Litigation funders’ new regulatory requirements – practical issues and the impact on class actions

Changing times

The Federal Treasurer has announced that all litigation funders will soon be required to hold an Australian Financial Services Licence (AFSL), which will dramatically increase the Australian Securities and Investments Commission’s (ASIC) regulatory oversight over those funders who do not already hold an AFSL. The announcement follows the Federal Attorney General’s referral to the Parliamentary Joint Committee on Corporations and Financial Services, for inquiry and report by 7 December 2020, of ‘…whether the present level of regulation for applying to Australia’s growing class action industry is impacting fair and equitable outcomes for plaintiffs’ (Inquiry).

In announcing the requirement to hold AFSLs, the Treasurer stated that ‘Now more than ever we want Australian businesses staying in business and focused on keeping people in jobs rather than fending off class actions funded by unregulated and unaccountable parties’. This article summarises some relevant features of the Australian class actions regime, to which litigation funding is particularly relevant, and sets out what changes the AFSL requirement may bring.

Key takeaways

• As AFSL licence holders litigation funders will subject to obligations set out under the licence instrument itself, and the general obligations under s. 912A of the Corporations Act 2001 (Cth), which include:
  • the provision of financial services ‘efficiently, honestly and fairly’, which could affect funders’ disclosure obligations to class members or approaches to multiple class actions;
  • whether funders will be subject to capital requirements;
  • whether plaintiff group members be able to take litigation funders to the Australian Financial Complaints Authority (AFCA);
  • mandatory breach reporting obligations; and
  • the expanded the civil penalties regime which would mean funders could be prosecuted for up to $525 million per contravention of s. 912A.
• It is unclear how AFSL obligations will overlap with the Courts’ jurisdiction.

A brief history of litigation funding and class actions

Litigation funding activity has experienced significant growth in Australia in the past decade. Whereas prior to 2006 no class actions were funded, in the five-year period from 1 June 2012 to 31 May 2017, 46.2% of all class actions were funded nationally.[1] One report identified that an average of 23 class actions have been filed each year since 1992, with an average of 46.8 class actions filed each year in the five years preceding November 2019.

The growth of litigation funding started in 2006 following the decision in Campbells Cash and Carry Pty Limited v Fostif Pty Ltd[2] where the High Court found that litigation funding was not an abuse of process or contrary to public policy. The decision followed the abolition of maintenance and champerty by various states e.g. the Maintenance, Champerty and Barratry Abolition Act 1993 (NSW).

As litigation funding became more readily available, more class actions were commenced. In particular class actions by shareholders against companies have become more common. One report indicates that 22 shareholder class actions were filed in Australia from 1992 to 2019 (19.2% of all class actions), with 78 shareholder class actions filed in the last five years (equivalent to 33.3% of all class actions filed in the last five years).

The question of the nature of the financial service provided by funders has arisen before the Courts previously.

• In 2009 the Federal Court, in Brookfield Multiplex Ltd v International Litigation Funding Partners Pte Ltd[3], determined that funding arrangements constituted a managed investment scheme, and thus were required to be registered under s. 9 of the Corporations Act 2001 (Cth) (Act).
• The NSW Court of Appeal, in International Litigation Partners Pte Ltd v Chameleon Mining NL[4], agreed and further held that litigation funding constitute a ‘financial product’ within the meaning of the Act (which would require them to hold an Australian Financial Services Licence, and be regulated directly by ASIC). On appeal, the High Court found that litigation funders were dealing in ‘credit facilities’ and instead could be regulated under the National Consumer Credit Protection Act 2001 (Cth) i.e. by ASIC.

The Federal Government intervened by making the Corporations Amendment Regulations 2012 (No 6) (Cth), which exempted litigation funders from holding a financial services or credit licence. The rationale, as expressed in the post implementation review of the law, was that litigation funders were already subject to sufficient court scrutiny.

‘If not addressed, these decisions would have imposed a considerable additional regulatory burden on litigation funders, in turn raising the cost for consumers of pursuing court proceedings and potentially reducing their capacity to seek justice.’[5]

It is relevant to note, in the context of the growth of litigation funding, that Australian solicitors, unlike in the US, have traditionally been prohibited from charging contingency fees e.g. a portion of any judgment sum. The question as to why solicitors, with their greater ethical duties and regulation by professional bodies and the court, should be prohibited from obtaining a share of any judgment, and why litigation funders should not, has been an area of some debate also leading to likely changes in Victoria. The Justice Legislation Miscellaneous Amendments Bill 2019 (Vic) provides for the Supreme Court of Victoria to order contingency fees in class action proceedings; at the time of writing the bill had passed the Victorian Legislative Assembly and was being considered by the Victorian Legislative Council.

