5 September, 2016
Lewski v Australian Securities & Investments Commission [2016] FCAFC 96
What you need to know
- The Full Federal Court of Australia has overturned civil penalties imposed on directors of a responsible entity in relation to payment of substantial fees under a constitutional amendment effected without member approval. In the circumstances, the directors were entitled to proceed on the basis that actions approved at prior directors' meetings were valid for the purpose of determining future actions.
- The Court has also expressed views as to when the constitution of a managed investment scheme can be amended by the responsible entity without member approval, and as to the legal effect of an invalid amendment prior to its invalidity being determined.
The Full Federal Court in Lewski v Australian Securities & Investments Commission [2016] FCAFC 96 ('Lewski') allowed an appeal against civil penalties imposed by Murphy J at first instance on the directors of a responsible entity (RE) of a managed investment scheme (MIS). While the unusual facts of Lewski may limit its broader application, the case highlights the need for precision in considering allegations of breaches of duties of directors of a RE under the Corporations Act 2001 (Cth) (the Act), and provides guidance as to the effect of an invalid deed purporting to amend the constitution of an MIS.
The facts
Australian Property Custodian Holdings Limited (APCHL) was the RE of an MIS, the Prime Retirement and Aged Care Property Trust (the Fund). APCHL was owned by Mr Lewski and associated entities. The directors of APCHL sued by ASIC were Mr Lewski and four other persons.
On 19 July 2006, four of the five directors (the fifth not having been appointed) resolved to amend the Fund's constitution. The amendments provided for new and substantial fees to become payable to APCHL in certain events, including on listing of the Fund on the ASX.
The directors later held a board meeting on 22 August 2006 at which they resolved to lodge the amended APCHL constitution with ASIC (the lodgement resolution). The amended constitution was lodged on 23 August 2006. Subsequently, the Trust was listed on the ASX and listing fees of $33 million were paid to APCHL from the Fund, and distributed to entities associated with Mr Lewski.
The contraventions alleged by ASIC
ASIC commenced proceedings in the Federal Court in August 2012 seeking declarations of contravention of the statutory duties of the directors in respect of the lodgement resolution and their approval of the payment of the fees, and consequential civil penalties. It also alleged the directors were involved in the RE breaching the prohibition on related party transactions. S 1317K of the Act requires that proceedings for a declaration of contravention must be brought within six years of the contravention. Because that limitations period had expired, ASIC was unable to seek civil penalties in respect of the 19 July 2006 resolution amending the constitution to allow for the fees. The Full Court noted the "failure of ASIC to commence proceedings" before that limitations period expired complicated the proceedings as no direct reliance could be placed on the 19 July 2006 amendment resolution.
Importantly, it was not alleged the directors acted dishonestly or that the directors ought to have been aware the amendment resolution was invalid.
The trial decision
At first instance, Murphy J held that ASIC had established the contraventions. In approving the lodgement resolution, the directors had breached their statutory duties including their duties of care under s 601FD(1)(b) and to act in the best interests of members under section 601FD(1)(c) of the Act.
Murphy J also held the directors were involved in a contravention by the RE of the prohibition on related party transactions in s 208 of the Act (as modified and applied to MISs by s 601LC). His Honour held the exception in s 208(3), which permits an RE to pay fees to itself as provided in the scheme's constitution without member approval, was inapplicable as the amendments were invalid.
The Appeal
Greenwood, Middleton and Foster JJ overturned Murphy J's decision and dismissed all ASIC's allegations against APCHL and its directors.
In concluding the contraventions based on the lodgement resolution were not made out, the Court emphasised the importance of the specific circumstances. On 22 August 2006, the constitution had already been purportedly amended by the deed approved on 19 July 2006. Although APCHL as RE could not validly amend the constitution to impose additional fees (as such an amendment would adversely affect members' rights and thus need member approval under s 601GC(1)(b) of the Act), the directors were not required to re-visit that decision (at least where, as here, there was no allegation they were acting dishonestly or did not believe the original resolution to be valid).
The directors had acted in accordance with the constitution as purportedly, but ineffectively, amended.
The Court considered that the RE could amend the constitution without member approval under s 601GC(1) of the Act, despite the constitution prohibiting amendments in favour of the RE (ie the mechanism in the Act is freestanding).
In respect of one of the directors, who had not been appointed at the time of the July 2006 amendment resolution and who said he did not participate in the lodgement resolution, the Court held ASIC had not discharged its onus of showing he participated in the lodgement resolution. The Court noted it may have been prudent for him to have had his abstention recorded.
Similarly, payment of the listing fees were provided for in the constitution as purportedly amended, and therefore
s 208(3) applied such that member approval for payment of the fees was not required. The directors were entitled to regard the lodgement resolution and deed as objective facts that existed as a basis for decision making. Hence, their actions in paying the fees on the assumption the amendments were valid did not result in a breach.
Implications
The Full Court in Lewski indicated its support for the narrow interpretation of an RE's power to amend a constitution and the concept of "members' rights" in s 601GC(1)(b) in 360 Capital Re Ltd v Watts (2012) 36 VR 507 ('360 Capital'), over the broader view of Barrett J in ING Funds Management Ltd v ANZ Nominees Ltd (2009) 228 FLR 444 ('ING').
Under the 360 Capital approach (described by the Full Court as "compelling"), members have a right to have the scheme managed in accordance with the fund's constitution as it stands. This would not, for example, allow the RE to amend the constitution to permit issue of units at a discount, as this would affect the rights of members to have the scheme administered in accordance with the constitution.
ING by contrast applied a narrower test, distinguishing between an amendment which affects members' rights as such and an amendment which merely affects the enjoyment of members' rights. Under this approach, an amendment to permit the issue of interests at a discount would not, without more, affect the rights of members and could be made by the RE without a resolution of members.
Furthermore, Lewski indicates that once amendments to a scheme constitution are lodged with ASIC, they will have at least some legal effect (and even be valid) until set aside – at the least, the amendment resolution provided a basis for subsequent decision making by the directors here.
It is worth noting the Court stressed that the approach in a civil penalty case such as this may not necessarily be the same in an action by members.
For further information, please contact:
Andrew Carter, Partner, Ashurst
andrew.carter@ashurst.com
