Managed Investment Schemes Report

This chapter explains the background to the review of managed investment schemes, sets out the terms of reference, provides a dictionary   of   key   terms,   describes   the   review   process   and summarises the CAMAC position and recommendations.

1.1) Background

The failure in recent years of a number of high profile managed investment schemes (schemes) has highlighted the difficulties that can arise where this form of commercial structure suffers financial stress.

Some of the problems encountered were referred to in the report by the Parliamentary Joint Committee on Corporations and Financial Services Inquiry into aspects of agribusiness managed investment schemes (September 2009). That report noted concerns that had been raised in consequence of the financial collapse of some large agribusiness schemes, including what was the most suitable external administration process for these schemes, whether the interests of affected parties were properly recognised in that process, how potential conflicts of duty in conducting an external administration might be dealt with, and whether fair consideration could be given in that process to continuing a scheme through restructuring its arrangements.1

In part, these problems reflect difficulties arising from the specific arrangements entered into  to  operate particular agribusiness schemes. However, from a broader perspective, they also reflect developments in recent years in the use of schemes, from their original predominant role as passive investment vehicles, to their increasing use as vehicles to conduct entrepreneurial activities with enhanced investor involvement. The failure of some entrepreneurial schemes  has  generated  legal  problems  that  were  not  anticipated when the current legal framework for schemes was developed. This (paras 3.99 ff.) failure, and developments in practice, point to the need for a considered review of that framework, to make it more workable by reflecting the changed nature and size of schemes and responding to financial stresses that can occur with schemes.

1.2) Reference to CAMAC

In a letter of 18 November 2010 (set out in the Appendix), the then Parliamentary Secretary to the Treasurer, the Hon. David Bradbury MP (the PST), referred various matters concerning the regulation of schemes to CAMAC.

In his letter, the PST referred to:

the difficulties that arise for responsible entities (REs), scheme members, and creditors where a [scheme] comes under financial stress.

The PST letter referred to the current lack of certainty with respect to the arrangements for dealing with unviable schemes, pointing particularly to the collapse of a number of significant participants in the agribusiness market:

While the corporate insolvency provisions in the Corporations Act provide creditors and directors with certainty about their rights and obligations, the Corporations Act sets out very few specialised rules regarding the administration of insolvent trusts or trustees. Instead, the administrations of such are determined by a mix of legislation, common law and equitable principles. The lack of clarity has led liquidators to resort often to the Court in order to obtain advice about the legality of future actions.

It is therefore not clear whether the legislative arrangements contained in the Corporations Act are adequate to maintain the confident participation of retail investors in [schemes] because of deficiencies in the way the Act deals with: resolving the consequence, for otherwise viable schemes, of the insolvency of their RE; and what is to occur when the RE is insolvent and the Scheme itself has failed.

The PST letter also stated that:

Informal stakeholder consultations have also raised issues with the general operation of the [schemes] regime, which has not been reviewed since 2001.

The  PST  letter  then  referred  the  following  specific  matters  to CAMAC for consideration and the provision of advice.

Changing the RE of a viable scheme

In some situations, the responsible entity (RE) of a viable scheme may act in a manner, or in some other capacity suffer financial loss, that makes that RE ineligible or unsuitable to continue in its role as operator of the scheme. However, the future of the scheme may be placed in jeopardy through difficulties in immediately securing a suitable  replacement  RE,  given  that  a  scheme  cannot  continue without an RE.

In this context, the PST letter asked CAMAC to:

examine whether the current temporary RE framework enables the transfer of viable [scheme] businesses where the original RE is under financial stress, and if not whether it should be reformed or replaced.

Restructuring a financially stressed scheme

Companies in financial stress may be placed in voluntary administration (VA), with a view to their possible rehabilitation, rather than be immediately wound up. There is no equivalent procedure for schemes. In consequence, a financially stressed, but potentially viable, scheme may  have to  be  wound up  without a formal opportunity to assess the possibility of a compromise or other arrangement that could allow the scheme to continue.

In this context, the PST letter asked CAMAC to:

examine whether REs are unable to restructure a financially viable [scheme] and advise if the current legislative methods available to companies under the Corporations Act should be adapted to managed schemes.

Winding up a scheme

Where a scheme is no longer viable, or otherwise is to be wound up, the question arises how best to ensure a suitable outcome for all affected parties, without the level of procedural complexity and potential disputation that currently can beset the winding up process.

In this context, the PST letter asked CAMAC to:

examine   whether   the   current   statutory   framework   is adequate  for  the  winding  up  of  a  [scheme],  and agribusinesses in particular, and whether it provides the necessary guidance for liquidators, creditors, investors and growers advise what legislative amendments should be made if the current legislative framework does not provide the necessary legislative tools with respect to the arrangements for dealing with non-viable [schemes].

Other matters

The PST letter also asked CAMAC to:

examine  other  proposals  to  improve  Chapter 5C  of  the Corporations  Act,   including   in   relation   to:   convening scheme meetings; cross-guarantees entered into by REs on behalf  of  other  group  members;  and  statutory  limited liability.

1.3) Key distinctions

This   report   draws   two   distinctions   that   are   central   to   an understanding of how schemes operate and to any consideration of the matters referred to in the reference to CAMAC:

• The distinction between pooled schemes and common enterprise schemes
• The  distinction between sole-function REs  and  multi-function REs.

1.3.1) Pooled schemes and common enterprise schemes

The statutory definition of ‘managed investment scheme’ refers to contributions from investors being ‘pooled or used in a common enterprise’.2

Pooled schemes involve contributions by scheme members being pooled   and becoming   scheme   property,   for   use   in   scheme’2. Paragraph (a)(ii) of the s 9 definition of ‘managed investment scheme’.

Investments or otherwise to operate the scheme. Schemes of this type  are  typically  established  as  trust-based  investment arrangements, with scheme members playing no active role in the affairs of the scheme.

Common  enterprise  schemes  involve  the  use  of  member contributions in a common enterprise that constitutes the scheme, without those contributions being pooled. In these forms of entrepreneurial arrangements, a distinction must be drawn between scheme property and property owned by individual scheme members that is used in the operation of the scheme. Schemes of this type are typically established as contract-based arrangements, with scheme members playing an active entrepreneurial role to some degree, at least in theory.

1.3.2) Sole‐function and multi‐function REs

A sole-function RE is an entity whose only role is to operate one particular scheme.

A multi-function RE is an entity that is the operator of more than one scheme or is the operator of at least one scheme and has other dealings in its own right, such as conducting its own business. The legislation contemplates schemes being operated by multi-function REs.3

1.4) Terminology

For ease of reference, throughout this report:

• Affairs of a scheme refers to all agreements forming part of a scheme
• AFSL refers to an Australian financial services licence, issued by ASIC, and authorising an RE to operate a scheme
• Agreement refers to any legally binding contract, transaction, understanding or other arrangement’3. Subparagraph 601FC(1)(i)(ii) refers to an RE holding scheme property ‘separately from property of the responsible entity and property of any other scheme’.

• Agreement forming part of a scheme refers to any agreement entered into by the RE pursuant to its role in operating the scheme, and any agreement entered into by a scheme member pursuant to the terms of the scheme
• common   enterprise   scheme   refers   to   a   scheme   where contributions by members are to be ‘used in a common enterprise’ (para (a)(ii) of the definition of ‘managed investment scheme’ in s 9) (rather than those contributions being placed in a common pool) and where members typically enter into a series of agreements with the RE and/or other parties related to the ongoing  operation  of  the  scheme.  In  practice,  this  type  of scheme may also be referred to as a contract-based scheme or an enterprise scheme
• DOCA means a deed of company arrangement, entered into as the result of a corporate VA
• insolvent scheme means a scheme where the scheme property is insufficient to meet all the claims that can be made against that property as and when those claims become due and payable
• limited  recourse  rights  refers  to  rights  of  recovery  of  a counterparty against an RE, under an agreement with that RE as operator of a scheme, that are limited to the scheme property available to the RE through the exercise of the RE’s indemnity rights and exclude rights of recovery against the personal assets of the RE
• MIS refers to the proposed separate legal entity under the SLE Proposal (set out in chapter 3) that would hold all the scheme property and, through its RE as agent, would be the principal to all agreements involving scheme property
• multi-function RE means an entity that is the operator of more than one scheme or is the operator of at least one scheme and has other dealings in its own right, such as conducting its own business
• personal assets of the RE means all assets of the RE, including assets acquired by the RE through dealings unrelated to its operation of any scheme and any funds that the RE has received through exercise of its indemnity rights against the property of any scheme that it operates. The term excludes scheme property, and any other property, held on trust by the RE. The term also excludes any unexercised indemnity rights of the RE against scheme property. While as a matter of law these unexercised indemnity rights form part of the personal assets of the RE, they are,  for  the  purposes  of  this  report,  not  included  in  this definition, but are separately defined below

• personal liability of the RE refers to the obligation of the RE under the current legal framework to meet, from its personal assets, liabilities under agreements into which it enters as operator of a particular scheme and which do not restrict the counterparty to limited recourse rights
• pooled  scheme  refers  to  a  scheme  where  contributions  by members ‘are  to  be  pooled’ (para (a)(ii) of  the  definition of ‘managed investment scheme’ in s 9), typically in a trust-based investment arrangement, and where members typically do not enter into further agreements with the RE or any other party related to the ongoing operation of the scheme. In practice, this type  of  scheme  may  also  be  referred  to  as  a  passive  or trust-based scheme
• RE means the responsible entity of a scheme, as defined in s 9
• sole-function RE means an RE whose only function is to operate one scheme
• scheme means a managed investment scheme, as defined in s 9
• scheme administrator/liquidator means the person appointed to administer/wind up a scheme, as proposed in this report
• scheme creditors means all persons who have claims as creditors by virtue of having entered into agreements with the RE as operator of the scheme, except where the RE is acting as agent for scheme members. The rights of particular scheme creditors may differ, depending upon whether they have agreed to having only limited recourse rights (see above)
• scheme  members/members of  a  scheme means  those  persons who, pursuant to the definition of managed investment scheme in s 9,   have   contributed   money   or   money’s   worth   as consideration  to  acquire  rights  to  benefits  produced  by  the scheme

• scheme  property/property  of  a  scheme  means  all  property coming within the definition of ‘scheme property’ in s 9
• subrogation remedy means the process by which counterparties to agreements with the RE as operator of a scheme can indirectly gain access to the property of that scheme through the indemnity rights of the RE regarding that property, as a means of satisfying their claims under those agreements
• TRE  means a  temporary responsible entity  appointed by  the court to operate a scheme on an interim basis
• unexercised indemnity rights of an RE means rights of an RE, not yet exercised, to be indemnified out of the property of a scheme in consequence of operating that scheme
• VA means voluntary administration. A corporate VA is regulated under Part 5.3A of the Corporations Act.

1.5) The review process

To  invite  and  facilitate  the  expression of  views  from  interested parties on the matters referred to CAMAC, the Committee published a discussion paper Managed Investment Schemes in June 2011.

