Litigation funding – ASIC’s submission to the ALRC

ASIC’s submission[1] to the Australian Law Reform Commission on class actions and litigation funding seemed to be a surprise to some.[2]  ASIC says that, consistent with other jurisdictions, litigation funding should be regulated as a legal service, under the control of the courts, rather than as a financial service, regulated by ASIC or other appropriate regulator.

In making that submission, ASIC did not refer to the existing law whereby it is the courts that regulate the entry into litigation funding arrangements by liquidators in pursuing recovery proceedings under the Corporations Act. 

This was explained in my 2 July 2018 comments at Litigation funding of liquidators – the ALRC inquiry.

In fact, the ALRC itself does not raise this separate body of law and most submissions do not raise it. Its focus is on class actions, although the terms of its reference include litigation funding generally.

As I earlier explained, there are parallels between the collective interests of creditors in a company external administration, on whose behalf a liquidator may bring a proceeding, and the collective plaintiffs in a class action. In the same way that a funded class action assists individual claimants who do not have the resources or capacity for risk to pursue their justice, a funded liquidator’s claim assists creditors collectively to bring a claim in their interests, which they cannot in law bring individually, and where, collectively, they have insufficient funds.  In both cases, the claim could not be brought but for the litigation funding provided.

Insolvency law goes further and allows those who do fund to be granted priority dividend payment out of the recoveries from the litigation, under s 109(10) of the Bankruptcy Act[3] and s 564 of the Corporations Act – with funding agreements often conditional upon that priority being obtained, subject to court approval.[4] Courts have developed criteria for allocation of priority based on risk and other factors.

One submission to the ALRC did refer to insolvency funding, that of CAANZ[5] of 30 July 2018, which, correctly in my view, points out that the ALRC

“discussion paper largely focuses on ‘class action’ cases, however we note that litigation funding is also a useful model for the insolvency industry. It allows liquidators/trustees in bankruptcy to commence legal action in certain matters, where ordinarily they may not have commenced such action due to no funds being available. Some of our members are also concerned that the proposed changes could inadvertently affect funding advanced by creditors of insolvent administrations for litigation purposes, including funding by the ATO or under the Fair Entitlements Guarantee Recovery (FEG) Program. We recommend that the Inquiry recommendations distinguish between third party funding for class actions and the funding of professionals, such as insolvency practitioners”.

To the extent that such funding is not mentioned, that distinction may well be made.  Nevertheless, ASIC might well have alerted us to the arrangements in insolvency in its preference for court oversight and approval.

These arrangements extend from no oversight, to oversight and approval by the creditors, through to oversight and approval by the courts.  As explained, the courts can then give a priority payment to the funder from any moneys recovered because of the litigation funding. This is how it works:

Insolvency practitioner Approval required? from whom? What for? Statutory priority for funder
Trustees in bankruptcy No creditor or court approval required Any litigation funding agreement Section 109(10) BA
Liquidators No creditor or court approval required Litigation funding agreements under 3 months Section 564 CA
Creditor approval, or court approval required – s 477(2B) CA Litigation funding agreements over 3 months
Liquidators funded by ASIC No creditor or court approval required – s 477(2C) Any litigation funding agreement

Court and creditor approval

The courts regularly approve litigation funding arrangement for liquidators, whether through individual or group creditor funding, or through litigation funders, under s 477(2B) Corporations Act. Criteria have been developed by the courts over time, set out in my earlier comment.

But before that, creditors are the first option for approval, with the courts only approached if creditor approval is not possible.  What many creditors would know about litigation funding is problematic, and their decision depends much on the professional integrity of the liquidator in explaining the details of the agreement.

Agreements extending beyond 3 months

The statutory requirement in s 477(2B) in fact only applies to ‘agreements extending beyond 3 months’, which most funding agreements are. It therefore has nothing to do with litigation funding. The object of the approval process under 477(2B) is rather to ensure that timing provisions in contracts do not cut across the general expectation that the winding up will proceed in an expeditious fashion as circumstances allow.  Law and practice has found that the most common agreements extending over that period are those for litigation funding, as well as those for the retention of lawyers for the conduct of the proceedings.

Bankruptcy – no approval required

There is however no requirement for bankruptcy trustees to obtain creditor or court approval to enter long term agreements, perhaps as a matter of history because they were less likely to have been needed in bankruptcy cases.

Reforms?

In the interests of harmonisation, and reduction in the costs of insolvencies, consideration could be given to removing the need for liquidators to obtain creditor or court approval.  Apart from bankruptcy, there is no approval required for a liquidator to commence major litigation proceedings or make a range of significant commercial decisions. No approval is required for a liquidator or trustee to enter into a variety of litigation funding, that of assignment of the liquidator’s or trustees’ cause of action, for some payment, potentially out of the proceeds of the proceedings brought by the assignee: s 100-5 Schedule 2.

Alternatively, given the focus on litigation funding, there could be a specific requirement introduced that litigation funding be approved according to general statutory criteria for the courts in deciding whether to approve such an agreement.  Those criteria used by the courts now are a good start.

However, as a threshold point, whether litigation funding approval is a matter for the courts in each individual case is open to question.  The ALRC is considering the licensing of litigation funders, according to set financial standards, and the courts may prefer to have evidence of the capital adequacy of the particular funder removed from their consideration by being able to rely on the regulation of the funder’s licence.

That could lead to the removal of the need for liquidators to obtain any approval and be left to the commercial decision of the liquidator, as it is with trustees in bankruptcy.

In any event, the issue of whether insolvency funders should be part of the outcome of the ALRC inquiry, or kept separate, as CAANZ has raised, might well be considered. If insolvency funders are kept separate, a review of the present arrangements, unharmonized between bankruptcy and liquidation, should be examined.

Whether ASIC’s submission is accepted in relation to litigation funding generally, including of class actions, is another matter.

 

[1] No 72, of September 2018

[2] ASIC says no to reform push on class action funders, AFR 18 October 2018, M Pelly – ASICsays funding deals are not financial products and that the courts should be left to police claims. This places it in conflict with the ALRC’s two main recommendations, which have received broad support ahead of the commission’s final report, which could now go to the federal government next month. Leading litigation lawyers expressed disappointment at ASIC’s submission, with one saying “the ball had been passed back to judge” and another saying a regulator should “set a benchmark for basic funder behaviour”’.

 

[3] See Woodgate, in the Matter of Eaton [2010] FCA 550.

[4] See for example In the matter of ACN 152 546 453 Pty Ltd (formerly Hemisphere Technologies) (in liq) [2018] NSWSC 1224).

[5] No 28,30 July 2018

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