Back to the future: Funded class actions are not managed investment schemes

What you need to know

• The Full Federal Court has determined that the class action litigation funding arrangements are not "managed investment schemes" under the Corporations Act. This reverses the Court's previous ruling in 2009.
• As a result, class action litigation funders are no longer required to comply with the managed investment scheme provisions of the Corporations Act. This will reduce the regulatory burden on litigation funders, and increase the attractiveness of funded class actions in Australia.
• At the time of writing, an AFSL is still required to carry on the business of dealing in, or providing financial product advice in relation to, a "litigation funding scheme" (effectively a funded class action). This is because such schemes are declared to be a "financial product" for the purpose of the Corporations Act. 
• Following the LCM Funding decision, the Government has indicated that it is considering doing away with the AFSL requirements for funded class actions altogether. This would further increase the attractiveness of funded class actions in Australia.
• Labor has previously indicated that it will implement the ALRC's 2018 proposals in relation to litigation funding. These include that the Court have greater oversight over litigating funding in class actions (including additional statutory powers to approve, reject, vary or amend the terms of litigation funding agreements).

Background

Class actions in Australia are often funded by third party litigation funders. Typically, litigation funders enter into an agreement (primarily with a class representative) to pay the legal costs of the class representative and to pay the respondent's costs if the class action is unsuccessful. In return, if the claim is successful, the funder receives its money back together with a share of the amount awarded.¹

In Brookfield Multiplex Ltd v International Litigation Funding Partners Pte Ltd (2009) 180 FCR 11, the Full Court of the Federal Court of Australia held that the litigation funding arrangements and solicitors' retainers for two representative proceedings were an unregistered "managed investment scheme" for the purpose of the Corporations Act. The decision left a number of important questions unanswered, including who was operating the "scheme" (e.g., the litigation funder, the plaintiffs, the plaintiffs' solicitors, the Court, or some combination of these), how Chapter 5C of the Corporations Act (the managed investment scheme provisions) applied to the "scheme", and how Chapter 5C interacted with Part IVA of the Federal Court of Australia Act (the representative proceedings provisions).

Shortly after the Brookfield decision, ASIC made class orders relieving funded class actions from the requirements relating to managed investment schemes. This effectively negated the Brookfield decision. Parliament subsequently amended the Corporations Regulations to exempt funded class actions from the managed investment scheme provisions.

In 2020, Parliament amended the Corporations Regulations again to:

• remove the exemptions for funded class actions; and
• declare that a "litigation funding scheme" (effectively defined as a funded class action) is a financial product for the purpose of the Corporations Act.²

The effects of the 2020 amendments, coupled with the Brookfield decision, included that:

1. Funded class action "schemes" with more than 20 members were required to be registered and comply with Chapter 5C of the Corporations Act.³ This included a requirement that the "scheme" be operated by a responsible entity that is a public company and holds an AFSL authorising it to operate the scheme.
2. A person carrying on the business of dealing in, providing financial product advice in relation to, and/or operating a funded class action "scheme" was required to hold an AFSL covering the provision of those financial services.⁴
3. Funded class action "schemes" were subject to Chapter 7.9 of the Corporations Act, including the requirement to give a Product Disclosure Statement in certain circumstances.⁵

The LCM Funding decision

In LCM Funding Pty Ltd v Stanwell Corporation Limited [2022] FCAFC 103, the Full Court of the Federal Court of Australia unanimously held that a funded class action is not a managed investment scheme for the purpose of the Corporations Act, and that the Brookfield case was wrongly decided. 

The Court reasoned that:

• Characterising a funded class action as a "managed investment scheme" is inconsistent with the purpose of Chapter 5C of the Corporations Act. Accordingly, even if the definition of "managed investment scheme" can be read as encompassing a funded class action, a reading that does not encompass a funded class action should be preferred if it is available. ⁶
• Many of the provisions of Chapter 5C of the Corporations Act are incapable of being applied to a funded class action, are impossible for the "scheme" to comply with, or result in "conceptual incoherence".⁷ For example, it is uncertain who the responsible entity of a funded class action "scheme" is or should be. If the litigation funder is taken to be the responsible entity, it is difficult to see how it would be able to comply with its obligations under Chapter 5C in relation to the "scheme" (some of which are fiduciary in nature).⁸
• Characterising a funded class action as a managed investment scheme creates incoherence between the provisions of Chapter 5C of the Corporations Act and Part IVA of the Federal Court of Australia Act.⁹ For example, it is not clear how the managed investment scheme provisions sit with the extensive powers and supervisory role of the Court in relation to representative proceedings.¹⁰

The Court specifically held that a funded class action does not meet the definition of a "managed investment scheme" (read in context and in accordance with the general purpose and policy of the managed investment scheme regime) because:

• alleged scheme members do not contribute money or money's worth;¹¹
• even if such contributions are made, they cannot properly be characterised as consideration for the acquisition of rights to benefits produced by the alleged scheme;¹² and
• any such alleged contributions are not pooled, or used in a common enterprise, to produce financial benefits.¹³ 

The implications

The main implication of the LCM Funding case is that funded class actions are not classified as "managed investment schemes", and therefore do not need to comply with the provisions of Chapter 5C of the Corporations Act. For example, it is not necessary to register a funded class action "scheme" with more than 20 members or appoint a responsible entity to operate the scheme. This will lessen the regulatory burden on class action litigation funders (and possibly plaintiff class action law firms), and therefore likely make funded class actions more attractive.