In  response  to  the  invitation  in  the  discussion  paper,  CAMAC received submissions from:

• Allens Arthur Robinson (AAR)
• Alliton Securities
• Ashurst Australia (formerly Blake Dawson)
• Australian Compliance Institute
• Australian Securities and Investments Commission (ASIC)
• Baker & McKenzie

• Garry  Bigmore QC,  Samuel  Hopper  &  Matthew  Kennedy, Victorian Bar
• Chartered Secretaries Australia (CSA)
• Clarendon Lawyers
• Financial Services Council
• Freehills
• Henry Davis York
• Insolvency Practitioners Association (IPA)
• Alan Jessup, Partner, Piper Alderman
• McCullough Robertson
• McMahon Clarke Legal
• Primary Securities Ltd
• Property Council of Australia
• Property Funds Association of Australia
• The Trust Company
• Richard Wilkins.

A summary of submissions on each of the issues is included in this report.  The  submissions  are  published  in  full  on  the  CAMAC website.

CAMAC was greatly assisted in its consideration of issues related to schemes by the information and views provided by respondents. The Committee expresses its thanks to all those who participated in this consultation process.

CAMAC also acknowledges, with appreciation, the work of the CAMAC schemes subcommittee (Bob Seidler (chair), Pamela Hanrahan, James Marshall, Michael Murray, Geoff Nicoll and David Proudman) on this review.

1.6     Outline of the CAMAC position

1.6.1    Issues under the current legal framework

The problem of common enterprise schemes

In considering the issues raised by this reference, CAMAC observes that the  problems encountered with the  operation of  schemes in recent years have arisen principally, if not exclusively, in the context of common enterprise schemes. These problems centre on the difficulties that can arise, particularly when a common enterprise scheme or its RE is in financial stress, from the intermingling of the affairs and property of the scheme itself and of its members.

Recent experience with the collapse of some agribusiness common enterprise schemes points to the possibility of confusion arising in attempting to untangle these arrangements, with a range of involved parties, including scheme members, each seeking to assert what they perceive to be their proprietary and other rights and attempting to determine the way forward, often in an environment of conflict and resort to litigation.

CAMAC has considered whether an effective way to avoid these problems arising in the first place might be to permit only pooled schemes.

CAMAC notes that this option was not adopted when the current Chapter 5C of the Corporations Act was introduced in 1998. At that time, however, it may not have been possible to anticipate the extent to which schemes would continue to develop beyond primarily passive pooled investment vehicles to encompass large business enterprises, adopting the common enterprise scheme structure for taxation and other reasons.

More recent experience suggests that many of the problems encountered in attempting to deal with schemes in financial stress, including how best to respond to the various proprietary and other claims of scheme members, may have been avoided if the types of permissible schemes had been limited to pooled schemes. Entrepreneurial  activities  in  which  investors  sought  a  greater personal proprietary or other involvement could have adopted a corporate based structure, although it is recognised that a corporate entity is not as effective from a taxation perspective as a collective investment vehicle in attracting a wide range of investors with different tax profiles.

CAMAC considers that, while it may not be feasible to require the redesign  or  termination of  existing  common  enterprise  schemes, there is considerable merit in forestalling future problems through a legislative initiative to prohibit the creation of new common enterprise schemes. This legislative initiative would be equally necessary under the current legal framework or under the SLE Proposal (see Section 1.6.2), if adopted.

The problem of multi-function REs

A further problem that became apparent during the course of the review was the potential for complexity where schemes were run by multi-function REs. For instance, the task of administering an insolvent multi-function RE can be made more difficult by having to disentangle  its  own  dealings  in  its  personal  capacity  from  its dealings as operator of a number of schemes, and then determine which dealings as scheme operator go with which schemes. This process can be further complicated by disputation amongst a range of  affected parties about the nature of their rights and remedies where the RE fails.

This potentially complex untangling task would not arise if schemes could be operated only by sole-function REs.

CAMAC acknowledges that requiring all existing schemes to be operated only by a sole function RE would require a considerable number of new REs to be registered, each of which would have to hold an Australian financial services licence (AFSL).4 Also, it would be necessary to ensure that the transfer of scheme property from a multi-function RE to a new RE of the scheme was tax neutral, including being exempt from stamp duty.

While it may not be feasible to require all existing schemes to be operated by sole-function REs, CAMAC sees merit in a legislative initiative to  require each new scheme to  be  operated only  by  a sole-function RE. However, this legislative initiative would not be necessary if the SLE Proposal (see Section 1.6.2) were adopted.

4 ASIC  indicated  that  in  July  2012  there  were  487  REs,  operating  some  3950 registered schemes.

Specific matters raised in the reference

In addition to these general considerations, CAMAC also makes a series of specific recommendations on various matters arising out of the terms of reference. For instance, CAMAC recommends, for each scheme, the creation of a definitive register of the affairs of that scheme and a definitive register of the property of that scheme. Clear identification of the affairs and property of each scheme is essential to the effective day-to-day operation of a scheme, the transfer of the RE of a viable scheme, the restructuring of a financially stressed but potentially viable scheme, and the winding up of a scheme.

These recommendations are summarised in Section 1.6.3.

1.6.2) Alternative legal framework: the Separate Legal

Entity (SLE) Proposal

During the course of the review, and in response to the problems identified   under   the   current   legal   framework,   CAMAC   has developed an alternative framework for the regulation of schemes, described as the Separate Legal Entity (SLE) Proposal, which is set out in chapter 3 of this report.5

The SLE Proposal would also create a greater alignment between commercial enterprises operated through a corporate vehicle and those enterprises operated through a scheme, making it easier for the community to undertake business activity and simplifying legislative reform in the future.

In essence, under the SLE Proposal, each scheme would involve a registered MIS, which would be a separate legal entity, distinct from the RE or members of the scheme. The MIS, not the RE (as under the current legal framework), would hold legal title to all scheme property and would be the principal in all agreements entered into by the RE as operator of the scheme. The RE would act only as the agent of the MIS, not as principal, when entering into these agreements.

5 CAMAC acknowledges the role of the Alternative Proposal put forward in the submission by Freehills in the development of the SLE Proposal.

The SLE Proposal would simplify the regulatory structure for schemes, while overcoming many of the problems that have arisen under the current legal framework. It would:

• Ensure the full separation of the property, affairs and liabilities of a scheme from those of its RE, thereby avoiding liability and other overlaps that can occur under the current legal framework. Given this separation, it would be irrelevant, in terms of legal consequences,    whether   a    scheme    was    operated   by    a sole-function or by a multi-function RE, thereby avoiding any need to restrict the use of multi-function REs
• provide counterparties to agreements with direct rights against scheme property, which are not available to them under the current legal framework
• assist the process of replacing the RE of an ongoing scheme, as a TRE or new RE would not be subject to personal obligations and liabilities for  agreements entered into by  a  former RE  (who would only be an agent), as is the case under the current legal framework (where the RE acts as principal)
• simplify the external administration process, including for any VA or separate winding up procedures for schemes. The full separation of the affairs of a scheme from those of its RE would avoid the types of external administration overlap problems between a scheme and its RE that can arise under the current legal framework.

While the simplified regulatory structure under the SLE Proposal would resolve many difficulties, the key problem under common enterprise scheme arrangements of the possible intermingling of member and scheme affairs and property would remain. CAMAC therefore takes the same approach under the SLE Proposal as under the current legal framework, namely a recommendation to forestall the creation of new common enterprise schemes.

CAMAC puts forward in  chapter 3  a  number of options for the introduction of the SLE Proposal. Its preferred position is that the SLE Proposal be adopted for both common enterprise schemes and pooled  schemes,  and  that  there  be  no  exemption  for  existing schemes. CAMAC recognises that applying that regulatory framework to existing schemes would first require amendments to revenue legislation to ensure that the transfer of legal title to scheme property from an RE to an MIS is treated as a form of tax-free rollover of property, including being exempt from stamp duty.

For the SLE Proposal to  operate, it would also be necessary to amend the taxation legislation to ensure that each MIS is taxed at the investor level rather than at the corporate level in the same manner as a passive scheme is currently taxed.

Specific matters raised in the reference

In addition to these general considerations, CAMAC also makes a series of specific recommendations on various matters arising out of the terms of reference, which are summarised below. Some of these recommendations would be unnecessary if the SLE Proposal was adopted. Other recommendations deal with issues concerning the effective operation of schemes that would arise in any event, including the proposals for definitive registers of the affairs and property of each scheme.

In putting forward each recommendation in this report, CAMAC has taken into account the implications for the recommendation if the SLE Proposal were adopted.

1.6.3) Specific recommendations Proposed key legislative reforms

CAMAC recommends:

• every  RE  be  obliged  to  maintain,  for  each  scheme  that  it operates, a definitive register of the affairs of that scheme6
• every  RE  be  obliged  to  maintain,  for  each  scheme  that  it operates, a definitive register of the property of that scheme7
• the ASIC record of registration identifying the party who is the RE be definitive8
• 6 Section 4.3.4.
• 7 Section 4.4.3.
• 8 Section 4.6.4.
• in lieu of the subrogation remedy, counterparties to agreements with the RE as operator of a scheme have rights to claim directly against   the   scheme   property9     (irrelevant   under   the   SLE Proposal)
• any provision in a scheme constitution, or otherwise, that affords an RE an indemnity for any form of maladministration on its part in relation to that scheme be unenforceable.10

Changing the RE of a viable scheme

CAMAC recommends:

• an incumbent RE be obliged to provide reasonable assistance to a prospective RE in certain circumstances11
• restrictions  be  placed  on  an  RE  receiving  remuneration  in advance12
• controls  be  introduced  to  prevent  an  RE  from  becoming entrenched13
• changes  be  implemented  to  voting  requirements  for  scheme members to replace the RE of an unlisted scheme14
• the court be given an extended power to appoint a TRE15
• the  court  be  empowered  to  appoint  as  a  TRE  any  person considered suitable16
• restrictions be placed on the transfer of rights, obligations and liabilities  (s 601FS)  to  a  TRE17   (irrelevant  under  the  SLE Proposal)
• 9. Section 4.7.5.
• 10. Section 4.8.3.
• 11. Section 5.2.3.
• 12. Section 5.3.2.
• 13. Section 5.3.3.
• 14.  Section 5.4.3.
• 15. Section 5.5.3.
• 16. Section 5.6.4.
• 17. Section 5.7.4.
• the  powers  of  the  court,  upon  appointment  of  a  TRE,  be expanded18
• modifications   be   made   to   s 601FS   to   avoid   unintended consequences19 (irrelevant under the SLE Proposal)
• the duties of a TRE be modified20
• the  court be  empowered to  determine the remuneration of  a TRE21
• the  TRE  be  obliged  to  provide  reasonable  assistance  to  a prospective RE22
• the TRE be given the power to place a scheme in VA23
• the TRE be obliged to assist an external administrator.24

Restructuring a financially stressed scheme

CAMAC recommends:

