12 Jun 2020

Litigation funders have nothing to fear from reform in Australia

Government plans to tighten regulation of funders is inevitable and should be welcomed, argues Sophy Woodward

Sophy Woodward

Sophy Woodward: 'Greater regulation of litigation funders appears inevitable and is already occurring.'

Class actions financed by litigation funders loom large in the Australian legal landscape.

As reported previously by the Global Legal Post, the Morrison government has announced a wide-ranging inquiry into the regulation of class actions and the litigation funding industry, which has been welcomed by defendant law firms, such as Allens and Herbert Smith Freehills. 

Greater regulation of litigation funders appears inevitable and is already occurring. The Australian federal treasurer, Josh Frydenberg MP, also recently announced that litigation funders will be subject to greater regulatory oversight by requiring them to hold an Australian Financial Services License (AFSL) and to comply with the managed investment scheme regime in the Corporations Act 2001. Litigation funders will have three months to obtain an AFSL.

So what will these changes mean for the litigation funding industry? For funders who already hold an AFSL (of which I am aware of only one) these changes will do no more than level the playing field. For all of the other funders, the additional requirements are likely to have a significant impact, at minimum by increasing regulation costs.

This may produce a consolidation of the litigation funding market in Australia and act as a disincentive for new entrants to the market. In relation to those funders that survive, the changes should be welcomed on the basis that they are likely to increase the transparency of litigation funding arrangements and ensure that funders are able to meet their funding commitments. 

Regulatory change and parliamentary scrutiny

While the Parliamentary inquiry will examine all aspects of the class action system, including whether further regulation of litigation funders is needed to improve justice outcomes, it is the latest in a series of such inquiries, including by the Australian Law Reform Commission, and state-level equivalents. 

On the regulatory side, for over a decade, litigation funding schemes have been exempt from the requirement to hold an AFSL and its definition of a managed investment scheme. The trade-off for this was that they had to maintain adequate conflict management processes.

Now, although the details of the changes have not been released, these exemptions look set to be removed. Litigation funders as holders of an AFSL will need to comply with a range of requirements. These include matters such as providing financial services efficiently, honestly and fairly, having adequate resources, and maintaining an appropriate level of competence.

There are also various audit and reporting requirements where litigation funding schemes are offered to retail clients. Of course, increased regulation is not always a good thing, and a balance must be struck. However broadly speaking these requirements appear reasonable and appropriate. 

Increased transparency

It is too soon to tell what broader measures will emerge from the parliamentary inquiry on class actions and litigation funding. However, the announcement that litigation funders will be required to hold an AFSL and be subject to the managed investment scheme regime appears to be a positive development. 

There is a level of distrust of litigation funders by corporates and insurers in Australia as a result of years of escalating numbers of class actions and rising directors' and officers' insurance premiums. Greater regulation and increasing the transparency of litigation funding arrangements, has the potential to go some way towards remedying this distrust. 

At the very least, it will ensure that unscrupulous operators are not allowed to muddy the waters for those litigation funders who are doing the right thing. 

Sophy Woodward is a special counsel specialising in insurance disputes at HFW Australia

Further reading

We have allowed a sophisticated class action industry to grow without bespoke regulation - Jason Betts welcomes the Australian parliamentary review into class actions and calls for town hall-style public debates

The multimillion-dollar settlement with a sting in its tail for Australia class actions — The Vocus judgment will have a chilling effect on litigation funding hindering access to justice, argues Steven Friel