazarus SC, who appeared with Mr Foran for the Franchisor Defendants, accepted that the plaintiffs' claim was bona fide, not frivolous and that there appeared to be real issues to be tried.
3. However, they are not the only matters to consider. Thus, in Live Board Holdings Pty Ltd v Cody Live Pty Ltd, [4] the Court of Appeal said: "… it is true that in many cases it will not be possible to form a meaningful view as to the strength or weakness of a plaintiff's claim for the purposes of an application for security for costs. Such applications are ordinarily brought before pleadings are closed and evidence filed. But that does not mean that, for example, there may never be a case in which a court can be satisfied that an impecunious corporate plaintiff has prima facie a very strong case, such as to inform the exercise of discretion on an application for security for costs. The starting point in the exercise of discretion is the legislation conferring the power, not some gloss upon it." [5]
4. Mr Byrne, who appeared for the plaintiffs, submitted that now that the lay and expert evidence has been served, that evidence reveals "the strength of the plaintiffs' claims" and that "the primary contentious issues that will need to be determined by the Court at trial are the quantum of the plaintiffs' recoverable losses" and the issues that will arise in relation to a cross-claim that the Franchisor Defendants have brought against the Recruitment Defendants.
5. Mr Byrne pointed out that, to a large extent, the representations upon which the plaintiffs rely are in writing.
6. Mr Byrne also pointed out that it appears to be common ground between the plaintiffs' expert and the Franchisor Defendants' expert that the trampoline centres' equipment supplied by the Franchisor Defendants did not comply with the relevant Australian standards.
7. Mr Byrne also pointed to documents which, when taken alone, might suggest that the Franchisor Defendants were aware of the inaccuracy of the representations made as to establishment costs associated with the trampoline centres.
8. On the other hand, Mr Lazarus submitted that issues will arise in relation to whether the critical representations can be attributed to the Franchisor Defendants in circumstances where they were, by and large, made by the Recruitment Defendants; there being a live issue as to whether the Recruitment Defendants were acting as agents of the Franchisor Defendants.
9. Mr Lazarus also submitted that the evidence will show that the plaintiffs signed agreements through which they disclaimed reliance on the very type of pre-contractual representations on which they now rely; and that the first and third defendants did so after receiving legal advice.
10. Mr Lazarus also submitted that there will be difficulties for the plaintiffs in relation to the reliance case. Mr Lazarus said that, for example, the plaintiffs' submissions suggest that they relied upon representations concerning establishment costs of $400,000, and yet the evidence will show that the first and third plaintiffs were provided with a specific estimate for establishment costs of $560,000, prior to entering into the franchise agreements. Mr Lazarus said that the evidence will also establish that the plaintiffs' businesses failed because of sustained trading losses caused by poor management and matters that routinely affect new businesses, such as overcapitalisation and the establishment of competitor centres nearby.
11. It would not be appropriate for me to endeavour to engage in any detailed analysis of these matters and, in any event, I am not in a position to do so.
12. The best that can be said at this stage is that the plaintiffs appear to have a reasonably arguable case but that the outcome of the proceedings is impossible to predict, even in the broadest way.

Attribution

1. Mr Byrne also submitted that there was a basis to conclude that the plaintiffs' adverse financial circumstances can be attributed to the conduct of which they complain in the proceedings and that, in particular, their current financial position can be said to have been caused by the acquisition of equipment to which the experts, it is said, agree was not compliant with the relevant Australian standards.
2. The difficulty with this submission is that this question has already been dealt with by Hammerschlag J [6] in his reasons for ordering security on 21 April 2020. His Honour concluded: "The Court is not satisfied that their impecuniosity is to be attributed to the conduct of the defendants. Their losses were trading losses."
3. I do not propose to revisit that finding on this, the third application for security for costs, made in the proceedings.

Stultification

1. The bulk of the parties' submissions were directed to the question of whether an order for security would stultify proceedings. The potential stultification of proceedings is recognised to be a powerful factor to be taken into account when considering whether an order for security is appropriate, but does not automatically lead to refusal to make an order. [7]
2. Mr Lazarus accepted that the evidence establishes that the plaintiffs are not themselves in a financial position to provide security.
3. The focus of the parties' submissions was directed to the questions of whether: 1. the plaintiffs have demonstrated that the parties who allegedly stand behind and stand to benefit from this litigation, namely the Funder, and the plaintiffs' solicitors, Levitt Robinson, are relevantly unable to provide security; and 2. in the events that have transpired in the last few months, the proceedings are like to be stultified in any event.