• the legislation define a scheme as being insolvent where the scheme property is insufficient to meet all the claims that can be made against that property as and when those claims become due and payable25
• a scheme VA procedure be introduced, with the approach under the SLE Proposal being the preferred option26
• the ambit of a scheme moratorium include all rights or claims concerning the RE, scheme members or external parties that might   affect   the   ability   of   the   scheme   administrator   to restructure the affairs of the scheme27
• 18. Section 5.7.4.
• 19. Section 5.8.3.
• 20. Section 5.9.3.
• 21. Section 5.10.3.
• 22. Section 5.11.4.
• 23. Section 5.11.4.
• 24. Section 5.11.4.
• 25. Section 6.3.2.
• 26. Sections 6.3-6.4.
• 27. Section 6.5.3.
• voting rights on one or more scheme deeds be determined in the first instance by the scheme administrator, with the administrator or affected parties having standing to apply to the court to challenge the administrator’s determination28
• the court be given a residual power to order that a scheme be discontinued or wound up29
• only    registered    liquidators    be    eligible    to    be    scheme administrators30
• a  scheme  administrator  have  similar  functions,  powers  and liabilities to those of a corporate administrator31
• the court be empowered to determine the remuneration of the scheme administrator if affected parties cannot agree32
• the powers of the court in the VA of a scheme include the equivalent of s 447A33
• the scheme administrator or the scheme deed administrator have standing to apply to the court for the appointment of a TRE.34

Winding up a scheme

CAMAC recommends:

• scheme members be able to approve the winding up of a scheme by 75% of the votes cast, provided the votes in favour of the winding up constitute at least 25% of the total votes of scheme members35
• the court be empowered to give directions whenever it thinks it ‘appropriate’ to do so36
• 28. Section 6.6.3.
• 29. Section 6.7.3.
• 30. Section 6.8.
• 31. Section 6.8.2.
• 32. Section 6.8.3.
• 33. Section 6.9.3.
• 34. Section 6.10.3.
• 35. Section 7.2.2.
• 36. Sections 7.2.6, 7.5.4.

• there be provision for a  solvent winding up of a scheme to become an insolvent winding up37
• only a registered liquidator be permitted to conduct the winding up of an insolvent scheme38
• the court be given a power to wind up a scheme on the basis that it is insolvent, and, in consequence, the unsatisfied execution ground for winding up a scheme be repealed39
• where an insolvent scheme and its insolvent RE are being wound up without first going through a VA procedure, the liquidator of the RE administer a combined winding up, unless or until the liquidator determines otherwise, with rights of affected parties to apply to the court for a determination on this matter40
• the Corporations Act provide general procedures for the winding up of an insolvent scheme, comparable to those for the winding up of an insolvent company41
• there be a statutory order of priorities in the winding up of a scheme, providing a first priority for payments to a TRE and thereafter an order of priorities based on that provided for companies in s 556 (which subsequent order of priorities would commence with an equal ranking for payments to a scheme administrator, a scheme deed administrator or a scheme liquidator)42
• a former RE or a new RE with claims against scheme property under   its   indemnity   rights   be   treated   as   an   unsecured, non-priority, creditor of the scheme43
• there  be  voidable  transaction  provisions  applicable  in  the winding up of an insolvent scheme.44
• 37. Section 7.2.7.
• 38. Sections 7.2.7, 7.3.2, 7.4.3.
• 39. Section 7.4.1.
• 40. Section 7.4.2.
• 41. Section 7.5.3.
• 42. Section 7.5.5.
• 43. Section 7.5.5.
• 44. Section 7.5.6.

Other matters

CAMAC recommends:

• scheme members be given an extended power to call scheme meetings45
• scheme  members  be  given  statutory  limited  liability  (which should not be subject to any contrary provision in a scheme constitution).46

In response to matters raised in the terms of reference, CAMAC:

• recommends against ASIC having a power to convene a meeting of scheme members47
• recommends against an obligation to hold an annual general meeting of scheme members48
• recommends  against  additional  controls  regarding  guarantees given by REs in their personal capacity or as operator of a scheme.49

1.6.4) Other proposals

In addition to the specific matters raised in the PST letter, CAMAC was asked to:

Examine  other  proposals  to  improve  Chapter 5C  of  the Corporations Act.

Various respondents to the CAMAC discussion paper raised proposals concerning the functioning of schemes, over and above the issues dealt with in this report. Included in the submissions were references to matters considered in a series of papers in 2001-2002 on schemes by Mr M Turnbull,50  Treasury51  and the Parliamentary Joint Committee on Corporations and Financial Services.52

• 45. Section 8.2.3.
• 46. Section 8.4.3.
• 47. Section 8.2.3.
• 48. Section 8.2.3.
• 49. Section 8.3.3.
• 50. Review of the Managed Investments Act 1998 (December 2001).

These proposals, including matters considered in those papers, will be set out in a further CAMAC review, with an invitation to make submissions on the proposals.

1.7) The Advisory Committee

The Advisory Committee is constituted under the Australian Securities and Investments Commission Act 2001. Its functions include, on its own initiative or when requested by the Minister, to provide advice to the Minister about corporations and financial services law and practice.

The members of the Advisory Committee are selected by the Minister, following consultation with the States and Territories, in their personal capacity on the basis of their knowledge of, or experience in, business, the administration of companies, financial markets, financial products and financial services, law, economics or accounting.

The members of CAMAC are:

• Joanne Rees (Convenor)—Chief Executive Officer, Allygroup, Sydney
• Belinda Gibson—Deputy Chairman, Australian Securities and Investments Commission (nominee of the ASIC Chairman to May 2012)
• David Gomez—Principal, Merit Partners, Darwin
• Jane   McAloon—Group  Company   Secretary,   BHP   Billiton Limited, Melbourne
• Alice McCleary—Company Director, Adelaide
• Denise McComish—Partner, KPMG, Perth
• Marian Micalizzi—Chartered Accountant, Brisbane

51. Review of the Managed Investments Act 1998: Consultation Paper (April 2002).

52. Report on the Review of the Managed Investments Act 1998 (December 2002).

• Michael   Murray—Legal   Director,   Insolvency   Practitioners Association, Sydney
• Geoffrey Nicoll—Co-Director, National Centre for  Corporate Law and Policy Research, University of Canberra
• John     Price—Commissioner,     Australian     Securities     and Investments Commission (nominee of the ASIC Chairman from May 2012)
• Ian Ramsay—Professor of Law, University of Melbourne
• Robert Seidler AM—Consultant, Ashurst Australia, Sydney
• Greg  Vickery AM—Special Counsel,  Norton  Rose  Australia, Brisbane.

A Legal Committee has been constituted to provide expert legal analysis, assessment and advice to CAMAC in relation to such matters as are referred to it by CAMAC.

The members of the Legal Committee are selected by the Minister, following consultation with the States and Territories, in their personal capacity on the basis of their expertise in corporate law.

The members of the Legal Committee are:

• Greg Vickery AM (Convenor)—Special Counsel, Norton Rose Australia, Brisbane
• Rosey Batt—Principal, Rosey Batt and Associates, Adelaide
• Lyn Bennett—Partner, Hunt & Hunt, Darwin
• Elizabeth Boros—Barrister-at-Law, Melbourne
• Damian Egan—Partner, Murdoch Clarke, Hobart
• Jennifer Hill—Professor of Law, University of Sydney
• James Marshall—Partner, Ashurst Australia, Sydney
• David Proudman—Partner, Johnson Winter & Slattery, Adelaide
• Brian Salter— General Counsel, AMP, Sydney
• Rachel Webber—Special Counsel, Jackson McDonald, Perth. The Executive comprises:
• John Kluver—Executive Director
• Vincent Jewell—Deputy Director
• Thaumani Parrino—Office Manager.

2) Current position

This chapter summarises the various types of scheme and provides an overview of their regulation.

2.1) Economic role of schemes

Schemes are a means of pooling, or using in a common enterprise, wholesale or retail investors’ funds or other property for commercial projects. These include:

• listed real property and infrastructure schemes
• unlisted property trusts and syndicates, and mortgage funds
• cash, bonds, equity and multi-sector managed funds
• timeshare, horse-breeding or  racing,  serviced  strata  and  film schemes
• various agribusinesses, including forestry.

Some schemes are principally investment vehicles, while others are enterprises in their own right.

The managed funds industry, which includes various types of schemes, forms a substantial part of the Australian economy.53  For instance, listed schemes with a capitalisation of over $100 billion

53. As summarised by P Hanrahan in Managed Investments Law and Practice (CCH)

at ¶1-100:

Schemes range in size from multi-billion dollar property, equity, and cash trusts to small agricultural projects and syndicates. The funds management industry (retail and wholesale) is a significant part of the national economy. Total unconsolidated assets held by fund managers as at June 2011 were just under $1.855 trillion; this figure includes $1.29 trillion in superannuation funds. Public offer (retail) unit trust assets totalled $282,833m, made up of $124,890m in listed property trusts, $35,243m in listed equity trusts, $3,715m in unlisted property trusts, $97,920m in unlisted equity trusts, $4,725m in unlisted mortgage trusts (down from a high of $9,652m in December 2007) and $16,340m in other unlisted trusts. The total assets of cash management trusts was $24,236m (down from $50,732m in June 2008): see Australian Bureau of Statistics 5655.0 Managed Funds Australia June 2011.

• constitute some 8% of the total market capitalisation of securities listed on the ASX market.54 Some 80% of investment-grade commercial  real  estate,  comprising  office  buildings,  shopping centres and industrial facilities, are held in schemes. Most major infrastructure projects that involve private sector investment utilise schemes.
• A  scheme  in  the  form  of  a  trust  is  a  tax-efficient  vehicle  for collective investments, in that investors with different tax profiles (for instance, companies, pension funds, individuals) can invest together without adversely affecting their tax positions.
• The taxation regime for passive trusts in Australia means that they can be used as vehicles for a greater range of collective investments than in other jurisdictions, such as the United States and Japan. The burgeoning use of schemes in Australia can be mainly attributed to:
• the compulsory superannuation scheme generating exponentially increasing investible funds and the need to invest such funds in a variety of asset classes to manage volatility, and
• the tax environment referred to above, which permits trusts, as schemes, to be used for investment purposes without restriction on the nature of the investment.
• For tax and other purposes, an enterprise may be conducted through a combined scheme/corporate structure. Under a simple ‘stapled’ security  arrangement,55    the  company  takes  the  active  role  of
• 54. Approximately 68% of listed schemes are Real Estate Investment Trusts (REITS), with the remainder being infrastructure trusts, exchange-traded funds (ETFs) and Listed Investment Trusts.
• Listed schemes are subject to various ASX Listing Rule requirements. A court may order that the RE of a listed scheme comply with the Listing Rules: s 793C.

