Focus: Getting your constitutional amendment right – the Centro decision
13 October 2011
In brief: A recent NSW Supreme Court decision held that, in the context of a restructure, a responsible entity was not required to seek members' approval to amend the provisions of the scheme constitution dealing with the issue price of units. As Partner Penny Nikoloudis (view CV) and Senior Associate Zoe Green report, although the case removes a great deal of uncertainty, it is still advisable for a responsible entity to proceed with caution before acting unilaterally.
How does it affect you?
- The Centro case1 reinforces the previously accepted position that unit pricing provisions of a constitution do not confer 'rights' and therefore can be amended unilaterally (subject to all other RE duties being satisfied).
- The court emphasised that the responsible entity (RE) must only exercise the unilateral amendment power if this is consistent with the RE's duties to act honestly, in good faith and for the benefit of the members. This is particularly relevant where pricing amendments allow units to be issued at a discount.
- In Centro, the court relied heavily on evidence that the RE was able to demonstrate that it:
- properly identified the members' rights that may be affected by the proposed amendments;
- gave due consideration to the effect of the proposed amendments on members' rights; and
- formed the view, based on the above considerations, that the amendments would not adversely affect members' rights and were for the benefit of members.
- REs should therefore continue to:
- have in place robust procedures when considering any proposal to amend a scheme constitution without member approval; and
- clearly and comprehensively document the basis on which the decision was made.
Section 601GC(1)(b) of the Corporations Act 2001 (Cth) (the Act) has had a roller coaster ride over recent months.2 This is the section that allows the RE of a registered managed investment scheme to amend the scheme's constitution without member approval if the RE 'reasonably considers that the change will not adversely affect members' rights'.
The three-step process
Recent cases3 have established that three requirements must be satisfied for a constitutional amendment made under s601GC(1)(b) to be valid:
- The first step involves an assessment of how the RE viewed members' rights before the modification and whether those rights – as distinct from the enjoyment of them or their value – would be changed or impinged upon by the modification.
- The second step requires the RE to demonstrate that, based on a comparison of members' rights before the modification with the changed rights that would exist after the modification, the RE considered that there would be no adverse affectation on those rights.
- The third step requires that the opinion of the RE as to the absence of adverse affectation is seen to be something that the RE reasonably considers.
What are 'rights'?
Central to this analysis is the concept of 'rights' and the types of amendments that change 'rights'.
In the ING case, Justice Barrett drew a clear distinction between members' 'rights' (that is, the contractual and equitable rights conferred on members by the constitution), and the 'interests' of members. His Honour commented that:
It is possible to argue that 'members' rights' include a right to have the managed investment scheme operated and administered according to the constitution as it stands. If that is so, any modification of the constitution involves an invasion of that right that is arguably adverse. I am not persuaded that this is a correct approach. It denies all efficacy to s601GC(1)(b) and must, for that reason, be rejected.
Although the ING case did not concern amendments to pricing provisions, there was a widely held view that pricing provisions did not confer 'rights', but instead conferred a power on the RE.
The Wellington case
In June 2011, however, the Federal Court reached a different conclusion in the Wellington case. In that case, the RE sought to amend the scheme's constitution unilaterally to introduce new pricing provisions for a placement and a rights issue. Justice Gordon determined that:
- the provisions of the constitution setting the issue price for new units were the source of a contractual right on the part of every existing member to insist that no new unit be issued except at the price set out in the constitution;
- as a factual matter, the directors of the RE failed at the first step by not considering all of the rights created by the scheme constitution and by limiting their assessment to a narrow set of rights identified in the board minutes; and
- even if the directors had correctly identified the members' rights being modified, it could not be said that the amendment would not adversely affect members' rights, as the amendment 'removed or impaired existing rights in a way that was disadvantageous to unitholders'.
As a result, there has since been considerable uncertainty about the ability of an RE to amend the unit pricing provisions of a scheme constitution unilaterally, especially where the impact of the pricing amendment may have a dilutive impact on existing members.
This uncertainty has now been removed by the decision in the Centro case, which was handed down on 5 October 2011.
Application for judicial advice
Centro MCS Manager Ltd in its capacity as RE of the Centro Retail Trust (CRT) applied to the NSW Supreme Court for judicial advice under s63 of the Trustee Act 1925 (NSW) in connection with a proposed restructure of CRT. The proposed restructure involved the stapling of units in CRT with units and shares in certain other Centro entities, to form a new listed stapled group, to be known as Centro Retail Australia.
In order for the restructure to take place, the RE would be required to issue CRT units at an issue price based on the value of the fund assets rather than the market value of existing units (as prescribed under the existing constitution). Therefore, for the purposes of the restructure, certain amendments needed to be made to the CRT constitution to introduce transaction-specific pricing provisions authorising the issue of units at an asset value price.
The Australian Securities and Investments Commission, which had leave to assist the court as amicus curiae, relied on the decision in Wellington to argue that the RE would not have the power under s601GC(1)(b) to amend the issue pricing provisions unilaterally – that is, on the basis that the provisions of the CRT constitution setting the issue price for new units constituted a contractual right of all existing members to insist that no new units be issued except at the price set out in the constitution.
Justice Barrett gave judicial advice that the RE was justified in amending the CRT constitution unilaterally to include transaction-specific pricing provisions.
