The ING Case: a cautionary note for fund managers
The current turmoil in global financial markets and the Government’s guarantee on bank deposits have prompted an exodus of investment from managed funds. In order to avoid a “run” on funds, a number of funds managers have suspended redemptions. On 3 April 2009, Barrett J of the New South Wales Supreme Court handed down his decision on ING Funds Management Ltd v ANZ Nominees Ltd (ING v ANZ). The decision relates to a responsible entity’s power to unilaterally amend a registered managed investment scheme’s constitution to suspend redemption rights under subsection 601GC(1)(b) of the Corporations Act 2001 (Cth) (Corporations Act) and has important implications for fund managers.
ING Funds Management Limited (INGFM) is the responsible entity of the ING Wholesale Enhanced Cash Trust (Enhanced Trust) and the ANZ Cash Plus Fund (Cash Fund). Both funds are managed investment schemes registered under Chapter 5C of the Corporations Act. ANZ Nominees Ltd, Professional Associations of Superannuation Ltd and ACRIT Pty Ltd, being significant investors in the Enhanced Trust and the Cash Fund, were joined as representative defendants to represent the interests of investors in the Enhanced Trust and the Cash Fund.
The constitution of the Enhanced Trust provided that, where the fund is “liquid” within the meaning of section 601KA of the Corporations Act, the responsible entity must satisfy a redemption request within thirty days of the receipt of the request. Further, the constitution allowed the responsible entity thirty days extension to satisfy a redemption requests where circumstances beyond the responsible entity’s control prevented it from satisfying from redemption requests despite having taken all reasonable steps to realise assets to satisfy the request.
The constitution of the Cash Fund provided that an investor in the fund could make a redemption request, but did not prescribe a time period within which the request was required to be effected by the responsible entity. The parties accepted that there was an implied obligation for the responsible entity to satisfy the redemption request within a reasonable time. The Cash Fund’s constitution allowed the responsible entity to suspend redemptions for up to thirty days in case of certain kinds of market emergencies.
In November 2008, INGFM purported to amend the constitutions of each of the funds by executing documents to:
- suspend redemptions from each of the funds until a meeting of their respective investors could be held to vote on resolutions to extend INGFM’s powers to suspend redemptions under the constitution. The meetings were to be held within fifty business days after the date of the deeds otherwise the suspensions would be lifted after that time; and
- deem any redemption requests received by INGFM during the suspension period to have been received after the end of the suspension period.
Recitals in each of the deeds noted that the responsible entity has the power to unilaterally amend the constitutions under subsection 601GC(1)(b) of the Corporations Act. INGFM exercised its power to modify the constitutions in the belief that the modification of the constitutions in the above manner would not adversely affect the rights of investors.
INGFM relied on comments made in obiter by J D Phillips J in Eagle Star Trustees Ltd v Heine Management Ltd (1990) 3 ACSR 232 (Eagle Star) which related to similar factual circumstances.
In Eagle Star, J D Phillips J suggested that a suspension of redemption rights by a trustee of a prescribed interest scheme may not “adversely effect” investor rights if it was done in an emergency and the suspension only until a meeting of investors is convened.
Subsequently, INGFM executed further documents in December 2008 and January 2009 to modify the deeds and ratify the execution of the deed.
INGFM sought, amongst other things, a declaration by the court that the deeds executed in November 2008 were effective to modify the constitutions of the Enhanced Trust and Cash Fund.
Unilateral power to amend the constitution in section 601GC(1)(b)
Section 601GC of the Corporations Act provides that “the constitution of a registered scheme may be modified, or repealed and replaced with a new constitution:
- by special resolution of the members of the scheme; or
- by the responsible entity if the responsible entity reasonably considers the change will not adversely affect members’ rights.”
Barrett J stated that under subsection 601GC(1)(b), the task of the responsible entity is to compare investors’ rights before and after the modification of the constitution and assess whether the change in the constitution will remove, curtail or impair (ie “adversely effect”) existing rights of investors in a disadvantageous way.
It was further noted that the power to unilaterally amend the constitution is only available if the responsible entity “reasonably considers” that the modification will not adversely effect member’s rights. The responsible entity must demonstrate that it actually held the relevant belief or opinion and that the existing facts are sufficient to induce such a belief or opinion (see Gypsy Jokers Motorcycle Club Inc v Commissioner of Police  HCA 4).
Barrett J found that the purported modification of the constitutions of the Enhanced Trust and the Cash Fund by INGFM would have changed investors’ rights by denying the immediate effectiveness of redemption requests lodged in the period immediately after the modification came into place. He further held that because redemption is a process whereby investors turn their units into money, a deferral of the availability of the money is adverse from the perspective of investors. It was also found that INGFM could not have “reasonably believed” that the modification of the constitutions to suspend redemptions would not have been adverse to investor’s rights.
