Client Update: Regulations clear the way for litigation funding (again)
6 February 2013
In brief: In recent years, questions relating to the regulation of litigation funding have been the subject of a series of appeal court decisions. Are funding arrangements managed investment schemes? Do funders require an Australian Financial Services Licence? Are funders providers of credit? At various times, each of those questions has been answered in the affirmative. The Federal Government has, however, recently implemented new legislation that reverses that position. Partners Ross Drinnan (view CV) and Jenny Campbell (view CV), and Senior Associate Georgia Steele comment on the latest development in the regulation of litigation funding.
- The story so far ...
- Why were the new regulations required?
- The new regulations – the basics
- Is this the final word on the regulation of litigation funding?
In December 2012, the Federal Government enacted the Corporations Amendment Regulation 2012 (No.6) (Cth) (the new regulations) to effectively exempt litigation funding from all forms of regulation, save for a requirement to have adequate processes in place to manage conflicts of interest. The new regulations supersede regulations (with the same name) enacted in July 2012.
The new regulations are a direct response to all that has come before and, accordingly, it is necessary to provide a brief account of those events before discussing the new law.
- Litigation funding is not an abuse of process: In August 2006, the High Court gave a 'green light' to litigation funding when it found that the concept of third-party funding was not contrary to public policy or an abuse of process.1 Since that decision, litigation funding has remained a controversial issue, but the focus has shifted to questions of regulation.
- Class action funding is a managed investment scheme: In October 2009, the Full Federal Court held that the funding arrangements in a shareholder class action constituted a 'managed investment scheme'.2 This meant that the funders of class actions were subject to the onerous disclosure and licensing requirements applicable to the operators of managed investment schemes. However, in November 2009, the Australian Securities and Investment Commission (ASIC) granted transitional 'class order' relief to class action funders from the need to comply with those requirements while ASIC and the Federal Government considered how to respond.3 In May 2010, the Federal Government announced its intention to reverse that position through legislative reform.4
- Litigation funding requires an Australian Financial Services Licence: In March 2011, the NSW Court of Appeal held that funding arrangements were a 'financial product' because they were a facility for managing risk.5 The result of this decision was that funders required an Australian Financial Services Licence (AFSL). Shortly after that decision, however, ASIC extended its class order relief to exempt funders from the need to hold an AFSL.6
- Class action funding arrangements are not managed investment schemes and do not require an AFSL: In July 2012, the Federal Government enacted regulations (which were to be effective from January 2013) that excluded funded class actions from the definition of 'managed investment scheme' and exempted the funding of class actions and other grouped proceedings from the requirement to hold an AFSL (the superseded regulations).7 The AFSL exemption was contingent on funders having adequate processes in place to manage conflicts of interest. Importantly, the superseded regulations only applied to the funding of class actions or other group proceedings (despite the fact that ASIC's class order relief from the requirement to hold an AFSL applied to all funders).
- Litigation funding does not require an AFSL because it is a credit facility: In October 2012, the High Court held that litigation funders did not require an AFSL because funding arrangements are 'credit facilities' and the Corporations Act 2001 (Cth) provides that a 'credit facility' is not a 'financial product' (even if it may otherwise satisfy the definition of a 'financial product').8
The High Court's decision raised a number of issues that had not been contemplated by the superseded regulations including the following:
- The effect of the decision was that class action funders would not need to rely on the exemption in the superseded regulations from the requirement to hold an AFSL and, in those circumstances, would not be required to comply with the requirements in those regulations to have adequate processes in place to manage conflicts of interest.9
- The characterisation of litigation funding arrangements as 'credit facilities' raised a question as to whether funders are subject to the provisions of the National Credit Code. This would require funders to hold an Australian Credit Licence and comply with the applicable conduct, disclosure and responsible lending requirements.
As a result, the superseded regulations did not take effect in January 2013 as intended. Instead, they were amended to address these (and other) issues and re-enacted in the form of the new regulations.
In summary, the key points to note about the new regulations as they concern litigation funding are as follows:
- The new regulations apply to all forms of funding and not just to the funding of class actions or other grouped proceedings (as was the case with the superseded regulations).
- The new regulations exclude all forms of funding from the definition of a managed investment scheme. The extension of this exclusion to non-group funding arrangements appears to be a matter of drafting convenience rather than a matter of substance as there has never been any suggestion that the funding of non-group proceedings could satisfy that definition.
- The new regulations declare funding arrangements to be 'financial products' and not to be 'credit facilities'. This has the effect of ensuring that funders need to rely on the AFSL exemption and also removes any question as to the applicability of the National Credit Code.
- The new regulations exempt the providers of services associated with funding arrangements from the requirement to hold an AFSL, subject to them having adequate processes in place for managing conflicts of interest. The regulations relating to those processes (and ASIC's consultation paper in relation to how funders might comply10) were prepared at a time when the requirement was intended to apply only to the funders of class actions or other grouped proceedings – this may give rise to some questions as to the applicability of the regime to individual proceedings.