The Funding Agreements

1. By Commercial Litigation Funding Agreements ("the Funding Agreements") made between the Funder, the plaintiffs and their solicitor, Mr Stewart Levitt, on 11 March 2019 and 1 April 2019, [8] the Funder agreed to fund these proceedings on the basis that it would be entitled to 35% of the value of all amounts received by the plaintiffs from final resolution of these proceedings, whether by settlement, judgment or otherwise.
2. There were terms of the Funding Agreements that the Funder would: 1. advance funds for legal costs, and in respect of any order for security for costs "pursuant to the indemnity hereby given by the Funder to [the plaintiffs] against their primary liability to pay Legal Costs of [Levitt Robinson]"; [9] 2. pay any amount ordered for security for costs; [10] and 3. indemnify the plaintiffs against any costs orders. [11]
3. Although the Funding Agreements were entered into prior to the commencement of these proceedings, and were thus on foot at the time of each of the applications made by the defendants for security for costs, the plaintiff did not disclose to the defendants, nor to the Court, that the proceedings were externally funded until June of this year.
4. This is notwithstanding the fact that a submission was made to Hammerschlag J that the making of an order for security would stultify the proceedings because "the directors standing behind a corporate plaintiff are without means". The submissions made no reference to the Funder.
5. Further, shortly before Hammerschlag J considered the question of security, one of the defendants served on the plaintiffs a Notice to Produce seeking documents concerning the engagement of Levitt Robinson including "any agreements for third-party funding" of the proceedings. A senior associate from Levitt Robinson stated in an email to the Court, copied to the legal advisers of the defendants, that: "The First Plaintiff informed the Court that only one document required production, being a standard cost agreement and retainer with Levitt Robinson, with the Land he was seeking to claim privilege over".
6. The Funding Agreements were not produced nor disclosed.
7. The fact that the proceedings were then being externally funded should have been disclosed to the Court. I will, following publication of these reasons, require that those responsible give the Court an explanation for the failure to make this disclosure to the Court.
8. The Funder's involvement was revealed to the defendants when Mr Levitt wrote to the solicitor for the Franchisor Defendants on 28 June 2023, responding to a Notice to Produce served on the plaintiffs in aid of the current application for security for costs, enclosing a copy of the Funding Agreements and stating: "A dispute has arisen between [the Funder] and Levitt Robinson in relation to the budget for this matter. The Funder has refused to continue to fund the proceedings."
9. The nature of that dispute "in relation to the budget for this matter" has not been disclosed to the Court. I infer that the dispute relates either to the fees charged to date by Mr Levitt or some forecast Mr Levitt has made concerning future costs. I see no reason to conclude that the dispute relates in any way to the manner in which the defendants are conducting the proceedings.
10. In that regard, an employee of Levitt Robinson has deposed that, as at 30 June 2023: 1. the Funder had advanced $191,654.36 for disbursements and $16,020.26 for Levitt Robinson's costs; and 2. Levitt Robinson has unpaid fees, that is work in progress, of $774,041.24, and unpaid disbursements of $32,686.18.
11. On 9 August 2023 Mr Levitt swore an affidavit in which he stated: "On 3 July 2023, [Levitt Robinson] and I agreed with [the Funder], the litigation funder who has to date been funding these proceedings, that: a. at [the Funder's] election, the Court will be told either that [the Funder] will not continue to fund the litigation or that [the Funder] will post further security for costs; and b. that [the Funder] was urgently required to communicate its position to [Levitt Robinson] to convey to the funded clients and to the Court, and if it declined or failed to do so, [the Funder] would forfeit its entitlement to a funder's commission. On two occasions, I have requested that the election be made by [the Funder] as a matter of urgency, being on 21 July 2023 and then again on 3 August 2023. At 12:15pm on 9 August 2023, [the Funder] informed me via email that it has elected to cease funding these proceedings."
12. The solicitors for the Franchisor Defendants sought copies of the documents referred to.
13. The earliest document produced is an email from Mr Levitt to Mr Frederick Shulman at the Funder in New York, which email has been redacted "for privilege".
