Full Federal Court decision lowers the bar for litigation funders

In a decision that has significant implications for the class action industry, the Full Court of the Federal Court has determined that litigation funding schemes are not managed investment schemes (MIS) subject to regulation under Chapter 5C of the Corporations Act 2001 (Cth).

The Court's decision in LCM Funding Pty Ltd v Stanwell Corporation Limited [2022] FCAFC 103 overturns a long-established precedent, and will undoubtedly prompt further debate over the need for regulation of the litigation funding industry. In the short term, we can expect the growth in funded litigation to continue.

Definition of Managed Investment Scheme under the Corporations Act

There are three characteristics defining a MIS:

• people contribute money or money's worth as consideration to acquire rights or interests to benefits produced by the scheme;
• contributions to the scheme are pooled or used in a common enterprise to produce financial benefits;
• the members of the scheme do not have day-to-day control of the scheme.

The first two characteristics have been contested since the Full Court's 2009 decision in Brookfield Multiplex Ltd v International Litigation Funding Partners Pte Ltd (2009) 180 FCR 11 (Brookfield), in which the Full Court held that a litigation funding scheme was a MIS.

The result of the Brookfield decision was to require litigation funders to hold an Australian Financial Services Licence (AFSL) and comply with Chapter 5C of the Corporations Act. In 2013, (in response to Brookfield) the then Federal Labor Government passed regulations exempting litigation funders from these requirements, subject to the condition that they must implement adequate procedures to manage conflicts of interest.

However, the Federal Coalition Government changed these regulations with effect from 22 August 2020. From that date, most types of litigation funding arrangements were declared to be financial products requiring litigation funders to hold an AFSL and, under the Brookfield interpretation, comply with the MIS rules. Litigation funding schemes that began prior to 22 August were excluded from this change under "grandfathering" rules.

The Full Court's decision

In a decision that has significant implications for the class action industry, the Full Court of the Federal Court has determined that litigation funding schemes are not managed investment schemes (MIS) subject to regulation under Chapter 5C of the Corporations Act 2001 (Cth).

In last week's LCM Funding decision, the Full Court overruled Brookfield on the basis it was "plainly wrong" to say that a litigation funding scheme was a MIS.

The proceedings relate to a class action against Stanwell and CS Energy alleging misuse of market power leading to inflated electricity costs to retail customers in Queensland between 2012 and 2017. The class action includes 61,000 group members who entered into funding agreements with the litigation funder, LCM Funding.

At first instance, Stanwell argued that the litigation funding scheme operated by LCM Funding was an unregistered MIS and sought declarations restraining LCM Funding from continuing to operate it. In reply, LCM Funding cross-claimed arguing that its litigation funding scheme was a grandfathered scheme entered into before 22 August 2020, and that Brookfield was plainly wrong.

Justice Beach:

• held the litigation funding scheme was a grandfathered scheme;
• delivered detailed reasons questioning the correctness of the Brookfield decision but considered he was bound to follow it as a decision of the Full Court.

LCM Funding appealed the decision to the Full Court. Among the list of reasons given by Justice Anderson, who delivered the leading judgment, as to why litigation funding schemes do not satisfy the definition of a MIS in s 9 of the Corporations Act were:

• group members did not contribute money or money's worth to a litigation funding scheme, and any benefits received by group members would be generated by the realisation of their claims with the funding agreement only providing a mechanism for the payment of legal services;
• a litigation funding scheme did not include any "pooling" of funds to produce a common benefit - pooling only occurs at the end of the operation of the scheme at the time the Court exercises its power on judgment or approves a settlement of the class action;
• the contractual rights in a typical litigation funding scheme could not constitute "scheme property" because they are not capable of being invested or otherwise dealt with by the operator of the scheme;
• group members did not acquire rights or interests to any benefits produced by the scheme as their rights lay in their individual legal claims, which remain their property until they merge in judgment or settlement;
• it is not possible for a typical litigation funding scheme to comply with various Corporations Act provisions relating to MIS; for example, it is not possible to maintain a register valuing the interests of each member when that value is not known until the proceeding is resolved;
• it is not possible to identify the operator of the scheme, since none of the three possible operators (the litigation funder, the representative applicant, and the lawyers acting for the representative applicant) meet the statutory definition of an operator ("Responsible Entity");
• key Corporations Act provisions regulating MIS were rendered incoherent or potentially conflicted with Part IVA of the Federal Court of Australia Act 1976 (Cth) regulating class actions; and
• the legislative history of the MIS provisions in the Corporations Act supported the conclusion that class actions were never meant to be treated as MIS.

In separate reasons, Justice Lee summed up the Full Court's approach by saying that characterising a litigation funding scheme as an MIS was a case of "placing a square peg into a round hole".