In a decision that has significant ramifications for class action litigation in Australia, the Full Court of the Federal Court1 on 14 June 2013 overturned an earlier Federal Court decision2 and granted security for costs to the respondents in the Willmott Forests class action.
The costs burden imposed on respondents defending class actions is almost invariably substantial, running into the tens of millions of dollars.
Where representative proceedings are successful, group members, litigation funders and their lawyers stand to benefit. Where such proceedings are successfully defended, however, respondents face the unappetising prospect of being entitled to recover costs only from the representative applicant, whose capacity to meet a costs order of many millions of dollars may be limited.
There are strong competing policy considerations at play here, which were evident both in the trial judge's decision and on appeal, but the decision is consistent with earlier Full Federal Court authority.3 In our view, it strikes an appropriate balance between the interests of group members seeking to pursue legitimate claims, and respondents upon whom a heavy costs burden falls when defending these sorts of proceedings
In late 2010, the Willmott Forests Group collapsed, one of a string of high profile agribusiness collapses - think Great Southern, Timbercorp, Enviroinvest and Forestry Enterprises Australia. Receivers and managers were appointed and the Willmott companies were ultimately placed into liquidation.
Armed with instructions from several hundred investor clients in a number of schemes issued by Willmott Forests over the period 2007 to 2009, Macpherson + Kelley Lawyers (M+K) commenced three related class actions on behalf of group members just prior to Christmas 2011. The class actions were commenced against two Willmott companies and their directors, the Commonwealth Bank (CBA) and another financier, MIS Funding No 1 Pty Ltd (MIS).
The CBA and MIS provided finance to investors in connection with their investments in the various Willmott schemes. The financiers had previously commenced a number of debt recovery actions against individual investors and those investors, also represented by M+K, had issued counterclaims joining the Willmott companies and their directors. When the class action commenced, the individual actions were stayed.
In April 2012, the respondents issued applications seeking security for costs. In support of the security applications, uncontested evidence was filed as to the amount of party-party costs that would likely be awarded if the respondents were successful. Those estimates totalled $7.38m to $9.2m.
Federal Court Act and relevant case law
The general rule, under section 43(1A)4 of the Federal Court of Australia Act 1976 (Cth) (Act), is that when dealing with representative proceedings commenced under Part IVA, the Court may not award costs against a person on whose behalf the proceeding has been commenced.
However, section 33ZG(c)(v) of the Act provides that nothing in Part IVA affects the operation of any law relating to security for costs. Section 56 of the Act5 permits the Court to make an order for security for costs against an applicant.
The interplay between these sections has been examined before. In Bray v F Hoffman-La Roche Ltd6 Justices Carr and Finkelstein held that there was no overlap between sections 33ZG(c)(v) and 43(1A) and that security orders should not be regarded as operating to remove the costs immunity provided in section 43(1A).
In determining whether to award security for costs against group members, their Honours were of the view that it would be necessary to examine the characteristics of the group members, their financial circumstances and whether an order for security might stifle the proceedings. Justice Finkelstein held:7
Dependent upon the type of proceeding, the represented group may be quite diverse. The group may include corporations as well as natural persons. The members of the group, whether corporate or not, may be rich or poor. In my view, the characteristics of the group should be taken into account on an application for security. Accordingly, if there is still a rule that an order for security should not be made against an impecunious natural person … the rule may have little application to many class actions.
Justice Finkelstein also dealt in general terms with the issues arising when persons stand behind named applicants, in the sense that they fund the litigation. In dealing with this category his Honour made several observations concerning a representative applicant's solicitors, who stand to benefit from the action, especially as regards the additional fee charged if the action is successful. This issue was canvassed in Willmott.
Federal Court judgment
In the Federal Court judgment, handed down on 17 December 2012, Justice Murphy considered the various factors summarised by Justice Hollingworth in Hall v Finance Direct Ltd8 and refused the application for security on the following grounds.
This was not a case where the representative applicants were 'persons of straw', although there was no doubt they would not be in any position to fund the security sought.
A survey conducted by M+K indicated that a large proportion of the known group members were unable or unwilling to contribute to a pooling arrangement so as to share the burden of any security order.
The bona fides of the applicants' claims was not in doubt.
There was significant difficulty for a Court in assessing prospects of success in a class action however these proceedings disclosed arguable causes of action, with reasonable prospects of success.
The proceedings against the lenders were to a significant degree defensive in nature because the investors who borrowed from the CBA and MIS were being sued or were about to be sued for recovery of the loan moneys that were due. The proceedings against the Willmott companies and the Directors were interwoven with the proceeding against the lenders and had defensive elements.
The vast majority of group members were individual investors.
There was no evidence of a commercial litigation funder standing behind the applicants. M+K, while acting under a conditional costs agreement, was not a litigation funder and did not stand behind the litigation or relevantly stand to benefit from it.
Had the case been commenced not as a representative proceeding, it would be highly unlikely that security would be ordered against the individual applicants.
Taking into account the survey evidence adduced by M+K on behalf of the applicants, an order for security would stifle the applicants and group members from pursuing their arguable claims.
It is apparent from the judgment that the evidence concerning the financial circumstances of group members comprised evidence filed by the lenders as to the average net assets and average gross annual incomes of several hundred investors who borrowed money. That evidence disclosed that, at least in the case of those investors, they had average net assets in excess of $1.3 million and average gross annual incomes in excess of $230,000.
