Supreme Court decision seen as warning for litigation funders
In PricewaterhouseCoopers v Walker,(1) the Supreme Court issued a somewhat controversial decision of significance in the area of litigation funding. The decision contains guidance on the key question of whether a funding agreement (referred to as the 'market standard') amounted to an impermissible assignment of a bare cause of action that would constitute trafficking in litigation. This update considers whether, and to what extent, the decision may be used by defendants seeking to challenge funding agreements.
The decision arose in litigation brought by Property Ventures Limited (In Liquidation) (PVL) and its liquidators against PriceWaterhouseCoopers (PwC), alleging that PwC was in breach of contract and negligent in carrying out its functions as the auditor of PVL and other related companies. As described by the Court of Appeal, the gist of the claim was that, if PwC had done its work competently, the group's insolvency would have become apparent much sooner than it did and significant trading losses could have been avoided.
At the time that proceedings were issued, PVL was in liquidation with debts of approximately NZ$69.3 million (NZ$68.3 million to secured creditors, NZ$311,000 to preferential creditors and NZ$745,000 to unsecured creditors). The liquidators had concluded that PVL had no further realisable assets and that any further realisations could only be through legal action.
The litigation was funded by an agreement between PVL and litigation funder SPF 10 Limited. The relevant terms of the funding agreement were as follows:
- SPF agreed to provide investigative, management and other expertise to assist PVL in pursuing the claims.
- SPF agreed to pay for certain court costs, legal fees, witness and investigator fees, security for costs and adverse cost orders, as it had approved in advance in writing, by way of a loan repayable on settlement or judgment.
- Except for settlement or discontinuance, PVL would make all final decisions in relation to the conduct of the litigation.
- The lawyers representing PVL in the litigation were required to be approved by SFP, to assume a duty of care to SPF in relation to the proceedings and supply SPF with copies of all advice and correspondence.
- Although SPF could ask PVL to make or accept an offer of settlement, PVL was not obliged to act on such a request. SPF was entitled to be present at all settlement meetings and all settlement communications required its approval. PVL could neither accept an offer of settlement nor discontinue proceedings without SPF's prior written consent. If a dispute concerning settlement arose between PVL and SFP, it would be determined by an expert appointed by SPF after consultation with PVL.
- In the event of a settlement or successful outcome in the litigation, PVL would pay SPF all costs associated with the litigation (with interest) and a service fee of up to 42.5% of the resolution sum.
- SPF could terminate its obligations with five working days' notice, thereafter remaining liable only for costs approved to that date.
The funding agreement was conditional on SPF obtaining a first-ranking security interest over PVL's assets. This condition was satisfied when SPF received assignment of a general security agreement in March 2013. PVL had previously been involved in the development of a large site near Queenstown and a wholly owned subsidiary had borrowed a considerable sum from Hanover Finance Limited to finance the development. PVL guaranteed the indebtedness to Hanover by a general security agreement over its assets and undertakings. Hanover subsequently assigned the general security agreement to Allied Farmers Investments Limited, which in turn assigned it to SPF.
Clause 6.3 of the general security agreement provided that, if an event of default occurred (and it was acknowledged that at the time of the litigation a default had occurred), one of the enforcement powers that could be exercised by SPF as assignee was to "bring, defend, submit to arbitration, negotiate, compromise, abandon or settle any claim or proceeding, or make any arrangement or compromise, in relation to the secured property".
The combined effect of the funding agreement and general security agreement meant that, in the event of a settlement or successful outcome in the litigation, SPF would receive:
- its costs associated with the litigation (including interest);
- a service fee of up to 42.5% of the resolution sum; and
- from the remaining proceeds, amounts owed in connection with the general security agreement as first-ranking creditor, before anything would be paid to remaining unsecured creditors.
In the High Court, PwC offered evidence to show that SPF would receive a net return (after its costs of funding the litigation and procuring assignment of the general security agreement) of NZ$319 million from a resolution sum of NZ$334 million, with only NZ$209,000 to be paid to unsecured creditors.