55. A  stapled  security  is  a  type  of  financial  instrument  that  combines  shares  in  a company with units in a scheme. These combined securities can only be purchased and sold together. The stapled structure has been intensively used in Australia by real estate investment trusts and infrastructure funds. At the end of 2011, 15 of 18 listed infrastructure funds and 28 of 49 real estate funds had stapled security structures:  ‘Why  Stapled  Securities?’  Financial  Regulation  Discussion  Paper SeriesFRDP 2012-3 (4 June 2012) (at p 1). In relation to the tax advantages of stapled structures, that paper notes (at p 3):

Because the  trust  is  a  “pass-through” entity  for  tax  purposes, income  it receives is not subject to company tax as long as paid out to unit holders. Consequently lease payments by the company reduce its taxable income and company tax paid, and increase the income of the trust on which company tax is not paid.

operating the enterprise, while the property of the enterprise is held passively through the scheme structure. Some stapled arrangements may involve multiple schemes or companies. Where more than one scheme is involved, they may have the same RE or separate REs.

2.2) Legal framework

The  current  legal  structure  for  schemes,  primarily  set  out  in Chapter 5C of the Corporations Act, was introduced by theManaged Investments  Act  1998.  The  design  of  that  legislation  took  into account the joint Australian Law Reform Commission (ALRC)/Companies and Securities Advisory Committee (CASAC)56 report Collective Investments: Other People’s Money (1993) (the ALRC/CASAC report).57

2.2.1) Legal structure of a scheme

Basic features

While there is no prescribed structure for a scheme, the various types of trust, contractual, limited partnership58 and other entities have key common features, including:

The contributions59 of members of the scheme are either ‘pooled’ (typically  in  a  trust-based  arrangement)  or  are  ‘used  in  a common  enterprise’  (typically  in  a  contract-based arrangement).60 Most schemes are either pooled schemes or common  enterprise  schemes,61   though  schemes  can  combine both   types   of   arrangement.62     Scheme   members   receive’56. In  2002,  the  name  was  changed  to  the  Corporations  and  Markets  Advisory Committee (CAMAC).

57. Collective investment vehicles were previously regulated as ‘prescribed interests’, which involved an approved deed, with responsibilities for the scheme divided between a management company and a trustee.

58. See, for instance, Re Willmott Forests Ltd (No 2) [2012] VSC 125 at [73]-[74].

59. Contributions  can  be  in  money  or  money’s  worth:  subparagraph (a)(i)  of  the definition of ‘managed investment scheme’ in s 9.

60. Subparagraph (a)(ii) of the definition of ‘managed investment scheme’ in s 9.

61. This distinction between trust-based and contract-based structures was drawn by the Companies and Securities Law Review Committee (CSLRC) in 1987, using the terms fiduciary [trust] and non-fiduciary [contract] prescribed interests: CSLRCDiscussion Paper No 6—Prescribed Interests (1987), Ch 4.

62. For instance, in Commonwealth Bank of Australia v Fernandez [2010] FCA 1487 at [86], the Federal Court referred to members in a common enterprise scheme having ‘an interest in scheme assets that are acquired with pooled money’.

contractual  or  property  ‘interests’  in  the  scheme,63    being ‘financial products’ regulated by Chapter 7 of the Corporations Act

• members do not have day-to-day control over the operation of the scheme (though under the terms of a scheme’s constitution they may have the right to be consulted or to give directions in some instances)64
• the scheme is operated by the RE,65 given that a scheme is not a separate legal entity and therefore cannot enter into legal agreements in its own right. In operating the scheme, the RE acts as  the  principal  to  agreements  with  external  parties,  except where (as in some common enterprise schemes) the scheme members themselves transact as the principals, which may involve using the RE as their agent.

Some arrangements are specifically excluded from the definition of a scheme.66

The concept of ‘scheme property’ covers:

Contributions of money or money’s worth to the scheme. If what a member contributes to a scheme is rights over property, the 63. Subparagraph (a)(i) of the definition of ‘managed investment scheme’ in s 9.

64. Subparagraph (a)(iii) of the definition of ‘managed investment scheme’ in s 9.

65. s 601FB(1). One of the key initiatives recommended in the ALRC/CASAC report, and implemented in Chapter 5C, was the introduction of a single licensed RE to operate the scheme and hold scheme property on trust for scheme members. The RE replaced the previous two-tiered trustee and management company structure for the operation of these schemes.

66. The definition of ‘managed investment scheme’ in s 9 of the Corporations Act sets out a number of specific exclusions. ASIC has pointed out that, in general, only investments that are ‘collective’ are schemes. Some examples given by ASIC of investments that are not schemes include:

• regulated superannuation funds
• approved deposit funds
• debentures issued by a body corporate
• barter schemes
• franchises

direct purchases of shares or other equities

schemes operated by an Australian bank in the ordinary course of banking business (eg term deposit).

See further www.asic.gov.au

rights in the property that the member retains do not form part of the scheme property67

• money borrowed or raised by the RE for the purposes of the scheme
• property  acquired,  directly  or  indirectly,  with,  or  with  the proceeds of, contributions or money referred to above
• income  and  property  derived,  directly  or  indirectly,  from contributions, money or property referred to above.68

Despite this apparently wide definition, whether property used in connection with a scheme is ‘scheme property’ as defined may depend on whether the scheme is one in which members pool their funds or is one in which members use their funds in a common enterprise. Common enterprise schemes are more likely than pooled schemes to have property of the members used in the enterprise.

Pooled schemes and common enterprise schemes

Schemes that hold real estate or other assets for investment purposes are generally structured as trust-based pooled schemes, largely for tax reasons. In the listed property and infrastructure sectors, interests in these pooled schemes are often stapled to shares in an operating company, with the trust part of the structure owning the real estate or infrastructure. Scheme members hold shares in the corporate part of the structure and have a beneficial interest in the whole of the property of the trust.

By contrast, common enterprise schemes are often structured as a series of bilateral or multilateral executory agreements between the member, the RE and various external parties. The ‘scheme’ in that case  is  not  a  pool  of  assets  under  management,  but  rather  the common enterprise carried out over time in accordance with those agreements. For instance, for taxation or other reasons, various agribusiness common enterprise schemes were structured so that scheme members (‘growers’) operated their agribusiness investment in their own right, entering into agreements with the RE or external parties  to   perform  the   cultivation  and   management  activities

• 67. Note 1 to the definition of ‘scheme property of a registered scheme’ in s 9.
• 68. Definition of ‘scheme property’ in s 9.

property of the scheme and the property of scheme members used in the enterprise.70

Trust and non-trust elements

There are some key trust elements that are applicable to all schemes, whether pooled or common enterprise schemes, in particular:

• the RE holds scheme property on trust for scheme members.71 It has also been held that, in consequence, an RE is a ‘trustee’ for the purposes of the court’s jurisdiction to provide judicial advice and direction to an RE under relevant state trustee legislation72
• the  RE’s  rights  to  recover  from  scheme  property  for  its remuneration and costs in operating the scheme are derived from the constitution of the scheme and based on trust law indemnity principles.73
• On the other hand, there are areas where the legislative structure for schemes differs from the general law of trusts. For instance, the Corporations Act sets out a regime for the transfer of rights, obligations and liabilities where the RE of a scheme changes,74 independently of any trust law principles applicable when there is a’70. For  instance, in BOSI Security Services Limited v Australia and New Zealand Banking Group Limited & Ors [2011] VSC 255, the Court held, on the facts, that the members of the common enterprise scheme had only a contractual, not a proprietary, interest in certain land used in the operation of that scheme. Those contractual rights were insufficient to establish their entitlement to share in the proceeds of the sale of that land. In Re Willmott Forests Ltd (No 2) [2012] VSC 125 at  [59] ff,  the  Court  gave  consideration  to  whether  certain  freehold and leases should be taken to have been ‘contributed’ to the schemes and therefore would constitute scheme property.
• 71. s 601FC(2). There may be a difference of view whether this section only applies to scheme property in fact held by the RE (in which case that property is held on trust) or extends to any scheme property, whether or not in fact held by the RE (in which case all scheme property is deemed to be held by the RE and held on trust).

72. Mirvac and Mirvac Funds [1999] NSWSC 457 at [41]:

[S]ection 601FC(2) states that the responsible entity holds scheme property (in  this  case  the  property  of  the  respective  trusts)  on  trust  for  scheme members (in this case the respective unitholders). There are therefore express trusts here and each responsible entity clearly falls within the definition of the ‘trustee’ for the purposes of section 63 [of the Trustee Act 1925 (NSW)]. I see nothing in Chapter 5C of the Corporations Law to suggest that it is intended to exclude the Court’s jurisdiction to provide judicial advice to a responsible entity under general trustee legislation.

See also Re Elders Forestry Management Ltd [2012] VSC 287 at [6]-[7].

• 73. s 601GA(2).
• 74. ss 601FS, 601FT.

change of trustee.75  Also, under general trust law, there is no such thing as the formal winding up of a trust. The trust simply comes to an  end  in  certain  circumstances  and  the  property  is  distributed among the beneficiaries.76 By contrast, the legislation regulating schemes contains various provisions for their winding up.77

2.2.2) Regulation of schemes

The various Parts of Chapter 5C of the Corporations Act, based to a large extent on recommendations in the ALRC/CASAC report, deal with the regulation of a scheme and its RE.

Registration of a scheme

All schemes must be registered except for ‘private’ schemes and ‘wholesale’ schemes78 (the discussion in this paper will deal with registered schemes except where otherwise indicated). The scheme must also have a scheme constitution,79 a compliance plan80 and, in some instances, a compliance committee.81 There is provision for the winding up of unregistered schemes.82

Scheme constitution

Each scheme must have a constitution, which must make adequate provision for the consideration to be paid to acquire an interest in the scheme, the powers of the RE to deal with scheme property, the method of dealing with complaints by scheme members, and the winding  up  of  the  scheme.83   Various  other  rights  or  powers, including the right of the RE to be paid for operating the scheme,

• 75. Some of the legal issues that arise at general law when there is a change of trustee are discussed in V Stathakis & S Harrison, ‘Practical consequences of a change of trustee on receivers and secured creditors’ (2011) 11(8) Insolvency Law Bulletin.
• 76. See, for instance, Westfield QLD No. 1 Pty Limited v Lend Lease Real Estate
• Investments Limited [2008] NSWSC 516.
• 77. Part 5C.9.
• 78. s 601ED. The process of registration with ASIC is set out in Part 5C.1.
• 79. Part 5C.3.
• 80. Part 5C.4.  The  Parliamentary  Joint  Committee  on  Corporations  and  Financial Services report Inquiry into the collapse of Trio Capital (May 2012) rec 7 makes various recommendations concerning the compliance plan.
• 81. Part 5C.5.  The  Parliamentary  Joint  Committee  on  Corporations  and  Financial Services report Inquiry into the collapse of Trio Capital (May 2012) rec 7 makes various recommendations concerning the compliance committee.
• 82. s 601EE.
• 83. s 601GA(1).

can only be exercised if included in the scheme constitution.84 The RE  can  unilaterally  amend  the  scheme  constitution  if  the  RE ‘reasonably considers the change will not adversely affect members’ rights’.85   Scheme  members  can  also  amend  the  constitution  by special resolution.86

Investing in a scheme

The process of offering interests in a scheme is regulated by various disclosure requirements, including that potential retail investors must be   given   a   product   disclosure   statement,   and   other   related documents, in advance of any investment.87 ASIC has also provided disclosure   guidance   for   various   types   of   schemes,   including mortgage schemes, property schemes, infrastructure funds, hedge funds and agribusiness schemes.88

Role of the RE

A scheme cannot operate without an RE, which must be a public company that holds an AFSL permitting it to operate the scheme.89

ASIC imposes requirements on REs through this licensing system, including that they have available adequate financial resources to provide the financial services covered by their licence.90  A scheme 84. s 601GA(2)-(4). 85. s 601GC(1)(b). The relevant principles concerning the exercise of this power by the RE are set out in ING Funds Management Ltd v ANZ Nominees Ltd [2009] NSWSC 404 at [92]-[105], and further summarised in Re Elders Forestry Management Ltd

[2012] VSC 287 at [53]-[58].

