On 4 October 2012, the Victorian Court of Appeal in 360 Capital Re Limited v Watts & Ors [2012] VSCA 234 delivered a unanimous judgement affirming the decision of Sifris J by declaring unilateral amendments made by the responsible entity (RE) of the 360 Capital Industrial Fund to be invalid.
The judgment also addressed the competing authorities and unequivocally endorsed a broader view of members’ rights. This decision, which is now the leading authority, means it is no longer open for a responsible entity to conclude that amendments to allow an issue of units at a deeper discount than permitted prior to the amendment do not affect member’s rights.
As a result of the appeal decision, it is now imperative for REs to carefully consider and document their consideration of the effect of amendments on members’ rights prior to exercising their power to unilaterally amend the constitution.
Decision at first instance
In Watts v 360 Capital RE Limited [2012] VSC 320, Sifris J held that a number of modifications to the constitution of a managed investment scheme which were unilaterally made by the RE, 360 Capital RE Limited (360 Capital RE), were invalid due to 360 Capital RE’s failure to comply with section 601GC(1)(b) of the Corporations Act 2001 (Cth) (Act). The amendments involved changes to the constitution to facilitate the issue of convertible notes and changes to the meeting procedure.
360 Capital RE subsequently appealed the decision.
Decision on appeal
In dismissing the appeal from 360 Capital RE, the Court of Appeal explicitly approved the approach of Gordon J in Premium Income Fund Action Group Incorporated v Wellington Capital Limited and disagreed with the reasoning of Barrett J in the more recent case of Re Centro.
The Court of Appeal decision provides clarification that REs should follow the approach of Gordon J as to what constitutes members’ rights and adopts a more restrictive view of a RE’s powers to unilaterally amend a scheme constitution.
The 360 Capital RE appeal was focussed on 2 key arguments:
- The primary judge erred in holding that the rights of members to have the managed investment scheme operated and administered according to the constitution as it stands are ‘members’ rights’ within the meaning of section 601GC(1)(b); and
- The primary judge erred in finding that the directors of 360 Capital RE failed to undertake the reasonable consideration required by section 601GC(1)(b).
Members’ rights
The Court of Appeal accepted Gordon J’s interpretation that a member’s rights to have a managed investment scheme managed and administered in accordance with the constitution are ‘members’ rights’ within section 601GC(1)(b).
The Court of Appeal emphasised this point by stating:
“the right of a member to have a managed investment scheme administered according to the constitution of the scheme is fundamentally the most important right of membership… Consequently, according to the natural and ordinary use of language, the expression ‘members’ rights’ in s 601GC(1)(b) is in our view calculated to embrace a member’s right to have a managed investment scheme managed in accordance with its terms.”
The judgment stated that Barrett J’s reasoning in Re Centro, and the authorities relied on in this case, did not provide persuasive reasons against this proposition.
The Court of Appeal dismissed Barrett J’s concerns that to hold that members’ rights to have a managed investment scheme managed and administered in accordance with the constitution are ‘members’ rights’ within section 601GC(1)(b) would render section 601GC(1)(b) ineffective. It stated that just because a change to the constitution would affect members’ rights, it does not necessarily follow that such a change would always adversely affect those members’ rights and therefore require a special resolution of members.
Furthermore, the Court of Appeal affirmed Sifris J’s comments that Barrett J’s distinction between something which affects members’ rights and something which merely affects the value or enjoyment of members’ rights may not be helpful in determining whether section 601GC(1)(b) could be invoked. The court stated that:
“Given that a member has a right to have the scheme conducted according to the scheme’s constitution, a change to the constitution must inevitably change the nature and quality of that right as such, as opposed to the value and enjoyment of the right.”
Board’s reasonable consideration
The Court of Appeal’s broad interpretation of members’ rights pursuant to section 601GC(1)(b) means that REs will now generally be required to consider whether there are any adverse effects as a result of the proposed amendments. In this regard, the Court of Appeal confirmed that the primary judge did not make a finding that the changes purportedly made to the constitution were adverse to members’ rights. Importantly, Sifris J struck down the amendments on the basis that as the changes unquestionably affected the rights of members, the board’s failure to consider the adverse effects was sufficient to deny the RE the modification power.
In considering the relevance of legal advice which 360 Capital RE relied on in amending the constitution unilaterally, the Court of Appeal held that it is generally reasonable for a board to act on the basis of legal advice on questions of law. However, it asserted that the mere fact that the board of 360 Capital RE had legal advice does not necessarily mean that the board ought to be taken to have reasonably considered that the proposed changes did not adversely affect members’ rights. No more follows from the tabling of the legal advice, other than that because the board was incorrectly advised that there were no members’ rights affected, no consideration was given to whether the effect of the proposed changes would be adverse to members’ rights.
The Court of Appeal held that a board’s conclusions and reasoning are liable to review if it can be shown that the decision was affected by a mistake of law, the inclusion of extraneous considerations or the exclusion of relevant considerations.
Implications
Given the Court of Appeal’s wide reading of members’ rights, REs will need to consider the more complex question of whether members’ rights are adversely affected.
The Court of Appeal decision is the latest judicial warning that boards of REs must undertake careful consideration of this aspect prior to exercising its power to unilaterally amend the constitution. Although boards can reasonably rely on legal advice, they must not do so mechanically and must evidence their own considerations to demonstrate compliance with section 601GC(1)(b).
One Investment Group operates a number of Responsible Entities with a broad and experienced team. Members of One Investment Group act as responsible entity/trustee for in excess of 100 managed investment schemes with assets greater than $2bn.