The leading case in the area of litigation funding is the earlier Supreme Court decision in Waterhouse v Contractors Bonding Ltd.(2)
In that case, the court held that it is not the courts' role to:
- act as general regulators of litigation funding arrangements;
- give prior approval to such arrangements; or
- assess the fairness of a funding arrangement as between the funder and the claimant party.
However, the Supreme Court noted that the courts had jurisdiction to stay for abuse of process, and that an impermissible assignment of a bare cause of action, in the light of the torts of maintenance and champerty, could give rise to an abuse of process. In determining whether an arrangement constituted an impermissible assignment, it was necessary to consider:
- the level of control held by the funder;
- the profit share to be taken by the funder; and
- the role of the lawyers acting.
In the present proceeding, PwC had applied for a stay on the basis that the combined effect of the funding and general security agreements was that SPF had effectively taken assignment of PVL's causes of action against PwC. As the causes of action were claims based on a breach of duty of care in tort and contract, and the assignment of such causes of action is not permitted in New Zealand, PwC argued that the litigation amounted to an abuse of process. Other arguments that PwC had raised earlier were not pursued on appeal.
In support of its application, PwC highlighted:
- the likelihood that the proceeds of the claim would accrue to SPF with only a theoretical possibility that unsecured creditors would benefit;
- the high level of control that SPF had in relation to the conduct of the litigation (especially under Clause 6.3 of the general security agreement); and
- the fact that SPF had no prior commercial relationship with PVL.
PVL and the liquidators opposed the application on the basis that there was no assignment of the cause of action; the funding agreement and the general security agreement were two unobjectionable transactions that had occurred in parallel (the general security agreement not being an agreement to which the respondents were even a party). Further, even if there was an assignment of a cause of action, it was ancillary to an assignment of debt and therefore permissible.
Notably, neither party argued that the funding agreement in isolation involved the assignment of a cause of action; PVL's counsel referred to it as the 'market standard'.
The High Court dismissed PwC's application. Its decision was upheld by the Court of Appeal, on the basis that there had been no assignment of a cause of action to SPF, and certainly no bare assignment. In summary, the reasons given were that:
- the funding was not in the form of an assignment, as the liquidator remained the party prosecuting the claim;
- there was no objection to the funding agreement in isolation; SPF would receive funds under the general security agreement as a creditor of PVL and not a litigation funder; and
- in the absence of evidence as to what would be recovered in the litigation and the costs of achieving that recovery, it was impossible to draw the inference that SPF would receive too much relative to its investment in the litigation.
Following the Court of Appeal decision and the argument of a further appeal with leave to the Supreme Court, but before judgment was given by the Supreme Court, the following developments occurred:
- SPF acquired the rights of Dominion Finance Group Limited in connection with debts owed to Dominion that was guaranteed by PVL, including those arising from a general security agreement granted to Dominion by PVL.
- SPF gave the following undertakings:
- it would not rely on Clause 6.3 of the Allied general security agreement; and
- it would pay a proportion of the proceeds of the litigation to the liquidator for the benefit of unsecured creditors of PVL.
- The litigation between the parties was settled.
The court (with the exception of Chief Justice Elias) considered that, despite the settlement, it was appropriate to deliver judgment on the basis that the "appeal involved important issues, on which the court heard full argument".
The majority considered that it was arguable that the combined effect of the funding agreement and the general security agreement constituted an assignment of the bare cause of action pursued by the liquidator against PwC and other defendants. The basis for the argument was that the combination of rights in those documents gave SPF:
- control in a legal sense over the liquidator's claim against PwC (in particular, as a result of Clause 6.3 of the general security agreement); and
- an entitlement to all or substantially all of the proceeds of a successful claim.
However, the majority went on to hold that both concerns were resolved by the undertakings provided by SPF following the Court of Appeal's decision. If the dispute had not settled, the court would have directed SPF and the liquidators to enter into a contractually enforceable document recording the undertakings, which would be filed in the High Court and served on PwC.
Elias's minority view
Elias differed from other members of the court in a number of respects. Contrary to the other members of the court, she took the view that the Supreme Court should deliver no judgment. She said that the case concerned neither a point of statutory interpretation nor a question of law of public interest and was not one where it was necessary to correct an error made by the Court of Appeal. Elias stated that the judgment involved "a one-off dispute concerning particular agreements between the parties, unlikely to arise or present in similar circumstances again".
