More than they bargained for – litigation funder slugged with costs overflow

• Litigation funder offers very limited and specific funding to enable liquidators to meet a $150K security for costs requirement.
• After the liqudiators' claim is dismissed, the litigation funder is ordered to pay the other side's costs, claimed in an amount of almost $500K.

A decision handed down by the NSW Supreme Court today will send a shiver down the spine of litigation funders.

In Jin Lian Group Pty Ltd (in liq) v ACapital Finance Pty Ltd (No 2) [2021] NSWSC 1202 , the Supreme Court ordered that a litigation funder pay the other side's costs in a sum far exceeding the allowance made in the funding agreement.

The decision was made on the basis that, but for the litigation funder providing funding to enable a security for costs order to be complied with, the claim would have been knocked out early, and the bulk of the costs would not have been incurred.

The funder's decision to fund payment of the security for costs amount therefore resulted, in the event, in the funder becoming liable for all of the other side's costs (including trial costs ordered on the indemnity basis) as and from the date of the payment.

The funding agreement was never contemplated to cover any such costs, and it must be assumed that the funder was completely unprepared for such a finding. The finding is likely to have far-reaching ramifications for litigation funding practice, and today's decision is a "must read" for litigation funders, and those who advise them.

Background

An earlier decision sets out the background and context to today's decision .

Jin Lian Group Pty Ltd (Jin Lian) was a property development company. It was looking to knock down 11 houses in Carlingford, amalgamate the site, and build three residential apartment buildings, comprising 120 apartments and car parking.

In September 2016,?Jin?Lian approached Australian Capital Holding for finance for the project. Ultimately, a subsidiary of that company, ACapital Finance Pty Ltd (ACapital), agreed to lend Jin Lian $15 million for 12 months. Jin Lian hoped to be in a position to refinance out of the loan at or before maturity.

As a condition of its loan, ACapital also insisted that Jin Lian obtain a guarantee from am associated company, Australia Capital Investment Management Pty Ltd?(ACIM), for which Jin Lian was to pay ACIM a $165,000 "guarantee fee", increased by a further $660,000 "conditional fee" if the guarantee was called upon.

ACIM was owned by the same family group as ACapital, but the two companies were not "related" in the legal sense. Jin Lian agreed to this loan condition but, rather than pay ACIM the guarantee fee up front, it secured it (as well as the conditional fee) by a second mortgage over the development site, ranking behind ACapital's first mortgage.

Jin Lian collapses

Unfortuantely, Jin Lian's development was a failure. Jin Lian was placed into administration in May 2018. ACapital ended up appointing receivers, who sold the development site for $21.6 million in December 2018.

Out of this amount, the receivers:

• paid back the $15 million ACapital loan, plus interest;
• paid ACIM's $165,000 guarantee fee;
• paid ACIM's $660,000 conditional fee
• paid themselves $345,213.73, and
• paid the surplus of $293,200.54 into?the Supreme Court.

Meanwhile, the voluntary administration of Jin Lian was not a success, and it was wound up on 8?March?2019.

Claim by liquidators

Thereafter, on 2 July 2019, the liquidators sued both ACapital and ACIM, challenging the way the proceeds of sale had been allocated. They made a number of claims in the proceedings, including:

• that interest had been calculated incorrectly;
• that the various interest rates amounted to unlawful penalties;
• that ACapital had engaged in "third line forcing" by requiring Jin Lian to pay for a guarantee by ACIM;
• that ACIM's $660,000 conditional fee was an unlawful penalty;
• that ACIM had no right to charge interest on the conditional fee; and
• that ACapital was not entitled to charge interest on amounts advanced to its receivers and their lawyers on account of their costs.

The liquidators also applied to the court for release of the surplus funds and. In August 2019, the court ordered that the surplus (less $19,310.21 on account of?legal?costs) be paid out to?the liquidators.

Security for costs

The claim the liquidators had caused Jin Lian to bring against ACapital and ACIM involved the usual pre-trial skirmishing and, in February 2020, ACapital successfully obtained an order for security for costs for $149,271.65. Security was ordered to be paid in two tranches:

• $68,257.20?by 27 March 2020; and
• $81,014.45?no later than 14 days after the proceedings had?been set down for trial.

The liquidators found themselves without funds to pay the first tranche of the ACapital security (what became of the money paid out by the court is not clear from the decision), but they obtained ACapital's agreement to have the timeframe for payment extended.

However, they were also unable to meet the extended deadline, and ACapital ultimately applied to strike out their claim.

The strike-out application was listed for hearing on 19 June 2020.

Funding for security for costs

In an effort to obtain funding to pay ACapital's security for costs entitlements, the liquidators approached a number of litigation funders. Ultimately, in May 2020, they found a litigation funder who was interested. Discussions with the funder ensued, and progressed throughout May and June 2020.

ACapital was ultimately successful in obtaining orders striking out the proceedings on 19 June 2020, but the orders were stayed on condition that the liquidators put up the (now long overdue) first tranche of security for costs by 14 August 2020.

By this time the liquidators' discussions with the funder were well advanced and, on 30 June 2020, the liquidators finally entered into a funding agreement, finally enabling Jin Lian to meet the security for costs requirements.

The funding agreement

The funding agreement was not the usual "full service" arrangement, whereby the funder is a part of the claim from the outset, agrees to pay legal costs as they are incurred, agrees to put up security for costs as required, and agrees to provide an adverse costs indemnity. This funding agreement was a special purpose arrangement, designed specifically to address ACapital's security for costs entitlements.