14. It appears that it was the contents of that letter that caused Mr Levitt to say on 28 June 2023 that a dispute had arisen between Levitt Robinson and the Funder "in relation to the budget for this matter" and that "the Funder has refused to continue to fund the proceedings".
15. A further document produced was a "Deed of Compromise" made on 3 July 2023 between Mr Levitt and the Funder. The plaintiffs are not parties to that document.
16. That document recited that: "[The Funder] and [Levitt Robinson] have had a longstanding association, which has involved [Levitt Robinson] acting as lawyer for [the Funder] and the Clients whose litigation or prospective litigation has been funded by [the Funder]."
17. The document included a "Schedule of Matter Balances" said to be generated from Levitt Robinson's software as at 6 June 2023, showing "WIP" [12] and "Unbilled Disbs" totalling $716,907.69. [13]
18. Clause 1.7.2(a) of the 3 July 2023 Deed of Compromise recorded that it was agreed that "no payment will be sought" from the Funder for WIP and disbursements.
19. The clause continued: "[Levitt Robinson] agrees that [the Funder] shall have a preference as against [Levitt Robinson] with respect to reimbursement of monies outlaid by [the Funder] pursuant to the funding agreements with the Clients."
20. This was evidently a reference to the security of $266,000 that the Funder has paid in these proceedings, as well as the further amount of $191,654.36 that the Funder has paid in respect of disbursements [14] .
21. Clause 1.7.2(b) provided: "The Parties further agree that at [the Funder's] election, the Court will be told either that [the Funder] will not continue to fund the litigation or that [the Funder] will post further security for costs, if a further order for security for costs is made. It is further agreed that as between [Levitt Robinson] and the [F]under, if [the Funder] does elect to post further security for costs as ordered by the Court, the Funding Agreement will continue in effect and [the Funder] will remain entitled to receive its contractual funder's premium. [The Funder] must urgently communicate its position to [Levitt Robinson] to convey to the funded clients and to the Court."
22. On 21 July 2023, Mr Levitt wrote to a representative of the Funder: "It follows that unless [the Funder] elects to post further security, it will forfeit its rights under the Funding Agreement, other than to recover its outlays and security already posted, if we settle adequately or win. The election needs to be made now."
23. Further documents produced in response to the Franchisor Defendants' solicitor's request revealed the following.
24. On 9 August 2023, the Funder's Director of Litigation - Australia wrote to Levitt Robinson: "As you are aware, pursuant to clause 1.7.2(b) of the [D]eed of [C]ompromise, [the Funder] is required to inform Levitt Robinson as to whether it will cease funding the Flip Out matter (being Levitt Robinson matter numbers 190046 and 190059) (Flip Out Matter) or that it will post further security for costs if a security for costs order is made. We hereby inform you that [the Funder] elects to cease funding the Flip Out Matter. I understand that to date [the Funder] has paid $266,000 into Court by way of security for costs for the Flip Out Matter. I note that the [D]eed of [C]ompromise is silent as to what will happen to this security. In this respect, I expect that it is not in dispute that should an alternate funder be sourced for the Flip Out Matter, [the Funder] will be reimbursed for the $266,000 it has paid into Court and for the costs and disbursements paid to date."
25. On 29 August 2023, Mr Levitt replied to that email: "In the circumstances, and noting that clauses 1.3 and 3.1 of the Deed dated 3 July 2023 ("Deed") expressly acknowledged that the relationships and legal and ethical obligations owed to third parties remain unaffected, [the Funder's] election amounts at law to a repudiation of the Funding Agreements listed at items B and J on Schedule 2.2 to the Deed, namely the Funding Agreements between [the Funder] and [the plaintiffs]. We are instructed by those named parties to the Funding Agreements to accept the repudiations, thereby bringing the Funding Agreements to an end."
26. Although Mr Lazarus submitted that in these circumstances the status of the Funding Agreements was "uncertain", it appears to me that, for the purposes of this application, I should proceed upon the basis that the Funding Agreements are now considered by the plaintiffs and the Funder to be at an end. It appears from the communication at [52] that the Funder accepts that, in these circumstances, it is no longer entitled to recover 35% of any proceeds of this litigation. It may be that it has an accrued right to recover from any such proceeds the funds that it has actually advanced to date, including the monies paid into court for security.

