The Australian Securities and Investments Commission (ASIC) brought proceedings in the Federal Court of Australia against Australian Property Custodian Holdings Limited (Receivers and Managers appointed) (in liquidation) (Controllers appointed) (APCHL) and each of its directors (Directors) alleging breaches of duties owed as responsible entity of the Prime Retirement and Aged Care Property Trust (Prime Trust) and directors of the responsible entity.
The judgement again illustrates to responsible entities and their directors the high levels of caution and prudence they must exercise when making decisions in their capacity as responsible entity of a managed investment scheme and officers of the responsible entity, especially when such decisions involve a conflict of interest between the interests of members and the interests of the responsible entity.
In a comprehensive judgement outlining the nature of the duties of a responsible entity and directors of a responsible entity, Murphy J held that APCHL and its Directors at the relevant time breached a number of statutory duties that they owed to the Prime Trust’s members. The breaches related to unilateral amendments made to the Prime Trust constitution (Constitution) which provided for additional fees to be paid to APCHL and the payment of the additional fees.
Responsible entities and their directors need to be acutely aware that:
Courts will apply section 601GC(1)(b) strictly in determining whether constitutional amendments may be made unilaterally by the responsible entity, even if the decision to amend was made prior to the recent decisions clarifying the scope of the section.
In making constitutional amendments, the board needs to go further than considering whether the amendments adversely affect member’s rights under section 601GC(1)(b). In order to ensure that their statutory duties are fulfilled, the board must also assess the propriety of the amendments and whether the amendments should be made.
The duties owed by responsible entities and their directors are more demanding compared to the duties owed by officers of companies given their role as professional trustees of members’ assets.
Where a decision involves a conflict of interest between the interests of the responsible entity and the interests of members, the board must act with extreme caution and prudence. The board needs to undertake serious and focussed deliberations and record these deliberations.
Directors are not only required to inform themselves of matters under consideration, but they must also ensure that the board also considers and understands the matters.
The board should insist on unequivocal legal advice in relation to questions of interpretation of constitution and statutory provisions.
APCHL was the responsible entity of the Prime Trust. The Prime Trust owned a number of retirement villages around Australia. APCHL was owned by the managing director of APCHL and his associates.
In mid 2006, as a part of plans to list the Prime Trust, the board approved amendments to the Constitution that provided substantial additional fees to be payable to APCHL (Constitutional Amendments). These included a new listing fee if the trust was listed (Listing Fee), a new removal fee if APCHL were removed as responsible entity (Removal Fee) and an increased takeover fee if the Prime Trust was subject to a takeover offer (Takeover Fee).
The Constitutional Amendments were made unilaterally by the board without member approval. The Constitutional Amendments were enacted despite the fact that the Constitution contained a provision prohibiting the responsible entity from making constitutional amendments in favour of (or resulting in any benefit to) the responsible entity. (Clause 25.1)
Following the listing of the Prime Trust on the ASX, a Listing Fee of approximately $33 million was paid to APCHL.
ASIC sought declarations that the conduct of APCHL and the Directors contravened their duties under Chapter 5C.2 of the Corporations Act 2001 (Cth) (Act), as well as the related party transaction provisions of the Act.
The court made the following key findings in respect of the conduct of APCHL and the Directors’ conduct:
The Constitutional Amendments were invalid and of no effect, despite the fact that they had been lodged with ASIC.
In making the Constitutional Amendments, APCHL contravened section 601FC of the Act by breaching its duty of care and diligence, its duty to act in the best interests of the members of the Trust and give priority to the interests of members if there is a conflict between the members’ interests and its own interests and its duty to comply with the Constitution.
By resolving to approve the payment of the Listing Fee, APCHL also contravened section 601FC of the Act and breached its duty to act in the best interests of the members of the Trust and give priority to the interests of members if there is a conflict between the members’ interests and its own interests and its duty to ensure that all payments out of the scheme property were made in accordance with the constitution.
In making the Constitutional Amendments, each Director breached his corresponding duties under section 601FD of the Act. In addition, each Director breached his duty not to make improper use of his position as an officer of the responsible entity and his duty to take all reasonable steps to ensure the Trust’s compliance with its Constitution and the Act.
