In the recent Federal Court case of Premium Income Fund Action Group Incorporated v Wellington Capital Limited [2011] FCA 698, the plaintiffs successfully challenged constitutional changes made unilaterally to a constitution of a listed registered managed investment scheme, the Premium Income Fund (“PIF”), without unitholder approval.  The court said that the changes were contrary to the Corporations Act.

Justice Gordon of the Federal Court handed down her judgment on 20 June 2011 with reasons published on 1 July 2011.  Her honour found that changes to the PIF constitution made without unitholder approval by the responsible entity of PIF, Wellington Capital Limited (“Wellington”), were adverse to members’ rights and therefore contrary to the Corporations Act.  The amendments were made to enable Wellington to undertake a capital raising at a price that was different to the price that would be arrived at under the pre-existing pricing provisions in the constitution. 

This is an important judgment for two reasons:

  • it may impact on the ability of responsible entities to change the pricing provisions in their constitutions unilaterally; and
  • it highlights the need for responsible entities in seeking to unilaterally amend a constitution to meet the statutory requirements in doing so.

Background to the decision

PIF is a registered managed investment scheme listed on the National Stock Exchange (“NSX”).  Its responsible entity is Wellington. 

The existing pricing provisions in the constitution at the time the capital raising was announced required that units were issued at:

  • an issue price of $1; or
  • net asset value (“NAV”) per unit (in certain circumstances, if the responsible entity considered that NAV per unit was less than $1).

Amendments were made to the constitution of PIF to insert a different price at which units could be issued to facilitate a placement and a rights issue at an offer price of $0.10 per share.

The amendments were made without unitholder approval and in reliance on section 601GC(1)(b) of the Corporations Act.  That section allows responsible entities to amend constitutions without unitholder approval if “…the responsible entity reasonably considers the change will not adversely affect members’ rights”. 

Changes that do adversely affect members’ rights may be made, so long as unitholder approval is obtained (as a special resolution).

Ability to change pricing provisions

Findings

Her Honour found that, in the context of the PIF constitution, members had a right to have additional units issued in the scheme (to themselves or others) only at the fixed price specified in the constitution (ie $1 or NAV).

In this context, a change to enable the responsible entity to issue units at a different price was a change in rights, and Wellington needed to be satisfied that that change was not adverse.

In her Honour’s view, this was not  a case where the responsible entity had a broad-ranging discretion to issue units at a particular price - and merely amended the constitution to record an exercise of its discretion.  Rather it was a change to the right to have units issued in accordance with pricing provisions in the constitution.

Her Honour made orders preventing the issue of units under the rights issue (which had not yet completed at the time proceedings were brought).

However, she refused to exercise her discretion to order that units that had been issued under the placement were cancelled.  Doing so would impact on the rights of third parties (who had bought some of the newly issued units on market).

Analysis

The central point in this case is that her Honour took the view that unitholders have a right to have units issued only in accordance with the pricing provisions specified in the constitution.  This is a conclusion that is likely to generate some debate given the approach by a number of issuers to amendments of this nature in the past.

The decision may lead to some responsible entities seeking member approval of changes to pricing provisions (including the insertion of a fixed price in a constitution) where there is any doubt as to whether the change may adversely effect members’ rights.  Alternatively, responsible entities may consider approaching a court for directions that they would be justified in unilaterally amending their constitution to make the proposed changed.

Both alternatives will involve some delays which may be less than ideal if the capital raising is pressing.  Moreover, under both alternatives, the potential capital raising will become public before it is formally launched or will need to be conditional on the successful outcome of whichever alternative is adopted.

Responsible entities may also consider reviewing their constitutions, in light of the decision, to determine whether any amendments to the issue price provisions can be made to accommodate the findings in this case and so avoid the need to seek member approval or court sanction at the time a capital raising is proposed.

The refusal of her Honour to cancel units already issued under the placement is significant and will provide comfort to responsible entities who have issued units in the past after unilateral amendments to pricing provisions.

Process for considering unilateral amendments

Findings

Her Honour also found, on  the evidence, that Wellington’s board did not consider the effect of the constitutional changes on the specific right in question (namely the right to have any new units issued in PIF on the terms that were fixed by the constitution and not otherwise). 

Accordingly, her Honour also found that the manner in which Wellington exercised the discretion granted under section 601GC(1)(b) was invalid.  This means that even if the change had not been adverse to rights, the amendments would have been invalid on the basis that the responsible entity had not properly undertaken the decision-making process required by the amendment power.  This was a crucial failure to comply with the statutory requirements for unilateral amendment of a scheme constitution.

Analysis

This aspect of the decision highlights that directors of responsible entities need to carefully consider the impact that proposed amendments to the constitutions of registered managed investment schemes have on members’ rights before undertaking a unilateral amendment.  The key requirement to determine whether any change is adverse to members’ rights is to compare the rights of members both before and after the change is made.  The board’s consideration needs to be clearly recorded to provide evidence that it has occurred. 

This decision follows other recent cases where the courts have emphasised the need for responsible entities to ensure that the statutory requirements for unilateral amendments are met.1