08 Oct 2012

Litigation funding survives a legal challenge in the High Court

The litigation funding industry has survived a legal challenge in the High Court, in a decision which has found that a litigation funder was not providing a financial service and did not need an Australian Financial Services Licence (International Litigation Partners Pte Ltd v Chameleon Mining NL (Receivers and Managers Appointed) [2012] HCA 45).

International Litigation Partners' litigation funding arrangement with Chameleon

Chameleon wanted to pursue litigation in the Federal Court, so it entered into a litigation funding agreement with International Litigation Partners. Under it, International Litigation Partners paid Chameleon's legal bills directly to the lawyers (so Chameleon never saw the money itself).

Chameleon would not be required to reimburse International Litigation Partners until either the proceedings were resolved or there was a change in control of Chameleon.

How they got to court

There was a change in control of Chameleon, which triggered an Early Termination Fee. This turned out to be over $8 million. Rather than pay it, Chameleon claimed that the funding arrangement was a financial service within the meaning of Part 7.6 of Chapter 7 of the Corporations Act.

If a financial service is provided in the course of a financial services business by someone who must hold an Australian Financial Services Licence (AFSL), but doesn't, then the other party has the right under the Corporations Act to rescind the contract and walk away.

International Litigation Partners argued that it provided a credit facility, which does not require an AFSL. As a result, Chameleon had no right to walk away under the Corporations Act, and was liable to pay the Early Termination Fee.

Why this was a credit facility – so ILP didn't need an AFSL

According to the Corporations Regulations, a credit facility arises where credit is provided:

  • for any period;
  • with or without prior agreement between the credit provider and the debtor; and
  • whether or not both credit and debit facilities are available.

"Credit" means a contract, arrangement or understanding under which payment of a debt to the credit provider is deferred, and includes "any form of financial accommodation". As a result, said the High Court, "a contract, arrangement or understanding that is any form of financial accommodation is 'credit', and its provision 'for any period' will be a 'credit facility'". There does not need to be a defined period of time in which money is owed but not payable.

Here, International Litigation Partners promised to pay Chameleon's legal bills within 28 days of getting written notification. The time limit came from the stipulation that the legal bills had to relate to particular proceedings. Chameleon in turn promised to make certain payments if the proceedings were resolved in its favour. That, said the High Court, was a credit facility. International Litigation Partners did not need an AFSL, and consequently Chameleon had no right under the Corporations Act to rescind the agreement and avoid paying the $8 million fee.

So what does this mean?

This is not the first time that the legality of a litigation funding agreement has been challenged.

A previous ruling that a litigation funding agreement could be challenged as an unregistered managed investment scheme, and the Court of Appeal decision in Chameleon, had created uncertainty about the need for funders to hold an AFSL and otherwise comply with provisions in the Corporations Act. In order to provide some stability to the class action and litigation funding industries, ASIC provided interim relief by way of class order.

In July 2012, the Government made new Corporations Regulations that exempted some types of litigation receiving litigation funding (class actions and actions involving companies in external administration) from the definition of managed investment scheme, and from the AFSL requirements.

While those regulations provided some clarity for particular kinds of funded litigation, this High Court decision provides further comfort to litigation funders that they are not providing services that require an AFSL, so long as they fit within the models that are currently clearly exempt.

However, this is not the end of the matter. First, the High Court did not need to consider an alternative argument – that this arrangement was a derivative. It is conceivable that an arrangement might not be a credit facility, or within the exemptions in the Regulations, but could be a derivative. This may trigger the requirement for an AFSL.

Second, the High Court was not asked to consider if the Early Termination Fee amounted to a penalty. Given the recent focus on penalty clauses after the ANZ v Andrews decision in the High Court, it is again not inconceivable that this could be an issue in the future.

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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 communication. Persons listed may not be admitted in all States and Territories.