Ongoing funding of the proceedings

1. In the meantime, the solicitors for the Franchisor Defendants wrote to Levitt Robinson: "Your clients submit that an order for further security will bring the proceedings to an end, in circumstances where a very significant body of lay and expert evidence has already been prepared. However, they do not disclose how they can continue to fund the litigation in the absence of a litigation funder. The Costs Agreement with [the third plaintiff] dated 20 February 2019 and the Costs Agreement with [the fourth plaintiff] dated 1 April 2019 do not (on our review) provide for a contingency fee arrangement. If there are more recent costs agreements, please provide them as a matter of urgency."
2. Levitt Robinson replied on 30 August 2023: "Funding of the litigation With respect to the balance of your letter we confirm that there are no other documents to produce concerning arrangements for the payment of legal fees." (Emphasis in original.)
3. It is common ground that, as the Franchisor Defendants' solicitors observed in their letter of 28 August 2023, the costs agreement between the plaintiffs and Levitt Robinson did not provide for a contingency fee arrangement.

The position of the Funder and Levitt Robinson as parties standing behind and likely to benefit from the litigation

1. Both the Funder and Levitt Robinson stand to benefit from the successful prosecution of these proceedings. In that event, the Funder will likely be entitled to recover the amounts it has advanced for costs, disbursements and security. There would also be a fund from which Levitt Robinson could be paid its outstanding fees and disbursements.
2. The starting point is the familiar statement in Bell Wholesale Co Limited v Gates Export Corporation [15] that parties in the position of the plaintiffs who seek to resist paying security on the basis that to do so would stultify proceedings must show that "those who stand behind [them] and who would benefit from litigation if it is successful … are also without means". [16]
3. In that regard, the focus is on inability and not mere unwillingness of such persons to provide security. [17]
4. My attention was drawn to the observations of Hodgson JA in Porter v Gordian Runoff Limited & Anor [18] that, in the particular circumstances of that case, "a factor in favour of an order for security [was] that the appellant's legal advisors were owed substantial amounts of money giving them a 'large stake' in the success of the appeal". [19] The relevance of that factor is "that lawyers with such an interest may reasonably be expected to provide some financial support for the prosecution of" the proceedings. [20]
5. However, the fact that such a person is "reasonably unwilling" to provide security is also a "factor that would be taken into account". [21] If a plaintiff demonstrates that a party that stands to benefit from the litigation has a "rationally and practically reasonable unwillingness … to give financial support" to the litigation, this is also "something it may be taken into account in the exercise of the undoubtedly wide discretion with respect to security for costs". [22]
6. I cannot see how I could conclude that it would be reasonable to expect that the Funder would now provide further security for costs. Unlike the position considered by Bond J [23] in Equititrust Limited v Tucker, [24] to which my attention was directed by Mr Lazarus, the Funder no longer funds the proceedings; the plaintiffs have purported to terminate the Funding Agreement.
7. It is less clear whether the plaintiffs have shown that it would not be reasonable for Mr Levitt to provide security.
8. However, it is also appropriate to take into account "commercial impracticability" in the sense of "any practically insurmountable difficulty facing the plaintiff in gaining any advantage from such financial capacity as may exist in other persons". [25]
9. Here, the matter of "commercial impracticability" is that the plaintiffs appear to have no "commercially practicable" ability to "gain any advantage" from what I assume is the "ability" of the Funder to provide security. The Funder is a Wyoming corporation whose registered office is in New York. And the plaintiffs have purported to terminate the Funding Agreement.
10. Mr Levitt has stated that he has no obligation to, and is not prepared to provide security for the plaintiffs costs. He may have the financial ability to provide "financial support" to the plaintiffs. But I cannot see how the plaintiffs could compel him to do so.
11. I am not, in those circumstances, persuaded that any ability of the Funder and Mr Levitt to provide security is, itself, a factor weighing in favour of the ordering of security.
12. However, I see there being a wider reason why security should be ordered.
13. These proceedings have been, from the outset, funded.
14. That fact was not made known to the defendants until June of this year.
15. Had the plaintiffs earlier revealed the involvement of the Funder, it appears to me to be likely, if not certain, that the defendants would have adopted a different and more robust position in relation to the two applications for security that they have made.
16. I also think reasonable to infer that the plaintiffs would not have been in a position to embark on this litigation, which was from the outset likely to be protracted and complicated, had they not had external funding.
17. Thus, the proceedings have only been brought about and prosecuted because, until very recently, they were externally funded.
18. It is only for that reason that the plaintiffs had been able to provide security to date; which security would not otherwise have been able to be provided.
19. The Court is more ready to order security where a non-party with no interest in the vindication of the particular rights agitated in the proceedings, such as the Funder, stands to benefit from the proceedings. [26]
20. The Court should also be more ready to order security where a party without the means to meet an adverse cost order brings proceedings supported by a litigation funder, but where the Funder for some reason not associated with the manner in which the defendants having conducted of the proceedings, withdraws that support. Or, where the funding agreement is, for some reason, again not associated with the manner in which the defendants have conducted the proceedings, brought to an end.
21. That is the position here. As I have explained, the dispute between Mr Levitt and the Funder evidently relates to what Mr Levitt described in his 28 June 2023 letter as the "budget for this matter".
22. Now that the proceedings, at least for the moment, are unfunded, it appears to me that it would be most unjust to allow the proceedings to continue without giving the defendants the protection of appropriate security.

