The unregulated status of the litigation funding industry in Australia ended with the Corporations Amendment Regulation 2012 (No. 6) dated 12 July 2012.  The effectiveness of this 'light touch' regime is likely to impact the protections that exist for consumers who are expected to avail themselves of class actions in seeking access to justice and the volume of litigation commenced against Australian businesses, especially listed corporations who are the target of shareholder class actions.

What is Litigation Funding?

In a typical litigation funding arrangement, the funder will enter into an agreement with one or more potential litigants. The funder pays the costs of the litigation (such as the lawyer's fees, disbursements, project management and claim investigation costs) and usually accepts the risk of paying the other party's costs in the event that the claim fails through providing the plaintiff with an indemnity. In return, if the claim is successful, the funder will receive a certain percentage of any funds recovered by the litigants either by way of settlement or judgment, and the litigants will assign the funder the benefit of any costs order they receive. The share of the proceeds is agreed with the litigants, and is typically one third of the proceeds (usually after reimbursement of costs).

How is Litigation Funding Regulated?

The Full Federal court in Brookfield Multiplex Limited v International Litigation Funding Partners Pte Ltd (2009) 260 ALR 643 found that funded class action 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 [2011] NSWCA 50 found that a litigation funder of commercial litigation 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 litigation funding in relation to class actions or insolvency proceedings from the MIS and AFSL regime but imposes requirements on litigation funders to manage conflicts of interest.  Pre-existing consumer protection laws such as prohibitions on misleading conduct, unfair contract terms and unconscionable conduct continue.  However, two important regulatory pillars, capital adequacy and licensing, are omitted.

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 or $5500. 

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. 

Capital Adequacy

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.  As a result, the representative party in a class action 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. 

Licensing

The lack of a licensing regime means anyone or any entity can fund class action litigation in Australia (except for lawyers).  A licence permits a person or firm to operate in a market provided they have obtained the requisite permission and comply with the conditions of the licence.  The conditions of the licence can include specified levels of competency (such as education) and restrictions based on status or background (such as criminal record, bankruptcy or a previous licence was cancelled).  None of this is required to fund litigation in Australia. 

The omission of capital adequacy and licensing requirements means that the regulations fail to adequately protect the consumers who are being encouraged to pursue class action litigation by the government.

Litigation Funding in the UK

The Australian approach to regulating litigation funding can be contrasted with the UK approach.  In the United Kingdom, litigation funding has been adopted and will be further promoted when Part 2 of the Legal Aid, Sentencing and Punishing of Offenders Act 2012 comes into force in April 2013.  Litigation funding is regulated through self regulation in the form of A Code of Conduct for Litigation Funders launched in November 2011.  The Code is voluntary but sets out the standards of practice and behaviour to be observed by those funders who are members of The Association of Litigation Funders of England and Wales.  The hope is that consumers will draw comfort from the Code and, therefore, seek funding from those entities which have adopted it.  The Code is comprised of 11 provisions including requirements that:

• the funder take reasonable steps to ensure that funded entities seek independent legal advice;
• the funder will not seek to influence the solicitor or barrister to cede control of conduct of the dispute to the funder;
• the funder will maintain at all times adequate financial resources to meet its obligations to fund the litigation it is contractually obligated to fund;
• the funding agreement specify the grounds on which the funder may terminate the agreement; and
• if there is a dispute between the funder and a funded entity about settlement or termination, resort may be made to an independent Queen's Counsel.

The UK approach is far more comprehensive than the Australian approach and applies to all types of litigation not just class actions.  The UK approach could serve as guide to the issues that Australian regulation should address, albeit in a mandatory rather than voluntary manner.