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Moves to undo the Coalition’s changes to the class action framework have commenced, with the Labor government intending to remove regulatory oversight for litigation funders before the likely introduction of contingency fees. Draft regulations have now been released, meaning if they are approved, funders will not be required to hold an Australian Financial Services Licence (AFSL) nor comply with the rules for Managed Investment Schemes (MIS).
In 2021, the Morrison government made changes to the laws governing litigation funders which were designed to ease the continuous disclosure laws for directors and officers. Even before the Albanese government came to power, it was widely understood that a Labor government would seek to wind back amendments in a move to bring back a more strict Corporations Law framework.
Submissions for the new draft regulations were due by 30 September, but it has been made clear that the MIS regulations are to be removed, especially after the Federal Court ruling in favour of LCM Finance in June, where the appeal court argued that class actions financed by litigation funders were not classified as MISs under Corporations law, meaning ASIC had less regulatory power.
The draft bill explanatory statement also argues the current regulatory regime for litigation funding schemes is not fit for purpose and the MIS and AFSL regimes were not intended to regulate the litigation funding industry. Against this backdrop, the government is also considering the Australian Law Reform Commission’s report on litigation funding which made 24 recommendations to enhance fairness and efficiency in class action proceedings, including contingency fees and common fund orders.
It's worth noting that the introduction of contingency fees would likely help the Federal Court reduce the flow of actions to the Supreme Court of Victoria since it introduced class action contingency fees in 2020. Under the current framework for all other jurisdictions, a law firm can only seek its professional fees and disbursements, whereas in Victoria, an alternate order can be sought for a percentage payout from damages. This clears the way for large law firms to compete with funders when running claims.
Several notable class action lawyers have stated the Coalition’s changes were indeed a shift towards reasonable prudential requirements and put appropriate limits on the control of litigation and breach reporting requirements to ASIC because achieving bespoke licensing with a basic regulatory framework is the end goal. Other firms have argued that removing the Coalition’s amendments promotes justice without negatively impacting class member protections. It will be interesting to see how these diverging opinions play out in the coming years.
There is a view that the removal of the AFSL/MIS regime, especially in today’s macroeconomic environment may encourage more funder-backed class action activity. Others contend the removal of the prohibition on contingency fees would result in litigation funders no longer being the only ones primarily bringing these actions to court.
In our view, the cumulative effect of these changes could lead to more opportunistic class actions; and with respect to the D&O continuous disclosure regime, may enable a return to the strict liability approach; as opposed to the at-fault “knowledge, recklessness or negligence” test introduced by the Coalition. We also believe the unwinding to be a backwards step to the amendments implemented by the previous government, which puts excessive pressure on directors. This could also result in additional costs to businesses, namely through lost efficiency and lost entrepreneurialism (and subsequently business performance) given the increased rigidity in the compliance framework.
Conversely, some believe there may not be a material change in the number of opportunistic actions if litigation funders and large plaintiff firms implement rigorous due diligence by identifying director negligence before entering litigation. Some argue the introduction of contingency fees will ensure remuneration arrangements are more reasonable and appropriate. This is because actions are often strictly supervised by the Court and likely require leave before being implemented, offsetting the high costs that would otherwise be payable under a traditional fee structure. Other commentators argue contingency fees may also increase competition between class action lawyers and litigation funders, resulting in lower fees for plaintiffs and reduced defence costs.
Despite the potential regulatory headwinds for directors, we strongly believe the D&O insurance market has the resilience to contend with such changes. Carriers have spent the last six years remedying their D&O portfolios through considerable premium and deductible increases, meaning the industry segment is in a much stronger position to sustain any losses.
We will provide timely updates about the impact on insurance premiums and future coverage conditions as this situation evolves.
Client Manager - Professional and Executive Risks