Barrett J disagreed with the position taken by J D Phillips J in Eagle Star. In particular, Barrett J questioned J D Phillips J’s proposition that the removal of a right to redemption by investors could possibly be construed as not “adversely affecting” investors’ rights because there was a requirement that investor meetings be held in the future to determine whether the constitution should be modified to allow longer term suspension of redemptions. Barrett J opined that J D Phillip J’s comments in Eagle Star confused the “interests” of investors with the “rights” of investors and were unjustifiably influenced by the economic and financial factors making it generally desirable to halt a “run” on funds.
Barrett J refused to make a declaration that the constitutions were validly amended and the deed polls were not properly executed and they were therefore not legally enforceable as required by section 601GB of the Corporations Act.
Execution of documents
Barrett J further concluded that section 601GB of the Corporations Act which provides that “the constitution of a registered scheme must be contained in a document that is legally enforceable as between the members and the responsible entity”, also applied to any amendments to the constitution under section 601GC. Accordingly, any amendments under section 601GC must be effected either by:
- a special resolution of investors; or
- the method specified in the constitution of the registered scheme for the modification of the constitution (commonly, constitutions provide that amendments must be in the form of a deed).
In the case of the constitutions for the Enhanced Trust and the Cash Fund, both constitutions required that any amendment be effected by a deed. Consequently, Barrett J ruled that, irrespective of the whether INGFM had complied with subsection 601GC(1)(b) in its unilateral amendment of the constitution, the initial purported amendments to the constitutions were nevertheless ineffective because they were not properly executed as deeds.
Practical implications for fund managers
ING v ANZ sends a clear message that responsible entities of registered schemes must be extremely careful when considering making unilateral amendments to constitutions, especially in the context of amending redemptions rights in constitutions to prevent “runs” on redemptions. Following this decision, it appears unlikely that a responsible entity will be able to rely on subsection 601GC(1)(b) to unilaterally amend a constitution to remove, curtail or limit redemption rights.
When considering making unilateral amendments to the constitution of a registered schemes under subsection 601GC(1)(B), responsible entities should:
- actively consider whether or not the amendment would be “adverse” to the rights of investors by comparing the rights of investors before and after the amendment;
- differentiate between what are the rights of investors and what are the interests of investors. Broadly, rights of investors include, but are not limited to, rights to income, capital, voting, redemption and information; and
- clearly document its reasoning as to why it reasonably considers the amendment would or would not be adverse to the rights of investors. Generally, the provision of a legal opinion, without more, would not be sufficient to establish that the responsible entity has reasonably considered the consequences of the amendment on investor rights.
Responsible entities should ensure that any purported constitution amendment is properly executed and enforceable as between the responsible entity and the unitholder.
Amendment of constitutions in the context of hardship relief
We note that the Australian Securities and Investments Commission (ASIC) has recently released guidelines on hardship relief for illiquid schemes (see ASIC release 08-214).
Broadly, these guidelines state that ASIC will grant relief on a case-by-case basis for responsible entities of illiquid unlisted mortgage schemes who wish to allow redemptions by investors suffering from hardship. This relief is generally only available to registered schemes whose constitutions explicitly permit payments in the case of hardship. Based on our experience, very few schemes have constitutions which contain provisions relating to hardship redemptions and, in most cases responsible entities would need to amend the constitution of the relevant scheme to include hardship redemption provisions in order to obtain relief.
A number of responsible entities have already successfully applied for relief from ASIC to accept hardship redemption applications. In most cases, the relevant responsible entity had unilaterally amended the constitution to include hardship redemption rights on the basis that such an amendment would not be adverse to investor’s rights. We understand that ASIC is unlikely to challenge unilateral amendments made by responsible entities in order to apply for hardship redemption relief. However, ING v ANZ could nevertheless provide support for investors who wish to challenge the propriety of those unilateral amendments to the constitution. As such, caution is advised.
The Financial Services team at Hall & Wilcox has extensive experience and expertise advising clients on the modification of scheme constitutions, hardship redemption relief, redemptions, liquidity and meetings of scheme members.
Partner and Head of China Practice
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Current issues for responsible entity directors
Whilst the managed funds industry, including responsible entities (REs) and their directors, has always been subject to stringent regulation and strict obligations, there is no doubt that many REs and RE directors are faced with an increasing number of complex legal and compliance issues issues emerging as a result of the current economic climate.
Given the number of recent high profile fund collapses, increased litigation activity and increased regulatory scrutiny of the managed fund industry, it is imperative that REs and directors of REs are acutely aware of their obligations and ensure that effective and rigorous controls are in place to identify and manage risks.
In this article we outline the general obligations of RE directors and highlight a few issues of particular importance for them in the current market.
Specific duties of RE directors
Directors of REs (by virtue of their position as officers) are subject to specific duties under the Corporations Act 2001 (Corporations Act). These are set out in section 601FD of the Corporations Act and include duties to:
- act honestly;
- exercise the degree of care and diligence that a reasonable person would exercise if they were in the director’s position;
- act in the best interests of the members and, if there is a conflict between the members’ interests and the interests of the responsible entity, give priority to the members’ interests;
- not make use of information acquired through their position in order to:
- gain an improper advantage for the officer or another person; or
- cause detriment to the members of the scheme;
- not make improper use of their position to gain, directly or indirectly, an advantage for themselves or for any other person or to cause detriment to the members of the scheme; and
- take all steps that a reasonable person would take, if they were in the director’s position, to ensure that the RE complies with:
- the Corporations Act;
- any conditions imposed on the responsible entity’s Australian financial services licence;
- the scheme’s constitution; and
- the scheme’s compliance plan.
