Clayton Utz Insights
24 November 2011
By Ross McInnes and Alexandra Kennedy-Breit.
While there is general consensus that the litigation funding industry needs to be regulated, there is vigorous debate about the appropriate kind of regulation.
Litigation funding in Australia is now a prominent feature of Australia's litigation landscape, particularly in the class action industry. However, despite being home to a relatively mature litigation funding market, the industry is essentially unregulated in Australia.
What is litigation funding?
Litigation funding agreements are commercial arrangements under which the funder agrees to pay the costs of litigation. Depending on the agreement reached, they may agree to be liable for an adverse costs order or to meet any order for security for costs. In return, if litigation is successful or settles, the funder will be reimbursed for the costs they have paid and will also receive a portion of any amount awarded (generally one to two-thirds of the award after their costs are repaid).
Is litigation funding legal?
While initially a matter of some debate, the validity of litigation funding was established by the High Court in Campbells Cash and Carry Pty Limited v Fostif Pty Limited (2006) 229 CLR 386. Notwithstanding this affirmation of legitimacy, the litigation funding industry is still subject to some uncertainty due to its lack of regulation.
This deficiency was put in the spotlight in two recent decisions – the Full Federal Court's decision in Brookfield Multiplex Limited v International Litigation Funding Partners Pte Ltd (2009) 180 FCR 11; and the NSW Court of Appeal's decision in International Litigation Partners Pte Ltd v Chameleon Mining NL and Anor (2011) 276 ALR 138.
The issue for the Court in Brookfield was whether the arrangement between the representative parties, the litigation funder and solicitors to pursue the action against Brookfield constituted a managed investment scheme. If the arrangement could be so characterised, the parties would be in breach of the Corporations Act 2001 (Cth) for failing to register that scheme, and the proceedings would have to be stayed until the issue was addressed. The majority found that the arrangement was a managed investment scheme.
In Chameleon, the Court found that a litigation funding agreement was a "financial product" as defined by the Corporations Act, and therefore the funder was required to hold an Australian financial services license.
The effect of the Brookfield decision in particular was profound - the entire litigation funding was put "on hold" as they were forced to consider whether their own arrangements constituted unregistered managed investment schemes.
This issue was addressed in the short term by ASIC, which issued a Class Order that allowed for the "temporary operation of funded representative proceedings" without the need to comply with the Corporations Act. This Order has been extended four times, and is now set to expire on 29 February 2012.
Why should litigation funders be regulated?
There is an inherent conflict of interest in the relationship between funders and claimants – claimants are generally motivated by personal drivers, whereas funders, by their nature, have a more commercial focus. As such, their approach to litigation, motives for pursuing the claims and desire to resolve it can be quite different.
Also, litigation funders play an important role in the class action industry. Many class actions only proceed because of litigation funding. For example, a potential class action between Vodafone and 23,000 customers was recently put on hold when the firm representing the class was unable to secure funding. Class action litigation can often be long and expensive, which means the prudential health of litigation funders is critical to ensuring individuals' claims are able to be pursued to finality.
A regulatory regime is the most appropriate means of managing this conflict of interest and providing prudential controls – this much is relatively uncontroversial. It is the precise manner in which regulation should achieve that goal that is the subject of current debate. It has also been the subject of debate in other jurisdictions.
What regulation is proposed?
The Australian Government has recognised concerns about the lack of regulation, and proposes to address them by amending current corporate regulations. The Treasury Department released an exposure draft of the proposed Corporate Amendment Regulation 2011 for comment.
The amendments propose to exclude litigation funders from the definition of "managed investment scheme" and the financial products regime in the Corporations Act. This will remove any requirement for a funder to comply with the regulatory regime or hold an Australian Financial Services Licence. However, such exemptions are contingent upon "appropriate arrangements" being put in place to manage conflicts of interest.
The exposure draft closed to public consultation on 12 August 2011. Commentary on the proposal was lukewarm.
Some suggested that litigation funders should not bear the burden of ensuring "appropriate arrangements" are put in place and rejected the need for regulation. Others acknowledged the need for regulation, but believed an Australian Financial Services Licence would be too onerous a burden and would stifle competition in the funding industry, particularly from overseas funders.
Others argued that the only sensible regulation would be a requirement for funders to hold an Australian Financial Services Licence because of the prudential and conflict control measures mandated by such a license.
A final regulation from the Government is expected shortly.
What does this mean?
Litigation funding is now a cornerstone of the Australian litigation landscape, especially in large-scale litigation such as class actions. In many circumstances class actions are dependant upon receiving financial backing from litigation funders in order to commence.
The final form of litigation funding regulation is still up for grabs.
However, it seems unlikely that the final regime will place such an onerous burden on funders that class action litigation will dry up. Litigation funding is likely to remain a profitable endeavour and a mainstay of the Australian legal landscape.
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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.
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