Determining the priority of litigation funders vs secured creditors to litigation proceeds

08 August 2008

---

Although present in Australia for over a decade, the practice and regulation of professional litigation funding remains unsettled. The recent Federal Court decision of Meadow Springs Fairway Resort Ltd (In Liq) v Balanced Securities Limited (No 2) (2008) 245 ALR 726 dealt with the principles applicable when a priority dispute arises between a litigation funder funding litigation on behalf of a company in liquidation and secured creditors of the same company as to the litigation proceeds.

Facts

Using moneys secured under floating charges, Meadow Springs (MS) built a block of apartments. Prior to undertaking the construction, MS obtained an ‘on completion’ valuation of the land. Upon completion the apartments did not sell and MS went into administration then liquidation.

The liquidator obtained funding from a professional litigation funder, IMF (Australia) Ltd (IMF), to bring an action in negligence against the valuer. The funding agreement entered into by the liquidator required the payment of fixed management fees to IMF in addition to a percentage of any resolution sum. The negligence action was settled with the valuer paying $6.4 million to MS.

IMF contended that a portion of the resolution sum and the management fees under the funding agreement were to be met in priority to any claims by secured creditors. Two secured creditors with fixed and floating charges over MS disputed IMF’s contention and claimed priority over the sums claimed by IMF.

The decision

IMF argued that it was at least in the same position as the secured creditors as they had all obtained an equitable interest in the resolution sum when it was forwarded to MS.

Siopis J stated that the secured creditors had acquired their equitable interest in the resolution sum when their floating charges first crystallised. This was when the company had first gone into administration, which effectively assigned the negligence action to the secured creditors and gave them an earlier interest to IMF. IMF was held to have entered into the funding agreement with full knowledge of the existence of the secured creditors’ registered charges.

Any assertion that IMF’s interest in the resolution sum was superior because it had assumed the risk of the litigation was rejected because IMF took its interest in the resolution sum subject to the prior interest of the secured creditors.

His Honour also rejected an argument by IMF that the liquidator had an equitable lien over the money which secured payment in favour of IMF under the funding agreement. In doing so, Siopis J drew a distinction between IMF’s contractual right under the funding agreement to a portion of the resolution sum on the one hand and its management fees on the other. The former was held to be a mere obligation on the liquidator to account as trustee to IMF’s beneficial entitlements under the agreement. However, the latter was an obligation comprising an expense reasonably incurred in undertaking the litigation and establishing the resolution fund and therefore held to take priority over the secured creditors’ claims.

The decision is currently the subject of an appeal by IMF. However, the message is clear that litigation funders must factor in the position of any secured creditors when assessing whether to fund litigation on behalf of company liquidators.

---

This article provides information about topical legal issues.
Information contained in this article is intended as an introduction only and should not be relied on in place of legal advice.