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ASIC Relief for Litigation Funding Schemes

ASIC has made a series of announcements to support the transition to the new regulatory framework for litigation funding schemes. These include the introduction of the ASIC Corporations (Litigation Funding Schemes) Instrument 2020/787 (Amending Instrument) and a no-action position in relation to setting up and maintaining a register of members.

This article provides an overview of these announcements and the implications for those running litigation funding schemes.

Background

The definition of ‘litigation funding scheme’ in the Corporations Regulations 2001 (Cth) (Corporations Regulations) includes what is commonly understood as a class action.  Briefly, a class action involves legal action brought by one or more persons on behalf of a wider group against one or more defendants where the claims arise out of the same circumstances and there is a common issue being considered. 

On 22 May 2020, the Federal Government announced that it would be making litigation funders subject to greater regulatory oversight by requiring them to hold an Australian financial services (AFS) licence and comply with the managed investment scheme regime.   These changes were made to address issues currently being examined by the inquiry into litigation funding and the regulation of the class action industry by the Parliamentary Joint Committee on Corporations and Financial Services.

To implement these changes, the Corporations Amendment (Litigation Funding) Regulations 2020 (Amending Regulations) were issued.  The Amending Instrument removed exemptions from the Corporations Regulations that specified:

  1. A person providing financial services for litigation funding schemes was exempt from the requirement to hold an AFS licence.
  2. Litigation funding schemes were exempt from being considered a managed investment scheme.

These changes came into effect on 22 August 2020, but do not apply to litigation funding schemes entered into before 22 August 2020.

The removal of these exemptions means that operators of litigation funding schemes will need to hold an AFS licence and each litigation funding scheme that is offered to retail clients will need to be registered.  This is because class actions funded by a third party litigation funder are generally considered to be a managed investment scheme.  

These changes will have wide ranging ramifications for operators of litigation funding schemes, including: 

1. Further obligations as a result of AFS licence requirements:

  • The obligation to provide efficient, honest and fair financial services.
  • The obligation to comply with the financial requirements of AFS licensees including the net tangible assets and cash flow projections requirements.  
  • To comply with the risk management system requirements. 
  • To comply with dispute resolution and compensation arrangements, including becoming a member of the Australian Financial Complaints Authority.
  • An Australian public company will have to apply for the AFS licence as the litigation funding schemes will generally be registered schemes.

2. Further obligations as a result of having to register the scheme:

  • A product disclosure statement (PDS) will need to be prepared.
  • The scheme’s constitution and compliance plan will have to be lodged with ASIC.
  • A scheme auditor and a compliance plan auditor will have to be appointed. 

ASIC Amending Instrument

Both the Treasurer and ASIC have recognised that, in certain circumstances, compliance with the obligations in Chapters 5C and 7 of the Corporations Act will be difficult for operators of litigation funding schemes.   To address these difficulties, and to manage the transition to the new regulatory regime, ASIC has made the exemptions and modifications set out in the Amending Instrument.  The Amending Instrument, includes relief from: 

  1. The obligation to give a PDS to ‘passive’ members of open litigation funding schemes. 
  2. Some PDS content requirements.
  3. The statutory withdrawal procedures for members who withdraw from a class action under court rules. 
  4. Obligations in relation to the valuation of scheme property.

Each of these is considered in further detail below.

Obligation to provide a PDS to passive members of open litigation schemes

The Amending Instrument provides an exemption to the responsible entity of a litigation funding scheme from the requirement to give a PDS in certain circumstances.  Section 1012B of the Corporations Act sets out that a PDS must generally be given to a retail client before or at the time they are offered or issued an interest in a managed investment scheme.

ASIC has recognised that compliance with section 1012B may not be possible in relation to a member of a litigation funding scheme given the “opt-out nature” of class action proceedings.  As such, ASIC has formed the view that a responsible entity should not be required to give a PDS to a passive general member of an open litigation funding scheme.   A passive general member, as distinct from an active general member, is a general member of a litigation funding scheme who is not a party to a funding agreement or an agreement with lawyers representing the scheme and who has not provided notice that the person wishes to participate in the scheme.  