The applicants filed evidence of a random sample of 50 known members of the group. Those investors were evidently asked about their willingness to contribute $20,000 to $30,000 towards a financial pool and whether they would continue to participate in the actions. In response, 80% of them said they could not afford to pay security and 65% said they would no longer participate. Justice Murphy accepted this evidence.
His Honour noted that, until Bray, section 43(1A) of the Act gave some protection to group members on the basis that their immunity from costs exposure would be removed, in practical terms, if they were forced to provide security. His Honour was of the view that "the practical effect of the respondents' arguments … is that this important protection is removed, or at least substantially reduced."
Full Federal Court judgment
The Full Federal Court allowed the respondents' appeals, ordering that the applicants provide security for costs in an amount directed by the primary judge and remitted the matter to Justice Murphy for that purpose.
Chief Justice Allsop and Justice Middleton delivered a joint judgment and Justice Jessup delivered a separate judgment. Chief Justice Allsop and Justice Middleton:
Were of the view that the factors considered by Justice Murphy, emanating from Justice Hollingworth's decision in Hall , were legitimate matters to consider in an application of this nature.
Found no fault with Justice Murphy's analysis of a number of the factors relevant to the grant of security, including: the impecuniosity of the applicants; the bona fides of the proceedings; the question whether the proceedings were defensive or offensive; and the question whether M+K were relevantly standing behind the litigation in the sense that they stood to gain an additional fee in the event of success.
Found, however, that the trial judge's approach to section 43(1A) was erroneous insofar as it was inconsistent with Bray. Their Honours held that Justice Murphy failed to undertake the balancing exercise mandated in Bray which involved also taking into account the risks of injustice to the respondents in having no real capacity to recover the costs of a successful defence. There was nothing in Justice Murphy’s judgment which gave express consideration to the risks of the respondents being out of pocket to the tune of up to $9.2m should the applicants not succeed.
Agreed that an important consideration was whether an order for security would stifle the Part IVA proceeding, even if it would leave members of the group free to pursue their rights individually. Justice Murphy erred however in his approach to the issue of stultification and his conclusion that a grant of security would stifle the litigation. Their Honours held that Justice Murphy was wrong to regard the availability of litigation funding as being "of little relevance". They considered it not unreasonable to have regard to the question what, if anything, had been done by the applicants to secure litigation funding. No evidence was adduced in this regard and their Honours considered that in the absence of such evidence, Justice Murphy ought not to have concluded that the proceedings would be stifled by an order for security.
Held that it was not wrong for Justice Murphy to take into account the subject of the unwillingness of group members to contribute to security as a relevant factor, but that unwillingness was not in itself determinative. The reasonableness of group members’ unwillingness to contribute must, however, be considered when determining what is fair and reasonable.
Found that it was appropriate for security to be ordered but that did not necessarily mean the order should be for the full amount of the recoverable costs. Their Honours held that that question should be dealt with on a "robust and practical basis, taking into account the resources of the parties, the appropriateness of some security and balancing the respective interests of the parties."
Held that the broad evaluation of the question of security in class actions should be attended by many considerations including the desire not to undermine parliament’s intention to provide broad access to justice for common aspects of multiple claims and the element of fairness to respondents who may be at risk of having impecunious applicants as their only source of recovery of costs in the event of a successful defence.
Justice Jessup delivered a separate judgment. His Honour was highly critical of the survey evidence relied upon by Justice Murphy in supporting the finding that an order for security would stultify the proceedings. His Honour held that Justice Murphy erred in accepting such evidence because the survey was not calculated to elicit information about the objective financial circumstances of the group members represented by M+K. Rather, the questions were subjective and required judgments to be made by group members that ought instead to have been made by the Court.
His Honour considered there to be force in the criticism by the Directors that the concept of individual group members being able to afford security is a subjective concept that means different things to different people. In other words, the survey was not a sufficiently objective picture of the means of the people concerned.
His Honour was also critical of Justice Murphy's disregard of the prospect of the applicants being able to secure litigation funding.
This case is important for respondents to representative proceedings brought under Part IV of the Act or the equivalent provisions of Part 4A and potentially also the Supreme Court Act1986 (Vic).
It clarifies the factors that Courts must examine, particularly in a class action context, and the balancing exercise that must be undertaken. Courts in future must expressly take into account the often forgotten, and very significant, cost burden of class action litigation on respondents.
The financial composition of the group will be of crucial importance and it seems likely that survey evidence designed to elicit subjective responses to questions will be open to criticism. Applicants may be obliged to furnish objective evidence as to the financial capacity of group members to meet a security order, particularly where respondents can adduce evidence that group members are persons of substantial means and the investments were in large part tax driven.
While the willingness of group members to contribute to a pool of money will be of relevance, it must be judged against a background of reasonableness, which arguably brings into question their objective individual financial positions. In cases which involve tax driven investment schemes, such as this one, the financial makeup of the group would seem likely to include a high proportion of persons of substantial means. As the Full Court noted, those persons "made a choice of a commercial character to enter arrangements to advance their asset or income position. It seems entirely fair that those standing to benefit from such litigation make a real, but not oppressive, contribution to a fund to secure the costs of the respondents."9
At the very least, the decision will give plaintiff firms reason to pause when considering issuing class actions in the future, particularly where there is no litigation funder.