Focus: Amending registered scheme constitutions
6 May 2009
In brief: A recent decision of the NSW Supreme Court provides important guidance on amending constitutions of registered managed investment schemes. Partner Matthew McLennan (view CV) and Senior Associate Georgina Perry report.
- The issues
- Was a deed necessary?
- The precondition – the judge's approach
- The precondition – rights versus interests
- The precondition – actually believes and reasonable to do so
- Was ratification effective?
How does it affect you?
- The case confirms that, when amending a registered
scheme's constitution without unitholder approval, the responsible entity must
satisfy itself that the amendment will not adversely affect members'
rights. To do this, a responsible entity must:
- identify members' relevant existing rights;
- compare members' rights before and after the proposed change; and
- decide whether the change is adverse for unitholders.
Any adverse effect is enough to mean that the responsible entity can't proceed.
It is very unlikely that any amendment suspending or adding conditions to redemption rights can proceed without unitholder approval.
- More generally, the 'rights' in question are limited to the contractual and equitable ones given under the constitution. They are not 'rights' in the sense of a unitholder's commercial or financial interests.
- Responsible entities should review their processes for approving constitutional amendments, to ensure that they meet the standards set by this decision.
In this case,1 the plaintiff, ING Funds Management Limited (ING), was the responsible entity of two registered managed investment schemes. It sought declarations that amendments it had made to the constitution of each scheme were valid.
ING took three steps to alter the constitutions of the funds:
- In November 2008, it signed documents that purported
to add a new clause to the constitutions suspending redemptions for a period
while requiring that a members' meeting be held to consider a special
resolution to further amend the constitutions. As the judge, Justice
Barrett, said: [t]he objective was to freeze redemptions for a sufficient
time to allow a meeting of members to be held to consider a resolution to
modify the constitution so as to impose a further embargo on redemptions.
Some unitholders challenged the validity of the November 2008 documents.
- In December 2008, ING signed supplemental deeds largely to the same effect as the documents executed in November.
- Finally, in January 2009, ING signed deeds that sought to ratify or repair what had been done in November 2008.
The constitution of a registered managed investment scheme may be amended:
- 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 member's rights2.
The requirement that the responsible entity reasonably consider the modification will not adversely affect members' rights was referred to by Justice Barrett as the precondition.
The responsible entity conceded that the documents it executed in November 2008 were not valid deeds. Nevertheless, it maintained that a deed was not necessary to amend the constitutions of the funds. It also asserted that the precondition had been satisfied.
The issues that the judge had to decide were:
- Did the documents signed in November 2008 modify the constitution?
- Was the precondition satisfied in relation to the November 2008 documents or the December 2008 deeds?
- If the November 2008 documents were not effective, did the January 2009 deeds ratify the actions of November 2008?
The documents signed in November 2008, purporting to amend the constitutions, were signed by the responsible entity's general counsel and secretary, and were not deeds3.
Justice Barrett noted that the constitution in each of the cases before him was a deed executed and delivered by the responsible entity. His Honour concluded that, having regard to:
- the constitution of each of the funds – which required that amendments be made by way of deed;
- the common law about variation of deeds – which requires another deed to effect a variation; and
- the implicit requirement in the Corporations Act 2001 (Cth) that any amendment be made in such a way as to ensure that the constitutions continued to be legally enforceable between the members and the responsible entity4,
the constitution of the funds could only be modified by the responsible entity on the execution of another deed that has binding effect. As the documents signed in November 2008 were not deeds, they were ineffective.
The precondition – the judge's approach
Justice Barrett found that there were three components to the question of whether the precondition had been satisfied.
How did the responsible entity view 'members' rights' before the change and the impact that the change would have on those rights?
Justice Barrett explained this requirement as follows:
The task of the responsible entity...is first to ascertain the rights of members created by the Constitution, as they exist immediately before the modification. The responsible entity must then decide whether those rights – as distinct from the enjoyment of them or their value – will be changed or impinged upon by the modification. If that question is answered in the affirmative, the responsible entity must undertake a process of comparison and assessment in order to decide whether the impact is within the 'adversely affect' description.
Did the responsible entity consider that, according to a comparison of 'members' rights' before the change with the changed rights that would exist after the event, there would be no 'adverse' affectation of the 'rights' whatsoever?
Here, the responsible entity must:
decide whether the difference in the rights will be, from a member's perspective, unfavourable. To put this another way, the responsible entity must decide whether the change will remove, curtail or impair existing rights in a way that is disadvantageous to the persons whose holdings of units cause them to possess and enjoy the rights. No particular degree of affectation is contemplated by the legislation. Any adverse affectation at all, however slight, is sufficient to deny the responsible entity the modification power. (our emphasis)
Was the responsible entity's opinion reasonable?