Further, like all directors, RE directors are subject to the usual director duties under the Corporations Act and the general law. In particular, these include duties to:
- use care and diligence;
- act in good faith; and
- prevent the responsible entity incurring debts when it is insolvent or which would cause it to become insolvent.
If any of the specific duties conflict with any general directors’ duties, the specific duties will prevail.
What issues do RE directors need to look out for?
We have highlighted below a few particularly important areas and issues that RE directors are likely to have to deal with.
The general obligation in relation to continuous disclosure is that all information that a reasonable person would expect to have a material effect on the price or value of securities must be disclosed, unless it falls within a recognised exception. It is important to note that continuous disclosure obligations do not only apply to listed entities; managed investment schemes with 100 members or more (“enhanced disclosure” or “ED” securities as they’re referred to in the Corporations Act) are also subject to continuous disclosure requirements.
In this context, we note that:
- a ‘reasonable person’s’ expectations as to the information that should be disclosed may change over time. The Australian Securities and Investments Commission (ASIC) and the Australian Stock Exchange (ASX) have publicly stated that in the current market particular attention should be given to the level of disclosure of an entity’s financing arrangements, especially in relation to financial covenants;
- even if a reasonable person would not expect that incomplete information be disclosed immediately (eg information in draft valuation reports), if the information ceases to be confidential then it may be required to be disclosed; and
- as always, the RE must balance the requirement to keep investors and the market fully informed with the requirement that information disclosed is accurate and is sufficiently definite to warrant disclosure.
RE directors must be aware of the relevant obligations and take reasonable steps to ensure that all relevant disclosure in relation to schemes operated by the RE are made in a timely manner. This is especially important in the current market where investors are increasingly looking for opportunities to recoup losses where there is a suggestion that the RE or its directors has failed to disclose material information. Directors should be particularly vigilant to identify any information that may be required to be disclosed as a result of potential or actual breaches of loan covenants, falling asset values, reduced distribution forecasts and changes in scheme liquidity. RE directors should:
- review and ensure compliance with the RE’s continuous disclosure policies and procedures;
- consider whether the existing policies and procedures are adequate and whether any changes are required;
- ensure that management and the board are aware of the current and forecast financial status of the RE and its schemes, keeping in mind that it is not acceptable to wait until the board has approved or signed-off on information or disclosure before it is required to be disclosed; and
- be conscious of reporting any material variations in financial performance when they become aware of such information and not simply waiting to disclose such information in their financial reports.
Conflicts of interest
Another area of particular concern for RE directors are conflicts of interests that may arise in the context of the RE’s business. REs have specific duties to:
- act in the best interests of scheme members and to give preference to members’ interests in the case of conflict;
- not make use of information acquired through their position in order to gain an improper advantage for themselves or another or cause detriment to members; and
- not make improper use of their position to gain, directly or indirectly, an advantage for themselves or for any other person or to cause detriment to members.
As the holder of an Australian financial services licence, REs are also required to have adequate measures in place to manage conflicts of interest arising in the context of their financial services business.
The issue of conflicts is always particularly difficult for REs and their directors. Many REs operate a number of different schemes and are often part of a larger corporate group, other members of which may provide services in relation to those schemes. However, in a falling market these issues become even more difficult when existing arrangements are scrutinised and REs are faced with having to reconsider how they manage any actual or perceived conflict. RE directors need to pay particular attention to conflicts that may arise by virtue of the RE being the operator of a number of schemes and exercise caution with regards to any benefits given out of scheme property to related parties, for example, management arrangements and the acquisition from, or disposal of assets to, related parties. RE directors should:
- consider whether the RE’s existing governance controls are sufficiently rigorous to appropriately deal with conflicts of interest arising in the context of the RE’s business and that those controls
- continue to be effective in light of changing market conditions;
- review the management and handling of all conflicts of interest or related party transactions that arise in the context of the RE’s business;
- ensure that all relevant records in relation to conflicts of interest and/or related party transactions are being maintained; and
- ensure that:
- any breaches of existing policies or procedures are detected and recorded in the RE’s breach register;
- the circumstances giving rise to any breaches are reviewed and necessary measures are taken to ensure future compliance with policies and procedures; and
- in cases of significant breaches or likely breaches, ASIC is notified in accordance with the responsible entity’s breach reporting obligations; and
- consider whether the RE’s board composition is appropriate and whether any changes are required.
All RE directors have a general statutory duty to prevent the RE incurring debts while it (either in its personal capacity or as the RE of a particular scheme) is insolvent or which would cause it to become insolvent. RE directors need to continually consider both the solvency of the schemes operated by the RE and any situation which may give rise to the schemes incurring new debts.
