Publications / Financial Services
By Sean Robertson, Partner
The Corporations Act 2001 (Cth) (Corporations Act) allows a responsible entity to modify, repeal or replace the constitution of the scheme ‘if the responsible entity reasonably considers the change will not adversely affect members’ rights’.
The Court confirmed the Corporations Act requires the responsible entity to ascertain whether rights (legal or equitable rights) have been affected. If those rights (and not merely the commercial value or enjoyment of the rights) have been affected, the alteration can only proceed if the responsible entity considers the members’ rights before and after the alteration and is reasonably of the view that the members’ rights are not adversely affected.
On 6 June 2012, the responsible entity on behalf of 360 Capital Industrial Fund (Fund) contracted to buy four industrial properties to be funded by secured bank debt and the proceeds of a $27 million placement of redeemable unsecured notes (notes) to institutional investors (which included parties associated with the responsible entity) and up to an additional $13 million in notes to retail investors. The notes were in effect options to acquire units in the Fund. The ultimate aim of the responsible entity was to have the units in the Fund listed.
The options as part of the notes when exercised would result in units being issued at a 23% discount to the current net tangible assets. The notes until converted to units attracted a 12% per annum coupon payment. The notes were convertible to units in the Fund on a one-for-one basis. The Fund was currently paying minimal distributions to members who held ordinary units.
In order to proceed, the responsible entity unilaterally amended the constitution of the Fund to allow for the issue of the notes (effectively providing noteholders with an option to acquire units in the Fund).
The responsible entity also amended the constitution of the Fund to restrict the ability of members to convene and conduct meetings.
First constitutional amendments
The members claimed the constitutional amendments which authorised:
- the issue of notes which were in effect options, and
- their ability to convert to units at a discount
- were invalid because the constitution expressly prohibited the issue of options unless the Fund was listed.
The members also claimed the Fund did not ‘need’ to acquire additional properties, particularly where the money raised to acquire the properties resulted in a dilution of the existing members’ interests.
Second constitutional amendments
The members claimed the constitutional changes to the meeting and voting process restricted their right to participate in meetings.
The requirements of the section 601GC(1)(b) Corporations Act section 601GC (1)(b) states a constitution may be modified, repealed or replaced by the responsible entity:
‘if the responsible entity reasonably considers the change will not adversely affect members’ rights’
The Court referred to a range of previous decisions which discussed and ruled on the capacity of the responsible entity to alter the constitution without member approval.
In this case, there were two alterations made by the responsible entity. The first eliminated the constitutional provisions which precluded the issuance of the notes. The second alteration restricted the convening and conducting of members meetings. The Court concluded both were contractual ‘rights’ which were affected by the change. These changes did not merely alter the enjoyment of ‘rights’.
Once it is determined that members’ contractual or equitable rights under the constitution are being affected, the Court considered a responsible entity must undertake a three step approach to its considerations:
- the responsible entity should assess members’ rights as they exist before the modification
- the responsible entity should assess the members’ rights after the modification, and
- if the rights afterwards are different from the rights beforehand, the responsible entity must decide whether the difference in the rights will be, from a members’ perspective, unfavourable.
Once the responsible entity has determined that there is a difference between the legal rights before and after the changes, the responsible entity must, in order to comply with its obligations, consider whether the change is adverse. The Court stated:
‘The responsible authority must decide whether the change will remove, or curtail or impair existing rights in a way that is disadvantageous to the members’ 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 of the modification power.
The basis for the decision of the responsible entity and the rationale for the decision, as they actually existed in the mind of the decision maker, must be found to conform to the standard of reasonableness.’
Decision: the responsible entity had not properly changed the constitution
The Court first determined that the members as members of the scheme did have rights which were modified by the amendments.
Each member had a right under the constitution prior to the first amendment to ensure that no options could be issued unless the Fund was listed. Further, each member had a right to ensure new units were issued on the terms and at an issue price calculated in accordance with the constitution. These rights were important substantive rights, and the modification of these rights would go well beyond the enjoyment of such rights or the value of the rights.
Likewise the second amendments removed rights of members to participate in meetings as provided by the constitution.
Having determined both amendments had affected members’ rights, the Court reviewed the steps taken by the responsible entity in making the amendments. The evidence before the Court was limited to the minutes of the board meeting of the responsible entity. These minutes documented:
- advice received from a national law firm and senior counsel that the first amendments did not adversely affect members’ rights, and
- an independent expert report who concluded from a commercial perspective the acquisition of the properties, the issue of the options and the listing of the Fund was in the best interests of members.
The minutes then simply stated the board was satisfied it could make the amendments. Therefore the responsible entity did not establish that it gave due and proper consideration as to whether and to what extent members’ rights would be affected.
What was required (in the minutes) was a detailed assessment of the considerations (three step approach) above.
The failure of the responsible entity to establish that it had reasonably considered the consequences of the constitutional changes upon members’ rights meant the amendments were set aside by the Court.
The ability of a responsible entity to make changes to a scheme’s constitution can often be beneficial to the members of the scheme. In order for the scheme to react nimbly and quickly to commercial developments, inconsequential changes may be necessary.
The ability of the responsible entity of a scheme to change its constitution is not unconstrained. The responsible entity must ascertain what the members’ rights were before and after the change, and then consider whether those rights are adversely affected, using a standard of ‘reasonableness’.
While this case reiterates the processes to be followed in making unilateral alterations to a scheme constitution, it also reinforces the importance of providing evidence that the responsible entity has undertaken the appropriate considerations when making such alterations.
Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.