Has the long-antic­i­­pat­ed reg­u­la­tion of lit­i­ga­tion fund­ing final­ly arrived?

Inter­na­tion­al Lit­i­ga­tion Part­ners Pte Ltd v Chameleon Min­ing NL (2011) 276 ALR 138; [2011] NSW­CA 50; BC201101379.

Introduction

The recent deci­sion of the NSW Court of Appeal in Inter­na­tion­al Lit­i­ga­tion Part­ners Pte Ltd v Chameleon Min­ing NL (See Foot­note 1) has con­firmed that lit­i­ga­tion fun­ders are required to hold an Aus­tralian finan­cial ser­vices licence (AFSL) pur­suant to the require­ments of Ch 7 of the Cor­po­ra­tions Act 2001 (Cth) (the Act). The fail­ure on the part of a lit­i­ga­tion fun­der to hold such a licence, or be exempt­ed from doing so by the Aus­tralian Secu­ri­ties and Invest­ments Com­mis­sion (ASIC), may sub­ject any lit­i­ga­tion fund­ing agree­ment to rescis­sion pur­suant to s 925A of the Act, and there­by ren­der such agree­ment void ab initio.

Background

The first respon­dent to the appeal, Chameleon Min­ing NL (Chameleon), had entered into a lit­i­ga­tion fund­ing agree­ment (fund­ing agree­ment) with the appel­lant, Inter­na­tion­al Lit­i­ga­tion Part­ners Pte Ltd (ILP), for the pur­pos­es of fund­ing Chameleon’s lit­i­ga­tion pro­ceed­ings in the Fed­er­al Court against Murchi­son Met­als Ltd (Murchison).(See foot­note 2)

On 10 August 2010, a change in con­trol of Chameleon occurred when Chameleon signed a term sheet with a third par­ty, the sec­ond respon­dent to the pro­ceed­ings. The tri­al at first instance dealt prin­ci­pal­ly with the impact of that change in con­trol on the fund­ing agree­ment and the amount of mon­ey, if any, payable to ILP as a result.

It was alleged by ILP, both in the pro­ceed­ings at tri­al before Ham­mer­schlag J and before the Court of Appeal, that a term of the fund­ing agree­ment stip­u­lat­ed that upon a change in con­trol of Chameleon occur­ring, ILP would, in addi­tion to the recov­ery of the legal costs it had fund­ed, be enti­tled both to its ​“fund­ing fee” and to an addi­tion­al ​“ear­ly ter­mi­na­tion fee” as a result of the ear­ly ter­mi­na­tion of the fund­ing agreement.

It was con­tend­ed by Chameleon, how­ev­er, that as ILP was an unli­censed provider of finan­cial ser­vices, with­in the mean­ing of Ch 7 of the Act, Chameleon was enti­tled to, and did, rescind the agree­ment by a notice of rescis­sion issued to ILP. Chameleon sub­mit­ted that as ILP did not hold an AFSL, by effect of ss 925A and 925E of the Act, the notice of rescis­sion result­ed in the fund­ing agree­ment being void ab ini­tio and unen­force­able against Chameleon, and there­fore nei­ther the fund­ing fee nor the ear­ly ter­mi­na­tion fee were payable by Chameleon.

At tri­al, Ham­mer­schlag J found that the fund­ing agree­ment was not a finan­cial prod­uct with­in the mean­ing of the Act and that it could not be rescind­ed. On appeal, how­ev­er, the NSW Court of Appeal, per Giles JA and Young JA (Hodg­son JA dis­sent­ing in part), found that ILP was required to hold an AFSL and Chameleon had valid­ly rescind­ed the fund­ing agreement.

Lit­i­ga­tion fund­ing as a finan­cial product

The start­ing point of the court’s analy­sis was s 924A of the Act and whether the fund­ing agree­ment ​“con­sti­tutes, or relates to, the pro­vi­sion of a finan­cial ser­vice”. Sec­tion 766A(1)(b) then directs that a finan­cial ser­vice is pro­vid­ed if a per­son ​“deals in a finan­cial prod­uct”. This occurs by ​“issu­ing a finan­cial prod­uct” (s 766C(1)(b)).

