Brian Gaynor: Picking up the tab in bid for justice

The establishment of LPF Group, a litigation funder, is a positive development for the country's financial markets.

The new organisation has been established to help investors take legal action against companies and/or directors where large sums of money have been lost.

A litigation funder is particularly welcome in New Zealand because our regulators are reluctant to take legal actions and the courts are frustratingly slow and costly. And under our securities laws, there is a strong incentive for aggrieved parties to take legal action but individual investors don't have the expertise or financial resources to mount a long and expensive campaign.

Litigation funding could be used in a large number of situations including receiverships, breaches of continuous disclosure rules, insider trading, inaccurate prospectuses and valuations, related party transactions, breaches of directors' duties and breaches of care by financial advisers.

There are a number of recent circumstances, including Hanover, Bridgecorp, Blue Chip, the ING income funds, Vestar, Feltex and Tranz Rail, where litigation funding would have been welcomed by investors.

Litigation funding would give investors an alternative option to moratoriums or payout deals that essentially exclude them from taking any legal action. A strong funder may also encourage quicker resolutions to disputes as defendants settle out of court to avoid long and costly proceedings.

A successful and proactive litigation fund sector could have a positive impact on corporate governance in New Zealand and encourage investors to become less reliant on residential housing and have a higher percentage of their wealth in financial assets.

Litigation funding is where an outside party totally funds and manages a legal action in return for a percentage of a successful claim.

The funder normally receives between 20 per cent and 40 per cent of a successful claim, receives nothing if the case is unsuccessful but is still responsible for all the costs. The funder's share is determined through negotiation, on a case-by-case basis, at the beginning of the process.

Litigation funding has escalated in Australia because lawyers have legal restrictions on their ability to share in the financial outcome of successful cases and an old English law banning litigation funding has been abolished.

Litigation funding is popular with aggrieved investors because the funder manages the process and investors have plenty of upside but no downside as all costs, including security of costs, are incurred by the funder.

Individuals and institutions have been willing to invest in litigation funding structures because the returns can be extremely good. As well, many investors believe that a strong litigation structure will encourage directors and management to operate within the law and will enhance confidence in our financial markets.

There are a large number of litigation funders in Australia; one of the best known is IMF (Australia), an ASX-listed company with some big wins of late. IMF believes the best opportunities are available after the collapse of financial markets when the excesses of the prior bull market are exposed. Its result for the six months to last December 31 reflected this as the company announced net earnings of A$18.8 million compared with A$3.3 million for the first half of the June 2008 year.

Six major cases were concluded in the six months to December 31 and these are summarised in the accompanying table. The highly successful Aristocrat Leisure case was based on the gaming machine producer making misleading and deceptive statements regarding its profit forecasts and failing to disclose material information to the market.

IMF's other successful cases in the table were as follows:

Downer EDI also misled the market regarding its profit outlook.

The Shenton Park case was based on a negligent valuation report relating to the construction of a retirement village.

The Meadow Springs litigation also related to a valuation report which gave a land value substantially higher than the sale price.

The Concept Equity case was a dispute over a fee relating to a takeover offer.

Reynolds Wines' directors were accused of breaching their duty to prevent insolvent trading by the company.

The IMF examples show litigating funding can involve a wide range of issues with varying degrees of success.

Class actions, where a lawsuit is brought by a representative member of a large group on behalf of all of the group members, are a popular form of litigation funding but there may be barriers to this here under what is called maintenance and champerty.

Maintenance is the improper support or promotion of litigation by giving aid to one party to bring a claim without just cause. Champerty is the employment of impropriety to achieve a share of the proceeds. Ancient English law feared that a champertous maintainer might be tempted, for his or her own personal gain, to inflame damages or abuse the process of law.

Maintenance and champerty have been abolished in most states in Australia but it is still being used as a defence in New Zealand, particularly in the Feltex case.

Tony Gavigan, who describes himself as a "litigation supporter" of the Feltex and Southern Petroleum legal actions, set up a company called Joint Action Funding Ltd to finance the Feltex case.

This funding was done on an opt-out basis and public notices advised Feltex shareholders: "If you remain a member of the group you will not be liable for any legal costs ... except by way of deduction from any award made to you pursuant to the proceedings. Your share of the legal and management costs ... will be funded for you ... by Joint Action Funding Ltd."

The lawyers representing the Feltex directors put an application to the courts "to stay the proceedings as an abuse of process on the grounds of champerty".

Justice Christine French dismissed the application and noted: "At one time, the common law took a particularly hostile approach to champertous arrangements for reasons of public policy. However, in more recent years there has been a dramatic change in attitude, with some jurisdictions abolishing the tort of champerty altogether and courts generally adopting a much more liberal and relaxed approach, to the point where many authorities appear actively to support litigation funding as a matter of public policy."

Justice French went on to write in her judgment: "In an age when the costs of litigation are beyond the means of many people, professional funders undoubtedly have an increasingly important role to play in ensuring that legal obligations and rights are enforced and vindicated."

Maintenance and champerty haven't been abolished in New Zealand but the courts are looking at class actions and litigation funding far more sympathetically than they did before.

There have been a number of litigation funders in New Zealand, including Gavigan, Stephen Franks in the Kerry Hoggard insider trading case and Australian funders that have taken on individual cases here but LPF Group is the first stand-alone organisation to be established for this sole purpose. It has an office in Auckland and the main individuals behind it are Phil Newland, Paul Lindholm and Trevor Janes. Newland and Janes are company directors and are on the Abano Healthcare board. Lindholm is involved in litigation funding in Australia.

LPF has raised money from New Zealand and overseas investors.

Litigation funding is still relatively underdeveloped in New Zealand but it is expected to become increasingly important in the years ahead, with LPF playing a major role in its development.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.

bgaynor@milfordasset.com