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19 Jul 11
Watershed decision relating to responsible entity's power to amend constitution

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Key points

A recent decision of the Federal Court of Australia further clarifies, and potentially significantly limits, the circumstances in which a responsible entity of a registered managed investment scheme can rely upon section 601GC(1)(b) Corporations Act 2001 (Cth) (Corporations Act) in order to unilaterally amend a scheme constitution. Section 601GC(1)(b) enables a responsible entity to amend a scheme constitution without member approval where the change does not adversely affect members’ rights.

In Premium Income Fund Action Group Incorporated v Wellington Capital Limited [2011] FCA 698, Justice Gordon held that members’ rights for the purpose of section 601GC(1)(b) are the contractual and equitable rights conferred on unitholders by the constitution. Consequently, the scope of what constitutes ‘members’ rights’ are extremely broad and essentially encompass all powers, rights and obligations contained in the scheme constitution.

The facts

The case concerned a challenge to amendments made to the methodology for calculating unit prices in the constitution of the Premium Income Fund (PIF) which had been authorised by the responsible entity, Wellington Capital Limited (Wellington).

In two separate deed polls, Wellington sought to:

  • amend PIF’s constitution in order to allow it to issue units at an issue price not less than the 90 day volume weighted average price (VWAP) at which units in PIF were traded on the NSX, and
  • then to amend the constitution to enable it to issue units at an issue price representing a discount of up to 5% to the 30 day VWAP of units traded on the NSX.

Wellington then placed units to an investor at 10 cents per units. At that stage, units had been thinly traded on the NSX at about 8.1 cents per unit, being less than 25% of their net asset backing.

Following the placement of units, Wellington announced that it proposed to undertake a rights issue under which units would be offered to existing investors at a discount to their net asset value, in accordance with the amendments to the PIF constitution made by Wellington.

PIF Income Fund Action Group Incorporated (PIF Action Group) sought an injunction to prevent Wellington from undertaking the rights issue and sought a declaration that the placement of units was invalid on the basis that Wellington’s unilateral amendments to the PIF constitution to facilitate the issue of units at a discount contravened section 601GC(1)(b) Corporations Act.

The law - the ING case

Before this decision, the most authoritative case on section 601GC(1)(b) was the ING Funds Management Limited v ANZ Nominees Ltd [2009] NSW SC 243 (ING).

Justice Barrett's judgment in ING, endorsed by Justice Gordon in this case, provides a formula for any responsible entity considering making amendments to a scheme’s constitution under section 601GC(1)(b). The formula is:

  • identify members’ rights
  • undertake a comparison of members’ rights before the modification with the changes to rights that would exist after the modification, and
  • then reasonably consider whether there would be any adverse affectation of the members’ rights.

The key issue in this case was the question of what constitutes members’ rights. Wellington argued the provisions relating to the calculation of the issue price of units was not a right of members for the purposes of section 601GC(1)(b). The PIF Action Group contended that the requirement to have the issue price of units determined in accordance with the PIF constitution was a ‘member’s right’.

What are members’ rights

The Court had not previously conclusively determined what constitutes members’ rights for the purposes of section 601GC(1)(b). However, when the Court had previously considered what are rights in the context of shares and based upon a series of earlier cases, including in the cases of Smith v Permanent Trustee Australia Ltd (1992) 10 ACLC 906 and Seabrook, in the matter of the Takeovers Panel and the Corporations Act 2001 (2003) 21 ACLC 82, it appeared that a narrow construction of members’ rights was preferred.

The interpretation of members’ rights to include a right to have the scheme operated and administered according to the constitution was considered too wide by many commentators. Some argued that a better characterisation of members’ rights was the rights attached to units, such as:

  • distribution rights
  • withdrawal rights
  • voting rights
  • rights to receive information, and
  • rights in respect of scheme property.

Justice Gordon’s judgment in the PIF case rejects this approach as being too narrow and favours an approach that members’ rights are the contractual and equitable rights conferred on unitholders by the constitution.

PIF case

Justice Gordon found, in applying this interpretation of members’ rights, that unitholders had the right to have any new units issued in accordance with the terms of the PIF constitution. Therefore, unitholders had a contractual right for the issue price of units to be determined in accordance with the provisions of the PIF constitution.

Wellington had acknowledged that in approving the amendments pursuant to section 601GC(1)(b) it had determined that the proposed amendments did not affect members’ rights and consequently had not considered whether the amendments adversely affected members’ rights.

As Justice Gordon found that the requirement for units to be issued at the issue price specified in the constitution was a right of members, the consequence was that Wellington had contravened section 601GC(1)(b) as it (by their own admission) had not considered how members’ rights would be different following the amendment and whether this change was adverse to members.

Further, while Justice Gordon did not have to rule on whether the amendments adversely affected members’ rights in reaching her decision, she did comment that she believed members’ rights had been adversely affected (although she did not provide her reasons behind this conclusion).

In finding the amendments contravened section 601GC(1)(b), Justice Gordon ordered that the rights issue not proceed but did not unwind the placement. The effect of this finding was that the provisions of the PIF constitution, which were amended, reverted back to their original state.

Consequences

The PIF case further clarifies what constitutes members’ rights for the purposes of a unilateral amendment of a scheme constitution by the responsible entity. The historically broad interpretation of members’ rights taken by many lawyers and fund managers will narrow the circumstances in which a responsible entity can rely on the section 601GC(1)(b) power to amend a scheme constitution.

Effectively, many of the provisions of a scheme constitution will constitute a right of members, as the constitution is a contract between the responsible entity and members as to how the scheme will be operated. There will be limited situations where the change to the constitution may not relate to a right of members.

Therefore, in accordance with the formula laid out by Justice Barrett in the ING case, responsible entities will need to carefully consider how any proposed amendments affect member rights, by comparing the position before and after the amendment, and then consider whether the change is adverse for members. This analysis should be well documented in board minutes.

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.

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