Four additional points are worth noting in connection with the prevalence of litigation funding in Australia:

1. 1. (Australia’s class action regime) It is comparatively easy to commence a class action in Australia compared to the US or the UK. Court rules require the identification of seven or more plaintiffs with a claim, from the same or similar event/circumstances, and that the claim must relate to at least one common issue of law or fact. Once seven plaintiffs are identified, a representative plaintiff can then commence a class action on behalf of all other plaintiffs who fit their bespoke definition e.g. ‘People who bought shares in XYZ company between 2017 and 2018 (inclusive)‘. It is possible, therefore, for a plaintiff (with or without a funder) to commence a class action on behalf of people in a class without most plaintiff class members being aware of the action.
   2. (Common Fund Orders) Between the 2016 Federal Court Money Max decision[6] and the December 2019 High Court Brewster decision[7] parties could apply for courts to make common fund orders which allowed litigation funders to recover a percentage of the judgment sum in relation to the claims of class members who had not signed funding agreements with them i.e. the so called ‘free riders’. Prior to Money Max, litigation funders could only obtain a percentage of the judgment or settlement sum from those individual plaintiffs by agreement. Common fund orders encouraged the growth of funded class actions for that three-year period and there have been calls for the Victorian legislature to intervene to invest the Victorian courts with powers again to make these orders.
   3. (Australia’s continuous disclosure regime) ASX listed companies are subject to demanding continuous disclosure obligations as well as general obligations not to engage in misleading or deceptive conduct. That has meant that often when there is an appreciable price drop in a company’s share price, a question arises as to whether or not the company complied with its continuous disclosure obligations i.e. inform the market of the information it required in order to properly price the shares, which has caused shareholders to suffer a loss. Australia’s continuous disclosure regime, which does not include ‘safe harbour’ defences (unlike comparable jurisdictions such as the US), has meant that shareholder class actions are relatively common in Australia.
      The Treasurer has referred to concern about this situation when making a related announcement, on 25 May 2020, to amend the Corporations 2001 (Cth) for 6 months so that listed companies and their officers will only be liable for continuous disclosure breaches if there has been ‘knowledge, recklessness or negligence’ with respect to price sensitive information to the market.

1. 4. (Commercial viability) It is clear that litigation funding is economically viable as a business model. Overseas a secondary market has even developed. The secondary market for litigation funding is currently a feature of the US litigation funding market and affords opportunities to achieve significant returns. By way of example, the world’s largest litigation funder, Burford Capital, funded a particular arbitration claim for $US 18M in 2015 and in June 2019, it sold 10% of its stake in the arbitration proceeds for $US 100M (thereby valuing its initial asset at $US 1B).

Recent focus points in class actions

The funding of class actions has given rise to a number of interesting considerations and active debate. Examples of recent focus points are:

• (Competing class actions) It is relatively common for separately funded and separately represented plaintiffs to commence very similar class actions against the same defendant. One report identified that, of the 122 shareholder class actions filed in Australia since 1992, 59 were competing or related class actions based on the same or similar facts.

In the Bellamy’s decision in 2017 Beach J in the Federal Court effectively chose between two competing class actions. It was the first decision of its kind. His Honour considered that he had had five options: consolidate the proceedings; stay one of the two proceedings; make a ‘declassing’ order stripping one of the proceedings of its class actions status; closing one class, and leaving the other ‘open’; and, leaving both class actions open and ordering a joint trial. The Court’s decision was based on consideration of:

• • the experience and resources of the lawyers running each class action;
  • the fees to be levied by each plaintiff law firm;
  • the litigation funding agreements in each class action;
  • the order in which the actions were commenced;
  • the volume of group members signed up, as opposed to being caught as ‘open’ class action members; and
  • the possibility of a common fund order being made.

Similar decisions were made in 2018 by the case of Getswift,[8] which faced three competing class actions after a drop in share price suffered by the defendant, then in 2019 with the case of AMP[9], in which five competing class actions were filed against the defendant after a drop in share price.

Uniform regulation of litigation funders would likely feed into decisions around the management of competing class actions.

• (Returns for plaintiff group members) While litigation funding often allows plaintiffs to pursue claims that they may not otherwise have the ability to pursue, the question of the level of returns that members of the class achieve from class actions has continued to be a focus. For example, in a 2019 report, the Australian Law Reform Commission recorded that in funded matters, the median return to group members is 51% of the award. Unfunded matters return a median of 85% of proceeds to group members.[10]

The Inquiry to be conducted by the Parliamentary Joint Committee on Corporations and Financial Services will consider:

• • what evidence is available regarding the quantum of fees, costs and commissions earned by litigation funders and the treatment of that income;
  • the impact of litigation funding on the damages and other compensation received by class members in class actions funded by litigation funders;
  • the potential impact of proposals to allow contingency fees and whether this could lead to less financially viable outcomes for plaintiffs;
  • the financial and organisational relationship between litigation funders and lawyers acting for plaintiffs in funded litigation and whether these relationships have the capacity to impact on plaintiff lawyers’ duties to their clients.

This sort of focus on the impact of litigation funding on returns for plaintiff is useful context for considering the increased regulation of all litigation funders.

