It’s been some months since the appeal case in 360 Capital which made the funds management community reconsider the way in which a responsible entity can unilaterally change a registered scheme’s constitution.
So, what’s been the outcome?
Constitutions are not being modified – either unilaterally by responsible entities or with member approval. Gadens undertook a review of listed registered managed investment schemes (principally in the REIT sector) and a sample selection of unlisted registered managed investment schemes for the period August 2012 to March 2013. Our research revealed that no changes have been made to constitutions during this period.
If it is true that no changes have been made to any scheme constitution (we were not able to search all registered schemes) this would be unprecedented since registered schemes were introduced. We would normally expect to see many more constitutions modified during a six month period.
Why haven’t there been any changes to constitutions?
There may be two main reasons why there have been no changes to constitutions:
- Boards and management of responsible entities are unsure which changes will require member approval and are hesitant to go to a meeting unless absolutely necessary
- There have been no major transactions or issues which have required a scheme’s constitution to be modified
Reticence to modify a constitution since the 360 Capital case
The consequences of the 360 Capital case is that a responsible entity needs to consider the particular constitutional change more closely to see if members’ rights are being affected and to ensure that proper processes have been adopted.
You may recall that the case is authority for these principles:
- Members’ rights have been extended – these rights now include the right to have the constitution administered in accordance with its terms
The responsible entity unilaterally changing the constitution requires more consideration
- Boards will need to document what members’ rights are being affected
- Boards will need to demonstrate how they have formed a view that the change does not adversely affect members’ rights
- Boards can’t rely on legal opinions alone
- Boards will need to properly record their decision-making processes in minutes
- The content of the minutes is very important
- Constitutional changes will probably require a special resolution from members
Anecdotal evidence that we have received from directors and senior managers is that they are hesitant to make any constitutional changes. Decision-makers are concerned about failing to do things properly and the constitutional changes being illegal and ineffective. For example, other factors impeding constitutional changes include concern:
- that the analysis of what is a member right may be incorrect
- regarding the extent that they can rely on legal opinions from their law firms or counsel
- that the correct analysis is adopted
- that the correct procedures may not be followed; or
- that the minutes may not properly reflect the analysis undertaken by the Board
Confusion of this sort and paralysis in decision-making is not healthy for the proper administration of schemes. The funds management industry should be able to operate in a robust commercial and efficient manner.
Reduced transaction flow stymies need to change constitutions
Another reason why there may not have been changes to registered scheme constitutions is the lack of transactions. The number of transactions during the period from August 2012 to March 2013 has been at historic lows. Low transactional flows are not a consequence of the 360 Capital case but a consequence of the economy and business operating environment. More confidence in the commercial world will lead to more transactions and we would expect a need for some constitutions to be modified. Until deal flows improve there may be no reason to change constitutions.
What can Boards and management do?
- All constitution changes will now need to be analysed more closely to see if the changes are necessary
- Structuring transactions will need to be considered more closely – if constitutional changes are required this can affect the transaction timetable, confidentiality and cost (particular if a meeting will need to be called to obtain member approval for any changes)
- If it is a new structure – consider drafting the constitution more broadly to allow for flexibility in the future or introduce changes before the scheme is registered
- Place some administrative tasks in ancillary documents and not the constitution
What can the government do?
Often we call out for law reform – but clearly there is a need to consider law reform in this area. The Corporations Act needs to catch up with the court’s interpretation of the law or, better still, legislate around the 360 Capital decision. In our view, responsible entities should be given more latitude to amend constitutions, subject to the overriding requirement that the change is in the best interest of members.
Responsible entities, their directors and management need some clearer guidance on how a scheme’s constitution can be modified unilaterally. ASIC should seek feedback from the funds management industry to see how s. 601GC (changing the constitution) of the Corporations Act is affected by the recent cases and if some changes to the law are required.
It is unfortunate that ASIC wasn’t able to consider this in its most recent review of managed investment scheme constitutions (CP 188 Managed Investments: Constitutions – Updates to RG 134). We can hope that it is addressed in the new regulatory guide when it is issued sometime soon (it was due for publication in March 2013).