‘Square peg into a round hole’: Federal Court reverses ruling on funded class actions as managed investment schemes – implications for crypto assets

By John Bassilios 

In this article, we briefly outline a recent case of the Full Federal Court which overturns case law authority from 2009 that litigation funding schemes are ‘managed investment schemes’ under Australian financial services law. The case has significant implications for industry and, in particular, financial product and crypto-asset issuers, as we consider it narrows the scope of what arrangements may be considered a managed investment scheme under law.

Key points

• A ‘purposive’ approach that takes into account the context and purpose of the regulatory regime for managed investment schemes (rather than a technical or literal approach) should be taken when applying the general definition of ‘managed investment scheme’.
• In considering whether an arrangement would be considered a ‘managed investment scheme’, consider whether the arrangement is of such a nature that requirements under Chapter 5C of the Corporations Act 2001 (Cth) are incapable of applying to the scheme.
• If the purported ‘scheme property’ of an arrangement is incapable of being invested, or otherwise dealt with, this is an indicator (but not necessarily determinative) that the arrangement is not a managed investment scheme

The LCM Funding case

On 16 June, the Full Federal Court of Australia handed down its decision in LCM Funding Pty Ltd v Stanwell Corporation Limited [2022] FCAFC 103 (LCM Funding), allowing the appeal and holding that the previous authoritative decision on litigation funding schemes as managed investment schemes, Brookfield Multiplex Ltd v International Litigation Funding Partners Pte Ltd [2009] FCAFC 147 (Brookfield FC), was wrongly decided.

In Brookfield FC, the majority held that a litigation funding scheme constitutes a managed investment scheme (MIS) within the definition in section 9 of the Corporations Act 2001 (Cth) (Act).

Under s.9, an MIS is a scheme that has the following features:

1. people contribute money or money’s worth as consideration to acquire rights (interests) to benefits produced by the scheme (whether the rights are actual, prospective or contingent and whether they are enforceable or not);
2. any of the contributions are to be pooled, or used in a common enterprise, to produce financial benefits, or benefits consisting of rights or interests in property, for the people (the members) who hold interests in the scheme (whether as contributors to the scheme or as people who have acquired interests from holders);
3. the members do not have day-to-day control over the operation of the scheme (whether or not they have the right to be consulted or to give directions).

In construing the definition of an MIS, the majority considered that it ‘may not be appropriate‘ to look to the operative provisions of Chapter 5C of the Act, which regulated various aspects of MISs including registration, scheme property valuation and member withdrawals. According to the majority, it cannot be concluded that a scheme is not an MIS simply because its structure does not comply with Chapter 5C requirements.^[1]

In LCM Funding, on the other hand, the Court preferred a ‘purposive approach‘ to construing the definition of an MIS, and considered the majority in Brookfield FC to have adopted ‘overly technical approach‘.^[2] The Court in LCM Funding considered that the majority in Brookfield FC erred in not adequately taking into account the context and purpose of the MIS regime (primarily in Chapter 5C) when construing the definition of an MIS. In particular:

1. the fact that many provisions under Chapter 5C are incapable of application to litigation funding schemes is a ‘strong indicator‘ that the MIS regime is not intended to apply to litigation funding schemes;^[3] and
2. the overall legislative purpose of the MIS regime is to regulate the operation of a scheme where members (who surrender day-to-day control of the scheme) risk losing all of the capital they have invested, and to regulate the withdrawal of members from the scheme. Such a purpose is not consistent with litigation funding schemes, which are separately subject to the court’s supervisory jurisdiction.^[4]

The Court also made a number of key observations in relation to the ‘conceptual incoherence’ between Chapter 5C requirements and litigation funding schemes. Among other matters, the Court commented that:

1. the ability to identify a responsible entity of the scheme is key to the regulation of MISs under the regime in Chapter 5C. That there is uncertainty in identifying who is the responsible entity in a litigation funding scheme context suggests that such schemes are not intended to be regulated as MISs;
2. Chapter 5C imposes various requirements in relation to scheme property that are incapable of applying to what the majority in Brookfield FC considered to be the ‘scheme property’ of a litigation funding scheme – namely, promises given by group members that a percentage of the moneys realised from claims can be paid to the funder, and promises given by the funder that legal services and costs would be paid. The Court in LCM Funding took the view that scheme property ought to be ‘capable of being invested, or otherwise dealt with‘; the promises were not capable of such activity. Similarly, the Court considered the promises were not capable of being valued regularly or held separately from other property of the responsible entity, as is also required under Chapter 5C;^[5] and
3. in relation to the second limb (b) of the definition, the ‘pooling’ or use in a ‘common enterprise’ of contributions must be for the purpose of producing benefits for members (rather than mere pooling for no purpose, or for some other separate purpose).^[6] The Court agreed that the majority’s construction of the notions of pooling and common enterprise in Brookfield FC was arguably too broad, and inapposite to a funded class action

Where to from here?

The key takeaway from the decision in LCM Funding is that the definition of ‘managed investment scheme’ ought not to be interpreted in a technical and particularised manner. Rather, the context and purpose of the definition (and in particular, that MISs are subject to regulation under Chapter 5C) ought to be considered.

We think this is welcome news for financial product and crypto-asset issuers. The broadness of the definition of ‘managed investment scheme’ can be a thorn in the side for novel products and services, as a literal approach to the definition is capable of capturing almost any form of organised activity that involves relinquishing day-to-day control.

To take a common example, issuing a crypto-asset in return for money or effort may be considered the operation of a managed investment scheme as it can be argued that a contribution has been made in return for a benefit in the form of a token that could be sold or otherwise appreciate in value.

However, when considered in the context of the LCM Funding case and Chapter 5C of the Act, there may be strong arguments for the view that the crypto-asset will not be regulated as a managed investment scheme.

While each case is ultimately a question of fact and degree, we think the decision in LCM Funding lends authoritative credence to the view that arrangements which were never intended to be regulated as schemes, ought not to be considered schemes simply because of technicalities in the broad general definition.

Hall & Wilcox’s fintech and blockchain experts have extensive experience advising in this space. For any queries about how we can help you, contact our Fintech and Blockchain Lead, John Bassilios.

[1] Brookfield FC at [55] to [56].
[2] LCM Funding at [129].
[3] LCM Funding at [165].
[4] LCM Funding at [131].
[5] LCM Funding at [159].
[6] LCM Funding at [18].