Elias then traversed the policy of the law in relation to funding agreements. While she acknowledged that litigation funders must be permitted some level of control of proceedings in order to protect their investment, funders should be prevented from taking control "beyond that which is reasonable to protect money actually advanced or committed to by the litigation funder" (Paragraph ).
Elias rejected the analysis of the majority, the lower courts, and the parties in the following respects:
The general security agreement was irrelevant to the issue of whether there had been an assignment of PVL's cause of action against PwC. Elias observed that the assignment of the general security agreement was an assignment from Allied to SPF of a debt owed by PVL. In her view, the only claim that could be brought pursuant to the general security agreement was an action by SPF against PVL to recover that debt. SPF could not rely on Clause 6.3 of the general security agreement to bring or maintain the claim against PWC (not being a claim ancillary to the general security agreement).
It was well arguable that the funding agreement in itself amounted to an impermissible assignment of a bare cause of action. Elias noted at paragraph 131 that:
"The ability of the funder to withdraw from the agreement and the limitation of its provision of funding to the project costs agreed by it in advance in writing in
combination with the control reserved to it to approve settlement or discontinuance provides it with substantial control over the litigation and in particular to require
settlement or discontinuance. Such control arguably allows the claim to be treated as an investment to be maintained to the extent to which it provides a commercial
return to the litigation funder. If so, it is difficult to see that it would not operate as an assignment of the cause of action."
In addition, Elias found another factor which entailed effective surrender of much control of the litigation – namely that, owing to PVL's lack of assets, SPF was "effectively in a position to compel settlement if it is to its commercial advantage and without restriction as to amount even though there is no direct power in the agreement for it to compel Property Ventures to settle".
Elias findings were explicitly provisional because the matter had not been fully argued.
For the reasons set out above, Elias concluded that the Supreme Court should not have given judgment as "it is likely that the effect will be taken to be that the law has been developed beyond Waterhouse even though such development was not the subject of argument".
Even the Supreme Court decision to issue judgment in this case was contentious. Although the majority was of the view that the case involved important issues, both majority and dissenting judgments are clear that there was no intention to extend or alter the law set out earlier in Waterhouse.
It appears that the majority considered that it was necessary to clarify the Waterhouse decision on the question of what might constitute an impermissible assignment of a bare cause of action, possibly taking the view that its intended effect had been misconstrued. In this regard, all Supreme Court members agreed that a party entering into a litigation funding agreement must retain real (rather than illusory) control over the conduct of the claim and a material entitlement to the proceeds of the litigation.
Somewhat ironically (given her stated desire not to develop the law in this area), Elias's decision provides more generalised guidance than the majority. It is possible to derive a broad test, from Paragraph 131 of her decision (set out in full above) – namely, that the court may regard a funding agreement as constituting an assignment of a cause of action where:
- the agreement provides the funder with substantial control over the litigation (particularly to require settlement or discontinuance); and
- control allows the claim to be treated as an investment to be maintained to the extent to which it provides a commercial return to the litigation funder.
This statement might be read together with Elias's comments at Paragraph 122 that, to be objectionable, the control handed over to the litigation funder "must be beyond that which is reasonable to protect money actually advanced or committed to by the litigation funder".
The latest Supreme Court decision suggests that parties entering into litigation funding agreements should take care to ensure that the party bringing the litigation retains significant control over it. The funder's ability to control the proceedings should be limited to what is necessary to protect the funds actually committed by the litigation funder (not to protect or optimise the commercial return to the litigation funder). In addition, a funding agreement that permits the litigation funder to force settlement or discontinuance effectively carries the risk that it may be seen as assuming effective control and therefore constituting a bare assignment of a claim.
Although no further appeal lies, there has been a further development. The litigation funder has lodged a complaint with the judicial conduct commissioner against Elias raising a possible conflict of interest arising from her husband's directorship of a major insurer.
For further information on this topic please contact Sam Holden at Wilson Harle by telephone (+64 9 915 5700) or email (firstname.lastname@example.org). The Wilson Harle website can be accessed at www.wilsonharle.com.
(1)  NZSC 151.
(2)  NZSC 89.