RE directors are also required to make declarations in all full and half year financial reports lodged in respect of the RE or any scheme operated by it as to whether, in their opinion, there are reasonable grounds to believe that the relevant entity will be able to pay its debts as and when they become due and payable. In certain circumstances, it may be necessary to consider whether to qualify their solvency statement (such as where negotiations in relation to refinancing remain ongoing with financiers) or whether such a statement, even qualified, can be made at all.
RE directors need to regularly monitor the solvency of the RE both in its personal capacity and as RE of the schemes it operates in order to be able to properly discharge these duties. Where an RE director relies primarily on other persons, particularly senior management or accountants, to prepare accounts which disclose the financial position of the company or scheme (as is necessary in the case of larger companies and schemes where it cannot be expected that directors will have control over every action taken in the conduct of the entity’s business) then the directors may rely on those other persons to make the required statement. This is provided that they have reasonable grounds to believe, and do believe, that the person is competent, reliable and responsible for providing adequate information about the company’s solvency and the director believes, on the basis of this information, that the company is solvent.
RE directors should obtain regular reports from management or other relevant people in their organisation in relation to schemes’ financial conditions and ensure that appropriate measures are in place to monitor solvency, particularly in light of changing market conditions.
RE directors have always been subject to an additional layer of regulation and higher standards by virtue of being directors of REs that are entrusted with the public’s investments. It is particularly important for RE directors to be vigilant in respect of the issues and risks that are bound to emerge as a result of the current economic climate, especially in light of the potential personal liability that they may face. This is necessary both in order to discharge their personal duties and also to demonstrate reasonable steps to ensure the RE’s compliance with its obligations. RE directors need to keep abreast of how their business is affected by market conditions and satisfy themselves that the RE’s governance procedures and controls are, and continue to be, effective and robust in the changing funds management landscape.
The Hall & Wilcox Financial Services team has extensive experience in advising REs and their directors on their obligations and potential liability.
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The basics of borrowing by trustees of managed investment schemes
This article explores some of the basic principles relevant to borrowing by trustees of managed investment schemes1 (MIS).
Registered and unregistered MISs are typically structured as unit trusts. Registered MISs are also trusts, irrespective of whether or not they are structured as unit trusts, given that s.601FC(2) of the Corporations Act 2001 (Cth) (Corporations Act) provides that responsible entities hold scheme property on trust for members.
The most important thing to note for both lenders and borrowers is that a trust is not a separate legal entity. A trust is a relationship between the trustee and the beneficiaries ie a set of obligations and duties which arise when the trustee holds property on behalf of the beneficiaries.
Accordingly, when trustees enter into loan agreements they do so in their own name. The trustee is liable personally as it is the contracting party, subject to contractual provisions to the contrary.
It is therefore important for trustees to ensure that all loan and security documents:
- note the capacity in which the trustee enters into the loan;
- preclude personal liability on the part of the trustee; and
- limit any liability of the trustee to the extent to which it is indemnified from trust assets.
Collectively, the above provisions will be referred to as the ‘limitation of liability clause’ throughout this article. Limitation of liability clauses are typically subject to the trustee not acting in breach of trust or the trustee not acting negligently ie if the trustee were to act in breach of trust or negligently, it would usually be personally liable. Trustee limitation of liability clauses are also important for lenders, as lenders will not have direct access to trust assets unless they are secured lenders (against trust property) or contractual provisions provide otherwise.
Provided that the trustee acts within its power and discharges its duties, it is entitled to be indemnified out of trust assets as trustees generally have a right of indemnity so that if they incur a liability they can use trust assets to satisfy that liability. However, there are limits on that right of indemnity, eg where the trustee acts in breach of trust.
The right of indemnity is supplemented by a lien in favour of the trustee over trust assets to retain and dispose of trust assets in order to reimburse the trustee or to pay the trust liability.
A trustee has certain duties under the law and the trust deed, eg the obligation to act honestly, not place itself in a position of conflict etc. If a trustee breached these duties the trustee would not be entitled to be indemnified out of the trust assets and will be liable to the beneficiaries. This in turn could result in the lender not having any recourse to the trust assets where trust property has not been provided as security (discussed further below).
The trustee’s substantive obligation is to hold the assets for the beneficiaries. The trust instrument2, and generally trust legislation, gives the trustees certain powers to deal with trust assets eg to invest, to carry on business, to borrow, to guarantee etc. Trustees are required to act strictly in accordance with these powers. Lenders dealing with trustees should ensure that they consider whether or not dealing with the trustee is within the express powers of the trust as this will have a bearing on the lender’s enforcements rights (also discussed further below).
The beneficiaries are entitled to trace trust property and lenders who knowingly receive trust property in breach of trust, or who knowingly assist in the breach of trust, may be liable as constructive trustees. This means that lenders dealing with trustees need to be particularly concerned as to whether or not the entering into a loan with a trustee is within their power and whether it conforms to the trustee’s duties. If not, the trustee would usually be personally liable to the lender and the lender may not have recourse to trust assets.