The regulatory landscape for litigation funders

AFSL licence holders are subject to obligations set out under the licence instrument itself, and the general obligations under s. 912A of the Corporations Act 2001 (Cth). Once litigation funders are subject to the serious level of regulatory oversight which being the holder of an AFSL entails, this could have interesting and unexpected results.

For example, s. 912(1)(a) requires an AFSL holder to ‘do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly’. Therefore, foreseeable areas of focus for litigation funders may be the level of disclosure provided to plaintiff group members on the level of financial return that will be taken by the litigation funder in the funding agreement or ‘opt out’ notice containing the details of the proposed common fund order. Another foreseeable issue is around efficiency, in connection with the issues with competing class actions outlined above.

Section 912(1)(aa) requires AFSL licence holders to ‘have in place adequate arrangements for the management of conflicts of interest that may arise wholly, or partially…’. Given the multiplicity of competing interests in funded class actions, the scope for conflicts of interest arising could be the subject of some scrutiny.

Section 912(1)(d) requires AFSL licence holders to ‘have available adequate resources (including financial, technological and human resources) to provide the financial services covered by the licence and to carry out supervisory arrangements’. Will this mean capital requirements on litigation funders? It is perhaps likely, given that this requirement is a recent feature of the Singapore and Hong Kong regulatory regimes for litigation funders (both being global centres for arbitration proceedings, which are commonly funded forms of dispute resolution). This may have a disproportionate impact on the newer and / or smaller entrants to the litigation funding market, who are unlikely to have the same financial resources as the more established players and are unlikely to have gone through the process of obtaining an AFSL.

Section 912(1)(g) requires AFSL holders to be a member of an external dispute resolution body – the Australian Financial Complaints Authority (AFCA). Will plaintiff group members be able to take litigation funders to AFCA in due course to resolve their grievances?

In addition, AFSL holders must report ‘significant breaches’ of their obligations under 912A to ASIC pursuant to s. 912D within 10 business days of becoming aware of the breach. What impact might that action, when it occurs, together with complaints being able to be made to AFCA, have on ongoing class actions? It is also worth noting that on 14 February 2019, the Senate passed the Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Bill 2018 (Cth), which expanded the civil penalties regime to breaches of s. 912A – up to $525 million per contravention.

We expect that the requirement for all litigation funders to hold an AFSL may make for quite new and in some ways unique regulatory territory – for example, ASIC may be required to consider regulatory issues concerning a funder while a funded class action is on foot.

A fascinating, and highly speculative area for thought is this; how will this additional regulation interplay with the oversight exercised by the court in respect of class actions?

For example, imagine a judge approves the wording of an ‘opt out’ notice to plaintiff group members regarding a novel funding mechanism to be used by the litigation funder (assuming the common fund orders come back into being in Victoria). In the absence of an amicus curiae, the judge does not have the benefit of anyone challenging the funding mechanism and has to work with the evidence put before the Court by the parties. ASIC, with its greater regulatory powers permitting it access to information, and focussed on issues of efficiency, honesty and fairness, subsequently could form a view that the notice is problematic in some way. The resulting tension would make for an interesting potential regulatory dilemma…

Another consideration, and potentially implicit in the Federal Treasurer’s statement, is how this development will affect the tenor of class actions litigation. Will different tactics be adopted? It is far too soon to say, but not too soon to appreciate the potential change.

Conclusion 

In announcing that litigation funders will need become AFSL holders, the Federal Treasurer stated that ‘There is no reasonable basis for litigation funders to continue to be exempt from the same regulation that applies to the entities which they seek to litigate against’.[11] 

It seems clear that change is coming for the litigation funding market and for the broader class actions industry as a result. The precise impact of the regulatory changes are, however, yet to be seen and difficult to predict – for example, the position that ASIC might take with respect to issues of ‘efficiency, honesty and fairness’ in this area could have significant implications in some cases.

Those likely to be affected by the changes should watch this space closely. Far from cooling down, the class actions industry is likely to increase in temperature in the coming years – though the heat may be coming from different angles.

Authored by:

Guy Edgecombe, Partner
Lionel Hogg, Partner

[1]  Victorian Law Reform Commission, access on 8 May 2020 at: <https://www.lawreform.vic.gov.au/content/2-litigation-funding-and-access-justice#footnote-83555-4>

[2] [2006] HCA 41

[3] (2009) 180 FCR 11

[4] (2011) 276 ALR 138

[5] The Treasury, Australia, Post-Implementation Review—Litigation funding—Corporations Amendment Regulations 2012 (No 6) (October 2015)

[6] [2016] FCAFC 148

[7] BMW Australia Ltd v Brewster; Westpac Banking Corporation v Lenthall [2019] HCA 45

[8] Perera v GetSwift Limited [2018] FCA 732

[9] [2019] NSWSC 603

[10] ALRC Report 134, ‘ Integrity, Fairness and Efficiency—An Inquiry into Class Action Proceedings and Third-Party Litigation Funders’, December 2018

[11] M. Pelly, ‘ Crackdown on class action funders’ Australian Financial Review (21 May 2020)