Stultification in any event

1. Further, it appears clear enough that the plaintiffs will be unable to fund their further costs in the proceedings unless an alternative funder is located or unless Mr Levitt is prepared to continue to act for the plaintiffs on a speculative basis. The exchange of correspondence to which I have referred at [55] and [56] above suggests that he is not. That suggests that, unless another Funder is located, the proceedings will be stultified in any event.
2. That provides a further reason why an order for security should now be made.
3. That may well provide an incentive to the plaintiffs and Mr Levitt to locate an alternative funder.
4. However that may be, I am persuaded that I should order that the plaintiffs provide further security for costs.

Quantum

1. The defendants have, in the usual way, given evidence through their solicitor of the future costs that the defendants are likely to incur in the proceedings and the amount of costs likely to be recoverable on assessment assuming success on the defendants' part.
2. The plaintiffs have adduced no evidence in response.
3. The defendants' estimates appear to me to be reasonable and, as Mr Lazarus pointed out, are very much less than the cost that the plaintiffs have incurred thus far. I accept those figures.

Conclusion

1. I propose to order the security sought. The parties should bring in short minutes to give effect to these reasons.

Endnotes

1. Competition and Consumer Act 2010 (Cth), Sch 2 - Australian Consumer Law.
2. Pursuant to Uniform Civil Procedure Rules 2005 (NSW) r 42.21.
3. As the Chief Judge in Equity then was.
4. [2017] NSWCA 302.
5. At [98] (Bathurst CJ, Leeming JA and Barrett AJA).
6. As the Chief Judge in Equity then was.
7. Live Board Holdings Pty Ltd v Cody Live Pty Ltd (supra) at [92] and [96] (Bathurst CJ, Leeming JA and Barrett AJA).
8. There were different agreements for the first and third plaintiffs, and the second and fourth plaintiffs. There is no material difference between the agreements.
9. Clause 2.1.
10. Clause 7.
11. Clause 10.1.
12. Work in Progress.
13. Cf the figures at [38] above.
14. See [38] above
15. (1984) 2 FCR 1; [1984] FCA 34.
16. At [4] (Sheppard, Morling and Neaves JJ).
17. See, for example, LRSM Enterprise Pty Ltd v Zurich Australian Insurance Limited [2014] NSWCA 88 at [36] (Barrett JA; McColl and Macfarlan JJA agreeing).
18. [2004] NSWCA 69.
19. Adopting the summary of Meagher JA in Murray John Carter v Ian Mehmet t/as ATF Ian G Mehmet Testamentary Trust [2021] NSWCA 32 at [34].
20. Ibid; a different view about these matters has been expressed in the Federal Court of Australia: see General Trade Industries Pty Limited (in liquidation) v AGL Energy Limited [2023] FCA 556 at [84] to [141], particularly [107] (Derrington J).
21. Dae Boong International Co Pty Ltd v Gray [2009] NSWCA 11 at [26] (Hodgson JA).
22. LRSM Enterprise Pty Ltd v Zurich Australian Insurance Limited (supra) at [43] (Barrett JA; McColl and Macfarlan JJA agreeing).
23. As his Honour then was.
24. [2020] QSC 269.
25. LRSM Enterprise Pty Ltd v Zurich Australian Insurance Limited (supra) at [38] (Barrett JA; McColl and Macfarlan JJA agreeing).
26. Green (as liquidator of Arimco Mining Pty Ltd) v CGU Insurance Ltd [2008] NSWCA 148 at [51] (Hodgson JA).

Amendments 09 October 2023 - Dates on coversheet amended DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 09 October 2023