Australian Inquiry into Litigation Funding and the Regulation of the Class Action Industry: final report released - time for meaningful and measurable change?

By Janette McLennan, Partner, Sydney

The Australian  Parliamentary Joint Committee on Corporations and Financial Services  (Committee) has completed its inquiry into Litigation Funding and the Regulation of the Class Action industry, with the report issued on 21 December 2020 (Final Report).   The Committee has examined the class action industry which has now been in place for almost three decades in Australia, finding many criticisms well-justified as the regime has become skewed towards entrepreneurial claims.  

Recommended Reforms

There are 31 recommendations in the Final Report directed towards addressing some of the adverse consequences of the class action regime in Australia, expanding powers of the Federal Court of Australia, enhancing regulation and oversight, and addressing the prevalence of shareholder class actions. 

Whilst the implementation of any of the recommendations and timing of reform is presently uncertain, the recommendations include:

• Conferring exclusive jurisdiction on the Federal Court of Australia with respect to shareholder class actions (Recommendation 30) to eliminate the practice of competing shareholder class actions in different state courts.
• An express power being introduced to permit the Federal Court of Australia to resolve competing and multiple class actions, although the discretion to allow more than one class action with respect to the same dispute to continue (Recommendation 2), with mechanisms proposed to be introduced to resolve questions around which class action should advance by reference to what is in the best interests of group members (Recommendation 3);
• Tighter controls on the litigation funding industry, including:
  • New legislation to address uncertainty in common fund orders (we have previously written about these orders here and here) (Recommendation 7);
  • Litigation funding agreements only to be approved by the Federal Court where they must provide a complete indemnity for adverse costs (Recommendation 8), with a requirement that an agreement will only be enforceable where it has received Court approval (Recommendation 11).  Whilst there has already been some class actions where this has already occurred, this change (if made) would provide legislative support for enabling the Court to reject, vary or amend the terms of such an agreement "when the interests of justice require"  (notwithstanding it has perhaps been perceived by litigation funders as contentious where there is third-party interference in private contracts);
  • Introduction of a statutory presumption which requires a litigation funder to provide security for costs (Recommendation 10); and
  • The Federal Court being empowered to make costs orders directly against litigation funders (Recommendation 15).
• Greater transparency and oversight as to conflicts of interest and the court approval process:
  • The publication of a consistent prescriptive list of information following approval of any settlement (Recommendation 17).    This would allow considerable visibility including as to class size, number of members that opt-out, funding details/terms and fees, average payments to group members (including by reference to the gross settlement sum) and the amount of corporate tax paid by the litigation funder in Australia in the three prior financial years;
  • The appointment of an independent contradictor where there is the potential for significant conflicts of interest to arise or complex issues in the court approval process, with guidance being prescribed in the Federal Court of Australia Class Action Practice Notice on scenarios where conflicts are likely to arise (Recommendation 18).  We are increasingly seeing the appointment of contradictors in the Federal Court and this is expected to continue;
  • The requirement on funders and plaintiff lawyers alike to disclose conflicts of interest to the Federal Court (Recommendation 25); and
  • Prohibitions on solicitors, law firms and barristers having a financial or other interest in a third party litigation funder that is financing a particular class action in which those individuals are acting (Recommendation 26).
• Proposals in relation to reasonable, proportionate and fair legal costs (Recommendations 13, 14, 16), the capping of uplift fees (Recommendation 21), and consideration to be given to the imposition of a minimum return of the gross proceeds of a class action to group members (Recommendation 20), with commentary on contingency fees (which until recently were banned in all Australian states and territories, but from 1 July 2020 are permitted in the Australian state of Victoria in certain circumstances - click here for our earlier update).
• That the Australian Government permanently legislate changes to continuous disclosure laws, consistent with the temporary changes introduced during the COVID-19 pandemic to introduce a fault based element into these laws (Recommendation 29). 

On that last recommendation above, we have previously written about the continuous disclosure moratorium here currently in effect from 26 May 2020 until 23 March 2021 (absent any further extension). As we have observed, the temporary changes do not prevent other causes of action from being pursued during the moratorium period (most notably, misleading or deceptive conduct claims which are also frequently deployed in shareholder class actions).  That gap was not the focus of the Committee, which said:

"[17.121] The temporary amendments do not address other laws used in shareholder class actions, such as misleading or deceptive conduct laws. The committee does not have information on what proportion of shareholder class actions rely on continuous disclosure versus misleading or deceptive conduct laws, and whether there were any differences in the outcomes of those cases.

