The litigation funders underwriting Australia's booming class actions industry have hit a setback, with the High Court deciding today that the common fund orders they use at the start of the class action to confirm its economics are not actually available in the two major forums for class actions, the Federal Court or NSW Supreme Court (BMW Australia Ltd v Brewster; Westpac Banking Corporation v Lenthall [2019] HCA 45).

This returns them to the pre-2016 position, but you should be cautious in assuming that this will be a permanent setback. That's because the Court made its decision on interpretation of the legislation (which can always be amended) and Victoria is introducing a scheme which provides for plaintiffs' lawyers to charge contingency fees in class actions and for those fees to be shared among all group members.

The economics of class actions: book building, free riders, common fund orders and funding equalisation orders

Pre-2016, class actions would be commenced after the funder and law firm engaged in "book building" ie. searching out potential class members via websites, social media or advertisement – an exercise which costs money. As class members who did not sign up to the funding agreement ("unfunded members") could also be covered by any award at the end of a successful class action, funders and funded members also had to deal with the classic free rider problem. Courts could address this at the end of a successful action by making a funding equalisation order, which allows deductions from unfunded members, which would then be distributed to funded members.

By contrast, common fund orders have often been made at the beginning of the proceedings, and have the effect of requiring all group members to pay a funding commission to the litigation funder, including those who do not sign up to the funding agreement. This is said to address two problems: the economic viability of the class action, and free riders.

Why the High Court has said the Federal Court and NSW Supreme Court cannot make common fund orders

The Federal Court has to date made common fund orders under section 33ZF of the Federal Court of Australia Act 1976 (Cth). The equivalent provision in the NSW Supreme Court is section 183 of the Civil Procedure Act 2005 (NSW); both allow a court in a class action to make any order it thinks appropriate or necessary to ensure that justice is done in the proceeding.

The High Court this morning said that while the power in these sections is wide, it only extends to doing justice between the parties, not between the parties and any third parties. While a common fund order might be the difference between the viability and non-viability of a class action from a litigation funder's perspective (and hence whether the class members can proceed at all), the Court said that this is not the problem the sections are designed to solve. The legislation in fact recognises that not all class actions will be an efficient and effective means of dealing with all claims. It also does not give clear guidance to the court on how to craft a common fund order fairly, which can be a challenge given the uncertainty at the start of proceedings. And the problem of free riders can be dealt with at the end of the proceedings.

Is this the end of common fund orders, or the start of something new?

As it stands, the decision brings both the Federal Court and NSW Supreme Court back to the pre-2016 position. Litigation funders will have to come to court with the economic viability already established, instead of using a common fund order to make the action viable – which will probably slow, but not stop, Australia's lively class action industry.

There are, however, three other factors at play here.

First, the High Court's decision was based on its interpretation of the legislation, so it is possible that the Federal and NSW Governments could amend the Acts to restore common fund orders. Given the finely balanced nature of the schemes in the two Acts, this would require more consideration than a simple amendment, and so we do not think this would be likely to happen soon.

Secondly, the appellants also raised constitutional objections to common fund orders. Although the dissenting Justices Gageler and Edelman rejected these arguments, the majority did not address them, so they are still live and could be used to challenge any statutory amendment.

Finally, Victoria is overhauling its class action regime to allow contingency fees to be charged by lawyers to all group members – which could simply draw future proceedings into the Victorian Supreme Court, albeit that the Victorian model does not on its face provide a place for litigation funders.