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Focus: Amending scheme constitutions – the latest on section 601GC

18 March 2010

In brief: The circumstances in which a responsible entity may amend a scheme constitution without member approval have been considered further in a recent decision of the Victorian Supreme Court. Partner Susan Burns (view CV) and Senior Associate Penny Nikoloudis report on this decision.

How does it affect you?

  • This case reinforces the importance of a responsible entity (RE) being able to demonstrate that it:
    • gave due consideration to the effect on members' rights of the proposed amendments; and
    • formed the view, based on the above considerations, that the amendments would not adversely affect members' rights.
  • REs should therefore continue to:
    • have in place robust procedures when considering any proposal to amend a scheme constitution without member approval; and
    • clearly and comprehensively document the basis on which the decision was made.
  • In determining whether an amendment can be made without member approval, the court in this case was prepared to take into account the surrounding factual context. This represents a somewhat more flexible approach than that which had been taken in another recent decision.

The ING case – a recap

In May 2009, we reported on a decision of the NSW Supreme Court (in ING Funds Management Limited v ANZ Nominees Limited and ING Funds Management Limited v Professional Associations Superannuation Limited; together, the ING case)1, which considered the circumstances in which an RE may amend a scheme constitution without member approval (under section 601GC(1)(b) of the Corporations Act 2001 (Cth), which allows an RE to amend a constitution if it 'reasonably considers the change will not adversely affect the members' rights')2. In that case, the RE had amended the scheme constitution to add a new clause suspending redemptions.

In the ING case, Justice Barrett observed that three requirements must be satisfied for a constitutional amendment effected under s601GC(1)(b) to be valid:

  • The first step involves an assessment of how the RE viewed members' rights before the modification and whether those rights – as distinct from the enjoyment of them or their value – would be changed or impinged upon by the modification.
  • The second step requires the RE to demonstrate that, based on a comparison of members' rights before the modification with the changed rights that would exist after the modification, the RE considered that there would be no adverse affectation of those rights.
  • The third step requires that the opinion formed by the RE as to the absence of adverse affectation is seen to be something that the RE reasonably considers.

Justice Barrett noted that the necessary inquiry for the first and second steps concerns the state of mind of the RE. It was significant in that case that no director of the RE, or member of any other relevant decision-making body of the RE, gave evidence about the RE's state of mind, including the procedures that were followed before the amendments were made. Accordingly, the court had to make inferences from the documentary evidence, especially the minutes of the relevant meetings, the management paper and the accompanying legal advice that were considered by the officers of the RE. Justice Barrett commented that:

...this case has been presented in such a way that regard can only be had to inferences available from documentary evidence, including the minutes of the relevant meetings. With no witness having been called by [the RE] to give evidence about relevant matters, those inferences, such as they may be, are all the court has.

Based on the documentary evidence available to the court, Justice Barrett concluded that the RE had failed to prove the grounds on which it formed the conclusion that the modification would not adversely affect members' rights and, therefore, had failed to prove that the grounds were reasonable grounds.

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The Timbercorp decision

The recent decision of the Victorian Supreme Court (in Re Timbercorp Securities Limited (in liq))3 arose in the context of the insolvency of the Timbercorp group of companies. Before its insolvency, the Timbercorp group had operated various agribusiness managed investment schemes, including the 2005 Timbercorp Citrus Project, which was the subject of the Timbercorp case.

The liquidators of the RE of the scheme had amended the scheme's constitution without the approval of members (referred to as 'growers') by adding a clause that empowered the RE to assign, terminate, surrender or otherwise deal with any licence agreement to which the growers were a party. Before the amendment to the constitution, the licence agreements could only be terminated in limited circumstances (including upon the winding up of the scheme), and there was no provision for the RE to terminate the licence agreements at will.

The growers argued that the amendment was not valid on the basis that:

  • the evidence showed that the liquidators did not consider whether the amendment would affect growers' rights but, rather, directed their consideration to whether the amendment would affect the growers' commercial interests; and
  • even if the liquidators considered that the amendments would not adversely affect growers' rights, that state of mind was not one that was reasonable as, on any objective view, the amendment adversely affected growers' rights because the security of tenure that the growers had under their licences was 'degraded' to a licence terminable at will by reason of the amendment.

Justice Davies referred to the three-step process that was applied in the ING case and noted that she generally agreed with the views of Justice Barrett about the approach to s601GC(1)(b).

Importantly, one of the liquidators of the RE gave evidence in cross-examination on the purpose of the amendments, the surrounding factual circumstances and the process that had been adopted before the amendments were made.

In applying the three-step process, Justice Davies relied heavily on this evidence to conclude that:

  • the liquidators addressed the question that s601GC(1)(b) formulates;
  • the liquidators considered that the amendment to the constitution would not adversely affect growers' rights; and
  • there was a reasonable basis for that view.

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The three-step process applied

The three-step process to considering whether a constitutional amendment can be made without member approval was applied in both the ING and the Timbercorp cases. However, the application of this process yielded a different outcome.

In relation to the first and second steps, which involve an assessment of the RE's state of mind, the different outcomes in the two cases can be attributed largely to the lack of evidence in the ING case when compared with the detailed evidence as to the state of mind of the RE (through its liquidators) that was available to the court in the Timbercorp case. This distinction was emphasised by Justice Davies throughout her judgment.

In relation to the third step, there is a subtle, but significant, difference in the way in which this was applied in the two cases. In the ING case, Justice Barrett focused purely on the impact of the amendment on members' rights and whether a reasonable person could have come to the conclusion that the modification would not adversely affect members' rights. Justice Davies, on the other hand, focused less on the reasonableness of the RE's conclusion, and more on the reasonableness of the RE's state of mind. Accordingly, Justice Davies considered that the factual context was part of the material that not only may, but should, be taken into account when considering whether the RE's view was reasonably based.

For a more detailed comparison of the three-step process as undertaken in the ING and the Timbercorp cases, see our separate article.

Footnotes
  1. [2009] NSWSC 243.
  2. Subsection 601GC(1) provides that the constitution of a registered scheme may be modified, or repealed and replaced with a new constitution:
  3. [2010] VSC 050 (26 February 2010).

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