This then leads to the ques­tion of what con­sti­tutes a finan­cial prod­uct. Sec­tion 763A(1) defines a finan­cial prod­uct as:

… a facil­i­ty through which, or through the acqui­si­tion of which, a per­son does one or more of the following:
(a) …
(b) man­ages finan­cial risk …

In turn, s 763C directs that a per­son man­ages finan­cial risk (among oth­er things) ​“if they man­age the finan­cial con­se­quences to them of par­tic­u­lar cir­cum­stances happening”.

His Hon­our Giles JA sum­marised the effect of the con­vo­lut­ed trail of pro­vi­sions as fol­lows (at [34]):

Draw­ing the pro­vi­sions togeth­er, did the agree­ment con­sti­tute or relate to ILP issu­ing a facil­i­ty through which, or through the acqui­si­tion of which, [Chameleon] man­aged the finan­cial con­se­quences to it of par­tic­u­lar cir­cum­stances happening?

Deci­sion at first instance

Ham­mer­schlag J con­clud­ed that the fund­ing agree­ment did not man­age finan­cial risk, as the prin­ci­pal object of the agree­ment was to enable Chameleon to pros­e­cute the pro­ceed­ings against Murchi­son (by hav­ing ILP pay its legal costs), rather than to man­age the risk of Chameleon’s pos­si­ble fail­ure in those proceedings:

Whilst in one sense the Deed has the effect of min­imis­ing one cat­e­go­ry of finan­cial risk for [Chameleon] (name­ly, the risk that it will incur expense in pur­suit of Murchi­son which will be wast­ed if no or an insuf­fi­cient Res­o­lu­tion Sum is received), on no real­is­tic view can it be said that the Deed is a finan­cial prod­uct where­by [Chameleon] man­ages that risk.

Rather the object of the Deed is to enable [Chameleon] to pros­e­cute the Pro­ceed­ings by hav­ing the Fun­der pay Legal Costs and per­haps (as the Recitals describe) pro­vide inves­tiga­tive and man­age­ment exper­tise to assist in the Pro­ceed­ings. The object of the Deed is to facil­i­tate [Chameleon] vin­di­cat­ing its claim against Murchi­son, not to man­age the risk of pos­si­ble fail­ure in that endeavour.(See foot­note 3)

Accord­ing­ly, his Hon­our con­clud­ed that as the fund­ing agree­ment was not a finan­cial prod­uct, it could not be rescinded.

Deci­sion on appeal

On appeal, the court unan­i­mous­ly con­clud­ed that the fund­ing agree­ment was a finan­cial prod­uct as it was a facil­i­ty through which Chameleon man­aged finan­cial risk. The court con­sid­ered that Chameleon man­aged the finan­cial con­se­quences to itself of cer­tain things hap­pen­ing, includ­ing adverse costs orders and the loss of the litigation.

How­ev­er, the court split on the ques­tion of whether the fund­ing agree­ment was exclud­ed from con­sti­tut­ing a finan­cial prod­uct by virtue of s 763E of the Act in that the man­age­ment of the finan­cial risk was only an ​“inci­den­tal com­po­nent of the facil­i­ty”. Giles JA and Young JA con­clud­ed that the finan­cial prod­uct aspect of the fund­ing agree­ment was not an inci­den­tal com­po­nent of the facil­i­ty and there­fore it was a finan­cial prod­uct with­in the mean­ing of the Act. In assess­ing whether man­age­ment of finan­cial risk was only an inci­den­tal com­po­nent, Giles JA deter­mined that the rel­e­vant test is an objec­tive one. Giles JA con­clud­ed (at [44]):

It is not cor­rect to cat­e­gorise the agree­ment as an enter­prise with a pur­pose exclu­so­ry of man­ag­ing finan­cial risk. The enquiry under the Act is rel­e­vant­ly whether the agree­ment was a facil­i­ty through which, or through the acqui­si­tion of which, [Chameleon] man­aged finan­cial risk. It is not an inquiry into [Chameleon’s] pur­pose in man­ag­ing finan­cial risk, trans­lat­ed to a pur­pose of the agree­ment, and the word ​“through” calls atten­tion to the oper­a­tion or effect of the facil­i­ty and not to the pur­pose of the person.

