Conflicts of interest in class actions and proof of debt schemes - ASIC issues guidance

In brief - Increasing role played by litigation funders in class actions points to need for guidance

On 22 April 2013, the Australian Securities & Investments Commission (ASIC) released Regulatory Guide 248 Litigation schemes and proof of debt schemes: Managing conflicts of interest (RG 248).

It provides guidance to litigation funders to avoid conflicts of interest whilst undertaking class actions, to insolvency practitioners managing proof of debt schemes (which have many similarities to class actions), and to their legal advisers. This guidance is critical in the present environment of increasing class actions and litigation funder presence.

Why is it important to manage conflicts of interest in class actions?

Litigation funding is an increasing feature of class action litigation in Australia, with the number of players and the number of class actions both on the rise.

According to the recent article Australia Litigation Funders Spur Record 2012 Settlements, the value of class action settlements in Australia in 2012 was $480 million. According to a recent article in The Australian, Asia-Pacific open to class actions, outside of the United States, Australia is the second largest class action jurisdiction.

By 2020, present stakeholders estimate the annual worth of class action settlements in the Asia-Pacific will be US$3.4 billion (A$3.2 billion). Backing the class actions are usually litigation funders, such as IMF (Australia) Limited.

Litigation funding scheme previously judged to be managed investment scheme

In 2009 the Full Court of the Federal Court held that a litigation funding scheme constituted an unregistered managed investment scheme (Brookfield Multiplex Limited v International Litigation Funding Partners Pty Ltd (2009) 260 ALR 643). This would mean that a litigation funder needed to be registered and to comply with the requirements of Chapter 7 of the Corporations Act 2001 (Cth) regarding licensing, disclosure, registration and so on for managed investment schemes.

In response, ASIC granted a series of exemptions to litigation funders from the obligation to register as a managed investment scheme. These interim measures were replaced by an amendment to the Corporations Act in July 2012, the Corporations Amendment Regulation 2012 (No 6), formally exempting litigation funders from the managed investment scheme regime. (For more information please see our earlier articles Recent developments in litigation funding in Australia and the UK and Litigation funding - legislative relief arrives.)

Risk of conflicts of interest is obvious and ever present

However, the possibility for conflict between the interests of the litigation funder and the class members it is backing, and even between members of that class with differing interests, is obvious and ever present. A press release issued by ASIC on 22 April 2013 referred to an "inherent tension in these types of schemes between the interests of the funders, liquidators, lawyers and participating members".

Placed in the context of the numbers involved and the increasing role of litigation funders in the class action landscape, the need for guidance on this issue is clear.

RG 248 also gives guidance to insolvency practitioners who manage proof of debt schemes, and have similarly competing interests to manage. Proof of debt schemes are also on the rise as a means of resolving complicated disputes involving insolvent entities. A recent example is the contemplated use of a proof of debt scheme by the liquidators of Lehman Brothers Australia Limited.

When does RG 248 apply?

The overarching principle of RG 248 is that conflicts will arise. It is aimed at potential actual or perceived conflicts, and having appropriate structures in place to manage those conflicts.

RG 248 is effective from 13 July 2013 and applies to:

• A litigation scheme: defined in the accompanying Corporations Amendment Regulations, as one that has all seven identified features, including that the dominant purpose of the scheme is that each general member is seeking remedies to which they may be legally entitled, based on the same or similar questions of fact and law. The steps taken to seek those remedies include a lawyer providing certain services, a funder providing funds or indemnities (or both) to enable the scheme's general members to seek remedies, and the funder not being a lawyer or legal practice providing (in effect) a no win/no fee service.

• A proof of debt scheme: defined in the accompanying Corporations Amendment Regulations as having all of the three identified features, including that it relates to an externally administered body corporate, the creditors or members of which provide funds or indemnities to the body corporate or external administrator (eg a liquidator) to enable it to conduct investigations, seek or enforce a remedy against a third party or defend proceedings against the body corporate.

Managing the conflict of interest: what must be done?

A person providing a financial service to a litigation scheme or proof of debt scheme must maintain and follow, for the duration of the scheme, adequate practices for managing any conflict of interest that may arise in relation to activities undertaken by a person in relation to the scheme. Failure to do so is an offence.

RG 248 does not apply when lawyers provide services that are not financial services, and is therefore unlikely to apply to much of the work lawyers undertake in respect of litigation schemes or proof of debt schemes.

Written procedures must exist and must be followed

In summary, parties managing litigation schemes or proof of debt schemes must have written procedures:

• For managing situations in which interests may conflict: these must be reviewed at least every 12 months and are the responsibility of senior management. Proof not just that there are procedures but that they have been implemented is necessary. In particular there must be a review of business operations that relate to the litigation scheme or proof of debt scheme to identify and assess potential conflicting interests. What is required is scalable: it will depend on the nature, scale and complexity of the scheme in question.

• For protecting the interests of members.

• For effectively disclosing conflicts to existing or prospective scheme members. ASIC expects that such procedures will include providing the members with information about the different significant interests of the funder, lawyers and members, and how they may conflict, as well as details of any dispute resolution options that are available to members. Further, any disclosure should be timely, prominent and specific, and contain enough detail for members to understand the potential impact of the divergent interests on the litigation scheme or proof of debt scheme.

• Regarding recruiting prospective scheme members, including methods to avoid engaging in misleading and deceptive conduct when recruiting prospective members.

• For reviewing terms of funding agreements to ensure consistency with the relevant sections of the Australian Securities Investments Commission Regulations 2001. In particular, if there is no direct contractual relationship between the lawyers and members, any funder must engage the lawyers on terms that make clear that, if there is a divergence of interests between the funder and members, the lawyers will ensure that the members’ interests are adequately protected.

• Dealing with situations where the lawyer acts for both the litigation funder and members (as is commonly the case).

• Dealing with situations where there is a pre existing relationship between litigation funder, lawyer and members.

• Providing for a mandatory review by counsel of any settlement reached before proceedings are issued. (Once court proceedings are commenced in class actions, settlement can only take place with the approval of the court, an important safeguard for members).

This guidance will prove invaluable to litigation funders, insolvency practitioners and those who advise them. It will also assist members of schemes to gauge whether their interests are truly being protected. The bigger a feature of the litigation landscape litigation funders and proof of debt schemes become, the more critical this will be.