Third party funding regulation in Australia

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Wala Al-Daraji
University of Westminster, London
W.Aldaraji@westminster.ac.uk

Third party funding (TPF) provides greater access to justice in both arbitration and litigation. It allows the funded party to pursue a claim that otherwise, arguably, it would not be able to pursue. In England and Wales, TPF is voluntarily regulated through the Association for Litigation Funders (ALF). At the time of writing, there are no inquiries into law reform in relation to regulating TPF in the United Kingdom, however, in Australia, TPF regulation is fast approaching. On 22 May 2020, the Treasurer of the Commonwealth of Australia announced that litigation funders will become subject to financial regulation that requires holding an Australian Financial Services License (AFSL).¹ Moreover, funders will need to comply with the Australian Securities and Investments Commission (ASIC) Managed Investment Scheme (MIS) regulations.

An AFSL brings many obligations captured under ASIC Regulatory Guides (RG). RG 104 AFS Licensing; requires having adequate financial resources, arrangements for managing conflict of interest and maintaining competence in the financial services provided.² According to ASIC, the general licensing obligations of RG 104 are not designed to provide security nor protect against credit risk.³ RG 166 Licensing provides for a minimum net tangible assets (NTA) requirement, a cash needs requirement and an audit requirement.⁴

While some Australian lawyers may agree with having an ASFL, the move towards categorising TPF as MIS is causing concern among other lawyers.⁵ The obligations of a MIS include establishing a compliance plan, being a public company that holds an Australian financial services licence and putting the interests of the members ahead of the interests of the responsible entity.⁶ The changes are to be implemented within three months from the date of the Treasurer’ announcement. At the same time, there is an ongoing inquiry by the Parliamentary Joint Committee on Corporations and Financial Services (PJC) into litigation funding and the regulation of class action.⁷ PJC findings will be issued in December 2020 after implementing the new regulations. This means that the 93 submissions made by different parties to PJC will not be taken into account when the changes start to be implemented in August 2020.

It is worth considering three of the 93 submissions made to PJC. The Australian Competition and Consumer Commission (ACCC) recommends careful consideration of any changes that may reduce the availability of class action.⁸ This is because class action depends on pooling small claims into a worthwhile claim that largely depends on TPF to both fund and project manage the action. ACCC further considers that the threat of private litigation and class action is important in deterring conduct which may breach the Competition and Consumer Act 2010.⁹ ACCC concludes that no ‘substantial regulatory intervention’ is needed at this stage.¹⁰ The second submission that is particularly important is the submission of the future regulator of litigation funders which is ASIC. ASIC submission is objective in not arguing for or against regulation but practical in nature. It highlights areas of regulations that need to be adapted to accommodate third party funding. For example, ASIC highlighted that MIS obligations for the scheme property and valuations would need to be tailored for litigation funding schemes.¹¹ ASIC explains that TPF under MIS would need to disclose their fees and would ‘only be able to charge fees in relation to the proper performance of its duties’.¹² There is no cap on the fees or profits that could be charged under a MIS scheme. Moreover, MIS entities have to disclose in the Product Disclosure Statements (PDS) the costs of the financial product, amounts payable by a holder of the product after its acquisition and commissions or similar payments that will impact the final return.¹³ This makes litigation funding largely retail finance similar to mortgages, for example, where a lender has to provide specific information as required for by the Financial Conduct Authority in England and Wales. The third submission to consider is that of the Association of Litigation Funders of Australia (ALFA). ALFA states that ‘it would not oppose a licensing regime although such a regime may not add any meaningful value in consumer protection’.¹⁴ It adds that the existing licensing and MIS structures are unsuitable in the context of third party funding.¹⁵ ALFA also raises important practical considerations regarding applying the new regulations to ongoing funded class action cases, average time to obtain a licence exceeds the time period set by the federal government to implement the changes and existing proscriptions against conducting a MIS by lawyers.¹⁶