Trusts v Companies
When dealing with companies (compared with trusts), lenders have the benefit of the common law ‘indoor management rule’ which allows lenders (and other third parties) dealing with companies to assume, in the absence of forgery or circumstances which put the lender on notice, that those acting on behalf of the company correctly followed the relevant procedures. Similarly, s.128 and s.129 of the Corporations Act allow lenders, in the absence circumstances which put the lender on notice, to make the same assumptions despite any fraud of the officers of the company.
Further, the ‘ultra vires rule’ which limited what companies can do by reference to specified objects and powers has been effectively abolished by s.124 of the Corporations Act. Section 124 of the Corporations Act gives companies all of the powers of an individual and of a body corporate.
Additional protection applies to lenders to companies as there are provisions preventing unauthorised returns of capital and dividends are required to be paid out of profits.
The above principles reduce the due diligence required to be undertaken by lenders to companies. These principles do not exist for lenders dealing with trustees as they:
- are not entitled to make any assumptions as to compliance with trust powers or duties;
- must rely on the trustees strict compliance with its powers and duties;
- may wish to contractually limit returns of capital and payments of distributions to beneficiaries; and
- must conduct their own due diligence to at least confirm that the trustee has acted within power.
It is obviously preferable to be a secured lender of a trustee than an unsecured lender.
If equitable security is provided to a lender and is valid, ie in accordance with the trustee’s duties and within power, the lender has the normal suite of remedies against the secured property. If such a security is provided in breach of duty, the rights of the beneficiaries will prevail against the lender.
If the trustee gives a legal security and the lender takes full value without notice of a breach of duty or power the rights of the security holder will prevail. If a lender that takes security has the required degree of knowledge of breach of duty or power it could be a constructive trustee (in favour of the beneficiaries) in relation to any proceeds of enforcement or amounts received from the trustee to discharge a security.
Unsecured lenders are creditors of the trustee and not of the trust, subject to contractual stipulations which may limit enforcement against trust assets.
An unsecured lender has no direct rights against the assets and has to rely on:
- the trustee’s right of indemnity out of the trust assets;
- the trustee’s lien over those assets; and
- the lender’s right of subrogation against the lien and indemnity.
The right of subrogation gives indirect access to trust assets. However the lender, along with other unsecured trust creditors, stands in the shoes of the trustee and has no higher right than the trustee’s right of indemnity. This means that a trust lender can claim against the trust assets only to the extent of the amount the trustee could claim out of the assets by way of exoneration. The lender is therefore reliant upon the trustee’s right of indemnity with all of its imperfections arising out of the trustee’s activities. This is irrespective of the lenders knowledge of any disentitling conduct of the trustee, eg breach of trust, breach of power etc, which prejudices the right of indemnity. A lender subrogated to a trustee’s right of indemnity from the trust assets is subject to whatever interests the trustee has lawfully created in those assets in favour of third persons, eg secured creditors.
Directors of trustee companies
Pursuant to s.197 of the Corporations Act, if a trustee corporation cannot discharge a liability incurred by it while acting, or purporting to act, as trustee and “is not entitled to be fully indemnified” against the liability out of trust assets, each person who was a director when the liability was incurred is liable to personally discharge the liability. In particular s.197 provides that the director is liable to discharge the corporate trustee’s liability, or part of its liability, when the two following conditions are satisfied:
the corporation has failed to, and cannot discharge the liability or that part of it; and
the corporation is not entitled to be fully indemnified against liability out of trust assets solely because of one or more of the following:
- a breach of trust by the corporation;
- the corporation’s acting outside the scope of its powers as trustee; or
- a term of the trust denying, or limiting, the corporation’s right to be indemnified against the liability.
This is of some comfort to lenders as it is an incentive for directors of trustee companies to ensure that liabilities are properly incurred so as to avoid personal liability.
Any lender to an MIS and a trustee need to carry out due diligence to make sure that:
- the trust is properly constituted. Generally, in order for a trust to be properly constituted it must satisfy the rule against perpetuities; there needs to be certainty in respect of the identification of trust property and beneficiaries; and the trust deed must be properly executed;
- the loan and any security provided is for a proper purpose and for the benefit of the beneficiaries; and
- the trustee is not in breach of trust in entering into the transaction to the extent that a secured loan is provided; or at all to the extent that an unsecured loan is provided.
If the above matters are not satisfied, both the trustee and the security holder, to the extent of the security, may be liable to the beneficiaries.
The simplest way in which a lender can satisfy itself as to the above matters is to:
- inspect the trust deed to ensure that the trust is properly constituted and executed;
- obtain copies of the requisite minutes which evidence proper consideration of the loan by the trustee, ensuring that the purpose of the loan is for the benefit of the beneficiaries and ensuring proper application of the proceeds of the loan; and
- obtain warranties (and indemnities for breach of these warranties) from the trustee, in its personal and trustee capacity, that its has and will continue to comply with the matters referred to in items 2 and 3 above.The value of the indemnities obviously depends on the worth of the trustee. However, this may be backed up by the requirement for the trustee to maintain appropriate insurance (which also benefits the trustee and its directors).
Compliance with all of the above is beneficial for both the lender and trustees as it assists the trustee in precluding any personal liability where a limitation of liability clause is included in the documentation.
