Courts have no power to order all members of a class action to pay a portion of their recoveries to a litigation funder, Australia's High Court has ruled, in a decision some lawyers say is a major blow to the litigation funding industry.

Lawyers said the decision to reject so-called common fund orders will slow down, and potentially reduce, the number of class actions that are filed in Australia.

The decision will require funders to sign up many members of a class action before they file, known as a bookbuild, said John Emmerig, a highly respected litigation attorney in Australia who heads the class action defence practice for Australia and Asia at Jones Day.

"That's a good thing. It should mean that more considered decisions will be made before class actions are filed," Emmerig said. "It should help put a brake on the sometimes frenzied rush to the registry by competing funded class groups that we have seen occur in a number of class actions."

But common fund orders did serve a purpose: they increased access to justice for people who otherwise could not afford to make use of the courts and resulted in lower funding costs to class members, said Andrew Watson, national head of class actions at Maurice Blackburn Lawyers, Australia's most active class action plaintiffs firm. And the decision will not bring an end to class actions, he said.

"Class actions will continue to run and to play an important role in holding corporations to account and allowing people who otherwise would not be able to take on those corporations to access justice and compensation," Watson said in a statement.

A common fund order is a court order that obliges all group members in a class action to pay a share of a litigation funder's commission out of the proceeds, regardless of whether or not they have signed an agreement with the funder and the firm bringing the action. They have become commonplace since Australia's Federal Court held in 2016 that it had the power to grant common fund orders.

Before common fund orders became popular, litigation funders and plaintiffs firms had to go through the expensive exercise of a bookbuild to sign up enough plaintiffs to ensure they have a viable case.

The High Court's decision stemmed from two separate class actions where common fund orders had been granted. The defendants in those cases filed appeals.

In a matter involving potentially more than 200,000 members, each with a small claim, BMW was being sued by motorists for installing faulty Takata airbags in their cars. The plaintiffs obtained a common fund order, requiring that litigation funder Regency Funding be paid its legal costs from any resolution and 25% of what remains.

The other class action involved consumers who purchased life insurance from Westpac bank and alleged the bank's financial advisers breached their statutory and fiduciary obligations to advise them of equivalent or more advantageous insurance policies offered by third‑party insurers. The group included more than 80,000 members, each with a claim for damages in the range of $2,000 to $15,000.

A common fund order stipulated the litigation funder, JustKapital Litigation Pty Ltd., receive the lesser of three times the total expenditure on legal costs and associated expenses or 25% of the resolution. JustKapital did not return calls for comment.

After the ruling, shares in Australia's largest class action funder, IMF Bentham, fell 12 cents to A$3.68 (US$2.52).

Litigation funders and bookbuilding

But Bentham's chief investment officer in Australia, Tania Sulan, said the ruling would actually have a positive impact on the company relative to its rivals because it has experience in bookbuilds and has returned many billions of dollars to class action members using bookbuilds.

"I think for those funders that had a bookbuilding capacity, like IMF [Bentham], it is back to business like how we used to do things," she said, adding that the firm has been listed since 2001. "We're very well placed to continue funding class actions on that model."

However, Sulan conceded that it would slow down how quickly a class action would be filed.

"The bookbuild will take some time. It's quite different to being able to find a cause of the cause of action, find a representative plaintiff and then just file at court," she said. "It is a cost to our business and that was how we modelled that business from the start and then common fund orders came along."

Even with an open class subject to a common fund order, the litigation funder still had to identify and contact members of the class, she noted.

The ruling means that defenders of litigation will lose the certainty that comes with common fund orders, said Susanna Taylor, Sydney-based senior investment manager at funder Litigation Capital Management. Once a matter with a common fund order is finalised, no other plaintiffs can take action, but with a closed class there is nothing to stop new plaintiffs from launching their own class actions after the initial class action has been finalised, she explained.

Taylor said class action funding was only part of her firm's business and like IMF Bentham, it will go back to bookbuilds.

The additional cost, she noted, "may make it more difficult for those funds that don't have the capacity to do a bookbuild to bring a class action".

Rise in class actions

Australia has seen a steep rise in class actions in recent years, thanks to actions against banks and investment funds arising from last year's inquiry into the financial sector, an increase in employment class actions alleging underpayment of workers, and shareholder class actions around adequate disclosure of market-sensitive information.

Additionally, foreign litigation funders have come into the market and competed with local funders.

In making common fund orders, lower courts had relied on state and federal laws stating the court may make any order "that the court thinks appropriate or necessary to ensure that justice is done". But the High Court found this did not extend to the interests of litigation funders pursuing a case for commercial reasons.

The decision emphasises that the interests of class action members are the predominant consideration when courts assess justice questions around class actions, said Ruth Overington, a partner advising on class action defences at Anglo-Australian law firm Herbert Smith Freehills.

Overington expects fewer class actions as a result of the court's ruling. "The bookbuild process will mean less class actions being pursued," she said, noting that bookbuilds will require firms to incur costs.

In addition, the litigation funder might not sign up sufficient numbers of class members,  perhaps because their individual losses are very small. "I think in those sorts of cases, the funder will look at the return question [before deciding] whether or not to proceed," Overington said.

Contingency fees

Maurice Blackburn's Watson said it is now up to governments to pass laws allowing common fund orders. He also noted that contingency fees are another way forward.

Law firms in Australia are currently banned from charging contingency fees. However, the government of the state of Victoria, where Melbourne is located, recently introduced a bill in parliament to allow the practice. Additionally, a review by the Australian Law Reform Commission earlier this year recommended contingency fees be allowed.

Under the proposed law in Victoria, the contingency fee order would apply across the entire class of a class action regardless of whether a class member had signed up with the firm funding the action.

Herbert Smith Freehills' Overington said this would mean contingency fees would operate like common fund orders, raising the question of whether the government of Victoria will rethink its proposed law in the wake of the High Court decision.

"If it does proceed, we'll see Victoria become a more attractive place for class actions to be commenced because not only will contingency fees be available, you'll be able to recover from the entire group," she said.