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Australia – Door Shuts On Unilateral Amendments To Unit Pricing Provisions.

16 October, 2012

 

Legal News & Analysis – Asia Pacific – Australia – Capital Markets

 

In brief

 

  • Section 601GC(1)(b) of the Corporations Act 2001 (Cth) permits a responsible entity (“RE“) to unilaterally modify the constitution of a managed investment scheme (“Fund“) if it reasonably considers the change will not adversely affect members’ rights.
  • This section has been relied on many times by REs to unilaterally amend the constitution of a Fund to permit the issue of units at a deeper discount than previously permitted by the constitution. The view was taken that such amendments did not affect members’ rights. The potential dilutionary effect of a capital raising on existing unitholders may affect the enjoyment or value of members’ rights but did not affect members’ rights as such.
  • However, over recent years there has been a tug of war of judicial decisions as to whether an RE has the power to unilaterally amend a constitution in this way. Gordon J, in Premium Income Fund Action Group Inc v Wellington Capital Ltd (2011) 84 ACSR 600 (the “PIF Decision”) thought not. Barrett J in Re Centro Retail Ltd [2011] NSWSC 1175 (the “Centro Decision”) thought so. Sifris J in Watts & Watts & Ors v 360 Capital Re Limited & Anor [2012] VSC 320 (“360 First Instance Decision”) thought not.
  • On 4 October 2012, the Victorian Court of Appeal in 360 Capital Re Limited v Watts & Ors [2012] VSCA 234 (the “360 Appeal Decision”) upheld Sifris J’s findings at first instance. This decision which is now the leading authority means it is no longer open for an RE to conclude that amendments to allow an issue of units at a deeper discount than permitted prior to the amendment does not affect members’ rights. This means that in the face of such amendments an RE will be required to give due and proper consideration as to whether and to what extent members’ rights would be affected by those amendments and will only be able to make the amendments unilaterally if it reasonably considers that the amendments will not adversely affect members’ rights.

 

THE 360 APPEAL DECISION

 

On 31 July 2012, Sifris J in the 360 First Instance Decision found that that the relevant constitutional amendments to the Fund (which included amendments relating to the issue price of units) did modify members’ rights for the purposes of section 601GC(1)(b). 360 Capital Limited (“360 RE“), as RE, failed to give due and proper consideration as to whether and to what extent members’ rights would be affected by those amendments.

 

Grounds for appeal

 

360 RE appealed Sifris J’s decision on seven grounds:

 

  • It was wrong for the judge to hold that the rights of members to have the Fund operated and administered according to the Constitution as it stands are “members’ rights” within the meaning of section 601GC(1)(b).
  • It was wrong for the judge to hold that the changes purportedly made by the 31 May 2012 Supplemental Deed Poll adversely affected members’ rights.
  • That the judge erred in finding that the directors of 360 Capital failed to undertake the reasonable consideration, required by section 601GC(1)(b), of whether the purported amendments of 31 May 2012 would adversely affect members’ rights. 
  • The judge erred in holding that the amendments purportedly made by the Supplemental Deed Poll of 5 July 2012 affected ‘members’ rights’ within the meaning of section 601GC(1)(b).
  •  The judge erred in finding that the directors of 360 Capital failed to undertake the reasonable consideration, required by section 601GC(1)(b), of whether the purported amendments of 5 July 2012 would adversely affect members’ rights.  The judge erred in holding that, because of the invalidity of the purported amendments of 31 May 2012, the 360 Noteholders are not members of the Fund.
  • Inasmuch as the judge erred in holding that the purported amendments of 31 May 2012 and 5 July 2012 were invalid, his Honour also erred in holding that Notice of Meeting of 8 August 2012 was invalid.

 

The decision

 

On 4 October 2012, the Court of Appeal upheld Sifris J’s decision at first instance and dismissed 360 RE’s appeal on all grounds.

 

The key points from the decision are set out below.

 

Members’ rights

The Court of Appeal affirmed Gordon J’s approach in the PIF Decision and found that “members’ rights” for the purposes of section 601GC(1)(b) included the members’ rights to have a managed fund managed and administered in accordance with the constitution of the fund. This was “fundamentally the most important right of membership” (360 Capital Re Limited v Watts & Ors [2012] VSCA 234 at para 40.).

 

In following Gordon J’s approach, the Court of Appeal expressly declined to follow Barrett J’s approach in the Centro Decision.

Rights versus the enjoyment or value of rights The Court of Appeal rejected the distinction Barrett J in the Centro Decision drew between something that affects members’ rights as such and something that affects the enjoyment or value of members’ rights. Given that a member has the 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.
Failure to reasonably consider

The Court of Appeal accepted, that it was reasonable for a board to act on the basis of legal advice on questions of law and, in this case, it was not unreasonable for the board to conclude, as they were advised that the proposed changes would not affect members’ rights. However, this did not mean that the board ought to be taken to have considered that the proposed constitutional amendments did not adversely affect members’ rights. What it means is that because the board were incorrectly advised that the changes would not affect members rights they did not turn their consideration to whether the effect of the proposed changes would be adverse to member’s rights.

 

It was acknowledged that it was for a board and not the court to determine the proposed constitutional amendments would adversely affect members’ rights. However, this did not mean a board’s determination was unexaminable. The board’s conclusion would be liable to review if:

 

  • the board did not address itself to the question which section 601GC(1)(b) formulates;
  • the board’s conclusion were affected by a mistake of law;
  • the board took some extraneous reason into consideration or excluded from consideration some factor which should affect its determination.

 

 

The practical implications of the 360 Appeal Decision for capital raisings by listed funds

 

Following the 360 Appeal Decision, it is no longer open to an RE to conclude that an amendment to the constitution to allow an issue of units at a deeper discount than that permitted by the constitution prior to the amendment does not affect members’ rights. For an RE to determine whether it can rely on section 601GC(1)(b), the RE must:

 

  • ascertain the rights as they exist before the proposed amendment;
  • decide whether those rights will be changed by the amendment; and
  • undertake a comparison to decide whether the impact of those changes are adverse.

 

The basis of the RE’s decision and rationale must be fully documented. Any external advice given to the RE must not be accepted without discussion, deliberation or analysis.

 

One option which an RE may wish to consider, is to seek unitholder approval to amendments to the unit pricing provisions in its constitution which will confer the maximum flexibility on the RE to set the price in the context of a placement or rights issue, taking into account the requirements of the Corporations Act and ASIC Policy. For example, it might be possible to include pricing provisions which allow the price to be set by bookbuild or some other independently verifiable process. Such amendments may then enable the RE to respond effectively in the event a capital raising at a deeper discount, becomes necessary.

 

 
For further information, please contact:
 
Sarah Dulhunty, Partner, Ashurst
sarah.dulhunty@ashurst.com
 
Sarah de Flamingh, Ashurst
sarah.deflamingh@ashurst.com
 
Jeffrey Lau, Ashurst
jeffrey.lau@ashurst.com

 

 

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