Not better late - the Prime Trust appeal judgment

Banking Corporate Governance Financial Services Royal Commission Funds Superannuation Financial Services

In brief

Written by Partner Marc Kemp

The facts are tolerably well known by now.

Having decided that it was in the best interests of unitholders that the Prime Retirement and Aged Care Property Trust be listed, the board of the RE (Australian Property Custodian Holdings Limited, or APCHL) resolved on 19 July 2006 to amend the trust's constitution, without unitholder approval, to provide for substantial new or increased fees to be paid to APCHL personally if the trust was listed, if APCHL was replaced as RE, or if the trust was subject to a takeover. Making this decision, the board also formed the view that it had the power to amend the constitution notwithstanding a clause which prohibited any unilateral amendment of the constitution for the benefit of APCHL. Following a speedy 15 minute meeting, two directors signed a supplemental deed containing the amendments, but left the deed undated. On 22 August 2006 the board resolved to lodge the supplemental deed with ASIC (whereupon they would become effective). The deed was lodged on 23 August.

In due course the trust was listed and a fee of $33 million was paid to APCHL. The trust was unsuccessful and it sank gently to the sea floor, settling there for good in late 2011 when APCHL was wound up. Precisely five years and 364 days after the 22 August meeting, ASIC commenced proceedings against APCHL and its directors.

ASIC pleaded three groups of contraventions by the directors. Summarising these, it is helpful to refer to the resolutions passed on 19 July as the amendment resolutions, and the resolution passed on 22 August as the lodgement resolution.

First, ASIC alleged that in passing the lodgement resolution the RE and the directors breached their duties to act honestly, to comply with the trust's constitution, and to act in the best interests of unitholders and to subordinate the duties of the RE to the interests of unitholders (among other things).

Second, ASIC alleged that in paying the listing fee to itself, APCHL breached the prohibition against payments by an RE to itself without unitholder approval (in circumstances where none of the exceptions to the prohibition on related party transactions was available, and the constitution did not permit the payment), and that the directors were involved in that breach.

Third, ASIC alleged that in paying the listing fee APCHL and the directors breached their duty to act in the best interests of unitholders and to give priority to their interests over the RE's interests; that APCHL breached its duty to ensure that all payments out of scheme property were made in accordance with the constitution; and that the directors failed to take all steps that a reasonable person would take to ensure that APCHL complied with the Corporations Act.

ASIC's main difficulty was that by the time it brought proceedings, it had missed the six-year deadline for commencing proceedings in relation to, or relying on, the conduct at the 19 July meeting. This meant that it was forced to argue that APCHL and the directors' conduct in relation to the lodgement resolution, and not the amendment resolutions, gave rise to the relevant breaches. In practice, ASIC had to persuade the court that when they were meeting to pass the lodgement resolution, the directors needed to consider again whether the changes to the constitution (that would become effective on lodgement of the changes with ASIC) were proper and within their power to make. All of the contraventions depended on this, because if the lodgement resolution was tainted then the constitution was not amended and APCHL could not pay itself the listing fee.

The directors, on the other hand, argued in their defence that the lodgement resolution was merely 'an uncontroversial act of an administrative nature', and a step they were bound in any event to take; that a reasonable director would not have considered the matters already considered at the 19 July meeting; that the listing fee could be paid as it was provided for in the (amended) constitution; and that the directors held an honest belief that the amendments were valid and had no reason to reconsider them.

The appeal court agreed with the directors that the matters for consideration at the 22 August meeting were administrative, basing its decision largely on the facts that nothing happened between 19 July and 22 August requiring the directors to reconsider their decisions of 19 July (noting that the addition of a new board member during that period was not of itself such a circumstance); that the 19 July meeting was, on the facts, intended to be the meeting when those matters were to have been considered, and the relevant resolution to approve the amendments was minuted as having been passed; and that the directors honestly believed that the amendments to the constitution were valid. The appeal court was careful not to reach any conclusion about the soundness of the directors' conduct at the 19 July meeting when they considered the amendment resolution. The fact that ASIC was out of time meant that this meeting could not be directly relied on in the proceedings against the directors. The directors' appeal was therefore successful.

As is often the case it is not the main finding that will be of most interest to REs and their officers – that finding turned in large part on the facts, including ASIC's dilatoriness. But the appeal court said a few other things of more general application and interest.

First, the appeal court found that the power to amend a scheme constitution under s 601GC cannot be modified or qualified by the scheme's constitution – in other words, the restriction in clause 25 of the trust's constitution that prohibited any amendment which benefited APCHL did not limit its power to amend the constitution under s 601GC. The appeal court contrasted s 601GC with the corresponding provisions for amending company constitutions, noting that these specifically permitted the constitution to modify the operation of the Act as it applies to companies.

Second, the appeal court endorsed the view of the Victorian Court of Appeal in 360 Capital Re Limited v Watts (2012) 36 VR 507 that a unitholder's right to have a fund managed in accordance with its constitution is a 'member's right' within the meaning of s 601GC(1)(b) – ie, unitholders have a right to have the fund managed in accordance with the fund's constitution as it stands at any point in time, and any amendment to the constitution which is adverse to members requires unitholder approval by special resolution. This probably marks the end of a long-running divergence of views on this point.

Third, the appeal court found that amendments to a scheme constitution, once lodged with ASIC, are not automatically invalid but rather valid until set aside. In making this finding the appeal court did not distinguish amendments made wrongly but honestly from those made dishonestly; but it is probably safe to assume that an RE could not dishonestly amend a scheme constitution to authorise the payment of a new fee to the RE and rely on the amendment to avoid censure.

Fourth, the appeal court found that a reasonable director, honestly believing a previous decision of the board to be adequate, would not normally revisit that decision. Although this is probably welcome news for REs and their officers who may have felt that the judgement of the court at first instance set a high bar for boards continually to monitor past decisions, boards should remain vigilant - the appeal court said more than once that there had been no relevant changes between 19 July and 22 August requiring the board to revisit its decision, which means that boards should remain alert to changes and be prepared to respond to them. The appeal court certainly did not say that a board is never required to reconsider an earlier decision.

Finally, the appeal court did not disturb the conclusions of the court at first instance about the meaning of the duty of an RE (and its officers) to act in the best interests of unitholders, namely that it is a 'foundational' duty encompassing 'the fundamental duty of undivided loyalty' requiring an RE and its officers to 'use their best efforts to pursue solely the members' interests, to act honestly and to exercise care, competence and prudence in doing so, and to eschew any conflict of interests between the members' interests and its own.' The analysis of that duty by the trial judge, Justice Murphy, remains the most detailed recent exposition of that duty.

ASIC lost on appeal for reasons specific to its case. Although it is speculation to guess what the outcome may have been had ASIC been able to rely on the 19 July meeting, the speculation is not idle for RE directors looking for a memento mori to remind them of the potential cost of neglecting their onerous duties.