[17.122] Accordingly, the committee is not in a position to be definitive about whether other elements of Australia's substantive corporations law are impacting on the prevalence of shareholder class actions. Hence, the committee focuses on the connection between the continuous disclosure regime and shareholder class actions."

Other observations on shareholder class actions

The Committee was critical of the substantial growth in shareholder claims, and limited regulation of the funding market.  In what will likely be perceived as welcome news by ASX listed companies,  their directors / officers, and insurers, the Committee has concluded that shareholder class actions are inefficient and contrary to the public interest:

"[17.116] In the committee's view, shareholder class actions are generally economically inefficient and not in the public interest

[17.117] Shareholder class actions appear to often generate excessive profits for litigation funders and lawyers at the expense of listed companies and their shareholders. The company, rather than the directors and officers, are most often the liable party in shareholder class actions. Due to the circularity problem, the unnecessarily high costs of defending the class action litigation and any settlement payments are ultimately borne by shareholders. In essence, money is being taken from one group of shareholders and passed to another to compensate the latter group for wrongdoing by directors and officers. While some individual shareholders may gain, overall shareholders are losing money, particularly long-term or passive investors.

[17.118] Shareholder class actions do not appear to be limiting agency costs in corporations. Indeed, it appears that shareholder class actions may be costing shareholders more than the problems they seek to resolve. They provide limited deterrence for corporate misconduct, because those responsible for continuous disclosure breaches do not receive timely sanctions or bear the full costs of their actions.

[17.119] Additionally, the increasing prevalence of shareholder class actions has broader undesirable outcomes on the availability and cost of D&O insurance, with consequential challenges for attracting and retaining experienced and high quality directors and officers. A culture of risk-averse decision-making across Australian boards is a further adverse outcome of shareholder class actions, with harmful long-term impacts on economic growth, job creation and investors' returns on equity."

However, whilst these sentiments are likely to be welcomed, for there to be meaningful and measureable change in this area much depends on the nature of any reforms ultimately introduced.   

Licensing of Third Party Funders

Prior to the Final Report being issued on 21 December 2020, there has already been some regulatory change in Australia.  From 22 August 2020 litigation funders must now hold an Australian Financial Services Licence and they are required to register and operate most actions as a managed investment scheme. Whilst this increases operational costs for funders through new compliance and reporting obligations to ASIC, it is too early to tell if this (in and of itself) will have a material impact on the funding environment.

Where to from here?

You can read the entire Final Report here.  However, this is one of a number of inquiries into class actions in Australia in recent years. Most recently, the Australian Law Reform Commission (ALRC) completed a similar inquiry on 30 January 2019 (click here and  here for our updates on the ALRC review).  For further reading which touches on the ALRC review, the Final Report also incorporates a Minority Report by members of the current Labour opposition party in the Australian Government, which is found here.  In the Minority Report, the following observations are made:

"[1.1] Over the last three years, the current Government’s approach to policy-making in relation to class actions and litigation funding has been an embarrassing shambles.

…

[1.7] And now, three years after the ALRC launched its inquiry into class action proceedings and third-party litigation funders, this Committee is tabling a report that largely repeats the recommendations that the ALRC made two years ago – and which the Prime Minister, the Treasurer and the Attorney-General have ignored ever since.

[1.8] If that was all the majority report did, this inquiry could be dismissed as a waste of the Parliament’s time and resources. But, alarmingly, the Government members of the Committee have gone well beyond the terms of reference of this inquiry by endorsing the Treasurer’s ill-considered and rushed ‘temporary’ changes to Australia’s continuous disclosure laws. If Liberal members of this Committee had their way, those changes would be made permanent."

No doubt the Final Report presents ripe material for heated debate once the Australian Parliament resumes sittings in 2021 after the Australian summer.  The precise reforms ultimately implemented and any timing for real change remains uncertain.  Until then, we expect to see continued court intervention in class action proceedings as judges grapple with the challenges presented by the current regime and funding environment.