Clayton Utz Insights
19 July 2012
By Nicholas Mavrakis, Ross McInnes and Michael Legg.
The new regime to regulate litigation funders contains no requirements for capital adequacy or any form of prudential regulation, which could lead to inadequately resourced funders who will litigate for profit but avoid the costs if unsuccessful.
The unregulated status of the litigation funding industry in Australia has ended with the Corporations Amendment Regulation 2012 (No. 6), dated 12 July 2012.
The focus of the regulation is on managing conflicts of interest which has the potential to provide substantial protections for class action participants, depending on how the requirements are implemented. However, the regulation contains no requirements for capital adequacy or any form of prudential regulation.
This invites the use of inadequately resourced funders who will litigate for profit but avoid the costs if unsuccessful. This creates the prospect of defendants being subject to time-consuming and expensive litigation, but being left out-of-pocket if they are successful in their defence.
The effectiveness of this "light touch" regime is likely to impact the volume of litigation commenced against Australian businesses, especially listed corporations who are the target of shareholder class actions
The Full Federal Court in Brookfield Multiplex Limited v International Litigation Funding Partners Pte Ltd (2009) 260ALR643 found that funded litigation was a managed investment scheme (MIS) subject to Chapter 5C of the Corporations Act.
The New South Wales Court of Appeal in International Litigation Partners Pte Ltd v Chameleon Mining Ltd  NSWCA 50 found that a litigation funder was required to hold an Australian Financial Services Licence (AFSL). The Chameleon Mining case has been granted special leave by the High Court. The Federal Government initially instructed the Australian Securities and Investments Commission to grant interim class order relief to compliance with the AFSL and MIS regimes.
The Corporations Amendment Regulation 2012 (No. 6) excludes funded litigation from the AFSL and MIS regimes but imposes requirements on litigation funders to manage conflicts of interest.
Conflicts of interest
The regulatory requirement for conflicts of interest is that a litigation funder must have "adequate arrangements" for managing conflicts of interest. It is an offence not to have in place adequate arrangements, giving rise to a penalty of 50 penalty units.
The regulations provide that a person is taken to have in place adequate arrangements if it can show through documentation that it meets certain listed requirements. These include conducting a review to identify potential conflicts, monitoring of potential conflicts, disclosure and "protecting the interests of … members of the scheme". It is to be expected that guidance will be sought from the learning on the AFSL requirement to manage conflicts of interest in the Corporations Act and in particular ASIC's Regulatory Guide 181.
The broad language of requiring the funder to protect the interests of the members of the scheme (which is not defined) could give rise to effective obligations. The protection of interests may encompass such things as creating a mechanism for resolving differences between the funder and a plaintiff as to important decisions in the litigation such as discontinuance or settlement.
This is currently managed through a "QC clause" whereby an independent opinion is sought from a senior barrister as to the merits of the decision to be made. It may also mean prohibiting a funder from controlling proceedings or seeking to influence the legal practitioners retained in proceedings or placing limits on a funder's right to terminate a funding agreement.
The regulations contain no capital adequacy requirements. As a result there is no protection for plaintiffs (or defendants) that the funder has sufficient resources to be able to pay legal fees and meet any adverse costs order. This creates the potential for inadequately resourced subsidiaries to pursue litigation, and may also attract overseas based funders who are beyond the reach of Australian courts because they can litigate for profit but avoid the costs if unsuccessful.
The only partial protection against this is an order for security for costs by the courts. A security for costs order requires that a bank guarantee or other form of security is provided to meet the costs of a defendant if the proceedings are unsuccessful. However, it is common practice that the amount of security that a court generally requires to be posted is substantially lower than the costs actually incurred by the defendant, even on a party‑party basis. As a result, the representative party in a class action or the plaintiff in other types of proceedings may be liable for those costs if the litigation funder is insolvent. Where those people have inadequate resources, which is highly likely as they required litigation funding to commence the proceedings, they may become bankrupt.
Defendants, if successful, may find they secure a pyrrhic victory in which their costs are not recovered. There may also be a waste of judicial resources as cases are progressed to a certain point before coming to a halt when the money runs out or prospects of success dim. This leaves the court to work through incomplete proceedings and costs orders. It also seems unlikely that legitimate Australian funders would welcome this approach as it has the potential to harm the industry's reputation.
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