Focus: Amending scheme constitutions – the most recent Federal Court decision on section 601GC
15 July 2011
In brief: A recent decision of the Federal Court held that, in the context of a capital raising, a responsible entity was required to seek the approval of its members to amend the provisions of the scheme constitution dealing with the issue price of units. Partner Penny Nikoloudis (view CV), Senior Associate Marc Kemp and Lawyer Lisa Bau report.
How does it affect you?
- Some uncertainty now exists about the ability of a responsible entity (RE) to amend the unit pricing provisions of a scheme constitution unilaterally (eg by inserting a discounted issue price in the constitution when conducting a placement or entitlement offer).
- REs seeking to raise capital by way of a placement or rights issue may need to rely on Class Order 05/261 to discount the issue price, instead of inserting the discounted price directly in the constitution.
- The case reinforces the importance of an RE being able to demonstrate that it:
- properly identified and gave careful thought to the members' rights that may be affected;
- gave due consideration to the effect on members' rights of the proposed amendments; and
- formed the view, based on the above considerations, that the amendments would not adversely affect members' rights.
- REs should implement procedures to ensure that all relevant factors are taken into account when considering whether an amendment to the scheme constitution can be made without member approval and ensure that those deliberations and any reasoning behind the decision are documented.
Section 601GC(1)(b) of the Corporations Act 2001 (Cth) (the Act) allows an RE to amend a scheme constitution without member approval if it 'reasonably considers the change will not adversely affect the members' rights'.
In the ING case2 , Justice Barrett observed that three requirements must be satisfied for a constitutional amendment made under s601GC(1)(b) to be valid. This process was applied in the Timbercorp case3 , with a subtle difference in respect of the third requirement:
- 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 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 those rights would not be adversely affected.
- The third step requires that the opinion formed by the RE – that there is no adverse affect – must be an opinion that a reasonable person could hold (the ING focus), and must in fact be reasonably held by the RE (the Timbercorp focus).
For a more detailed comparison of the three-step process as undertaken in the ING and the Timbercorp cases, see our separate article.
The facts in the decision4 are as follows. Wellington Capital Limited is the responsible entity of the Premium Income Fund, a registered managed investment scheme. In May 2011, Wellington announced a proposal to raise capital through a placement and rights issue. On two separate occasions, Wellington sought to rely on s601GC(1)(b) to amend the provisions of the scheme constitution dealing with the issue price of units. The first amendment sought to allow Wellington to determine the issue price of units by reference to volume-weighted average price (VWAP) and the second amendment sought to introduce the possibility of a discount to VWAP.
The minutes of the directors' meeting at which the amendment to the scheme constitution was considered showed that Wellington's Board had limited its assessment of the rights of members to:
- the right to vote at meetings of members;
- the right to receive distributions;
- the right to receive statutory information;
- the right to a beneficial interest in scheme property;
- the right to withdraw from the scheme; and
- the right to participate in a surplus on winding up.5
The directors of Wellington accepted that, in making an assessment of whether the change did not adversely affect members' rights, they did not take into account any other rights.
Applying the three step process, Justice Gordon determined that the directors failed at the first step by limiting themselves to consideration of the members' rights listed in the minutes. The directors did not consider all the rights created by the scheme constitution. In this instance, Justice Gordon characterised the relevant right as the members' right to have new units in the scheme issued at a particular price in accordance with the constitution – in essence, any dilution of a members' interest was to be a dilution in accordance with the terms of the constitution unless the members agreed otherwise.
Justice Gordon went further to say that, 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 Unit Holders'.6
The effect of the decision
The decision reinforces the importance of REs having well-documented procedures for considering an amendment to the scheme constitution without member approval. REs should not limit their consideration to a closed list of 'members rights', but should think carefully and expansively about the rights granted by the scheme constitution, and whether the proposed amendment adversely affects them.
In the context of a capital raising, which may dilute the investment of members who do not take up their full entitlement, the decision also casts doubt about whether there is any situation in which an RE can amend the pricing provisions of the constitution without seeking member approval. To the extent that this is the effect of the judgment, it is open to criticism on at least two fronts.
- In the ING case, Justice Barrett said the following in relation to 'rights' for the purpose of s601GC(1)(b):
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.
- It is arguable that the power of an RE to issue units at an issue price calculated in accordance with the constitution is a power of the RE, which is, in turn, circumscribed (as required by the Corporations Act), but is not a right conferred on a unitholder by their units. By holding that members have a right to be issued units at a price calculated in accordance with the constitution as it stood, the decision in the Wellington case arguably crosses the line that Justice Barrett drew.
- Assuming that the changes Wellington sought to make did affect a right of members to have units issued on the terms that were fixed by the constitution and not otherwise, it is not clear that the changes would adversely affect that right. For example, to the extent that the issue of units under a capital raising at a discount would dilute the investment of members who did not take up their entitlement, the value of their rights would be adversely affected (ie they would – in the words of Justice Gordon – be 'simply personally affected in a commercial sense'), but not the rights themselves. This conclusion is consistent with the conclusion in the Seabrook case7, where it was held that the constitution could be amended to permit the responsible entity to issue options to subscribe for units, even if this would result in a dilution of the value of interests of unit holders on the basis that the incidents or character of a legal right is to be distinguished from the value of that right in any monetary sense.
Although REs are, in principle, still able to raise capital at a discount under the class order relief in Class Order 05/26, the relatively strict requirements of the class order may limit its utility unless REs are able to obtain relief from ASIC. At the very least, as it stands, the judgment reinforces the distinction between listed companies and listed trusts seeking to raise capital, by restricting the ability of listed trusts to issue units at a discount. This anomalous treatment is pronounced in the context of stapled groups.
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.
- Not restrict the analysis to a 'shopping list' of members' rights, but think expansively about the rights conferred on members under the scheme constitution.
- Given 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?
- REs seeking to raise capital may need to rely on Class Order 05/26 to discount the issue price, instead of inserting the discounted issue price directly into the constitution, as had become market practice during 2009 and 2010.
- ASIC Class Order [CO 05/26] (Constitutional provisions about the consideration to acquire interests).
- ING Funds Management Limited v ANZ Nominees Limited and ING Funds Management Limited v Professional Associations Superannuation Limited  NSWSC 243.
- Re Timbercorp Securities Limited (in liq)  VSC 050.
- Premium Income Fund Action Group Incorporated v Wellington Capital Limited  FCA 698.
- Premium Income Fund Action Group Incorporated v Wellington Capital Limited  FCA 698 at 10.
- Premium Income Fund Action Group Incorporated v Wellington Capital Limited  FCA 698 at 42.
- Seabrook, in the matter of the Takeovers Panel & the Corporations Act 2001 (Cth) (2003) 21 ACLC 82.
- Penny NikoloudisPartner,
Ph: +61 2 9230 4805
- Mark CerchéPartner,
Ph: +61 3 9613 8872
- Derek HeathConsultant,
Ph: +61 2 9230 4233
- John BeckinsalePartner,
Ph: +61 7 3334 3520