The new regulations are effective from 13 July 2013. ASIC has, however, granted class order relief which means that, for all practical purposes, each of the exemptions referred to above is already in effect.11
The new regulations appear to address each of the key outstanding issues in respect of litigation funding. It is now settled that, although funding arrangements are 'financial products', they are not managed investment schemes and litigation funders do not require an AFSL or a credit licence. There is, of course, always scope for litigants to come up with other grounds on which to challenge the legality of a litigation funding arrangement. It does, however, seem that the new regulations will limit the scope for such challenges in the future. The Federal Government's willingness to amend the law as necessary to facilitate third-party funding may also discourage further challenges.
The outcome is that anyone can fund litigation so long as they have adequate processes in place to manage conflicts of interest (except lawyers involved in the litigation, who are prohibited from entering into an arrangement that involves taking a share of the proceeds of the litigation). Accordingly, beyond the conflicts requirements and general corporate law (to the extent the funder is subject to Australian law), there are no supervisory, reporting or operational requirements for litigation funders.
The Federal Government appears to have taken this approach on the basis that to impose such requirements would limit the ability of consumers to access the justice system. In its Explanatory Statement for the superseded regulations (a separate statement was not issued for the new regulations), it said:
The Federal Court's decision would have imposed a wide range of requirements that apply to MIS, such as registration, licensing, conduct and disclosure requirements on litigation funders and their arrangements with their clients. The Government considers that these requirements are not appropriate for litigation funding schemes. The Government supports class actions and litigation funders as they can provide access to justice for a large number of consumers who may otherwise have difficulties in resolving disputes. The Government's main objective is therefore to ensure that consumers do not lose this important means of obtaining access to the justice system.12
A largely unregulated funding market may facilitate access to justice for consumers, but we question whether it provides sufficient protection for consumers. Among other things, an unregulated funding market leaves funded litigants exposed to an impecunious and/or unscrupulous funder (even more so if the funder is offshore). Accordingly, in our opinion, at the very least, capital adequacy requirements should be imposed to prevent a situation in which a funder puts itself into liquidation to avoid an adverse costs order (in which case the funded party would be liable and, if they can't pay, may result in a successful defendant not recovering its costs). The fact that funded litigants expose themselves to significant costs liability in reliance on their funding arrangements would also appear to be very good reason for subjecting funders to the additional obligations and supervision applicable to the holders of an AFSL. Arguments to this effect have, however, 'fallen on deaf ears' among policymakers for the time being. Accordingly, it may be that the questions are not revisited until a funded litigant is 'burned' by a funder.
Given the close association between litigation funding and class actions, these issues should also be considered in the context of the current class actions landscape. In recent years, an increasing number of law firms have been attempting to establish plaintiff class actions practices. That means that more class actions are being commenced, including more speculative claims. Speculative claims are less likely to receive funding from well-established funders and this creates opportunities for other funders to enter the market. Particularly in the context of speculative claims, this situation increases the prospect of a funded litigant being 'burned'.
In those circumstances, we doubt that we have heard the final word on the regulation of litigation funding – even if the scope for further legal challenge is limited, policy issues remain and are likely to be revisited at some stage in the future.
Nor do we think that we have heard the final word on the scope and reach of litigation funding in Australian proceedings. There is no reason to expect that funders will not continue to test the boundaries of what the courts will allow in the pursuit of their commercial interests (and that defendants will continue to look for ways to resist).
- Campbells Cash and Carry Pty Ltd v Fostif Pty Ltd  HCA 41. See Focus: High Court gives green light to litigation funding.
- Brookfield Multiplex Ltd v International Litigation Partners Pte Ltd  FCAFC 147. See Focus: A cross for litigation funding.
- ASIC Class Order [CO 10/333]: Funded representative proceedings and funded proof of debt arrangements.
- Announcement by Chris Bowen, former Minister for Financial Services, Superannuation and Corporate Law, No. 039, Government Acts to Ensure Access to Justice for Class Action Member (4 May 2010). See Focus: Clarification of class action funding.
- International Litigation Partners Pte Ltd v Chameleon Mining NL  NSWCA 50. See also Focus: Litigation funding hits another speed hump.
- ASIC Class Order [CO 11/555]: Variation of Class Order [CO 10/333].
- Corporations Amendment Regulation 2012 (No 6) (Cth). See Client Update: Obstacles to class action funding cleared.
- International Litigation Partners Pte Ltd v Chameleon Mining NL (Receivers and Managers Appointed)  HCA 45. See Client Update: Litigation funding ... Alas, back to where we began.
- These issues were expanded upon in Client Update: Litigation funding ... Alas, back to where we began.
- ASIC CP 185 Litigation Schemes and Proof of Debt Schemes: Managing Conflicts of Interest.
- ASIC Class Order [CO 13/18]: Funded representative proceedings and funded proof of debt arrangements exclusion from the National Consumer Credit Protection Act 2009; ASIC Class Order [CO 13/19]: Variation of Class Order [CO 10/333].
- Explanatory Statement, Corporations Amendment Regulations 2012 (No.6), 12 July 2012.
- Ross DrinnanPartner,
Ph: +61 2 9230 4931
- Jenny CampbellPartner,
Ph: +61 2 9230 4868
- Peter O'DonahooPartner,
Ph: +61 3 9613 8742
- Duncan TravisPartner,
Ph: +61 3 9613 8175
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