While acknowledging that it was not ultimately the basis for her decision, his Honour rejected Justice Gordon's conclusion in Wellington that the provisions of a constitution setting the issue price for new units were the source of a contractual right on the part of existing members to insist that no new units be issued except at that price. His Honour stated [at para 35] that:
the provision prescribing the price at which units may be issued is a provision that qualifies the power of the RE to issue new units. Proper and valid exercise of the power entails issue at the prescribed price and at no other price. The RE has discretion whether to accept an application for units but no discretion as to the issue price. To say that modification of the constitution to change the prescribed issue price affects the 'rights' of existing members is therefore to accept the proposition that members have a 'right to have the scheme administered and operated in accordance with the constitution....that, in my opinion, is not a 'right' of members in the relevant sense.
Power must be exercised for the benefit of the members
Justice Barrett also highlighted that, in considering whether to exercise the s601GC(1)(b) power to modify the constitution, the RE must think beyond the question whether the power exists. Relevantly, Justice Barrett said that the RE's power under s601GC(1)(b):
co-exists with the irreducible duty of a trustee to perform the trust honestly and in good faith, for the benefit of beneficiaries... An RE considering whether to exercise the section 601GC(1)(b) power to modify the constitution of a managed investment scheme must think beyond the question whether that power exists. It is also necessary to conclude that the exercise of the power of modification in a particular way proposed will benefit the members of the scheme, they being the beneficiaries for whom the RE holds trust property.
His Honour provided two extreme examples of where that conclusion could not be reached, even though the amendments may not affect members' 'rights':
- where the modification required an RE to give away virtually the whole of the scheme property to charity; and
- where the modification introduced a new provision to issue a vast number of new units for a purely token consideration.
His Honour noted:
In the hypothetical cases mentioned, the responsible entity might well conclude that the members' 'rights' as such would not be adversely affected by the modification... [However], each of the hypothetical cases involves a form of dilution, in that the value of each existing member's interest is reduced by the effect of the modification of the constitution. These matters of dilution and loss of value would be of crucial relevance to an assessment by the responsible entity whether exercise of the power made available by s601GC(1)(b) would be for the benefit of the beneficiaries and therefore consistent with the general law duty of the responsible entity as trustee. On the face of things, the responsible entity could not form a positive opinion on that matter in either of the hypothetical cases mentioned.
In Centro, Justice Barrett found that there was material before the court (in the form of RE board resolutions, an independent expert's report and affidavit material), showing that the directors of the RE had turned their minds to the question of the impact of the amendments on members and, in doing so, had made an assessment of benefit to the members of CRT. Relevant considerations included that new units would be issued on a one-off basis and at an issue price that was likely to be higher than the market price; that an independent expert was of the opinion that the value of the existing units would be higher after completion of the restructure; and, in light of these factors that the issue of units would not dilute the existing financial stake of each member.
The Centro case was unusual as it involved pricing amendments that were expected to result in units being issued at a premium to their market value. Where, as is often the case, the pricing amendments are intended to enable units to be issued at a discount that may have a diluting effect on existing members, the directors of the RE will need to document their reasons for determining that the amendments will nevertheless benefit members.
The Centro case confirms that, in the context of a placement, capital raising or scheme restructure, an RE can unilaterally amend the scheme constitution to make pricing amendments, provided that the RE:
- can reasonably determine, and actually determines, that the pricing amendments do not adversely affect the rights of any member;
- determines that the amended pricing provisions are for the benefit of all members; and
- complies with all its other RE duties, including the duty to treat members of the same class equally and members of different classes fairly.
A recurring theme in each of the recent decisions on s601GC(1)(b) is the reliance of the courts on evidence demonstrating the decision-making process of the directors of the RE. This reinforces the importance of an RE being able to demonstrate that it:
- gave due consideration to the effect of members' rights of the proposed amendments; and
- formed the view, based on the above considerations, that the amendments would not adversely affect members' rights and would benefit members, having regard to the particular circumstances that necessitated the proposed amendments.
When considering if an amendment to a scheme constitution can be made without member approval, REs should do the following:
- Carefully document the decision-making process outlined above clearly in board minutes.
- Do not restrict the analysis to a 'shopping list' of members' rights, but think expansively about the rights conferred on members under the scheme constitution.
- If there is any uncertainty in the distinction between rights and interests, if the RE concludes that an interest is affected, conduct an 'even if' analysis: even if members' rights were affected, would they be adversely affected?
- Always ask 'does the amendment benefit members?'
- In the matter of Centro Retail Limited and Centro MCS Manager Limited in its capacity as responsible entity of Centro Retail Trust  NSWSC 1175.
- See our earlier publications on the ING case of May 2009, the Timbercorp case of March 2010, and the July 2011 Focus on the Wellington case.
- This three-step process was established in ING Funds Management Limited v ANZ Nominees Limited and ING Funds Management Limited v Professional Associations Superannuation Limited and was applied in Re Timbercorp Securities Limited (in liq)  and in Premium Income Fund Action Group Incorporated v Wellington Capital Limited  FCA 698.
- Penny NikoloudisPartner,
Ph: +61 2 9230 4805
- Stuart McCullochPartner,
Ph: +61 2 9230 4420
- Derek HeathConsultant,
Ph: +61 2 9230 4233
- Mark CerchéPartner,
Ph: +61 3 9613 8872
- John BeckinsalePartner,
Ph: +61 7 3334 3520