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Australia Increases Scrutiny for Litigation Funders

In Short

The Situation: Following a boom in class actions backed by litigation funders, the Australian Federal Government has introduced new regulations which classify litigation funding schemes as "managed investment schemes" and "financial services licensing schemes" for the purpose of the Corporations Act 2001 (Cth).

The Result: From 22 August 2020, litigation funders must hold an Australian Financial Services Licence and must register and operate each litigation funding scheme as a managed investment scheme in accordance with various legislative requirements. The changes do not affect litigation funding schemes entered into before 22 August 2020.

Looking Ahead: The new regime means increased regulatory scrutiny for funders and an enhanced role for the Australian Securities and Investments Commission ("ASIC"), which is administering the regime, in the litigation funding market. The changes are expected to improve transparency around litigation funding and increase accountability of funders active in Australia. We are continuing to monitor whether the changes will have any material impact on class action activity.

Background

In 2009, a landmark Full Federal Court decision (in Brookfield Multiplex Ltd v International Litigation Funding Partners Pty Ltd [2009] FCAFC 147) found that arrangements between litigation funders and group members in class actions were managed investment schemes for the purpose of the Corporations Act 2001 (Cth) ("the Act"). In response, the Australian Government introduced regulations which excluded litigation funding schemes from the definition of managed investment schemes and exempted providers of litigation funding from the requirement to hold an Australian Financial Services Licence ("AFSL"), provided that they maintained adequate arrangements for managing conflicts of interest.

Since then, Australia has experienced major growth in class action activity, and particularly class actions backed by litigation funders.

On 22 May 2020, the Australian Government announced that it would subject litigation funders to greater regulatory oversight by removing the exemptions previously afforded to funders. To do so, it enacted the Corporations Amendment (Litigation Funding) Regulations 2020 (Cth) ("the Amendment Regulations") on 22 July 2020.

The effect of the Amendment Regulations is that any third-party litigation funding scheme entered into on or after 22 August 2020 will be regulated as a managed investment scheme. The existing exemptions for insolvency litigation funding schemes and single-plaintiff litigation funding arrangements will continue; that is, the new arrangements apply only to schemes where the possible entitlement of each of the scheme's general members to remedies arises out of:

  • the same, similar or related transactions or circumstances that give rise to a common issue of law or fact (that is, a class action); or
  • different transactions or circumstances but the claims of the general members can be appropriately dealt with together.

New Obligations for Litigation Funders

Any litigation funding scheme entered into on or after 22 August 2020 will be subject to the requirements under Chapters 5C and 7 of the Act. In particular, the scheme must be registered under Chapter 5C (provided it has more than 20 members or is promoted by a person who is in the business of promoting managed investment schemes) and must be operated by a "responsible entity", being an Australian public company that holds an AFSL authorizing the entity to operate the scheme. The responsible entity is subject to obligations under s 601FC to, among other things:

  • act honestly and in the best interests of members;
  • exercise the degree of care and diligence that a reasonable person would exercise if they were in the responsible entity's position; and
  • report breaches of the Act to ASIC.

The responsible entity will also be subject to the obligations that apply to all AFSL holders, including to do all things necessary to ensure that the financial services are provided efficiently, honestly and fairly; to take reasonable steps to ensure that its representatives comply with financial services laws; and to have adequate risk management systems in place.

However, ASIC has acknowledged that it may be difficult for litigation funders to comply with certain obligations under the Act. To address these practical difficulties and support the transition to the new framework, ASIC issued the ASIC Corporations (Litigation Funding Schemes) Instrument 2020/787 on 20 August 2020. This Instrument includes relief from:

  • the obligation to provide a copy of the Product Disclosure Statement to "passive" members of the litigation funding scheme (being members who have not entered into a funding agreement with the funder or a retainer or costs agreement with the law firm providing services for the purpose of the scheme, or otherwise notified the funder or firm that they agree to participate in the scheme), provided that the funder has made the Product Disclosure Statement publicly available on its website;
  • the obligation to regularly value scheme property;
  • the statutory withdrawal procedures for members who opt out of a class action under court rules; and
  • the requirement to disclose in the Product Disclosure Statement certain detailed fees and costs information under regulation 7.9.16N(2) of the Corporations Regulations 2001 (Cth) and information about labor standards or the impact of environmental, social or ethical considerations on investment decisions. However, the funder must still disclose fees and costs under the general rules in Part 7.9 of the Act.

ASIC has also issued a "no action" position, stating that ASIC will not take regulatory action if a funder of an open class action fails to comply with the obligation under Chapter 2C of the Act to set up and maintain a register of members of the scheme.

Four Key Takeaways

  1. The regulation of litigation funding schemes as managed investment schemes under the Corporations Act 2001 (Cth) is designed to increase transparency around the operation of litigation funders and to ensure that litigation funders are subject to the same level of regulatory oversight and scrutiny as comparable financial service providers.
  2. ASIC has introduced modifications to the existing managed investment scheme regime to address practical difficulties likely to be faced by litigation funders in complying with certain statutory obligations which were not introduced with litigation funding in mind.
  3. We are monitoring whether the changes will have any material impact on class action activity. Some litigation funders have foreshadowed that they may need to pass increased compliance costs on to group members, which may present a disincentive for some group members.
  4. The Australian Government introduced these amendments to the Corporations Regulations 2001 (Cth) to complement the inquiry being undertaken by the Parliamentary Joint Committee on Corporations and Financial Services into litigation funding and the regulation of the class action industry, which is due to report by 7 December 2020. It is likely that further changes will be made to the regulation of litigation funders for class actions in Australia following the delivery of that report.
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