1‘Trustees of managed investment schemes’ includes trustees of wholesale unregistered managed investment schemes and responsible entities of registered managed investment schemes. If an aspect of this article applies only to responsible entities then we will refer to ‘responsible entities’ rather than ‘trustees’
2This includes constitutions of registered MISs.
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Winding up and insolvency of managed investment schemes
The recent turmoil in global credit markets and financial markets and the introduction of the Federal Government’s bank deposits guarantee is having an acute impact on the managed investment industry in Australia. In the difficult economic times ahead, fund managers, investors and financiers of managed investment schemes are likely to seriously consider winding up schemes and withdrawing their investments as the value proposition of continued operation diminish.
This article takes a timely look at how retail managed investment schemes registered under Chapter 5C (registered scheme) of the Corporations Act 2001 (Cth) (Corporations Act) may be wound up voluntarily and compulsorily, ie in the event the scheme becomes insolvent, and generally some ‘tricks and traps’ of winding up procedures.
Initiating winding up: who can call for the winding up of a registered scheme?
A registered scheme may be wound up if:
- required or permitted under a provision of the constitution of that scheme (see section 601NA). Typically, constitutions of registered schemes will provide broad ranging powers for the responsible entity to wind up the scheme. However any provision which provides that the scheme will be wound up if a particular company ceases to be the responsible entity will not be effective;
- the members at a meeting of members resolve by extraordinary resolution to wind up the scheme (see section 601NB) or remove the responsible entity and a replacement responsible entity is not appointed (see section 601NE(1)(d));
- the responsible entity considers that the purpose of the scheme has been accomplished or cannot be accomplished (see section 601NC); or
The court may, by order, direct the responsible entity of a registered scheme to wind up the scheme if:
- the court thinks it is just and equitable to make the order. This action can be brought by the responsible entity, a director of the responsible entity, a member or ASIC but not by creditors (see section 601ND(1)(a)); or
- within 3 months before the application for the order was made, execution or other process was issued on a judgment, decree or order obtained in a court (whether an Australian court or not) in favour of a creditor of, and against, the responsible entity in its capacity as the scheme’s responsible entity and the execution or process has been returned unsatisfied. This action can be brought by a creditor (see section 601ND(1)(b)). Generally, this provision will be relied upon by creditors to wind up insolvent schemes.
Procedure for winding up
The procedures for winding up a registered scheme are contained in Part 5C.9 of the Corporations Act. Broadly this part provides that:
- the responsible entity may wind up the registered scheme in accordance with the constitution of the scheme (see section 601NE(1));
- the court may make orders with respect to the winding up of the registered scheme including the appointment of a person to wind up the scheme in accordance with its constitution (see section 601NF); and
- if, on completion of the winding up of a registered scheme, the person who has been winding up the scheme has in their possession or under their control any unclaimed or undistributed money or other property that was part of the scheme property, the person must, as soon as practicable, pay the money or transfer the property to ASIC (see section 601NG).
These procedures apply to both voluntary winding ups commenced by the responsible entity or members and winding ups in the event of insolvency commenced by creditors who have made an application to the court.
Section 601GC of the Corporations Act requires constitutions to contain provisions for the winding up of registered schemes. Commonly, these provisions would relate to the realisation of the scheme’s assets, settlement of claims by creditors, payment of costs and expenses to the responsible entity and distributions to the members.
However, as is often the case, winding up provisions in constitutions may be incomplete, impractical or inconsistent with the law. When carrying out the winding up the responsible entity must consider other legal requirements, particularly when winding up schemes which are trusts (trust schemes). These considerations may include:
- whether it had acted in accordance with its duties under the Corporations Act and trust law in realising the assets of the trust scheme;
- whether any fees it charges for winding up are in proper performance of its duties;
- the extent to which it could satisfy the claims of creditors and members by making in species distributions of assets of the scheme and valuation of any in species distributions under trust law; and
- requirements to send or publish notices calling for claims under the trustee statutes of various states.
The implications of scheme insolvency of responsible entities
It is important to note that where the registered scheme is a trust scheme, the responsible entity enters into all contracts and incurs all debts on behalf of the trust scheme personally. However, this is subject to its right to be indemnified from the assets of the scheme for debts incurred in the proper performance of its duties as trusts are not legal entities and cannot contract or incur debts on its own behalf.
Consequently, if a trust scheme does not have sufficient assets to fully meet all liabilities as and when they fall due, or if the responsible entity’s right to indemnity is impaired (for example the responsible entity was not entitled to borrow under the constitution) the responsible entity may, subject to any relevant limitation of liabilities, be required to meet any excess liabilities of the scheme itself.
Therefore, in some circumstances, it would be possible for creditors to seek to wind up the registered scheme under section 601ND(1)(b) of the Corporations Act as well as pursue the responsible entity, and if necessary, seek to appoint receivers or liquidate the responsible entity under Parts 5.2 and 5.4 of the Corporations Act. Further, if the responsible entity becomes insolvent as a result of debts incurred for the scheme, directors of the responsible entity may become liable under insolvent trading provisions under section 588G of the Corporations Act.