It is important to note that Parliament has not (as at the time of writing) amended the Corporations Regulations to remove the declaration that a "litigation funding scheme" is a financial product for the purpose of the Corporations Act, although the Government has indicated that it is considering doing so.¹⁴ 

In the interim, the position would appear to be that: 

1. an AFSL is still required to carry on the business of dealing in, or providing financial product advice in relation to, a "litigation funding scheme"; and
2. a "litigation funding scheme" remains subject to the requirements in Chapter 7.9 of the Corporations Act, including the requirement to give a Product Disclosure Statement in certain circumstances.

Where to from here?

Attorney-General Mark Dreyfus QC previously indicated (while in opposition) that a Labor government would remove the managed investment scheme arrangement for funded class actions because "it hasn't worked and wasn't required in the first place".¹⁵ Assistant Treasurer and Minister for Financial Services Stephen Jones has indicated that following the LCM Funding decision he sees "no reason the whole regime should not be scrapped".¹⁶ 

Subject to any further appeal to the High Court, it seems likely that Parliament will move to amend the Corporations Regulation in the near future to remove the provisions declaring a "litigation funding scheme" to be a financial product for the purpose of the Corporations Act. This would eliminate the remaining AFSL and PDS requirements in relation to funded class actions, further reducing the regulatory burden on class action litigation funders and increasing the attractiveness of funded class actions.

Finally, the Attorney-General also previously indicated that a Labor government would implement the proposals of the Australian Law Reform Commission in relation to class action litigation funding.¹⁷  These include the following proposals:¹⁸

• litigation funding agreements should be enforceable only with approval of the Court, and the Court should be empowered to reject, vary or amend the terms of litigation funding agreements;
• there should be a statutory presumption that litigation funders who fund representative proceedings will provide security for costs;
• litigation funders that fund representative proceedings should be required to report annually to ASIC on their compliance with requirements to implement adequate practices and procedures to manage conflicts of interest;
• a solicitor acting for the representative plaintiff whose action is funded by a litigation funding agreement should be prohibited from recovering any unpaid legal fees from the representative plaintiff or group members; and
• the Court should be expressly empowered to award costs against third-party litigation funders and insurers who fail to comply with the overriding purpose of the civil practice and procedure provisions of the Federal Court of Australia Act (which include to facilitate the just resolution of disputes as quickly, inexpensively and efficiently as possible). 

1. _{For further information, please see our earlier publication: Class Actions in Australia – Quickguide (2019)}
2. _{Corporations Regulations, reg 7.1.04N(3).}
3. _{See Corporations Act, s 601ED(1)(a). The other situations in which a managed investment scheme is required to be registered include where it is promoted by a person, or an associate of a person, who is, when the scheme is promoted, in the business of promoting managed investment schemes, or ASIC has determined that a number of managed investment schemes are closely related and each of them has to be registered at any time when the total number of members of all of the schemes exceeds 20 (see Corporations Act, ss 601ED(1)(b) and (c)).}
4. _{See Corporations Act, ss 764A, 766A and 911A.}
5. _{See Corporations Act, Chapter 7.9. Note that ASIC has issued ASIC Corporations (Litigation Funding Schemes) Instrument 2020/787 (due to expire on 22 August 2025), which relieves the responsible entity of a registered litigation funding scheme of the obligation to give a PDS to a "passive general member" of the scheme. A passive general member is essentially a person who has not agreed to actively participate in the scheme (including by signing a funding agreement and retainer with the law firm acting for the scheme).}
6. _{LCM Funding at [8], [20] (Lee J); [129]-[132] (Anderson J).}
7. _{LCM Funding at [9] (Lee J); [137]-[150], [156], [157]-[159] (Anderson J).}
8. _{LCM Funding at [139]-[141], [163] (Anderson J).}
9. _{LCM Funding at [153]-[155], [156] (Anderson J).}
10. _{LCM Funding at [153] (Anderson J).}
11. _{LCM Funding at [11]-[13] (Lee J); [133], [156], [166] (Anderson J). Cf. paragraph (a)(i) of the definition of "managed investment scheme" in s 9 of the Corporations Act.}
12. _{LCM Funding at [11], [14]-[15] (Lee J); [160], [166] (Anderson J) Cf. paragraph (a)(i) of the definition of "managed investment scheme" in s 9 of the Corporations Act.}
13. _{LCM Funding at [11], [16]-[19] (Lee J); [161], [166] (Anderson J). Cf. paragraph (a)(ii) of the definition of "managed investment scheme" in s 9 of the Corporations Act.}
14. _{'Labor to scrap class action funding regulations', Australian Financial Review, 20 June 2022 (accessed on 20 June 2022 at https://www.afr.com/politics/federal/labor-to-scrap-class-action-funding-regulations-20220618-p5aur6).}
15. _{'Shadow AG watching "in horror" as class action reforms advanced', Lawerly, 18 March 2022 (accessed on 19 June 2022 at https://www.lawyerly.com.au/shadow-ag-watched-in-horror-as-class-action-reforms-advanced/).}
16. _{'Labor to scrap class action funding regulations', Australian Financial Review, 20 June 2022 (accessed on 20 June 2022 at https://www.afr.com/politics/federal/labor-to-scrap-class-action-funding-regulations-20220618-p5aur6).}
17. _Ibid.
18. _{Integrity, Fairness and Efficiency—An Inquiry into Class Action Proceedings and Third-Party Litigation Funders, ALRC Report 134, December 2018, Chapter 6.}