• 86. s 601GC(1)(a).  See  Re  Elders  Forestry  Management  Ltd  [2012]  VSC  287  at [72]-[74].
• 87. An interest in a scheme is a ‘financial product’ for the purposes of Chapter 7 of the Corporations  Act  (Part 7.1  Div 3).  The  disclosure  requirements  for  financial products are set out in Part 7.9. They contain detailed requirements for disclosure to a ‘retail client’ (as defined in ss 761G, 761GA).
• 88. ASIC  Regulatory  Guide  45  (mortgage  schemes),  ASIC  Regulatory  Guide  46 (unlisted property schemes), ASIC Regulatory Guide 231 (infrastructure entities), ASIC Regulatory Guide 232 (agribusiness schemes) and ASIC Consultation Paper 174 (hedge funds).
• 89. s 601FA. The general obligations of licensees are set out in s 912A.
• 90. See   ASIC   Regulatory   Guide   166   Licensing:   Financial   requirements,   Pro Forma 209   Australian   financial   services   licence   conditions   (PF 209)   and CO 11/1140  Financial  requirements  for  responsible  entities.  Revised  minimum financial standards will apply from November 2012. The aim is to ensure that REs have adequate resources to meet operating costs and there is an appropriate alignment with the interests of scheme members. may be deregistered by ASIC if it does not have an RE that meets these requirements.91

The legislation sets out responsibilities and powers of an RE in operating the scheme,92 the processes for changing the RE93 and the consequences of any change of RE.94

The RE of a scheme must hold scheme property (as defined) separately from the personal assets of the RE and the property of any other scheme.95  The RE must also keep financial records that correctly explain transactions and the financial position and performance of the scheme, for the purpose of preparing true and fair financial statements.96

An RE, its officers and its employees are subject to various statutory duties in operating a scheme.97 Directors of the RE may also be personally liable in some stipulated instances in operating the scheme.98 Members of a scheme may have civil remedies against the RE and its directors where the scheme has been mismanaged.99 An RE may also seek remedies on behalf of scheme members in various circumstances, including where there has been a breach of trust by a former  RE  or  its  officers.100   In  addition,  as  an  RE  is  a  public

• 91. s 601PB(1)(a).
• 92. Part 5C.2 Div 1.
• 93. Part 5C.2 Div 2.
• 94. Part 5C.2 Div 3.
• 95. s 601FC(1)(i).
• The compliance plan of a scheme must set out the arrangements for ensuring   that   the   requirement   for   separation   of   assets   is   complied   with (s 601HA(1)(a)).
• 96. s 286.
• 97. ss 601FB–601FE. The duties of officers of the RE, set out in s 601FD, include to take all reasonable steps to ensure that the RE complies with the Corporations Act, any conditions imposed on the RE in its AFSL, the scheme’s constitution and the scheme’s compliance plan.
• 98. s 197.
• 99. See, for instance, ss 601MA, 1324, 1325.
• 100. See, for instance, ss 1317J(2) and 1317H. An RE may also act under general law principles to protect the interests of scheme members, and in some circumstances may be under a duty to do so. For instance, in Young v Murphy (1994) 12 ACLC

558 at 562, the Court observed that:

The standing of a trustee to take proceedings to have a breach of trust redressed against a trustee or former trustee or a stranger who has become liable to redress a breach of trust is well recognised. Not only may a trustee take such proceedings, but he runs the risk of himself committing a breach of trust if he fails to do so.

See also Permanent Trustee Australia Ltd v Perpetual Trustee Co Ltd (1994) 15 ACSR 722. company, its directors have the same duties as the directors of any other company,101  including a duty to prevent the RE from trading while insolvent.102

Any right of an RE to be paid remuneration out of the property of a scheme  must  be  specified  in  the  scheme  constitution  and  be available only in relation to the proper performance by the RE of its duties.103

The annual reporting requirements applicable to public and other companies also apply to schemes.104 Likewise, the requirements for maintaining financial records applicable to companies apply to schemes.105 However, there is no requirement that an annual general meeting of scheme members be held.

The RE of a listed scheme is also subject to the ASX Corporate Governance Council Corporate Governance Principles and Recommendations.

Replacement of the RE

There are procedures for replacing an RE, including the appointment of a temporary responsible entity (TRE) as an interim measure while a new RE is sought.106  A common goal of these procedures is to avoid a scheme being without an RE for any period of time, given that the role of the RE is to operate the scheme.107

Where an RE is replaced, the rights, obligations and liabilities of the outgoing RE under agreements it has entered into (or has inherited from any prior RE) as operator of the scheme are transferred to the incoming RE  (including any  TRE)  through  a  statutory  novation 101. The general duties are set out in Part 2D.1, in particular ss 180–184.

102. s 588G. Directors who fail to prevent the RE from incurring debts while insolvent are personally liable for any loss or damage suffered by creditors (s 588J), with criminal liability where this failure was dishonest (s 588G(3)).

• 103. s 601GA(2).
• 104. Part 2M.3.
• 105. Part 2M.2.
• 106. Part 5C.2 Div 2.
• 107. s 601FB(1).

process.108  The ostensible purpose of this transfer is to ensure that the  rights of  counterparties are  not  affected where the  RE  of  a scheme changes. Except when an RE is acting as agent for scheme members (who then become the principals), the RE transacts as the principal in operating a scheme. As principal, the RE personally takes on the rights, obligations and liabilities under each agreement it enters into as operator of the scheme, unless the counterparty agrees otherwise. These personal rights, obligations and liabilities of an RE are transferred to a TRE or new RE through the novation process.

Position of scheme members

By definition, members of a scheme have no day-to-day control over the operation of the scheme.109  However, meetings of scheme members may be called for various purposes, including to replace the RE,110 to alter the scheme constitution,111 to approve various related party financial benefits,112 or to direct that the scheme be wound up.113 There are statutory procedures for calling and holding meetings, as well as voting on resolutions and gaining access to the minutes of members’ meetings.114

Scheme members do not have an automatic right to inspect scheme accounts or other documents, unless this right is provided for in the scheme constitution or some other scheme document. However, the court may order that a scheme member have access to books of the scheme if the court is satisfied that the applicant is acting in good’108. ss 601FS,  601FT.  What  is  involved  in  the  concept  of  rights,  obligations  and liabilities,  and  what  agreements  might  be  covered  under  this  provision,  are discussed in Investa Properties Ltd [2001] NSWSC 1089 at [11], Syncap Management (Rural) Australia Ltd v Lyford [2004] FCA 1352 at [41] ff, Australian Olive  Holdings  Pty  Ltd  v  Huntley  Management  Ltd  [2009]  FCA  1479  at [114]-[120], Huntley Management Ltd v Timbercorp Securities Ltd [2010] FCA 576 at  [43]-[50],  [65]-[66]  and  Primary  RE  Limited  v  Great  Southern  Property Holdings Limited (recs & mgrs apptd) (in liq) & Ors[2011] VSC 242 at [166] ff.

• 109. Subparagraph (a)(iii) of the definition of ‘managed investment scheme’ in s 9.
• 110. s 601FM.
• 111. s 601GC(1)(a).
• 112. The related party provisions in Chapter 2E of the Corporations Act are applied, with modifications, to schemes by s 601LA. See Part 5C.7.
• 113. s 601NB.
• 114. Part 2G.4. In general, the RE and its associates are not entitled to vote their interest on a resolution if they have an interest in the resolution or matter other than as a scheme member: s 253E. There is a question as to the ambit of this provision.

faith and that the inspection will be made for a proper purpose.115

The court may also make ancillary orders, including restricting the use that a person who inspects the books may make of the information obtained.116

There is a statutory procedure for members seeking to withdraw their investment in a scheme (including the freezing of withdrawal rights for non-liquid schemes).117 There are also provisions dealing with certain contraventions by promoters or the RE.118

Restructuring

A  reorganization  or  change  of  control  of  a  company  may  be achieved through a scheme of arrangement under Part 5.1 of the Corporations  Act.  These  provisions  do  not  apply  to  schemes. Instead, changes of control or other reorganizations of schemes have tended to proceed through ‘trust scheme’ arrangements. There is no equivalent in these arrangements of the judicial and other procedural protections applicable to corporate schemes of arrangement under Part 5.1, though the proponents of a trust scheme may choose to seek judicial direction or advice on its implementation.

The CAMAC report Members’ schemes of arrangement (2009) recommended the extension of the Part 5.1 scheme of arrangement provisions to listed and unlisted schemes.119

The takeover and compulsory acquisition provisions in Chapters 6,

6A and 6B of the Corporations Act apply to the acquisition of interests in listed schemes.120 Attempts to entrench an RE of a listed trust may amount to ‘unacceptable circumstances’ for the purposes of Chapter 6.121

• 115. s 247A.
• 116. s 247B.
• 117. Part 5C.6.
• 118. Part 5C.8.
• 119. Sections 7.2 and 7.6.2.
• 120. s 604. See also ASIC Regulatory Guide 74 Acquisitions approved by members and Takeovers Panel Guidance Note 15: Trust Scheme Mergers.
• 121. Re AMP Shopping Centre Trust (No 1) (2003) 45 ACSR 496 at [66].

2.3 The RE transacting as operator of a scheme

2.3.1 Overview

A scheme is not a separate legal entity and therefore cannot enter into agreements in its own right. In a pooled scheme, the RE acts as principal in operating the scheme and will be personally liable under each agreement it enters into in that capacity, except where the counterparty agrees otherwise. Scheme members will not be parties to those agreements. Likewise, in common enterprise schemes, the RE will transact as principal in operating the scheme (and be personally liable, unless the counterparty agrees otherwise), except where the members themselves enter into agreements as principals, using the RE as their agent for this purpose. To assist the RE in acting as agent for scheme members, it has been the practice with some common enterprise schemes for the application form signed by any person seeking to become a scheme member to contain a grant of a power of attorney to the RE.122

A counterparty to an agreement where the RE acts as principal may agree to limit its rights of recovery against the RE to the amount for which the RE can be indemnified from the property of the scheme (limited  recourse  rights),  thereby  excluding  rights  of  recovery against the personal assets of the RE. It is common for limited recourse rights clauses to be incorporated in agreements drawn up by an RE as operator of a scheme.123

2.3.2 Indemnity rights of the RE

An RE, as operator of a scheme, and as the principal to agreements into which it enters in that capacity, has rights to be indemnified out of the property of that scheme, by application of trust law principles, for:

• its costs and remuneration in operating the scheme 122. See, for instance, Re Elders Forestry Management Ltd [2012] VSC 287 at [15]. 123. In some schemes, the RE may contract out its management role to another party, with agreements involving outside parties also containing limited recourse rights to protect the manager against personal liability.

