After the Inquiry: what's next for litigation funders and the class actions industry in Australia?

Litigation funding in the spotlight 8 min read

The Parliamentary Joint Committee on Corporations and Financial Services (the Committee) has now completed its inquiry into litigation funding and the regulation of the class action industry (the Inquiry). The public hearings saw strong support for the regulation of litigation funders and opposition to the lifting of the ban on contingency fees. The Inquiry is set to publish its final report in December 2020.

In this Insight, we identify the key themes arising from the Inquiry, which we expect to be a focus of the Inquiry's final report and recommendations. We also outline the practical implications of the recently introduced legislation giving effect to the announcements made earlier this year regarding the regulation of litigation funders and the introduction of contingency fees in Victoria.

The Inquiry

In May 2020, the House of Representatives referred the Inquiry to the Committee – the third government-led inquiry of this kind. You can read more about the terms of reference of the Inquiry here.
The Inquiry received over 90 submissions and heard from a range of witnesses, including litigation funders, superannuation funds, law firms (plaintiff and defendant), insurance bodies and legal academics.

Allens' submission to the Inquiry

In our submission to the Inquiry, we expressed the following views:

• increased regulation of the litigation funding industry is desirable – preferably through an Australian Financial Services Licence (AFSL) regime tailored to the circumstances of litigation funders. This is particularly so given the rapidly increasing number of class actions in Australia (read more in our 2020 Class Action Risk Report);
• the current ban on contingency fees should not be lifted (although that step has since been taken in Victoria);
• common fund orders and similar arrangements should not form any part of Australia's class action regime. They do not increase access to justice or facilitate fair and equitable outcomes for plaintiffs; and
• class closure orders are important in facilitating settlement and allowing for finality to be achieved for plaintiffs, group members and defendants.

Allens has previously made submissions to the Australian and Victorian Law Reform Commissions, which examined similar issues to those canvassed by the current Inquiry.

Submissions and public hearings

There were some key themes arising from the public submissions made to the Inquiry:

• Regulation of litigation funders: The submissions received by the Inquiry were overwhelmingly supportive of the regulation of litigation funders by way of an AFSL regime. However, we and others raised concerns about the appropriateness of the managed investment scheme (MIS) regime under the Corporations Act 2001 (Cth) (Corporations Act) as the mechanism for regulating litigation funding arrangements.
• Lifting of the ban on contingency fees: Many submissions opposed the lifting of the ban on contingency fees for similar reasons to those we identified in our submission, including that such arrangements raise conflicts of interest for lawyers by creating an incentive to settle early rather than to act in the best interests of the plaintiff and group members. A number of public submissions expressed the view that, in the event that the ban on contingency fees was lifted, courts should have the power to reject, vary or amend the terms of contingency agreements.
• Economic impacts of class actions: We and others supported a review of the continuous disclosure rules in the Corporations Act, including the introduction of a fault-based regime and a due diligence defence. However, others (in particular, plaintiff firms) strongly opposed any reform to these laws.

The Committee conducted five public hearings throughout July and August. The key themes emerging from those hearings included:

• general support of litigation funding as a key mechanism for access to justice – but with reform needed to better regulate funding arrangements and the potential conflicts of interest between litigation funders and the acting law firm;
• support for litigation funders being subject to an AFSL regime to improve transparency and accountability in the litigation funding industry;
• support for increased involvement by ASIC in the regulation of litigation funders and class actions, to alleviate the regulatory burden on the courts; and
• a variety of views about the power of the courts to make common fund orders.

Further regulatory developments since the Inquiry commenced

Regulation of litigation funders

On 24 July 2020, the Corporations Amendment (Litigation Funding) Regulations 2020 (Cth) (the Amending Regulations) commenced. The Amending Regulations give effect to the announcement made on 22 May 2020 by Treasurer Josh Frydenberg that litigation funders operating in Australia will be required to hold an AFSL and comply with the MIS regulatory regime under the Corporations Act. Read more about that announcement here.

The Amending Regulations will only apply to class action litigation funding schemes¹ entered into on or after 22 August 2020, limiting disruption to proceedings already on foot.