In assess­ing the pur­pose of the fund­ing agree­ment, he lat­er con­clud­ed (at [91]):

… the agree­ment is not a finan­cial prod­uct as an inci­den­tal com­po­nent of a facil­i­ty which also has oth­er com­po­nents or a facil­i­ty inci­den­tal to oth­er facil­i­ties; nor are the rel­e­vant terms inci­den­tal com­po­nents or inci­den­tal to oth­er terms or anoth­er facil­i­ty. There is no ​“main pur­pose” of obtain­ing fund­ing dis­tinct from the finan­cial prod­uct pur­pose of man­ag­ing finan­cial risk. The pur­pose of the agree­ment is to obtain lit­i­ga­tion fund­ing on the terms con­tained in it, and those terms make it a finan­cial product.

In dis­sent, Hodg­son JA, although acknowl­edg­ing that one aspect of the fund­ing agree­ment was the man­age­ment of finan­cial risk, held that this aspect was not the pri­ma­ry aspect and was inci­den­tal to the main pur­pose of the fund­ing agree­ment, which was the pro­vi­sion of financ­ing for the pur­suit of the proceedings.

Derivative

It was also sub­mit­ted by Chameleon that the fund­ing agree­ment was a ​“deriv­a­tive” with­in the mean­ing of s 761D of the Act and, as a result, fell with­in the spe­cif­ic things that are deemed finan­cial prod­ucts described with­in s 764A(1).

The major­i­ty of the Court of Appeal con­clud­ed (per Young JA and Hodg­son JA, Giles JA dis­sent­ing) that the fund­ing agree­ment was not a deriv­a­tive with­in the mean­ing of the Act. How­ev­er, all three mem­bers of the court pro­vid­ed dif­fer­ing reasoning.

Hodg­son JA sum­marised the def­i­n­i­tion­al test of a deriv­a­tive as fol­lows (at [129]):

Whether the amount of the con­sid­er­a­tion that must or may be required to be pro­vid­ed under the fund­ing agree­ment at some future time (or the val­ue of the arrange­ment) ​“is ulti­mate­ly deter­mined, derived from or varies by ref­er­ence to (whol­ly or in part) the val­ue or amount of some­thing else” with­in s 761D(1)(c).

Hodg­son JA con­clud­ed that the amount of con­sid­er­a­tion to be pro­vid­ed under the fund­ing agree­ment was ulti­mate­ly deter­mined, derived from or var­ied by ​“some­thing else”.

Hodg­son JA there­after rea­soned, how­ev­er, that the fund­ing agree­ment was exclud­ed from the def­i­n­i­tion of deriv­a­tive by virtue of the exclu­sion con­tained with­in s 761D(3)(b), ​“as a con­tract for the future pro­vi­sion of ser­vices”. He con­clud­ed that the fund­ing agree­ment was a con­tract where the amount to be paid was unknown and to be deter­mined by the future pro­vi­sion of ser­vices (at [132]):

Hav­ing tak­en a broad­er view of the basic def­i­n­i­tion [of deriv­a­tive], I would also take a broad­er view of the rel­e­vant excep­tion. The inten­tion dis­closed, in my opin­ion, is that where what deter­mines the amount to be paid at some future time is the future pro­vi­sion of ser­vices, the extent or val­ue of which is present­ly uncer­tain, or the out­come of which pro­vi­sion is present­ly uncer­tain, the arrange­ment should not be caught by the definition.

Young JA, how­ev­er, con­clud­ed that the fund­ing agree­ment was not a deriv­a­tive as the amount of con­sid­er­a­tion relat­ed, in every aspect, to an inter­est in the Fed­er­al Court pro­ceed­ings, as opposed to being deriv­a­tive­ly reliant upon the val­ue of ​“some­thing else”. As Young JA con­clud­ed that the fund­ing agree­ment was not a deriv­a­tive, he did not address in detail the exclu­sion in s 761D(3)(b), nor whether the fund­ing agree­ment was a con­tract for the future pro­vi­sion of ser­vices, oth­er than to con­clude that it was not and that the exclu­sion would not apply in any event.

