ASIC consults on the regulation of Litigation Funding Schemes

On 9 July 2021, the Australian Securities and Investments Commission (ASIC) issued Consultation Paper 345 – Litigation funding schemes: Guidance and relief (CP 345). CP 345 contains ASIC’s proposed changes aimed at providing greater clarity on the meaning and application of key provisions in the Corporations Act 2001 (Cth) (Corporations Act) to class actions that are litigation funding schemes. It also sets out ASIC’s position in relation to various relief instruments that currently apply to funded class actions.

CP 345 follows the release of the joint consultation paper on 1 June 2021 by Treasury and the Attorney-General’s Department titled Guaranteeing a minimum return of class action proceeds to class members, as well as the Final Report in December 2020 by the Parliamentary Joint Committee on Corporations and Financial Services on its inquiry into litigation funding and the regulation of the class action industry.

Summary of ASIC's Proposals

CP 345 seeks comments and submissions on ASIC’s proposals to do the following:

• to update Regulatory Guide 248 Litigation schemes and proof of debt schemes: Managing conflicts of interest (RG 248) to indicate how ASIC will apply and enforce the definitions of ‘managed investment scheme’, ‘member’ and ‘scheme property’;
• to update Regulatory Guide 166 Licensing: Financial requirements (RG 166) to provide guidance on the scope of ‘special custody assets’, as defined in subsection 912AA(11) of the Corporations Act, in the context of litigation funding schemes;
• to provide relief from the equal treatment rule contained in Chapter 5C of the Corporations Act;
• to extend to 22 August 2025 the dollar disclosure relief for registered litigation funding schemes provided under ASIC Corporations (Disclosure in Dollars) Instrument 2016/767 (ASIC Instrument 2016/767);
• not to renew the relief under ASIC Credit (Litigation Funding—Exclusion) Instrument 2020/37 which is due to expire on 31 January 2023 (ASIC Instrument 2020/37); and
• not to renew the relief under ASIC Corporations (Conditional Costs Schemes) Instrument 2020/38 which is due to expire on 31 January 2023 (ASIC Instrument 2020/38).

Summary of the Existing Regime

Pursuant to the Corporations Amendment (Litigation Funding) Regulations 2020 (Cth) (Regulations), the following regulatory regime has applied to certain funded class actions since 22 August 2020:

• class actions that are “litigation funding schemes”, as defined in Corporations Regulation 7.1.04N(3), are financial products and are therefore subject to the Australian financial services (AFS) licensing regime;
• litigation funding schemes are subject to Chapter 5C of the Corporations Act, namely the requirement to be registered and operated by a “responsible entity”;
• the responsible entity of a litigation funding scheme must comply with the disclosure requirements in Part 7.9 of the Corporations Act, including  the requirement to give a product disclosure statements (PDS) and to give periodic statements to members; and
• the anti-hawking provisions apply to interests in litigation funding schemes.

After the Regulations were made, ASIC issued ASIC Corporations (Litigation Funding Schemes) Instrument 2020/787 which granted relief to responsible entities of litigation funding schemes from the following:

• the requirement to provide a PDS to passive general members of open class actions that were litigation funding schemes, provided that the PDS was available on a website and referenced in advertising material;
• the requirement to value scheme property regularly;
• the statutory withdrawal procedures for members who withdraw from a class action in accordance with court rules; and
• the requirement to disclose fees and costs information and information pertaining to labour standards and environmental, social or ethical considerations.

Application of Key Definitions

ASIC proposes to amend RG 248 and RG 166 to provide guidance on the application of the following key definitions:

• managed investment scheme;
• member;
• scheme property; and
• special custody assets.

Managed Investment Scheme

ASIC asserts that, amongst other things, the definition of ‘managed investment scheme’ will be satisfied in the following circumstances:

• closed class actions where all general members have entered into a litigation funding agreement with the litigation funder; and
• either an open or closed class action where members have not all entered into a funding agreement, but the litigation funder and general members have made a contribution of money or money’s worth.

Member

According to ASIC, a person will be a member of a scheme if they hold some right (including a right that is prospective, contingent or unenforceable in nature) to a benefit product by the scheme. ASIC considers that lawyers:

• will be a member of a litigation funding scheme if they have accepted a payment deferral of part or all of their professional fees in return for an increased sum or uplift; and
• will not be a member if both, their right to receive professional fees and the amount of professional fees received, are not dependent on the result of the legal proceedings.

