Managed investment schemes – High standards imposed on responsible entities

There have been some interesting cases decided that are relevant for both investors in, and directors of, managed investment schemes (MISs).

The right of the RE and its associates to vote on resolutions

Section 253E of the Corporations Act provides that the responsible entity (RE) and its associates are not entitled to vote their interest on a resolution at a meeting of the scheme’s members if they have an interest in the resolution or matter other than as a member. There has been considerable confusion about the meaning of that section, and whether it prevents a member from voting where that member is an associate of the RE, and it’s the RE (but not the member) that has the interest in the resolution other than as a member.

In the case of AMP Life Ltd v AMP Capital Funds Management Ltd & Anor [2016] NSWCA 176, the New South Wales Court of Appeal had to consider whether AMP Life (the parent company and member of the scheme) could vote on resolutions being proposed by the RE, AMP Capital Funds Management (a subsidiary of AMP Life). It was argued by AMP Life that the Corporations Act did not prevent it from voting, because it was the RE that had an interest in the resolution and not AMP Life.

The court noted as follows:

• The Corporations Act was concerned with the role of the RE as a guardian and protector of the interests and welfare of members of the scheme and with the subordination of any conflicting interest of the RE.
• The section was designed to prevent any potential conflict of interest arising between the RE’s own interests and the interests of the member of the scheme.
• The prohibition on the RE voting on a resolution is extended to associates because they may act together to procure a result that benefits one or more of them, notwithstanding it might not directly benefit the individual associate.

For that reason, AMP Life was prevented from voting on the resolutions. The court clearly took a strict view of the provisions designed to protect scheme members. If either the RE or any associate has a relevant interest, the RE and all its associates will be excluded from voting.

The decision is a welcome one, as it provides much-needed clarity to REs when they’re conducting scheme meetings, and might have implications for the way they structure their schemes. It also highlights the investor protection focus the courts will apply when considering issues relating to MISs.

Higher duties imposed on directors of REs

In Trilogy Funds Management Limited v Sullivan (No 2) [2015] FCA 1452, a judge in the Federal Court had to consider the duties imposed on directors of an MIS.

Trilogy, as the RE for an MIS known as the Pacific First Mortgage Fund (the Scheme), brought proceedings against the directors and officers of the former RE, City Pacific. Under City Pacific’s control, the Scheme had lent $3.25 million to Atkinson Gore Agricultural Pty Limited (AGA) to purchase agricultural land. There were some further advances and drawdowns under the AGA loan facility over the period of about a year. Ultimately, a loss was made by the Scheme, and Trilogy claimed the directors of City Pacific had breached their duties in relation to the lending decisions made. Specifically, Trilogy argued they had acted unreasonably and had failed to adhere to the Scheme’s lending criteria, the compliance plan, the representations made in the product disclosure statements and the terms of the constitution.

Trilogy was successful, with the court finding the directors had breached their duties under the Corporations Act, including that they had failed to:

• exercise the degree of care and diligence a reasonable person would exercise in approving the further advances to AGA
• take reasonable steps to comply with the Scheme documents, and
• act in the best interests of the Scheme.

The judge had to consider the additional duties imposed on directors of an RE pursuant to section 601FD of the Corporations Act. The judge considered previous case law in some detail and looked at the duty of care and diligence which is owed under section 180 of the Corporations Act (see article on Directors Duties 101). He then concluded that the standard of care applicable to a director of an RE will often be higher than the standard expected of other directors. The basis for this was that scheme members are particularly vulnerable to potential conflicts of interest. Those potential conflicts of interest will arise because of the interest of the RE in obtaining fees balanced against the duty to act in the best interests of the scheme members and give their interests priority.

It looks like a trend…

The cases referred to above in relation to REs and the way in which they deal with conflicts of interest should put directors of MISs on their guard. It will also give comfort to investors seeking to recover losses from REs that have been less than prudent in the management of their funds.

Please contact us if you have any questions in relation to MISs. We can provide specialised legal advice in relation to the duties of REs and the rights of investors.