Litigation funders soon to require an Australian financial services licence

In a surprise move, last week the Treasurer announced changes to the way litigation funders operating in Australia will be regulated.

Under the proposed changes, funders will now be required to hold an Australian financial services licence (AFSL) and comply with the managed investment scheme regime. As a result, litigation funders will now face the same regulatory scrutiny and accountability as other financial service and product providers under the Corporation Act.

The proposed changes are said to complement the inquiry currently being undertaken by the Parliamentary Joint Committee on Corporations and Financial Services into litigation funding and the regulation of the class action industry (PJC Inquiry). The PJC Inquiry has been given broad terms of reference and includes consideration of the potential impact of Australia's class action industry on businesses suffering from the impacts of the COVID-19 pandemic. Submissions to the PJC Inquiry close on 11 June 2020 with its report due on 7 December 2020.

What do the changes mean for funders?

At this stage little detail has been provided by the Government on the exact nature of the changes, apart from the fact that they will be implemented through amendments to the Corporations Regulations and take effect from three months from the date of the announcement, or 22 August 2020.

It is also unclear what effect they will have on funded proceedings currently on foot and whether a bespoke licensing regime or streamlined application process will be adopted. If the recent legislation implemented following the Banking and Financial Services Royal Commission is anything to go by (for example, the new licensing requirements for APRA-regulated superannuation trustees), there are likely to be transitional arrangements during which time litigation funders could continue to operate without an AFSL.

As a holder of an AFSL, litigation funders will be required to:

• do all things necessary to ensure that their services are provided efficiently, honestly and fairly;
• have available adequate resources (including financial, technological and human resources) to provide their services covered by their licence and carry out supervisory arrangements;
• maintain an appropriate level of competence to provide the financial services covered by the licence; and
• have in place adequate risk management systems.

Where litigation funders provide their services to retail clients, they will also need to comply with additional requirements, including:

• having internal and external dispute resolution systems;
• providing a Financial Services Guide to each retail client; and
• ensuring minimum training standards are met by the licensee's representatives.

Perhaps the most significant aspect of the changes for funders will be the proposed changes which will see litigation funding schemes regulated as managed investment schemes, and in particular, the base level financial requirements which are imposed on operators of such schemes.

To date, litigation funding schemes have enjoyed certain exemptions contained in the Corporations Regulations, exempting them from the definition of a managed investment scheme in Section 9 of the Corporations Act 2001. These Regulations were included following the Court's decision in Brookfield Multiplex Ltd v International Litigation Funding Partners Pte Ltd [2009] FCAFC 147 which held that the relevant arrangement constituted a managed investment scheme. The Court in that decision stepped through the essential elements of the definition of a managed investment scheme (which is exceptionally broad) in concluding that:

• there was a contribution of money or moneys worth to acquire an interest in the scheme:
• there was both a pooling of contributions and a common enterprise; and
• the plaintiffs/members did not have day to day control of the scheme.

The proposed changes will acknowledge that litigation funding schemes are in fact managed investment schemes (and should be regulated as such). Where interests in such schemes are offered to retail clients, it will generally be the case that such managed investment schemes will need to be registered under Chapter 5C of the Corporations Act 2001. As noted above, this will have a significant impact on litigation funders, given operators of a registered managed investment scheme in Australia as holders of an AFSL need to:

• have positive net assets and be solvent;
• have sufficient cash resources to cover the next 3 months' expenses with adequate cover for contingencies;
• have significant "net tangible assets", which can be more than $10 million (in circumstances where a separate custodian is not appointed); and
• audit compliance with these requirements annually or when ASIC requests.

In addition to the above, such schemes will need to be registered with ASIC and operated by an Australian public company (which holds an AFSL that authorises the responsible entity to operate registered managed investment schemes). A product disclosure statement will also need to be prepared, together with a constitution and a compliance plan (both of which need to be lodged with ASIC).

Further, previous reviews that have considered Australia's litigation funding industry have noted an increase in the number of offshore funders operating in Australia. Given the recent changes to the licensing regime applying to foreign financial services providers, foreign litigation funders providing such services in Australia will need consider their obligations in the context of the foreign financial services licensing regime.

While the proposals are likely to introduce a significant change for litigation funders, they are a step in the right direction in providing transparency around the operations of litigation funders in Australia. These changes also provide some comfort that litigation funders can in fact meet their obligations under any relevant litigation funding agreement.