• the obligations or liabilities that it personally incurs under those agreements. 124 It has long been recognised that a trustee can resort to the property of the trust to  discharge a  liability that it  has properly incurred as trustee of that trust.125 A trustee can:
• apply the trust property directly in discharging the liability,126 or
• itself  discharge  the  liability  and  then  exercise  a  right  to  be reimbursed from the property of the trust for the costs it has incurred.127

These trust law principles are summarised in one case as follows:

The trustee is entitled to be indemnified out of the trust assets in respect of liabilities which it incurs in the course of administering the trust, but is personally liable to creditors in respect of such liabilities unless it has contracted with a creditor  to  limit  the  creditor’s recourse against  it.  If  the trustee has discharged the liability out of his individual property, he is entitled to reimbursement from the trust fund. If he has not discharged it, he is entitled to be exonerated from the trust fund for the liabilities properly incurred in the administration of the trust. He cannot be compelled to surrender the  trust  property  to  the  beneficiaries until  his claim has been satisfied.128

These indemnification rights of a trustee are available to an RE of a scheme only if:

•   they are specified in the constitution of the scheme, and

• 124. The applicable trust law principles are summarised in JA Pty Ltd v Jonco Holdings
• Pty Ltd [2000] NSWSC 147 at [50].
• 125. Worrall v Harford (1802) 8 Ves Jun 4.
• 126. In trust law this is described as the ‘right of exoneration’.
• 127. In  trust  law  this  is  known  as  the  ‘right  of  recoupment’  or  the  ‘right  of reimbursement’.
• 128. Stacks  Managed  Investments  Ltd  [2005]  NSWSC  753  at  [43].  See  also  CPT Custodian Pty Ltd v Commissioner of State Revenue [2005] HCA 53, which held that the trust fund available to the beneficiaries of a trust could not be identified and quantified until the trustee’s superior indemnity rights concerning those funds had been quantified and satisfied.

•   the RE has properly performed its duties.129

The RE will not have an indemnity claim against the property of the scheme where the RE has acted beyond power (including outside the terms of the scheme constitution) or otherwise improperly.130  This statutory limitation on an RE’s right of indemnity is reinforced by the  general  trust  law  limitation  whereby  a  trustee’s  right  of indemnity is subject to, and diminished by, any lawful claim by beneficiaries against the trustee in connection with breaches by the trustee, for instance misappropriation, or neglect, of scheme property.131

Any attempt in a scheme constitution or otherwise to deny a lawful indemnity right of the RE, otherwise given in the constitution, because the RE has gone into external administration, is void.132

2.3.3    Rights of counterparties

A scheme is not a legal entity133 and therefore cannot enter into agreements in its own right. Instead, the RE, as scheme operator, transacts as principal to all agreements into which it enters in that capacity, except where it specifically acts as agent for another party.134

• 129. s 601GA(2).
• 130. s 601GA(2).  This  is  based  on  trust  law  principles.  See,  for  instance,  General Credits Ltd v Tawilla Pty Ltd [1984] 1 Qd R 388 at 389-390, RWG Management Ltd v Commissioner for Corporate Affairs [1985] VR 385. See also RI Barrett, ‘Insolvency of registered managed investment schemes’, Paper delivered at the Conference of the Banking and Financial Services Law Association, Queenstown, July 2008, pp 5-7.
• 131. This ‘clear accounts’ rule and its consequences are discussed by N D’Angelo, ‘The unsecured creditor’s perilous path to a trust’s assets: Is a safer, more direct US-style route available?’ (2010) 84 Australian Law Journal 833 at 841 ff.
• 132. s 601FH.  This  adopts  a  recommendation  of  the  ALRC/CASAC  report  (vol 1, para 8.8), endorsing a recommendation of the ALRC’s General Insolvency Inquiry (ALRC 45)  (the  Harmer  Report)  vol 1,  para 251;  vol 2,  s T3  (see  also  vol 1, para 271  of  the  Harmer  Report  for  the  application  of  this  provision  to  the administrator and deed administrator).
• 133. Capelli v Shepard [2010] VSCA 2 at [92].
• 134. Where an RE enters into an agreement, consideration may need to be given to the terms of the agreement and other surrounding circumstances to determine whether the RE has acted as operator of a particular scheme. This is based on trust law principles, as set out in Re Interwest Hotels Pty Ltd (in liq) (1993) 12 ACSR 78.

Where RE provides security

A counterparty can enforce any security lawfully granted to it by an RE when acting, as principal or agent, in any capacity. For instance, the RE may provide particular scheme property as security for an external  financier  that  is  funding  the  scheme  under  a  limited recourse rights arrangement.

Where RE acts as agent

Where an RE has entered into agreements solely as the agent for members of a scheme (as in some common enterprise schemes), counterparties will have remedies against those members only, provided that the RE has acted within its agency powers. These agreements may include provisions that terminate or otherwise affect rights on the happening of certain events, such as the scheme being wound up.135  If an RE has acted ostensibly as an agent for scheme members, but beyond its agency powers, counterparties may have remedies against the RE only (applying relevant agency law principles).

Where RE acts as principal

Where the RE enters into an agreement as principal in operating a particular scheme, then, by application of general law principles, and subject to the counterparty having agreed to limited recourse rights only, the counterparty will have:

• a  direct  right  against  the  personal  assets  of  the  RE  (which include funds already received by the RE through the earlier exercise of its indemnity rights against the property of that scheme, or any other scheme that it operates), and
• an indirect subrogation remedy in relation to any unexercised indemnity  rights  of  the  RE  against  the  property  of  that scheme.136  Counterparties cannot make a direct claim on the 135. See, for instance, Re Elders Forestry Management Ltd [2012] VSC 287 at [13]. 136. This is based on trust law principles, as summarised by the High Court in Octavo Investments Pty Ltd v Knight [1979] HCA 61 at [13] ff. property of that scheme, which is held in trust by the RE for scheme members.137

A counterparty with limited recourse rights has no rights against the personal assets of the RE. Limited recourse rights are similar to the indirect subrogation remedy in that both are limited to the lawful indemnity claims that the RE can make against available scheme property.

As previously indicated (Section 2.3.2), an RE may lose its right of indemnity in various circumstances. In consequence, the improper conduct of the RE may affect the capacity of counterparties with limited recourse rights to obtain recovery from scheme property, or for other counterparties to exercise their subrogation remedies in relation to scheme property.

One judge, speaking extra-judicially, has summed up the position in the context of trusts:

The trustee’s [indemnity] rights … are fragile things. And their  fragility  may  rebound  upon  creditors.  The beneficiaries’ interest in trust property will not be postponed to a beneficial interest of the trustee unless the trustee’s interest exists. If the trustee’s interest does not exist, the trust property is shielded from the claims of the trustee’s creditors.138

Counterparties may also be disentitled from claiming against scheme property under the subrogation remedy by their own behaviour. One commentator139 has summed up the position as follows:

Some in commerce, including lawyers, refer to a ‘right’ of subrogation. In fact, it is not a right at all, or even a cause of action,  but  rather  an  equitable  remedy  acting  on  the 137. s 601FC(2). In Octavo Investments Pty Ltd v Knight [1979] HCA 61 at [30], the High Court indicated that trust property itself cannot be taken in execution by the creditors of the trustee.

138. RI Barrett (now a judge of the NSW Court of Appeal), ‘Insolvency of registered managed investment schemes’, Paper delivered at the Conference of the Banking and Financial Services Law Association, Queenstown, July 2008, p 5.

139. N D’Angelo, ‘The unsecured creditor’s perilous path to a trust’s assets: Is a safer, more direct US-style route available?’ (2010) 84 Australian Law Journal 833 at 843. conscience of the trustee.140 Being a creature of equity, it is discretionary and subject to all the usual rules for engaging equitable remedies. This means that an enforcing unsecured trust creditor may be denied subrogation by application of disentitling equitable defences such as unconscionability, laches, acquiescence, waiver, estoppel, clean hands, or who comes to equity must do equity. Potentially, parties with something to gain (for example, the beneficiaries or even competing trust creditors) could manoeuvre to deny an unsecured  trust  creditor  its  claim  to  subrogation  and, therefore access to  the  trust  assets, by  seeking to demonstrate  disentitling  behaviour  on   the  part  of   the creditor, leaving it to its rights against the trustee personally and a share out of the trustee’s personal assets (if any) in liquidation.

Where an RE goes into external administration, uncertainty remains about who can claim against any property recovered by its external administrator through exercise of any previously unexercised indemnity rights of the RE. One line of trust law authority is that, in the insolvency of a trustee, funds recovered under the trustee’s right of indemnity out of property of any trust should be available for all creditors of that trustee.141  Another line of authority is that, in the first  instance,  those  funds  should  be  available  only  for  those creditors who have dealt with the trustee as trustee of that particular trust.142

2.3.4 Position of scheme members

Scheme constitutions usually exempt scheme members from any obligation to indemnify the RE for costs and liabilities that it has 140. Lerinda Pty Ltd v Laertes Investments Pty Ltd (2009) 74 ACSR 65; [2009] QSC 251; see also Bofinger v Kingsway Group Ltd (2009) 239 CLR 269 at [6].

141. Re Enhill Pty Ltd [1983] 1 VR 561.

142. Re Suco Gold Pty Ltd (1983) 33 SASR 99. The Harmer Report (vol 1, para 262)

summarised the position reflected in Re Suco Gold as follows:

Equitable principles require that a [trustee] company’s own property and trust property, or property of two or more trusts, and the respective sets of creditors be kept separate and that each group of creditors be entitled to a distribution of the funds derived from the property in which they could claim an interest.