In summary, the key effects of the changes include that:

• litigation funders must obtain an AFSL and comply with the AFSL obligations in order to offer, or provide financial product advice in relation to, an interest in a litigation funding scheme.² This includes making a litigation funding agreement available to potential group members;
• a litigation funding scheme is very likely to constitute a MIS. Additionally, if the scheme meets the registration requirements in Chapter 5C of the Corporations Act, the scheme will need to be registered as a MIS and, correspondingly, will be subject to the requirements in Chapter 5C of that Act. Those requirements include that the scheme be operated by a Responsible Entity (which must be a public company that holds an AFSL authorising it to operate a registered MIS) and must have a scheme constitution and compliance plan;
• a funder or other person that offers, issues or recommends an interest in a litigation funding scheme to retail investors will be subject to the product disclosure requirements in Part 7.9 of the Corporations Act (including the requirement that a Product Disclosure Statement be given and requirements that apply when advertising the litigation funding scheme); and
• the anti-hawking provisions, which regulate unsolicited offers to issue or sell financial products, and related provisions will now apply to litigation funding schemes.

These changes are intended to subject litigation funders to greater regulatory supervision with the goal of improving accountability, disclosure, conflict management and protections for group members.

In our submission to the Inquiry, we recommended that further steps be taken to tailor the AFSL and MIS regimes to the specific circumstances of litigation funding, particularly with respect to financial adequacy, reporting and conflict management. We said that some legislative or regulatory intervention to modify the application of the MIS regime may be needed to ensure effective regulation of litigation funding arrangements. The need for this tailoring of the MIS regime to suit the litigating funding context is recognised in the Explanatory Statement that has since been released for the Amending Regulations, which notes that ASIC may need to consider whether the changes should be supplemented by exemptions and modifications made under an ASIC instrument. ASIC indicated in its appearance before the Inquiry that it was considering this, and ASIC has since conducted a roundtable on potential exemptions and modifications.³

We also expressed the view in our submission to the Inquiry that there should be increased court supervision of litigation funders (including an express statutory power to vary disproportionate or excessive funding commissions as part of any settlement approval) and of the relationships between funders and lawyers. Neither of these matters is addressed by the Amending Regulations.

Contingency fees introduced in Victoria

For reasons set out in detail in our submission to the Inquiry, we oppose the use of contingency fee arrangements in Australia. However, on 1 July 2020, the Justice Legislation Miscellaneous Amendments Act 2020 (Vic) came into effect, allowing lawyers to charge contingency fees for class actions in Victoria.

As a result of the Bill being passed, in Victoria, a representative plaintiff in a class action can now apply to the court for an order that the legal costs payable to the law practice representing the plaintiff and group members be calculated as a percentage of the amount of any award or settlement that may be recovered in the proceeding. There is no statutory limit on the percentage amount that the law practice may recover – the Opposition's proposal to cap such fees at 35% was defeated. Whilst we consider it necessary to have adequate checks and balances on, among other things, the amount of fees charged by a law firm using a contingency fee arrangement, we opposed the use of a statutory cap. In our view, having such a cap may simply encourage plaintiff firms acting on a contingency fee basis to use the cap as a default rate, rather than a maximum.

The new regime gives the court the power during the course of the proceeding to amend a group costs order, including, but not limited to, amending any percentage ordered. We support the court having this power to vary the percentage ordered as a more appropriate check on the appropriateness of the fees being charged than a statutory cap.

Together with the New South Wales Supreme Court and the Federal Court, the Victorian Supreme Court has long been a preferred jurisdiction for Australian class actions. As a result of contingency fees now being allowed in Victoria (and not being allowed in any other Australian jurisdiction), we may well see an increase in class actions filed in Victoria compared to New South Wales and the Federal Court, with entrepreneurial plaintiff firms seeing Victoria as a more desirable and lucrative jurisdiction in which to file proceedings.

Next steps

The Committee is due to produce its final report in December 2020. We will continue to report on key developments in this area.

The recent changes to contingency fees in Victoria and the application of the AFSL and MIS regimes to litigation funders takes some of the steam out of the current Inquiry. In light of these developments, we expect that the Inquiry's final report will focus on whether contingency fees should be permitted in class actions in the Federal Court, and the broader economic impacts of the class action regime, including the operation of the continuous disclosure regime in the context of shareholder class actions.