The regulations do not stop at TPF but will also cover intermediaries giving advice about a litigation funding scheme.¹⁷ This means lawyers who are involved in advising or recommending TPF would arguably be required to hold an AFS licence. Moreover, ASIC will have ‘product intervention power’ which allows it to address any breaches of funders’ obligations, including disclosure, and significant consumer detriment.¹⁸ The intervention can result, if necessary, in banning a financial product.¹⁹ So why are these changes being made? The Treasurer statement explains that this is to bring greater transparency and accountability.²⁰ However, it is argued that the motive is to put the brakes on class actions that have increased by 325 per cent in the last decade.²¹ As there will be no cap on the funders fees, this aim is arguably not to control how much profits funders can make but rather how they operate. The transaction costs for the move from the current status to the regulated status will be borne initially by the funders and eventually transferred to funded parties whether they are in class action or not. There will also be ongoing compliance costs which may increase the costs of litigation funding. In comparison, the UK litigation funding market is not based on class action as group litigation orders and collective proceedings are uncommon in the UK.²² This would make introducing similar changes in the UK arguably unlikely in the near future. However, in the context of international arbitration, some funders will have to follow the Australian measures when operating in Australia while not having to go through the same processes when funding a claim in other jurisdictions. This may initially make TPF in Australia more dominated by local rather than international funders.

In summary, the future of TPF in Australia is being shaped by new regulations due to come into force August 2020. Whether these changes will increase access to justice, expand TPF and improve the terms of funding are yet to be known. In terms of arbitration, the main benefit will be robust conflict of interest checks that, in theory, should reduce challenges of both arbitrators and awards. If the regulations succeed in reducing conflict of interest, this may be a success to arbitration in Australia. It may also reduce procedural irregularities that may otherwise provide procedural grounds for setting aside an award. In turn, this may attract the attention of other jurisdictions to bring similar regulations to TPF, not necessarily for class action, but for more transparency as advocated by the Treasurer of the Commonwealth of Australia and for improving procedural regularity when TPF is involved. Whatever the outcome, eyes of funders, lawyers and arbitrators will be on Australia as it leads the world in regulating TPF.

Notes

1. The Hon Josh Frydenberg MP, ‘Litigation funders to be regulated under the Corporations Act’ (22 May 2020) available at https://ministers.treasury.gov.au/ministers/josh-frydenberg-2018/media-releases/litigation-funders-be-regulated-under-corporations accessed 27 October 2020.
2. ASIC, Regulatory Guide 104 AFS Licensing: Meeting the general obligations, RG 104.1.
3. ASIC, ‘PJC inquiry into litigation funding and the regulation of the class action industry: Submissions by ASIC’ (Submission 39, June 2020).
4. AISC, Regulatory Guide 166 Licensing: Financial requirements, RG 166.30, RG 166.242.
5. Mike Taylor, ‘AFSLs and ASIC oversight not for us say litigation funders and lawyers’ (Money Management, 12 June 2020) available at www.moneymanagement.com.au/news/policy-regulation/afsls-and-asic-oversight-not-us-say-litigation-funders-and-lawyers accessed 27 October 2020.
6. Corporation Act 2001, Ch 5, s 601FC (1)(C).
7. Parliament of Australia, ‘Parliamentary Joint Committee on Corporations and Financial Services: Litigation Funding and the Regulation of the Class Action Industry’ available at www.aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financial_Services/Litigationfunding accessed 27 October 2020.
8. Australian Competition & Consumer Commission, ‘ACCC Submission to the Inquiry into Litigation Funding: Submission No 15’ (Letter dated 10 June 2020) available at www.aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financial_Services/Litigationfunding/Submissions accessed 27 October 2020.
9. Ibid.
10. See n 4 above.
11. Australian Securities & Investments Commission, ‘ASIC Submission to the Inquiry into Litigation Funding: Submission No 39’ (June 2020) at www.aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financial_Services/Litigationfunding/Submissions accessed 27 October 2020.
12. Ibid, at 81.
13. ASIC (n 11 above) 82; Corporations Act 2001, s 1013D(1).
14. Association of Litigation Funders of Australia, ‘ALFA Submission to the Inquiry into Litigation Funding: Submission No 57’ (1 June 2020) at www.aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financial_Services/Litigationfunding/Submissions accessed 27 October 2020, at 74.
15. Ibid, at 14.
16. Ibid, at 77.
17. ASIC (n 11 above), at 93.
18. Ibid, at 152.
19. Ibid, at 154.
20. The Hon Josh Frydenberg MP (see n 1 above).
21. TSMH, ‘New rules for litigation funders after jump in class actions’ available at www.smh.com.au/politics/federal/new-rules-for-litigation-funders-after-jump-in-class-actions-20200521-p54vak.html accessed 27 October 2020.
22. UK Government, List of all group litigation orders (2020) at www.gov.uk/guidance/group-litigation-orders#list-of-all-group-litigation-orders; Competitions Appeal Tribunal, Cases: Section 47B Competition Act 1998 (Collective Proceedings) at www.catribunal.org.uk/cases accessed 27 October 2020.

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