See also Re ADM Franchise Pty Ltd (1983) 7 ACLR 987, which is consistent with the Suco Gold approach. Various commentators also support the Suco Gold approach:   R Baxt,   ‘Trusts   and   Creditors   Rights’   (1982)   11   ATR   3,   9; BH McPherson, ‘The Insolvent Trading Trust’ in PD Finn (ed), Essays in Equity (Law Book Co, Sydney, 1985), 142; and HAJ Ford, ‘Trading Trusts and Creditors’ Rights’ (1981) 13 Melbourne University Law Review 1. incurred in operating the scheme. If not, the RE may have a right of indemnity against those members for those amounts.143

2.4 External controls

The RE of a listed scheme is under a continuing obligation to notify the market of any material price-sensitive information concerning the scheme that is known to the RE but is not generally available.144

ASIC has a range of powers under Chapter 5C, including to make various exemption and modification orders,145  to undertake surveillance checks of REs,146  to require modification of a compliance plan,147  and to apply to the court to have a TRE appointed148 or to have a scheme wound up.149

ASIC also has a range of investigative and other powers, including those pursuant to the licensing regime for the RE150  and its general information-gathering powers under the ASIC Act.151

ASIC provides regulatory guidance on various aspects of the operation of schemes.152 ASIC has also commenced a series of reviews across various schemes sectors, to examine whether the compliance behaviour of REs meets both their legal obligations and good industry practice.153

• 143. Fitzwood Pty Ltd v Unique Goal Pty Ltd [2002] FCAFC 285 at [135]-[138]. See further the CASAC report Liability of Members of Managed Investment Schemes (March 2000),    available    under    ‘Publications’    on    the    CAMAC    websitewww.camac.gov.au
• 144. Chapter 6CA Continuous disclosure. Specific reference to the obligation of the RE is found in s 674(3).
• 145. Part 5C.11.
• 146. s 601FF.
• 147. s 601HE(2).
• 148. s 601FN.
• 149. s 601ND. See also s 601NF.
• 150. See, for instance, ss 912C-912E.
• 151. Part 3 of the ASIC Act.
• 152. See, for instance, ASIC Regulatory Guides 132-136 and the best practice unit pricing guide (RG 94).
• 153. See ASIC Media Release 12-168MR (July 2012), which outlines the results of an ASIC review of the unlisted property scheme sector.

2.5 Voluntary administration of a scheme

The ALRC/CASAC report recommended that a voluntary administration (VA) framework for schemes be introduced, similar to that for companies under Part 5.3A.154  A scheme VA procedure may provide an opportunity to restructure a financially stressed, but potentially viable, scheme, or otherwise provide a better return for scheme creditors than if the scheme was immediately wound up.

Those recommendations were not adopted. Neither the second reading speech for the Managed Investments Bill 1997 (Cth), which provided for the introduction of Chapter 5C into the Corporations Act, nor the Explanatory Memorandum to that Bill, explained this omission.

2.6 Winding up a scheme

The procedures for the winding up of a scheme that were introduced in 1998 primarily envisage the winding up of solvent schemes, with the RE conducting the winding up, though the court has a power to order a winding up on the ‘just and equitable’ ground and to ‘appoint a person to take responsibility’ for the liquidation of a scheme if the court ‘thinks it necessary to do so’.155

Historically, little consideration was given to the winding up procedures for insolvent schemes, particularly when they were more in the nature of pooled schemes involving securities or other investment portfolios, with no significant creditor involvement. Pooled schemes of this nature were more likely to lose value and be wound up for that reason, rather than be unable to meet the claims of creditors as they became due and payable.

However, the approach in Australia over more recent years, driven in part by taxation considerations and the growth of superannuation funds under management, has been to expand the role of schemes, with some of them becoming significant commercial enterprises in their own right, with external financing or other creditors. There is no detailed procedure in the current law for the winding up of these types of schemes if they become insolvent.

154       vol 1 at Section 8.13 and vol 2 Pt 5.3B.

155       Part 5C.9.

3 MIS as a separate legal entity

This chapter sets out the elements of an alternative approach to the legal framework for schemes, based on making the MIS (as a separate  legal  entity),  rather  than  the  RE,  the  principal  to agreements forming part of the scheme and the holder of legal title to scheme property. This approach would simplify the regulatory structure for schemes and overcome some key problems that have arisen in practice.

3.1 Difficulties under the current legal framework

Currently, the RE, as operator of a scheme:

•   transacts as principal in agreements that form part of the scheme.

In  some  cases,  however,  the  RE  may  transact  as  agent  for scheme members

•    holds legal title to all scheme property. That property is held on trust for scheme members.

These arrangements can create legal complexities and problems in practice, as set out below.

Personal liability of the RE

The task of finding a suitable TRE or a new RE for a particular scheme can be made more difficult by the current legislative regime under which the obligations and liabilities that an RE has incurred as principal in operating a scheme (as well as the rights that it has acquired) automatically transfer to any TRE or replacement RE.156

This regime, while intended to protect counterparties to these agreements, whose rights should not be affected by a change of RE, can discourage suitable entities from agreeing to undertake the role of TRE or new RE.

156       s 601FS.

An RE can avoid incurring personal obligations and liabilities when entering into these agreements by the counterparty agreeing to have only limited recourse rights. However, an intending TRE or new RE, as part of its due diligence, would still need to determine, for all agreements that were entered into by a former RE as operator of the scheme, and that are still on foot, which of them did/did not give the counterparty only limited recourse rights.

No direct claim against scheme property

A counterparty to an agreement with an RE, with or without limited recourse rights, cannot claim directly against the property of the scheme. The counterparty has a subrogation remedy in relation to the indemnity rights of the RE over scheme property. However, those indemnity rights, and therefore the subrogation remedy, may be lost by the improper conduct of the RE.157

External administration

Where a scheme or its RE suffers financial stress, the process of attempting their rehabilitation or orderly winding up can be complicated by the entangling of the affairs of the scheme and of the RE.158

The CAMAC discussion paper highlighted some of these structural difficulties with schemes and included various reform proposals for further consideration. These proposals were put forward in the context of the current legal framework for schemes and prior to the development of the Separate Legal Entity Proposal (SLE Proposal).

3.2 Outline of the SLE Proposal

CAMAC  has  developed  the  SLE  Proposal  as  an  alternative  to reforms that would have sought to improve, but nevertheless maintain, the current legal framework for schemes.159 CAMAC considers that the SLE Proposal would resolve many of the problems that have been encountered with schemes under that framework.

• 157       See Section 2.3.2 of this report.
• 158       See Section 6.3 of this report.
• 159       CAMAC acknowledges the role of the Alternative Proposal put forward in the submission by Freehills in the development of the SLE Proposal.

Under the SLE Proposal, each scheme, whether a pooled or common enterprise scheme, would involve a registered MIS, to be given the status of a separate legal entity, distinct from its RE or the scheme members, for limited purposes:

• to own scheme property. The MIS would hold legal title to all scheme property. In doing so, the MIS would not be acting as a trustee for scheme members (who instead would hold residual rights to scheme property, similar to shareholders, in the event of the scheme being wound up). This would represent a change from the current legal position, whereby the RE holds legal title to scheme property, on trust for scheme members. This change would ensure that scheme property is fully separate from the personal assets of the RE or the property of any other scheme operated by the RE160
• to enter into agreements. In operating a scheme, the RE would enter into agreements as agent of the MIS, which would be the principal. This would represent a change from the current legal position whereby the RE, in operating a scheme, enters into agreements as principal161
• to sue or be sued. The MIS, acting through the RE as its agent, could sue or be sued in its own right. Counterparties to agreements  entered  into  by  the  MIS  through  the  disclosed agency of the RE would have direct rights against all scheme property, legal title to which is held by the MIS.162  This would represent a change from the current legal position whereby counterparties have only an indirect subrogation remedy against scheme property.163 The MIS, acting through the RE as its agent, could take action in its own name to enforce agreements into which it entered as principal.

• 160     Vesting legal title to scheme property in the MIS would not interfere with any obligation that ASIC may impose concerning the use of a custodian in some circumstances:   ASIC   Regulatory   Guide   133   Managed   investments:   Scheme property arrangements.
• 161       The only exception is where, under the terms of some common enterprise schemes, the RE acts as agent for scheme members, who are the principals to these agreements.
• 162       The SLE Proposal would not negate the use of a custodian of scheme property, if appropriate.
• 163       See Section 2.3.3.

An MIS would not have any directors, officers, members or employees.  It  would  itself  have  no  directing  mind  or  will,  or capacity to act in its own right. It would act exclusively through the RE, as its disclosed agent.

The RE would still be required to hold an AFSL. It would have two roles:

• manager of the scheme for the purpose of operating it on a day-to-day basis
• agent  for  the  MIS  for  the  purpose  of  binding  the  MIS,  as principal, in agreements entered into by the RE in its managerial role.

This separation of the affairs of a scheme from the personal affairs of its RE through this agency arrangement would simplify the operation of schemes in various ways:

• sole-function or multi-function REs. Under the SLE Proposal, it would be irrelevant from a regulatory perspective whether a scheme was operated by a sole-function or by a multi-function RE. The RE would only act as agent in operating a scheme, and in that capacity would not incur rights, obligations and liabilities on its own behalf. Accordingly, there would be no need to identify  the  various  rights,  obligations  and  liabilities  that  a multi-function RE  may  incur  and  determine  which  apply  to which   schemes.   This   separation   process   is   essential   for multi-function REs under the current legal framework in those instances where the RE incurs personal liability when operating a number of schemes
• solvency  of  the  RE.  Under  the  SLE  Proposal,  the  state  of solvency of the RE would be irrelevant to the solvency of a scheme (though it would be necessary to replace an insolvent RE of a solvent scheme). The rights of recovery of counterparties against the scheme would be limited to scheme property, held by the MIS. The external administration of a scheme would be independent of any external administration of its RE (though in some instances, from a practical point of view, they could be run in tandem164). By contrast, under the current legal framework, counterparties to agreements with the RE as operator of the scheme can recover against the personal assets of the RE, except where they have only limited recourse rights. This financial involvement  of  the  RE  can  complicate  the  external administration process of a scheme.

The  SLE  Proposal  would  not  interfere with  arrangements under some  common enterprise schemes whereby the  RE  is  given  the power to act as agent for the scheme members. In those cases, counterparties would have remedies directly against the members, as principals.

Under the SLE Proposal, scheme members would retain all existing procedural  rights,   such   as   to   have   the   scheme  administered according to the scheme constitution and any other rights conferred by scheme documents. However, unlike the current legal position, they would not hold any beneficial interest in the scheme property. Rather, they would have residual rights to any remaining scheme property on the winding up of the scheme, comparable to residual shareholder rights.

3.3 Other details of the SLE Proposal

The SLE Proposal would involve various other elements:

•    disclosed  principal:  an  RE  could  enter  into  an  agreement binding the MIS of a scheme operated by the RE only if the RE identifies that it is acting as agent for that MIS. Where the RE does not make this disclosure, it would be personally liable as a principal under the agreement, with no indemnity rights against scheme property for this agreement, and with the counterparty having remedies only against the RE 164. An example would be an insolvent scheme operated by a sole-function RE. The insolvency of the scheme may also lead to the insolvency of the RE, given that the only function of a sole-function RE is to operate the one scheme. The affairs of the RE and of the scheme may therefore sufficiently coincide that the practical course would be to run the external administration processes in tandem, which may include by the same external administrator.