Under the terms of the funding agreement, the funder agreed to:

• provide funding for up to $30,000 of legal costs, aimed at paying for work already done by the liquidators’?barristers in respect of the security for costs fight (which came to $28,671.50);
• pay a fixed management fee of $5,500; and
• provide an adverse costs indemnity capped at $150,000 – just a few hundred dollars more than was needed to cover ACapital's $149,271.65 security for costs entitlements.

In the circumstances, there was no funding at all for the costs of the "main" proceedings themselves, or for any adverse costs (over any above the amount of the ordered security). All that was offered was limited coverage for Counsel's fees relating to the security for costs issue, and just enough to cover ACapital's security for costs entitlements.

In order to fund the security for costs payments, the funder itself obtained “after-the-event” (ATE) insurance. It paid a premium of $54,175 to the ATE insurer, in return for which the insurer advanced?$150,000 to the funder, which the funder then used?to pay ACapital's security for costs.

Payment of security for costs and continuation of the proceedings

The first tranche of security was paid on 6 August 2020, and the claim was thereby spared the executioner's axe. The second tranche was paid in due course and the claim proceeded towards a hearing in April 2021.

In the meantime, settlement negotiations had been occurring in the background. On 16 January 2020, relatively early on in the proceedings, ACapital had offered to pay $35,000 in full and final satisfaction of the liquidators' claims. This offer had been rejected.

Over a year later, on 7 April 2021 (two weeks out from trial) ACapital made another offer, this time to pay $183,000. This, too, was rejected. The liquidators instead decided, based on "advice from?senior?counsel to the effect that?[Jin Lian] had good prospects of succeeding", to proceed to trial.

The trial

Unfortunately, the trial was a catastrophe. The liquidators' claims failed on every count. In a decision published on 29 July 2021 , the claims were all dismissed, and the court made a direction as to what the parties should do "[if] there is to be?a?dispute?as to costs".

Costs, by this stage, were eye-watering. The liquidator's total legal costs were $289,958.96. ACapital’s costs were $467,389.05. ACapital was in a particularly individious position; the $149K of security it had been given for its costs was clearly vastly insufficient and, equally clearly, Jin Lian—a company in liquidation—was without funds to make up the difference.

ACapital's attack on the funder

In an attempt to address this, ACapital applied for a costs order directly against the funder. It said that, but for the funder's support of the proceedings, the matter would never have gone to trial. It also sought an order that costs be paid on the indemnity basis from the date of its first ($35K) offer or, if not from then, from the date of its second ($183K) offer.

The court accepted the liquidators' submissions they they did not behave unreasonably in rejecting the first offer, but agreed that ACapital should have its costs on the indemnity basis from the date of its second offer. The court then addressed the liability of the funder for costs, and it is that aspect of the decision which is the main focus of this article.

The court first started by listing the factors relevant to a decision whether to make a costs order against a non-party, and noted (paragraph 23) that all five of the factors it had identified were present in this case, namely:

1. The funder provided the funds for the litigation.
2. The funder had?a direct interest in, and entitlement to, a substantial part of the fruits of the litigation.
3. The funder was involved in the litigation purely for commercial gain.
4. The funder had a right to information and involvement in decision making in relation to the litigation.
5. The funder agreed to provide an indemnity to the unsuccessful party for any adverse costs order.

The funder (which, by this stage, had its own lawyers acting) argued that it was not only the funder's funding which permitted the litigation to continue. In addition, the ATE insurer and the liquidators had contributed to the continuation of the litigation. The funder said that its liability for costs should be reduced to reflect that fact.

The court rejected those arguments.

1. As for the ATE insurer, the court noted that it was the funder who brought the insurer to the table to begin with, largely for its own convenience.
2. As for the liquidators, the court noted that the evidence did not reveal what role the liquidators had in the matter proceeding to trial, whereas it was certainly clear that the matter would not have proceeded without the funder.

The judgment then contains two paragraphs (paragraphs 67 and 68) which are likely to send a chill down the spine of funders and their lawyers:

The Funder agreed to involve itself in these proceedings purely for financial gain. Its Litigation Funding Deed is a sophisticated and extensive document. It was open to the Funder to negotiate with the Liquidators that, were the proceedings to fail,?the Liquidators share with it any potential liability for costs.

Litigation funders should be aware that if they involve themselves in pending court proceedings in circumstances where their intervention is the factor that causes those proceedings to continue and go to trial,?they risk an adverse costs order. Here the Funder took a gamble. It knew its involvement was to pay security for costs. It must have appreciated that it was likely, if not certain, that but for such payment the proceedings would not continue. Now that the proceedings have failed, I see no reason why it should not be jointly and severally liable for ACapital’s costs, including the costs that are to be paid to ACapital?on an indemnity basis.

After addressing a couple of further points, the court concluded:

For those reasons I propose to order that the Funder be jointly and severally liable for ACapital’s costs from and including?6 August 2020 [the date of payment of the first tranche of security], and?including indemnity costs from 8 April 2021 [the date of the second rejected settlement offer].

Conclusion

The court's decision seems very harsh. Intuitively, the arguments presented by Counsel for the funder seem to make sense. Why should a funder be wholly liable for costs based on nothing more than "but-for" causation? Why were the liquidators themselves let off the hook? Above all, what (if anything) did the funder do wrong?

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