Directors duties of a responsibility entity

Need a hand with understanding your duties as director of a responsible entity? Check out this case that made it all the way to the High Court.

The case

In the case, a responsible entity amended a scheme’s constitution to insert new fees which benefited the responsible entity as well as one of the directors and his family.

The case, Australian Securities & Investments Commission v Lewski [2018] HCA 63, is sometimes called the Prime Trust case. This is because Prime Trust was the name of the relevant managed investment scheme. The case involves a responsible entity called Australian Property Custodian Holdings Limited. We’ll call it APCH here.

ASIC was concerned that APCH had breached section 601GC of the Corporations Act 2001, which allows a responsible entity to change its constitution only if the members agree to the change or if the change will not adversely affect members’ rights. It also argued that the directors of APCH had breached their duties set out in section 601FD.

As APCH was insolvent, ASIC took action personally against each of the directors.

ASIC won (eventually).

The story

So what happened? Could this be you?

The board wanted to amend the constitution to insert some additional fees payable to APCH. APCH, one of the directors and his family (who owned all of the equity in APCH) stood to make a significant gain from the amendments.

The board sought legal advice as to whether the change was permissible. The advice suggested it might be possible but the position was not certain.

The board passed a resolution to amend the constitution, spending only 10 or 15 minutes considering the matter at the relevant meeting.

The following month, the board prepared a deed making the amendments and lodged the amended constitution with ASIC.

The proceedings

In an embarrassing twist, ASIC started legal proceedings too late to be able to tackle the resolution to change the constitution. Instead, its proceedings had to focus on the later meeting, at which the board agreed to lodge the amended constitution with ASIC.

This did not stop a single judge in the Federal Court from finding that the directors had breached various duties when they made the resolution to lodge the amended constitution.

However, the directors appealed the case to the Full Federal Court, which found that the resolution to lodge the amended constitution did not require the directors to turn their minds to whether the amendment was lawful and proper.

The case then made its way to the High Court. The High Court found that the original Federal Court decision should be largely restored. A large part of its reasoning was based on the view that the decision to lodge the amended constitution with ASIC was still subject to directors’ duties under section 601FD (even though the decision to amend the constitution had been made previously).

The matter was remitted to the Full Federal Court for a decision on disqualification periods and penalties for the directors.

The lowdown

Here’s what you need to know to avoid ending up where these directors did.

Members’ rights

When amending the scheme’s constitution on the basis that the change will not adversely affect members’ rights, the term “rights” needs to be read broadly. The High Court said to think of it more like “interests”.

Care and diligence

The Court found that the directors had breached their duty to exercise reasonable care and diligence. To avoid this happening to you when you amend the constitution or lodge the amended constitution with ASIC, you should:

• make sure you fully understand any fees that the responsible entity proposes to introduce
• consider whether it is proper to introduce the fees, particularly if the fees are substantial
• where legal advice is equivocal, address the uncertainty.

To address the uncertainty of equivocal legal advice, get:

• clear legal advice;
• a judicial direction; or
• as a safe harbour, member approval for the amendment.

Best interests

You cannot satisfy your duty to act in the best interests of members by merely believing that you’re acting in their best interests. The belief has to be reasonable. To help figure out what is in the best interests of members, look at the purpose and terms of the scheme.

Similarly, prioritising the members’ interests over those of the responsible entity is not satisfied by honest belief. The Court said “A contravention occurs when a director prioritises her or his own interests over those of members, no matter how honest or reasonable the director was in doing so.”

Improper use of position

Your duty not to make improper use of your position requires you to think about:

• whether you have authority to do the act you are proposing to do
• the purpose for which you are making a resolution.

If the purpose of a resolution is to give an advantage to the responsible entity, you are in trouble.

Compliance with the law

You have a duty to take reasonable steps to ensure that the responsible entity complies with the Act and with the scheme’s constitution. In the Prime Trust case, the amendments were not even made in accordance with amendment provisions set out in the constitution itself. The constitution said no change could be made to it without member approval where the amendment benefited the responsible entity. It also referred to section 601GC – the statutory provision applicable to amending constitutions.

When considering amending the constitution, make sure your actions ensure that the responsible entity complies with the requirements in the Act and the constitution itself.

Where to from here?

Navigating this and other areas of financial services law is hard. For more information about your obligations as a director or about the obligations of the responsible entity itself, contact us.

Author: Samantha Hills (Special Counsel)