•    indoor management rule: to protect counterparties, there would be an indoor management rule similar to that for companies.165 Under this rule, a counterparty would be entitled to assume that an RE that discloses that it is acting as agent for a particular MIS is acting within its agency powers and is otherwise complying with the requirements of the scheme, unless the counterparty knew or suspected otherwise166

Under this rule, a counterparty would be entitled to assume that an RE that discloses that it is acting as agent for a particular MIS is acting within its agency powers and is otherwise complying with the requirements of the scheme, unless the counterparty knew or suspected otherwise16

•    compliance  plan:  the  current  requirement  for  a  compliance plan167 would still apply, given that the RE would retain its managerial role, but with adjustments to reflect that scheme property is held by the MIS (not the RE) and that the MIS (not the  RE)  is  the  principal  to  agreements  forming  part  of  the scheme

•    accounting  obligations:  the  RE  would  continue  to  have  the obligation to ensure that the books and records of the scheme are maintained168

•    managerial duties: the RE would operate the scheme as the day-to-day manager, with the RE and its officers and employees having duties comparable to those set out in the current legislation.169 However, these managerial duties would be owed to the MIS, not to scheme members (as under the current legal framework for schemes)

•    recovery against the RE: where an RE acts in breach of its managerial duties or outside its agency powers, the MIS would have a right of action against the RE, and each of its directors,170 for maladministration. Given that the MIS itself has no controlling mind, other than through the RE, other parties should have the right to commence an action against the RE for breach of duty, namely:

–     a TRE

• 165       ss 128-129.
• 166       cf s 128(4).
• 167       Part 5C.4.
• 168       s 286.
• 169       ss 601FB-601FE.
• 170       For instance, in some circumstances rights of recovery might be available against the directors of the RE under s 197.

–     a replacement RE

–     an administrator or liquidator of the scheme

–     ASIC, or

–     a scheme member.

Scheme members should be entitled to act though a derivative procedure   for   schemes,   comparable   to   Part 2F.1A   of   the Corporations Act that applies with companies.

3.4 Rights of counterparties

As earlier indicated,171 under the current legal framework, a counterparty to an agreement entered into with the RE as operator of a scheme:

• has direct rights against the personal assets of the RE (except where  the  counterparty  has  agreed  to  only  limited  recourse rights)
• has an indirect subrogation remedy relating to scheme property held by the RE to the extent that the RE has lawful indemnity rights against that property (relevant also to limited recourse rights).

The  only  exception  is  where,  as  in  some  common  enterprise schemes, the RE acts as agent for scheme members. In those instances, only the involved scheme members would be liable, as principals,  under  the  agreements  (though  the  RE  may  agree  to assume some form of personal liability).

Under the SLE Proposal, where an RE lawfully acts as agent for the

MIS, or the indoor management rule applies, a counterparty:

•    would not have any rights against the personal assets of the RE (as the RE would not be a principal to those agreements). In this respect, the rights of the counterparty would be similar in effect to limited recourse rights, but 171       Section 2.3.3.

•    unlike  limited  recourse  rights,  the  counterparty  would  have direct rights against scheme property, held by the MIS. Those rights would not  depend on  the  indemnity rights of  the  RE against scheme property (which rights may be lost through the improper conduct of the RE).

Where the RE was acting beyond its agency powers, and the indoor management rule did not apply, the counterparty would have remedies only against the RE.

This report elsewhere recommends that scheme members be given statutory limited liability.172  This would ensure that, where the RE enters into agreements as agent for the MIS, counterparties cannot seek remedies against scheme members under those agreements.

The SLE Proposal would not prohibit counterparties from making additional private arrangements with the RE to protect their interests. In  those  circumstances,  however,  privity  of  contract  principles should apply, as the RE would be acting outside its role as agent of the MIS. For instance, a counterparty may require an RE to provide some form of financial accommodation as a condition of the counterparty entering into an agreement with the RE as agent for the MIS. The counterparty would have a direct right of action against the RE to enforce any such personal undertaking by the RE. However, under the SLE Proposal, that personal undertaking of an RE would not transfer to a TRE or new RE. In that respect, the intention is that s 601FS be redundant. A counterparty could take these matters into account in deciding whether to seek some personal undertaking from the RE, and the nature of its terms.

3.5 Indemnity rights of the RE

Under the current legal framework, the RE, as operator of a scheme, has indemnity rights against the scheme property for the obligations and liabilities that it incurs in entering into agreements as principal, as well as for its costs and remuneration.173

Under the SLE Proposal, the RE, being the agent for the MIS, would no longer incur personal liability for agreements into which it enters 172 Section 8.4.3. 173. See Section 2.3.2 of this report. as operator of the scheme. Its indemnity rights against scheme property would therefore be limited to its costs and remuneration for acting as manager and agent. The prerequisites that apply under the current legal framework to the exercise by an RE of its indemnity rights (namely that the rights must be specified in the scheme constitution and that the RE has properly performed its duties174) should also apply under the SLE Proposal.

As the MIS would not have a controlling mind in its own right, any member of the compliance committee (if established175), or a scheme member, should have the right to challenge in court the legality of any recovery by the RE from scheme property under an indemnity right claim.

3.6 Insolvent trading

As the day-to-day manager of a scheme, the RE would be best placed to monitor the scheme’s ongoing financial position and determine whether it  is  at  risk  of  insolvency. Elsewhere in  this report, a scheme is defined as insolvent (under both the current legal framework and the SLE Proposal) if there is insufficient scheme property to satisfy all claims that lawfully could be made against that property, as and when the claims became due and payable.176

To promote responsible behaviour by the RE and its directors in operating the scheme, and to provide better protection to counterparties, the RE and its directors should be personally liable if, at the time that the RE enters into an agreement as disclosed agent for the MIS, the scheme is insolvent. This would be comparable to the regime that applies to company directors.177

174       s 601GA(2). See further Section 2.3.2 of this report.

175       Subsection 601JA(1) sets out the circumstances in which a compliance committee must be established.

176       See also Section 6.3.2 of this report.

177       See ss 588G and 588H, which set out the duty of company directors to prevent insolvent trading by the company and the applicable defences. The role of the insolvent trading provisions in the corporate context was described by the New South Wales Supreme Court in Woodgate v Davis [2002] NSWSC 616 at [36]:

The approach under the SLE Proposal compares with the current legal position for schemes whereby the directors of an RE are personally liable if the RE is insolvent when it enters into any agreement under which the RE incurs personal debts, including as operator of a scheme.178

The extension of liability for insolvent trading to the RE (in addition to its directors) under the SLE Proposal is in recognition that the RE may be solvent and that better recovery may be achieved than applying the insolvent trading provisions only to the directors of the RE.179

Applying the insolvent trading provisions in this context would require a TRE or new RE to be cautious about entering into agreements as agent for the MIS until it sufficiently understood the overall financial position of the scheme it had undertaken to operate. However, a TRE or new RE would not be personally liable for insolvent trading transactions entered into by a former RE.

3.7 Replacing the RE

Under the current law (s 601FS), a TRE or a new RE is subject to the obligations and liabilities (as well as having the rights) of the former RE as operator of the scheme.180

The intention is that the SLE Proposal negate the need for this requirement.  The  MIS,  not  the  RE,  would  incur  the  rights, obligations or liabilities under agreements entered into by the RE within its agency power or under agreements covered by the indoor management rule presumption. In other circumstances (including where the RE undertook some form of personal liability), only the RE that has entered into an agreement would be personally liable,

Section 588G and related provisions serve an important social purpose. They are intended to engender in directors of companies experiencing financial stress  a  proper  sense  of  attentiveness  and  responsible  conduct  directed towards the avoidance of any increase in the company’s debt burden. The provisions are based on a concern for the welfare of creditors exposed to the operation of the principle of limited liability at a time when the prospect of that principle resulting in loss to creditors has become real.

• 178       ss 588G and 588H.
• 179       cf s 588V where a holding company may be liable for the insolvent trading of a subsidiary.  Recovery  orders  against  directors  of  companies  that  engaged  in insolvent trading can be made under Part 5.7B Div 4.
• 180       See further Section 2.2.2 under the heading Replacement of the RE. with the counterparty having remedies only against that RE, not any subsequent TRE or new RE.

The SLE Proposal would simplify the process of replacing the RE. It overcomes the problems raised in practice where an RE fails, or the scheme members wish to replace the RE, but no suitable entity is immediately willing either to be appointed by the court as a TRE, or to agree to become a new RE, because of the effect of s 601FS.

3.8 axation matters

The tax treatment of schemes is an important factor in their use as a collective  investment  vehicle.  CAMAC  intends  that  the  SLE Proposal be revenue-neutral, by ensuring that treating an MIS as a separate  legal  entity  (for  certain  purposes)  does  not  change  the current taxation treatment of a scheme, to which ‘pass through’ provisions apply.

If the SLE Proposal is applied to some or all existing schemes, it would also be necessary to ensure that the transfer of legal title to scheme property from the RE to the MIS is treated as a form of tax free roll-over of property, exempt from stamp duty.

3.9 CAMAC position

CAMAC sees the SLE Proposal as a means to resolve many of the legal problems that have arisen with the operation of schemes under the  current  legal  framework,  and  which  are  highlighted  when schemes  suffer  financial  stress.  The  SLE  Proposal  also  creates greater conformity between schemes and companies in an environment where many schemes are involved in major enterprises similar to companies. Schemes represent a significant proportion of the investment or enterprise market and, like companies, should have a consistent, well understood regulatory structure that both governs their operations and the dealings of those who invest in or deal with them, and can adequately respond to the various situations that can arise in practice.

CAMAC has closely considered the various ways in which the regulation of schemes could be adjusted for the SLE Proposal. They include:

• apply  the  SLE  Proposal  to  all  existing  and  new  common enterprise schemes (thereby exempting all pooled schemes)
• apply the SLE Proposal to all new common enterprise schemes (thereby exempting all pooled schemes and existing common enterprise schemes)
• apply the SLE Proposal to all new schemes (thereby exempting all existing pooled schemes and common enterprise schemes)
• apply the SLE Proposal to all existing and new schemes (thereby having no exemptions).

Further  variants  on  the  first  three  options  could  be  to  exempt schemes for no more than a stipulated transitional period or permit each exempt scheme to choose whether to be regulated under the SLE Proposal (for instance, through a statement in the scheme constitution).

While recognising that arguments could be put forward for each option, CAMAC’s preferred position is that the SLE Proposal be adopted for both common enterprise schemes and pooled schemes, and that there be no exemption for existing schemes. It is important to avoid any form of multi-tier regulatory system (either between pooled and common enterprise schemes or between existing and new schemes) and, in the longer term, to ensure a consistent approach to all scheme structures. Any option that exempts particular types of schemes from the  SLE  Proposal, or  permits exempt schemes to decide whether to be regulated under the SLE Proposal, would result in a significantly more complex regulatory structure. It would also create difficulties for outside parties in understanding their legal position when dealing with different types of schemes and raise the likelihood of the SLE Proposal having minimal or partial application for a considerable time.

The Committee recognises that its preferred approach would involve material conversion costs, to be borne by pooled schemes as well as common enterprise schemes. It would affect existing arrangements with, and the rights of, external parties, such as scheme financiers. It would also require amendments to the tax laws, both to exempt the transfer of title to assets from the RE to the MIS from stamp duty and  other  tax  consequences,  and  to  ensure  the  ongoing  ‘flow through’ tax treatment of schemes once they are converted to the SLE structure.