The responsible entity must establish both that it held the relevant opinion and that the opinion was supported by reasonable grounds.
The precondition – rights versus interests
The analysis to be undertaken by responsible entities requires a sense of what 'members' rights' actually are. His Honour recognised this and endorsed previous cases that held that there is a 'sharp and clear' distinction to be drawn between the rights of unitholders and their interests: rights of unitholders are the contractual and equitable rights conferred on unitholders by the deed 5.
Many may not find this distinction immediately helpful but his Honour referred to an example from another case: the dilution of the value of units by issuing more units may affect members interests but it does not affect their rights. Therefore, for example, an amendment to a constitution facilitating the issue of more units, should not, of itself, affect members' rights at all (adversely or otherwise). Of course, the responsible entity will still have to consider other matters, in particular whether the amendment and any action taken following it are in the best interests of members.
The precondition – actually believes and reasonable to do so
No witness was called by the responsible entity to give evidence about its state of mind. Accordingly, the court had to make inferences from the documentary evidence, especially the minutes of the relevant meetings. Justice Barrett noted that the responsible entity had, in making the decisions of November and December 2008, considered both a management paper and written legal advice, and also held meetings at which minutes were prepared that record those matters considered by those officers present.
Justice Barrett referred to the management paper and accompanying legal advice that was considered by the officers of the responsible entity during the meeting at which they resolved to amend the constitutions of the funds. His Honour summarised the effect of the management paper in these terms:
The whole tenor of [the] paper was that a combination of an abnormally large volume of redemption requests, both received and expected, and a tightening of markets productive of expected difficulties in realising assets except on heavily discounted terms exposed the funds to instability. There was a preoccupation with preserving value for members – of necessity, it seems, members who chose to remain into the period when the effects of the difficulties would actually be experienced, not those who had already sought redemption.
His Honour noted that the paper made little reference to the subject of members' rights although much attention was given to members' interests and the need to protect them. That was, however, something quite different from the question posed by the Corporations Act concerning members' rights.
Justice Barrett held that the minutes of the relevant board meetings did not contain evidence of the basis on which the responsible entity had made its decision that the change would not adversely affect members' rights.6
The judge concluded that the responsible entity had failed to prove the grounds on which it had decided that the changes would not adversely affect members' rights. It therefore could not prove that those grounds were reasonable.
Although not strictly required, Justice Barrett also considered whether there could have been a reasonable basis for the conclusion that the change would not adversely affect members' rights. He summarised the rights affected by the change as 'the right to be paid money, in return for surrender of units, within a specified period'. The effect of the change was, in summary, to extend that period and his Honour concluded: [i]t is...not possible that a reasonable person would have come to any conclusion other than that the modification would adversely affect members' rights.
The responsible entity executed deeds in January 2009 purporting to ratify the actions of November 2008. In summary, Justice Barrett held that ratification could not be used by the responsible entity to retrospectively amend the fund constitutions where the original action taken to amend the constitutions was invalid.
- ING Funds Management Limited v ANZ Nominees Limited and ING Funds Management Limited v Professional Associations Superannuation Limited  NSWSC 243.
- Section 601GC(1) of the Corporations Act.
- Under s127 of the Corporations Act, a company may execute a document as a deed if it is expressed to be a deed and is executed by two directors of the company or a director and a secretary of the company. The parties agreed that these requirements were not met and no other rule of law operated to cause the documents to be deeds.
- Section 601GB of the Corporations Act requires that the constitution be legally enforceable between the members and the responsible entity.
- Quoting with approval Justice Young in Smith v Permanent Trustee Australia Ltd (1992) 10 ACLC 906. Justice Barrett considered, but rejected, the argument that members' rights include a 'right to have the managed investment scheme operated and administrated in accordance with the constitution as it stands'. His Honour found that adopting this broad conception of members' rights denied all efficacy to s601GC(1)(b) and must be rejected.
- Justice Barrett did not make a finding on whether a responsible entity is able to delegate the decision to amend the scheme constitution. Considering the importance that he placed on the decision-making process, prudence suggests against delegating a decision to amend a scheme constitution.
- Matthew McLennanPartner,
Ph: +61 2 9230 4732
- Mark CerchéPartner,
Ph: +61 3 9613 8872
- John BeckinsalePartner,
Ph: +61 7 3334 3520
- Robert ClarkePartner,
Ph: +61 3 9613 8034