Compared to the corporate insolvency and voluntary winding up regime, Part 5C.9 of the Corporations Act relating to the winding up of registered schemes does not set out clear procedural guidelines for winding up, eg there are no provisions dealing with distributions, rights of receivers, administrators and liquidators, meetings of creditors etc) and is generally not very well understood.
However, key points for winding up of registered schemes are:
- a wide range of parties, including the responsible entity, members and creditors may take action to wind up the scheme;
- whilst provisions in Part 5C.9 relating to winding up procedures are simple and permit flexibility, other areas of law, particularly trust law, must be considered when conducting the winding up; and
- responsible entities which incur liabilities on behalf of the trust are potentially exposed to those liabilities in a personal capacity. Responsible entities should constantly monitor the solvency of the schemes they manage and obtain advice as soon as insolvency is suspected.
Partner and Head of China Practice
+61 3 9603 3553
+61 3 9603 3559
Implications of Australia’s proposed emissions trading scheme on financial services
On 10 March 2009, the Federal Government released exposure draft legislation to implement its carbon pollution reduction scheme. The exposure draft legislation codifies the government’s proposed carbon pollution reduction scheme framework and, in particular, its positions on emissions reporting and emissions trading. Following industry consultation, the exposure draft legislation package was tabled before parliament on 14 May 2009.
Under the proposed emissions trading scheme, regulated firms in key emissions intensive industries including stationary energy, transportation, industrial processes, waste (as well as firms which produce fugitive emissions) (regulated firms), will be required to report their emissions and surrender Australian Emissions Units (AEUs) or Eligible International Emissions Units (EIEUs) each financial year to meet their obligations under the scheme. Further, it is proposed that AEUs will be sold at government auctions, held each year, and may be purchased and held by both firms regulated under the scheme as well as unregulated entities, including individuals, companies, trusts and even managed investment schemes.
Whilst the scheme is expected to have the most profound consequences for emissions intensive industries, it will also have implications for the financial services industry. This article explores some of the major financial services regulation issues for the emissions trading scheme.
Regulatory framework: AEUs as financial products
The exposure draft of the Carbon Pollution Reduction Scheme (Consequential Amendments) Bill 2009 provides that AEUs and EIEUs will be treated as financial products for the purposes of the Chapter 7 of the Corporations Act 2001 (Corporations Act) and Division 2, Part 2 of the Australian Securities and Investments Commission Act 2001 (ASIC Act).
Broadly, Chapter 7 of the Corporations Act relates to the licensing of financial services providers, disclosures in relation to financial services (ie the requirement to provide financial services guides and statements of advice), disclosures relating to certain issues and sales of financial products (ie product disclosure statement requirements) and market conduct requirements.
Division 2, Part 2 of the ASIC Act deals mainly with unconscionable conduct and consumer protection in relation to financial services.
Importantly, Chapter 7 of the Corporations Act generally requires a person who provides financial services to have an Australian Financial Services Licence (AFS Licence) or be appointed as an authorised representative of an AFS licensee.
Generally, a person who advises in relation to financial products, such as AEUs and EIEUs, or deals in those financial products (ie by issuing, acquiring, disposing or varying those products) will be considered to be providing a financial service. However, section 766C of the Corporations Act carves out dealing in financial products on a person’s own behalf from the definition of financial service. Despite this, the carve out from the definition of financial services in section 766C does not apply where a person, who is the issuer of the financial product, deals in those products on its own behalf. Section 761E of the Corporations Act provides that parties to a derivative (a financial product which includes futures and options etc) are issuers of a financial product unless the derivative was acquired on a financial market, eg the Australian Securities Exchange or the Sydney Future Exchange.
Put simply, this means that regulated firms are generally not required to obtain an AFS Licence if they only trade AEUs and EIEUs on the spot market or deal in exchange traded derivatives for AEUs and EIEUs. However, if regulated firms want to manage their exposure to emissions costs using non-exchange traded futures, which is common in the European Union, those firms must be licensed to deal and possibly advise in derivatives.
Further, persons who provide advice in relation to AEUs and EIEUs or deal in those financial products on behalf of others, including wholesale and retail fund mangers who hold AEUs and EIEUs as underlying assets in their funds, must be licensed to provide such services.
It is interesting to note that under the exposure draft, AEUs and EIEUs will be specifically included as financial products in section 764A of the Corporations Act. This suggests that AFS licensees who wish to deal or advise in AEUs and EIEUs may be required to apply to the Australian Securities and Investments Commission (ASIC) for additional authorisations. If so, it would create practical difficulties for licensees and ASIC since it is hard to determine what relevant experience or qualifications responsible managers must have to advise or deal in emissions products.
Other obligations under Chapter 7
Based on the exposure draft, all obligations relating to the provision of financial services under Chapter 7 are likely to apply to AEUs and EIEUs and AFS licensees who advise and deal in these products. These generally include providing financial services disclosure, having appropriate licenses to provide financial services relating to AEUs and EIEUs and complying with market conduct requirements.