ASIC has provided this exemption on the condition that:

  1. the responsible entity has made the PDS publicly available on the scheme’s website; and 
  2. any notices to members or prospective members of the scheme and any advertising material in relation to the scheme contains a prominent reference to the PDS and the website on which the PDS may be accessed.

PDS content requirements

ASIC has also granted exemptions in relation to the prescribed information that PDSs must contain as set out in section 1013D of the Corporations Act.  ASIC has identified that some of the content requirements in section 1013D should be modified to apply appropriately to litigation funding schemes.  As such, the Amending Instrument removes the obligation to issue a PDS that contains:

  1. A fees and costs template and the additional explanation of fees and costs. 
  2. An example of annual fees and costs.
  3. The boxed consumer advisory warning statement. 
  4. Disclosure regarding the extent to which labour standards or environmental, social or ethical considerations are taken into account in the selection of investments.

Withdrawing from a litigation funding scheme

Part 5C.6 of the Corporations Act sets out how a member may withdraw from a managed investment scheme.  Conversely, the court rules for class actions specifically provide for how and when a general member may withdraw from a class action.  ASIC has identified that that these rules may not be consistent with the member withdrawal provisions of the Corporation Act.  To address this situation, the Amending Instrument sets out:

  1. That the member withdrawal provisions do not apply in relation to a general member of a registered litigation funding scheme. 
  2. The responsible entity must allow a general member to withdraw from the registered litigation funding scheme only:
    • if the general member opts out in accordance with the court rules or any order of the court; or
    • the general member otherwise ceases to have an interest in the outcome of the representative proceedings.  

Obligation to value scheme property

Finally, ASIC has identified that the duty of a responsible entity to ensure that scheme property is valued at regular intervals would be difficult for responsible entities of litigation funding schemes.  This is because there will likely be uncertainty as to the nature and characterisation of scheme property.  As such, the Amending Instrument exempts the responsible entity of a registered litigation funding scheme from the requirement to ensure that scheme property is valued at regular intervals. 

ASIC’s No-Action Position 

In addition to the Amending Instrument, ASIC has issued a no-action position in relation to certain obligations in Part 2C of the Corporations Act.  Under section 168 of the Act, the responsible entity of a registered scheme must set up and maintain a register of members. Similarly, under section 169 of the Corporations Act the register of members must contain the name and address of each member, and the date on which the entry of each member’s name in the register is made. 

ASIC has noted the practical difficulty responsible entities of registered litigation funding schemes may face in complying with the obligations to set up and maintain member registers where there are passive general members who cannot be individually identified.  Unfortunately, ASIC does not have the power to grant relief from the member register obligations under the Act.  ASIC has therefore issued a ‘no-action’ position in relation to the obligations under sections 168 and 169 of the Corporations Act for responsible entities of registered litigation funding schemes that are open litigation funding schemes.  This means that ASIC will not take regulatory action in relation to a breach of these sections.

Next Steps for the Regulatory Regime and Litigation Funding Schemes

ASIC has indicated that they will review the relief granted to litigation funders on an ongoing basis and once the final report of the Parliamentary Joint Committee is tabled in parliament. This may include providing additional relief or modifying the current relief. 

ASIC has also encouraged responsible entities of litigation funding schemes to contact them if they have concerns about their ability to comply with the Corporations Act and, for the initial three months of the new regime, to discuss their PDS, scheme constitution and compliance plan with ASIC.

Our Funds Management and Financial Services Team (in conjunction with our Litigation and Banking and Finance Teams) is well placed to assist you if you need assistance establishing a managed investment scheme, preparing a PDS or engaging with for ASIC. Please contact Justin Gross, Brendan Ivers, or Jack Peterson for more information.