Scheme Property

ASIC’s view set out in CP 345 is that “scheme property” includes the following:

• settlement sums or judgment awards obtained following the legal proceedings (Resolution Sum);  
• promises by members to pay an amount of the Resolution Sum to the litigation funder or lawyers;
• promises by the litigation funder to pay the costs associated with the conduct of the legal proceedings (including any promise to indemnify lead plaintiffs against any adverse cost orders);
• promises by lawyers to conduct legal proceedings, in part or whole, on a conditional costs or contingency costs basis;
• promises by an insurer made under an insurance arrangement, to provide indemnification against any adverse costs order made in the legal proceedings; and
• floats or running accounts set up for use as part of the scheme.

Special Custody Assets

ASIC proposes to amend RG 166 so that it reflects ASIC’s interpretation of “special custody assets” in the context of litigation funding schemes. Amended RG 166 will also set out the impact of “special custody assets” on the net tangible asset requirements imposed on AFS licensees that operate registered managed investment schemes.

According to ASIC, the following are special custody assets:

• promises by  members to pay an amount of the Resolution Sum to the litigation funder or lawyers;
• promises by the litigation funder to pay the costs associated with the conduct of the legal proceedings (including any promise to indemnify lead plaintiffs against any adverse cost orders);
• promises by lawyers to conduct the legal proceedings, in part or whole, on a conditional costs or contingency costs basis; and
• promises by an insurer made under an insurance arrangement, to provide indemnification against any adverse costs order made in the legal proceedings.

Application of the Equal Treatment Rule

Pursuant to subsection 601FC(1)(d) of the Corporations Act, responsible entities must treat members, who hold interests of the same class, equally when exercising their powers and carrying out their duties (Equal Treatment Rule). ASIC proposes to provide industry-wide relief from this requirement to enable a responsible entity to distribute to general members settlement sums obtained in class actions, provided the distribution is consistent with the constitution of the scheme and any orders or determinations made by the Court or a court-appointed resolution administrator. The relief is proposed not to apply to any other aspect of the conduct of the class action or the operation of the scheme generally.

Dollar Disclosure Relief

The Corporations Act requires various costs, fees, charges, expenses, benefits and interests to be stated as dollar amounts in a PDS for the scheme, subject to certain exceptions.

In April 2021, ASIC issued ASIC Corporations (Amendment) Instrument 2021/292 (ASIC Instrument 2021/292). ASIC Instrument 2021/292 provides interim relief for a period of 12 months from the requirement to disclose the relevant information in dollar amounts in a PDS issued for a registered litigation funding scheme.

ASIC is aware that, as a PDS is a public document, it is impracticable to include dollar amounts in connection with litigation funding schemes which may have ‘adverse strategic implications’. Taking this into account, ASIC proposes to provide relief from these disclosure requirements, subject to the following conditions that are aimed at ensuring members of litigation funding schemes receive the requisite information:

• the responsible entity must separately disclose the relevant information to active general members; and
• the responsible entity must notify active general members of any material changes to the relevant information 30 days before the change takes effect in connection with adverse costs insurance premiums and before, or as soon as practicable after, any other change to other relevant information.

Non-renewal Position for Provision of Credit and Conditional Cost Schemes Relief

ASIC proposes not to renew the temporary relief provided by ASIC Instrument 2020/37 that enables the operation of litigation funding arrangements and proof of debt funding arrangements without complying with the National Credit Code at Schedule 1 of the National Consumer Credit Protection Act 2009 (Cth).

ASIC also proposes not to renew the temporary relief provided by ASIC Instrument 2020/38 that enables the operation of conditional cost schemes, i.e. litigation funding schemes or proof of debt funding schemes that are funded under a conditional costs agreement, without the requirement to comply with the managed investment scheme requirements under Chapter 5C and the AFS licensing and disclosure requirements under Chapter 7 of the Corporations Act.

Depending on one’s interpretation of the definition of “litigation funding scheme” and the circumstances of a particular class action, this could have implications for law firms conducting class actions on a conditional or contingent costs basis. In proposing not to renew this relief, ASIC referred to the findings of the Senate Standing Committee for the Scrutiny of Delegated Legislation as well as Treasury’s intention to change the regulatory regime that applies to litigation funding schemes.

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