Importantly, the commentary to the exposure draft emphasises that market conduct rules under Chapter 7.8 of the Corporations Act. Unconscionable conduct and consumer protection rules in Division 2 Part 2 of the ASIC Act will apply to the provision of financial services relating to AEUs and EIEUs and appropriate adjustments to the regime to fit the characteristics of units and avoid unnecessary compliance costs may be made following further consultation.
Further, ASIC will be empowered to disclose information to the Australian Climate Change Regulatory Authority, the regulator of the carbon pollution reduction scheme, so that both agencies can cooperate to prevent market misconduct in relation to AEUs and EIEUs.
Partner and Head of China Practice
+61 3 9603 3553
+61 3 9603 3559
Is cyberspace ready for financial services regulation?
If you ever needed some particular advice, whether it be on how to set the timer on your DVD recorder, how to remove a stain from your favourite shirt or which hotel serves the best breakfast in Phuket, there is always one place to go where you know someone has the answer you are looking for: the internet, or as it is simply known, the ‘Net’. A one stop shop for any form of advice or hard to find piece of information. Only one proviso though – user beware – or so you would believe. Not the case if they are handing out investment advice.
Before the Financial Services Reform Act 2001 (FSR Act), the operator of an internet discussion site (IDS) that also conducted an investment advice business (eg a financial planner) was required to have a licence. It was the Australian Securities and Investment Commission’s (ASIC) view, as expressed in Regulatory Guide 162, that the FSR Act did not require an IDS operator to hold an Australian financial services licence (AFSL) provided it complied with particular guidelines, which included certain warnings and disclaimers.
The Net can be a powerful tool. A study published in the Accounting and Finance journal on market reaction to takeover rumours published on an IDS reported abnormal returns and trading volumes during the publication of the rumour and the 10 minutes immediately after, and concluded that an IDS has the potential to effect and therefore manipulate the market.
The increase in the use of an IDS and the ease of self publishing over the internet has allowed the fine line between offering financial advice as a business, or just communicating your personal investment view to become blurred and harder to regulate. ASIC policy currently applies to an IDS operated within Australia, targeting an Australian audience. The globalisation of the Net has also made the application of physical borders to internet related policy harder to maintain.
Some bloggers and operators of an IDS may soon find that they need to apply for and hold an AFSL to be acting in accordance with the law.
There are three main categories of a financial services IDS. The first, operated by a licensed financial adviser, is used as a means to attract clients and intentionally provide them with financial advice cheaply and efficiently. At the other end of the spectrum, an IDS operator merely provides the electronic meeting place for likeminded investors to share their investment experience. The third is where the operator moderates but does not contribute, to their site. Under current ASIC policy, it is possible to argue that both the second and third categories could comply with the ASIC guidelines and that only the first requires its operator to hold an AFSL.
ASIC’s policy on IDS
On 2 March 2009, ASIC released consultation paper number 104, “Internet discussion sites”. The consultation paper sets out ASIC’s current position on the legal issues surrounding internet discussion sites, how it proposes to review its policy and seeks the views of internet discussion site operators and users.
ASIC sets out that on application of the current law, it is only those IDS operators carrying on a business of providing financial services that requires an AFSL. The provision of financial advice is satisfied by a recommendation or statement of opinion intending to influence (an objective test) an investor’s decision on a particular financial product.
In ASIC v Matthews  NSWSC 201 (Matthews), postings about financial products were made on a internet chat site. Notably, postings were also made by the site’s operator and moderator. ASIC argued that the operator’s qualifications and experience were shown on the website and acted to encourage a naive investor to place considerable weight on the views expressed. The court determined that the postings could not merely be regarded as interested investors keen to chat or swap information and that the postings constituted financial advice.
The determining factor on whether an IDS operator will then need an AFSL will turn on the operators involvement in the content of the site as to whether it amounts to the carrying on of a financial services business. Quite clearly the first category of IDS operator discussed above is required to hold an AFSL, as their very intention was to operate such a business.
Where the operator’s involvement is limited to the mere distribution of all postings made by others, regardless of the content, ASIC points out that the exemption of ‘passing on’ is likely to apply, provided the operators involvement and role is made clear to the readers.
ASIC further points to operators of the third category of IDSs, those who themselves don’t post comments but are still involved as moderators of the content, who may also be caught as they may be considered ‘arranging’ or ‘authorising’ a financial service to be provided, which would also require an AFSL to be held.
ASIC policy must attempt to balance the freedom of communication with the need to protect consumers and prevent market manipulation.
ASIC sets out in its proposed policy that all IDS operators who are providing a financial service must hold an AFSL unless an exemption applies (rather than provide general relief so long as certain conditions are upheld). Practically speaking, this would attempt to differentiate between operators who merely facilitate to those who also moderate the content of their site. ASIC believes that this inclusive approach is an important means of ensuring it remains technology neutral, especially in light of this fast changing landscape.
Other proposals in the paper include that all IDS operators should, at a minimum:
- maintain the IDS in a fair and efficient manner;
- have good record-keeping practices; and
- give appropriate warnings to the users of their site.
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