The Federal Court has given the first substantial guidance into Part 5C.7, which regulates related party transactions made through MISs. The court addressed four discrete questions about the operation of Part 5C.7, but has also left some important questions to be resolved.

ASIC v Avestra Asset Management Ltd (in liq) [2017] FCA 497

The Federal Court (Beach J) recently approved settlement of a civil penalty proceeding against Avestra Asset Management Ltd and two of its directors. Through 2013 and 2014, Avestra had been engaged in a succession of related party transactions through managed investment schemes of which it was responsible entity and trustee. The Court held that Avestra had acted with a systemic and serious disregard of its fiduciary and regulatory obligations, made numerous declarations of contraventions against Avestra and the directors, and imposed financial services injunctions and disqualifications of 10 years each against both directors.

The number and variety of related party transactions that Avestra engaged in offered an opportunity for the Court to clarify a number of questions about the operation of Part 5C.7 of the Corporations Act 2001 (Cth). Part 5C.7 modifies the public company related party transaction provisions (in Chapter 2E) to apply to transactions where scheme property of a registered MIS is used to give a financial benefit to a related party. Where the modified form of s 208(1) (as set out in s 601LC) applies, then the transaction must be approved by members of the MIS, unless any of the exceptions in ss 210-212 or 215-16 is enlivened.

The Court addressed four aspects of the operation of Part 5C.7. The second and third issues, in particular, leave some important questions to be answered in future cases.

Is a cross-investment into a related party’s managed investment scheme a “financial benefit” to the related party?

In several instances, Avestra invested funds from one of its registered MISs into another scheme of which it, or a related party, was RE or trustee. The trustee of the destination scheme obtains only bare legal title to the funds invested, and so obtains no beneficial interest in those funds. Is the investment of those funds a “financial benefit” to the trustee of the destination scheme?

Applying the very broad definition of “financial benefit” in s 229, Beach J held that there are two ways that the trustee of the destination scheme can be said to receive a financial benefit:

  • by increasing the size of the funds under management of the trustee of the destination fund – a fact which the trustee might use to promote itself; and
  • through the possibility that the same party (or related parties) may earn multiple fees from the cross-invested funds.

The consequence is that every investment by a registered MIS into a scheme whose RE or trustee is a related party of the first scheme’s RE (or related party of an agent of, or an entity controlled by, the first scheme’s RE) must be formally approved by the first scheme’s members, unless any of the exceptions applies.

Is the acquisition of legal title to shares a “financial benefit”?

One of Avestra’s misadventures was that it set about acquiring a majority shareholding in a listed funds management company (AG Financial Ltd), primarily using funds of the registered and unregistered MISs of which Avestra was RE or trustee. In addition to a breach of s 208(1), the court held that this involved a serious conflict of interest between Avestra and scheme members, which resulted in Avestra contravening s 601FC(1)(c). Avestra also failed to disclose its own (as opposed to the schemes’) substantial shareholdings in AG Financial, and had previously been convicted of offences against the takeover and substantial shareholder provisions.

The first purchases made through Avestra’s schemes, which totalled f 22% of the shares in AG Financial, were off-market purchases from AG Financial’s former CEO. Avestra held the purchased shares on trust for the members of the schemes. By acquiring legal title to the shares, did Avestra obtain a “financial benefit”? On one hand, the financial benefits of the dividend stream, any capital gain, and any rights on a winding-up would accrue to the members of the purchaser schemes. Yet the agreed facts showed that, after making those initial purchases, Avestra’s directors were able to exert practical influence over AG Financial’s corporate decision-making. Justice Beach was satisfied that, as a matter of economic and commercial substance, Avestra did obtain a financial benefit.

When an RE acquires shares as trustee for the scheme member, it is usually accorded power (through the scheme constitution) to vote on the shares in its absolute discretion. Arguably, the power to exercise voting rights in respect of the shares may be a financial benefit to the RE in every case. And even where it only obtains bare legal title to the shares, the RE acquires “property” within the broad meaning of s 9 and s 229(3)(a).

Does it follow that any purchase of securities by an RE results in the RE obtaining a financial benefit, and therefore needing to obtain members’ approval (subject only to the statutory exceptions)? That would be an extremely surprising result. Where is the line to be drawn between acquisitions that trigger, and do not trigger, the requirement for member approval?

Giving a financial benefit through an interposed scheme

A registered MIS invests funds in an unregistered scheme. Trust property of the unregistered scheme is then used to give a financial benefit to the RE of the first scheme or one of its related parties. Is the financial benefit given “out of” the scheme property of the first scheme, as required by the modified form of s 208(1)(b)(i), such that the approval of the members of the first scheme must be obtained?

Justice Beach considered that the answer was provided directly by s 229(2)(a), which states that “giving a financial benefit” includes giving a financial benefit “indirectly, for example, through 1 or more interposed entities”.

Again, the question arises how far this principle may be extended. It may be necessary that the giving of the benefit out of the interposed scheme must be given by the RE of the first scheme or one of its associates (in order to trigger s 208(1)(a)). So, in practical terms, there may need to be a degree of connection between the first and interposed schemes. But it does not appear to be necessary that the giving of a benefit through the interposed scheme must be a deliberately-structured transaction. And the requirement to obtain approval of the first scheme’s members might be triggered even where the two successive transactions occur a long time apart, or no matter how small the first scheme’s interest in the interposed scheme is.

Who are the “related parties” of a non-RE giver of a financial benefit?

Under the modified form of s 208, member approval may be required where a financial benefit is given out of scheme property:

  • by the RE, an entity controlled by the RE, or by an agent of, or person appointed by the RE;
  • to any of those persons, or to any of their “related parties”.

“Related parties” are defined in s 228. But the modified form of s 228 tells us, in terms, who are the related parties of an RE, but not who are the related parties of an RE-controlled entity, or of an agent or person appointed by the RE (collectively, “non-RE givers”). Yet s 208(1)(c) (as modified) requires that the related parties of all of the non-RE givers can be ascertained, in order for the modified s 208 to operate as broadly as it was intended to. Plainly, this was a drafting oversight that occurred in the adaptation of the Chapter 2E framework to fit the managed investment scheme scenario.

Justice Beach accepted that a purposive interpretation of Part 5C.7 required that the s 228 definition of “related party” be applied mutatis mutandis to non-RE givers in the same way that it identifies who are the related parties of an RE. The same result could also be reached by “reading in” additional words to s 228. By adopting that purposive approach, the court effectively patched the drafting error.

Conclusion

The difficulty of unravelling and applying the Part 5C.7 provisions may explain why related party dealings out of MISs have been only rarely litigated. However, a handful of decisions have emerged in recent years, including in the APCH[1] and Octaviar[2] cases, each considering one or two isolated transactions.

Avestra presented an interesting series of permutations of related party dealings through registered and unregistered MISs, and so has provided a vehicle for some useful judicial consideration of how the Part 5C.7 provisions operate in practice. However, being a hearing on consent declarations, the court’s analysis was more limited than it might have been at a contested trial. The limits of the principles confirmed in Avestra remain to be delineated in future cases.