Giles JA, in dis­sent, con­clud­ed that the fund­ing agree­ment was a deriv­a­tive in that the val­ue of the con­sid­er­a­tion to be paid was affect­ed by the out­come of the Fed­er­al Court lit­i­ga­tion and the asso­ci­at­ed legal costs.

Giles JA did not con­sid­er that the fund­ing agree­ment was a con­tract for the future pro­vi­sion of ser­vices. His Hon­our found that it was over­whelm­ing­ly a con­tract for the pro­vi­sion of mon­ey by ILP, not services.

Cred­it facility

It was sub­mit­ted by ILP that the fund­ing agree­ment was a ​“cred­it facil­i­ty” with­in the mean­ing of s 765A(1)(h)(i) of the Act and, as such, was exempt­ed from the def­i­n­i­tion of a finan­cial prod­uct. ILP assert­ed that the fund­ing agree­ment pro­vid­ed for an advance of mon­ey by ILP to the ben­e­fit of Chameleon and pur­suant to which Chameleon deferred the repay­ment of the debt.

The sub­mis­sion was reject­ed by the major­i­ty on appeal (per Giles JA, Young JA, Hodg­son JA dis­sent­ing) as there was no advance of mon­ey by ILP to Chameleon and there was no debt owed, the pay­ment of which was deferred. There might nev­er be any­thing payable by Chameleon to ILP and in the event the pro­ceed­ings were unsuc­cess­ful, ILP would be liable to pay more mon­ey in respect of an adverse costs award in the proceedings.

Outcome

The Court of Appeal held that ILP was required to hold an AFSL as the fund­ing agree­ment was a finan­cial prod­uct for the man­age­ment of finan­cial risk. Accord­ing­ly, Chameleon was enti­tled to (and did) rescind the fund­ing agree­ment pur­suant to s 925A of the Act.

The deci­sion is of fun­da­men­tal impor­tance to any par­ty to a cur­rent or con­tem­plat­ed lit­i­ga­tion fund­ing agree­ment where the lit­i­ga­tion fun­der does not hold an AFSL, or is exempt­ed from doing so by ASIC. In the absence of an AFSL, a fund­ed par­ty may be in a posi­tion to rescind any fund­ing agree­ment ren­der­ing it void ab ini­tio and unen­force­able. This can result in the fun­der being required to repay all amounts paid to it by way of bro­ker­age fee, com­mis­sions or oth­er fees. It will like­ly be the case, how­ev­er, that the fun­der is enti­tled to repay­ment for any amounts advanced by it to a fund­ed par­ty in respect of legal costs and disbursements.

To valid­ly exer­cise a right of rescis­sion, a fund­ed par­ty is required to act with­in a rea­son­able peri­od of time of becom­ing aware of the AFSL require­ment by serv­ing a rescis­sion notice, fail­ing which the fund­ed par­ty may be deemed to have affirmed the fund­ing agreement.

The judg­ment hand­ed down by the NSW Court of Appeal on 3 June 2011 con­firmed that Chameleon Min­ing was enti­tled to rescind the fund­ing agree­ment. It is antic­i­pat­ed that ILP will seek spe­cial leave to appeal to the High Court.

Swaab Attor­neys act­ed for Chameleon Min­ing NL in the pro­ceed­ings at tri­al and on appeal.

Footnotes
1. Inter­na­tion­al Lit­i­ga­tion Part­ners Pte Ltd v Chameleon Min­ing NL (2011) 276 ALR 138; [2011] NSW­CA 50; BC201101379, on appeal from the deci­sion of Ham­mer­schlag J in Chameleon Min­ing NL v Inter­na­tion­al Lit­i­ga­tion Part­ners Pte Ltd (2010) 79 ACSR 462; [2010] NSWSC 972; BC201006296.
2. Chameleon Min­ing NL v Murchi­son Met­als Ltd [2010] FCA 1129; BC201008807.
3. Chameleon Min­ing NL v Inter­na­tion­al Lit­i­ga­tion Part­ners Pte Ltd (2010) 79 ACSR 462; [2010] NSWSC 972; BC201006296 (at [83] – [84]).

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