• Section 601GC(1)(b) of the Corporations Act 2001 (Cth) (Corporations Act) allows the responsible entity of a managed investment scheme to amend the constitution of the scheme without unitholder approval if the responsible entity reasonably considers that the changes will not adversely affect unitholders’ rights
  • The recent decision in Watts v 360 Capital RE emphasises the importance of the responsible entity conducting, and being able to demonstrate that it conducted, a proper and reasonable consideration of the impact of the proposed constitutional changes
  • The decision takes a broad view of the extent to which the benefit of the provisions of the constitution of a managed investment scheme constitute unitholders’ rights for the purposes of section 601GC(1)(b) – in that respect, it is more consistent with the analysis in Premium Income Fund than In the matter of Centro Retail Limited
  • The decision once again casts doubt on whether ‘dilutive’ constitutional amendments affect ‘rights’ of unitholders and the extent to which such amendments can be implemented unilaterally by responsible entities 
  • 360 Capital RE has announced that it intends to appeal the decision  

Background

360 Capital RE Limited (RE) is the responsible entity of 360 Capital Industrial Fund (Fund), a registered managed investment scheme comprising an unlisted industrial property trust.

On 31 May 2012, the RE purported to amend the constitution of the Fund to remove or change provisions that (broadly) provided that the trustee of the Fund could not issue options unless the Fund was listed, that an option does not confer on the optionholder any interest in the Fund, and that new units were required to be issued at a price determined in accordance with the constitution.

On 5 July 2012, the RE purported to further amend the constitution to introduce restrictions on the convening and conduct of meetings of members and the manner in which members could appoint proxies for such meetings.

The purported amendments were to facilitate the issue of redeemable unsecured convertible notes (360 Notes) to partly fund the acquisition of a property portfolio, and the holding of a meeting of members to consider the listing of the Fund and some further constitutional amendments to facilitate that listing.

On 6 July 2012, the RE issued a product disclosure statement for the offer of 360 Notes. 360 Notes appear to have been issued to institutional investors under the offer. The issue of 360 Notes to retail investors was scheduled for 7 August 2012. On 12 July 2012, a notice of the meeting was sent to members for a proposed meeting of members on 8 August 2012.

The plaintiffs, members of the Fund, brought an action in the Supreme Court of Victoria.

Judgement

On 31 July 2012, Sifris J delivered a judgement finding that the purported changes to the constitution of the Fund on 31 May and 5 July were ineffective, and restraining the RE from putting the special resolution proposed in the notice of meeting to members of the Fund.

Sifris J applied the three step process first articulated by Barrett J in relation to section 601GC(1)(b) in the ING Funds Management case (based on the 2003 Seabrook case and earlier case law relating to the modification or abrogation of the rights or privileges attached to a class of shares). Under this process, the task of the responsible entity is to:

  1. ascertain the rights of members created by the constitution, as they exist immediately before the modification,
  2. decide whether those rights – as distinct from the enjoyment of them or their value – will be changed or impinged upon by the constitutional modification, and
  3. if the answer to the second question is yes – the responsible entity must undertake a process of comparison and assessment in order to decide whether the impact is within the ‘adversely affect’ description.

Sifris J held that the RE did not give due and proper consideration to whether, and to what extent, members’ rights would be affected in purportedly making the 31 May or 5 July amendments to the Fund constitution:

As in the Premium Income Fund case, that determination was sufficient to dispose of the matter. However, unfortunately Sifris J expressed the view several times that the plaintiffs did have rights that were purportedly modified by the 31 May amendments, including:

‘In my opinion, each unitholder or member had a right to ensure that no options were issued unless the Trust was listed and that an optionholder would not have any interest in the Fund. Further, each unitholder had a right to ensure that new units were issued on the terms and at an issue price calculated in accordance with clause 5.4. These rights were and remain accrued and enforceable rights. They are important substantive rights. The modification of these rights in the manner contemplated goes well beyond the enjoyment of such rights or the value of the rights. Rather, the modification affects the characteristics and nature of the rights.’

His Honour appeared to be of the same view in relation to the 5 July amendments.

Sifris J distinguished the decision in In the matter of Centro Retail Limited as follows:

‘It is relevant to note that the Centro constitution does not contain any provision prohibiting the issue of options prior to listing. Barrett J was only dealing with rights associated with a proposed new pricing structure that was to be applied uniformly. Further and in any event, the responsible entity undertook the consideration required by the section and indeed went further to consider the best interests of members. The consideration was noted in the minutes of the meeting.

The rights considered in Premium Income Fund and more particularly the specific rights of members in this case are more extensive than the right considered by Barrett J in Centro Retail and such rights go well beyond the (rejected) right to have the scheme administered in accordance with the constitution or merely the enjoyment of rights.’

Sifris J also expressed the view that it is necessary to consider the rights of members in the context of a trust and a trustee and beneficiary relationship and excessive reliance should not be placed on the suggested comparable rights of shareholders, particularly in distinguishing alteration of rights from alteration of the enjoyment of rights.

What does this mean for you?

The decision in Watts v 360 Capital RE reintroduces uncertainty in determining the extent of the responsible entity’s power to amend a scheme constitution. Although the court did not expressly reject the distinction between a constitutional amendment that alters a right and one that merely affects the enjoyment or value of a right, it has made it more difficult to presume that a constitutional change affects the interests of members but not their rights. It is not clear that His Honour would regard a constitutional change that solely affects the price at which units may be issued as affecting rights (and indeed he distinguished the Centro Retail case on the basis that there ‘Barrett J was only dealing with rights associated with a proposed new pricing structure that was to be applied uniformly’). However, statements in the decision, particularly to the effect that members had a ‘right’ under the constitution to insist that options only be issued in particular circumstances and on particular terms, are cause for concern, since they are more consistent with the analysis in Premium Income Fund than that in Centro Retail. If (contrary to the Centro Retail approach) an amendment to change the price at which units may be issued affects rights, then the key issue will be to determine whether a proposed change adversely affects those rights.

It continues to be critical that responsible entities undertake and document a thorough and comprehensive decision-making process when deciding whether to make pricing or other amendments to scheme constitutions. Sifris J held it to be of first importance that full and proper consideration and deliberation is undertaken and that the basis and rationale for such consideration be recorded, and stated that if a responsible entity considers that rights will be affected but not adversely, that decision will not be interfered with if it was reasonably open to the responsible entity.