Changes to the Regulation of Litigation Funding in Australia

Amid a reported increase in the number of class actions over the past decade, the Australian Government has announced changes to the Corporations Regulations 2001 (Cth) to facilitate greater regulatory oversight of litigation funders operating in Australia. The changes, set to come into operation on 22 August 2020, will require funders of class action litigation to hold an Australian Financial Services Licence (‘AFSL’). After some initial confusion following the announcement, the Government has now provided welcome clarity that the changes are confined to class action litigation funders, and do not affect funders of insolvency litigation or single plaintiff claims.

The Changes

Since 2010, litigation funders have been exempt from requirements to register as managed investment schemes or obtain an AFSL. In the decade since then, the number of class actions has increased and class actions have been subjected to increased scrutiny from the media, parliamentary committees and independent law reform commissions. This has reignited public debate as to whether litigation funders should be more tightly regulated.

On 22 May 2020, the Australian Government announced that litigation funders operating in Australia will be required to hold an AFSL and to register as managed investment schemes, with the corresponding obligations set out in the Corporations Act 2001 (Cth) (‘the Act’). Initially little detail was provided as to the text or effect of the changes. On 23 July 2020, the Government released the Corporations Amendment (Litigation Funding) Regulations 2020 (Cth) (‘the Amendment Regulations’) which clarified the scope and impact of the changes.

Under the Amendment Regulations, class action litigation funders operating in Australia will be required to obtain an AFSL in accordance with Chapter 7 of the Act and register as managed investment schemes under Chapter 5C of the Act.

As AFSL holders, class action litigation funders will be required to (amongst other things):

• do all things necessary to act honestly, efficiently and fairly
• have adequate resources available to provide the services covered by the licence and carry out supervisory arrangements
• implement arrangements to manage conflicts of interest
• ensure its representatives are adequately trained to provide the services covered by the licence
• obtain membership of the Australian Financial Complaints Authority, an external dispute resolution body

As registered managed investment schemes, class action litigation funders will also be required to (amongst other things):

• ensure that any person operating the scheme is a public company holding an AFSL (see above)
• exercise the degree of care and diligence that a reasonable person would exercise if they were in the position of the responsible entity
• act in the best interests of the members and give priority to the interests of members where they conflict with the funder’s own interests
• ensure the funder’s constitution complies with the requirements of ss 601GA and 601B of the Act
• ensure the scheme has (and complies with) a compliance plan that meets the requirements of s 601HA of the Act
• report to ASIC any breach of the Act that has had, or is likely to have, a materially adverse effect on the interests of members
• have sufficient cash resources to cover at least 3 months’ expenses, including adequate cover for contingencies
• have net tangible assets
• audit compliance with these requirements annually, or when requested by ASIC

The Amendment Regulations apply to funding arrangements entered into on or after 22 August 2020.

Effect on Insolvency Litigation Funders

The Government’s initial announcement created uncertainty as to what types of litigation funders would be affected by the reforms. While the reforms are ostensibly targeted towards increasing transparency in the class action industry, there were concerns that funders of other types of litigation would also be swept up in the reforms.

This was of particular concern to the insolvency world since litigation funders play a vital role in assisting insolvency practitioners to recover assets for the benefit of creditors. Without funding, many claims could not be pursued, since insolvent estates are usually impecunious by definition. Such funding also has the public benefit of ensuring that those who acted in contravention of the law in connection with the business of an insolvent entity can be held accountable for their wrongdoing.

Thankfully the uncertainty created by the Government’s initial announcement has been alleviated now that the text of the Amendment Regulations and their accompanying Explanatory Statement has been released. These documents clarify that only funders of class action litigation will be subject to the new requirements to register as managed investment schemes and hold an AFSL. Other litigation funders, such as funders of insolvency litigation and single plaintiff litigation, will continue to be exempt from those requirements.

Conclusion

The Amendment Regulations are unlikely to be the last change to the regulatory landscape of class action funding in Australia. The Parliamentary Joint Standing Committee on Corporations and Financial Services is due to report on litigation funding and the regulation of the class action industry by 7 December 2020, and this may lead to further scrutiny and reform in this area.

The announcement of the Amendment Regulations provides some reprieve to insolvency practitioners and their litigation funders who had been left uncertain as to how any changes could affect their operations. Given the vital role litigation funders play in ensuring the administration of justice in an insolvency context, it is welcome news that the Government has heeded industry concerns and ensured that such funding continues to be exempt from increased regulation. This is particularly pertinent in these uncertain economic times, which may very well lead to an increase in insolvency-related litigation in the near future.