By resolving to approve the payment of the Listing Fee, each Director contravened section 601FD of the Act and breached their duty to act in the best interest of and give priority to the interests of the members over the interests of APCHL and their duty to take all reasonable steps to ensure compliance with the Constitution.
By approving the payment of the Listing Fee to APCHL without obtaining the members’ approval, APCHL contravened section 208 of the Act (as modified by Part 5C.7 of the Act) and each Director contravened section 209(2) (due to their involvement in APCHL’s breach of section 208).
Duties owed by responsible entities and directors of responsible entities
The decision extensively analysed the nature of the duties imposed upon responsible entities and their directors in Chapter 5C.2 of the Act and is the first to consider the content of the best interests duty. Murphy J noted:
The duty to act in the best interests of members is to be understood according to well-established general law principles applicable to corporate trustees and requires undivided loyalty and adherence to the terms of the constitution. The test is an objective one.
While the duties under Part 5C.2 in many ways mirror the duties owed by a company’s officers under Part 2D.1 of the Act, it must be noted that the duties of an officer under Part 2D.1 are owed to the company itself whereas the duties imposed under Part 5C.2 are owed to the members of managed investment schemes.
Where directors are required to act in the best interests of members, they must exercise a high level of care and caution when a conflict of interests or a conflict of interest and duty arises.
The directors’ duty to exercise reasonable care and diligence in Part 5C.2 corresponds with the duty Part 2D.1. However, ‘this does not mean that the standard of care expected will always be the same because that standard must be set having regard to the particular corporation’s circumstances… the result is that, while the duty of care under sections 601FD(1)(b) and s 180(1) correspond, the standard of care under section 601FD(1)(b) will often be higher’.
The business judgment rule defence in section 180 of the Act does not apply to duties owed by directors of responsible entities under section 601FD(1) of the Act.
What is required of the board of the responsible entity?
In line with recent authority (360 Capital Re Limited v Watts and Premium Income Fund Action Group Inc v Wellington Capital Limited), the decision again highlights the importance for boards of responsible entities to carefully consider the decision to make amendments to the constitution.
The decision also emphasises the importance of boards considering the propriety of any amendments to the constitution. Not only must boards understand and consider the impact of amendments on members’ rights, the board must also give the appropriateness of making the amendments serious and focussed consideration to ensure that they are fulfilling their statutory duties. Furthermore, the judgement stresses that directors are not only responsible for their own decision making process, but they also have a responsibility to ensure that the board as a whole has given adequate consideration to the issues.
His Honour was highly critical of the lack of board deliberations, as evidenced by the board minutes and found that the board did not give proper consideration to any of these crucial factors.
Given the nature of the Constitutional Amendments and the inherent conflict of interest between APCHL receiving additional fees and the interest of members in having APCHL perform the services for the existing fees, the board was obligated to exercise a high standard of care and to act with caution in approving the Constitutional Amendments. By merely ‘rubber stamping’ the Constitutional Amendments, the court held that the board gave in to the conflict of interest.
Although the Directors received legal advice in relation to the purported validity of the Constitutional Amendments (Legal Advice), the court found that the Legal Advice was inadequate in various regards. The Legal Advice was equivocal as to whether APCHL could unilaterally amend the Constitution given Clause 25.1. The court held that the interpretation of provisions in the constitution is a legal question and that a reasonable director would not have accepted advice that they should interpret the constitution and choose between alternative interpretations. The court declared that a reasonable director would have obtained unequivocal legal advice, a judicial direction or at least member’s approval of the amendments.
The Legal Advice as to whether APCHL could unilaterally amend the Constitution pursuant to section 601GC(1)(b) of the Act did not set out that members have a right to have the scheme managed in accordance with the terms of the existing constitution. Although the Directors argued that the prevailing case law at the time did not interpret section 601GC(1)(b) in this manner, the court held that this was an error made by the Directors. The court held that the Listing Fee, Removal Fee and Takeover Fee adversely affected the rights of members, as members respectively had rights to expect listing of the Prime Trust without additional fees, remove the responsible entity and a right to receive reasonable takeover offers. Therefore, the Constitutional Amendments were held to be invalid and of no effect.