‘Square Peg into a Round Hole’: Judgment commences the rollback of financial services regulation of the funding of class actions

The recent Full Federal Court decision in LCM Funding Pty Ltd v Stanwell Corporation Limited [2022] FCAFC 103 (LCM) has upended the former Coalition federal government’s attempt to regulate class actions as financial products and managed investment schemes (MIS), opening the way for an increase in class action activity.  

The judgment has come in advance of expected steps by the new Labor federal government to unwind the Coalition’s attempts at constraining the class action industry.

The LCM decision

The LCM decision has boosted plaintiff lawyers and litigation funders with the prospect of enabling more of class actions to commence due to the partial removal of a regulatory roadblock. 

Handed down on 16 June 2022, LCM overturned the decision in Brookfield Multiplex Ltd v International Litigation Funding Partners Pte Ltd (2009) 180 FCR 11 (Brookfield), which previously held that litigation funding schemes are MIS within the meaning of the Corporations Act 2001 (Cth) (Act).

When litigation fundings schemes were regulated as MIS, there were significant compliance costs for litigation funders, most notably in financial reporting and providing product disclosure statements. The Court in LCM pointed out numerous problems and contradictions in applying the MIS regulatory regime to litigation funding schemes, such as the difficulty of fitting a plaintiff’s interest in a litigation funding scheme into the definition of ‘scheme property’ that is ‘capable of being invested’ as was intended in the Act. The Full Court  described it as ‘a case of placing a square peg into a round hole’.  This echoes observations we made prior to the introduction of the regime, describing it as ‘inapt’.

Now that litigation funding schemes are not MIS, previously marginal class action lawsuits passed over by litigation funders may be financially viable, potentially bringing access to justice to more consumers.

Lingering Uncertainties in the Wake of the LCM Decision

Yet, litigation funding schemes are still declared a financial product by virtue of r 7.1.04N of the Corporations Regulations 2001 (Cth) (Regulations).  In practical terms, this means that litigation funders will still likely be required to hold an Australian Financial Services license.

However, it is now unclear what type of AFSL a litigation funder would require. The LCM decision established that litigation funding schemes are not MIS, but does not positively say what it is. 

Historically, during the regime in effect between January 2013 and August 2020, litigation funding schemes were declared to be financial products but not MIS or credit facilities. Litigation funders were also expressly exempt from the requirement to hold an AFSL, an exemption which does not exist in the current Regulations. In 2020, the Coalition government amended the Act and Regulations to remove the declaration that litigation funding schemes were not MIS, and the exemption for litigation funders to hold an AFSL.

Even before the LCM decision, the new Labor government has flagged its views on the issue, criticising the previous Coalition government’s attempts to stifle the funding of class actions. Stephen Jones, assistant treasurer, welcomed the LCM decision, and stated in respect of financial services regulation on litigation funding schemes that “I will now consult Treasury with a view to shutting this all down”.

Regardless of how far the Labor government intends to go with the reforms, any efforts to improve certainty on whether litigation funders require an AFSL would be welcome.

Even if financial services regulations under the Act and Regulations are rolled back entirely from litigation funding schemes, such schemes would still be regulated by the Courts by virtue of Part IVA of the Federal Court of Australia 1976 (Cth). 

In response to the argument that litigation funding schemes would become unregulated in the LCM case, the Court commented that ‘the spectre of their operation in some sort of Bir Tawil zone where no laws apply can be dismissed’.

The fact is, class actions have been effectively regulated by the courts through a framework of procedure developed by those courts over a number of years.  A regulatory regime separate to the courts, where the underlying basis of regulation (status as a financial product) is now at best uncertain, is unnecessary and of questionable effect.

Mackay Chapman

‍

The contents of this article do not constitute legal advice and it is not intended to be a substitute for legal advice and should not be relied upon as such.  It is designed and intended as general information in summary form, current at the time of publication, for general informational purposes only.  You should seek legal advice or other professional advice in relation to any particular legal matters you or your organisation may have.

‍