Australia’s High Court has struck down a key class action funding option in a ruling dubbed the most significant of the decade for the booming litigation funding industry by legal commentators.

The court yesterday (4 December) ruled that courts do not have the power to make common fund orders (CFOs), which are issued at the outset of proceedings and guarantee litigation funders a share of successful class action pay-outs. 

In so doing, they overturned the decisions made by a historic joint sitting of the Full Federal Court and the NSW Court of Appeal, which backed CFOs in February.

The court was ruling on two cases: Australian bank Westpac is facing a class action over insurance sales by its financial advisers and BMW is being sued over faulty airbags.

Free riders

CFOs have become a common way for litigation funders to get class actions off the ground because they overcome the so-called ‘free rider’ problem, whereby affected individuals benefit from a pay-out without signing up to a funding agreement.

Although the courts do have the power to issue equalisation orders at the end of proceedings, which allow deductions from unfunded members' awards, litigation funders argue that CFOs increase access to justice by making it easier to start class actions.

The High Court disagreed. It said: ‘Considerations of text, context and purpose all point to the conclusion that it is not appropriate or necessary to ensure that justice is done in a representative proceeding for a court to promote the prosecution of the proceeding by the making of a CFO.’

Commentators agreed that the order would have a dampening effect on class actions, returning Australia to the position before 2016, when the first CFO was made.

‘Litigation funders will have to resort to a funding model that includes “book building” to secure remuneration,’ said a Norton Rose Fulbright briefing. ‘Book building is a time-consuming process – litigation funders have to identify, contact and sign up as many class action group members as possible to funding agreements. Given the additional effort and expense, many class action claims may not be as attractive commercially for litigation funders.’

Rule changes 

There remains, however, the possibility that Australia’s legislators will take steps to bring CFOs back to life.

‘It remains to be seen whether the High Court’s decision will bring forward a Government response to the Australian Law Reform Commission’s (ALRC’s) recommendation last year that courts be given the express statutory power to make CFOs,’ noted Gilbert + Tobin in its commentary. 

The firm added: ‘We may also see state governments moving more quickly to legalise contingency fees in the context of class actions, as recommended by the ALRC last year, and on the back of the introduction of such legislation in the Victorian Parliament last week.’