04 Jun 2009
Managed funds - Amending a fund's constitution in the current economic climate
In efforts to maintain long-term sustainability of some managed funds, various responsible entities have, and continue to, suspend redemption requests, which may require amending the fund's constitution.
When seeking to amend a fund's constitution in such a scenario, responsible entities need to consider the guiding principles in ING Funds Management Ltd v ANZ Nominees.
In the current economic climate a combination of factors have left some managed funds with limited cash resources to fund redemption requests, while at the same time facing increasing redemption requests from their members.
This issue has forced some responsible entities (REs) to consider suspending redemption requests to maintain the long-term sustainability of their fund. In doing so, REs must consider balancing the interests of members wishing to redeem and the interests of the remaining investors. This concern is driven by the fundamental obligation of a RE to act in the best interests of its members.
Where a fund's constitution is permissive in providing redemption requests, some REs may consider it appropriate to take immediate action through amending the fund's constitution to temporarily prohibit redemptions. To allow for this, the RE can take advantage of certain ASIC relief which allows the RE to amend the constitution for suspension in various circumstances.
Amending the constitution
Section 601GC of the Corporations Act provides that a Fund's constitution may be modified:
"(a) by special resolution of the members of the scheme; or
(b) by the responsible entity if the responsible entity reasonably considers the change will not adversely affect members' rights."
In the current situation, the RE will want to implement the amendment as soon as possible. Passing a special resolution will require the RE to prepare a notice of meeting and call a meeting of members. This process causes delay and creates uncertainty as a 75 percent members' vote in favour of the proposal is required to pass the special resolution.
Accordingly, so long as the RE can satisfy itself that the amendment "will not adversely affect members' rights", a more timely and certain approach may be for the RE to amend the fund's constitution itself.
The lessons from the ING case
A similar scenario was recently brought before the Supreme Court of New South Wales in ING Funds Management Ltd v ANZ Nominees  NSWSC 243 (the ING case). In this case, ING Funds Management Ltd had taken various actions to amend its fund's constitution for the suspension of redemption requests. The procedures and process followed by ING Funds Management Ltd gave rise to concerns as to whether the constitution had been successfully modified. In this case, the court found that the amendments sought were invalid.
The ING case provides some useful and detailed principles surrounding the process and procedure to be implemented to ensure that a RE reasonably considers that a proposed amendment to a fund's constitution will not adversely affect members' rights (Affect to Members' Rights Test).
Assessment of members' rights
For a RE to satisfy itself that the Affect to Members' Rights Test is met, the first question is to assess what precisely is the members' rights immediately before and after modifying the fund's constitution.
The court made a useful distinction between the "rights" and "interests" of members: rights are the contractual and equitable rights conferred on members under the constitution, as opposed to interests which are simply the enjoyment or value of those rights.
In the ING case, it was held that the RE must assess the members' rights before the modification and the impact that the modification would have on those rights. In determining whether the RE has done so, the court will look to the responsible entity's state of mind. Given that there was no direct evidence on the topic in the ING case, the RE's state of mind was inferred from the minutes of the relevant meetings.
This suggests that it is prudent for any RE seeking to make amendments in accordance with section 601GC(1)(b) to ensure its state of mind is clear on the issue. The RE can achieve this by explicitly considering the matters going to the assessment of members' rights and the impact of the modification in the minutes resolving to approve the relevant amendment. In this context, it would also be prudent for the RE to comment on advice received on the issue and document all discussions to further evidence the state of mind of the RE.
Comparison of members' rights
The next stage of the Affect to Members' Rights Test is for the RE to compare the rights of its members immediately before and after the modification (as ascertained in step 1).
In the ING case, the court found that the RE must consider whether, according to the comparison of members' rights as they exist immediately before and after the modification, there would be any adverse affect on members' rights whatsoever. That is, the RE must decide whether the change will remove, curtail or impair existing rights in a way that is disadvantageous to the members possessing those rights.
This is a very specific test. It is not a general question of whether members will be worse off or whether they will be commercially disadvantaged. Nor is there any element of materiality in this assessment. The court concluded that any adverse effect at all, however slight, to members' rights was enough to deny the RE the power to modify the Fund's constitution.
Form a reasonably considered opinion on members' rights
The final stage of the Affect to Members' Rights Test is for the RE to form a reasonably considered opinion as to whether the modification will not adversely affect members' rights.
The court held that there are two aspects that the RE must consider:
- firstly, the RE must actually believe that the amendment will not adversely affect the members' rights; and
- secondly, there must be facts to support that belief sufficient enough to "induce the belief or opinion in a reasonable person".
The court's finding highlights the importance of the process, including supporting documentation such as board papers and board minutes, to ensure that the analysis and debate is robust and fully documented.
What should REs do?
If an RE decides to make any amendment to its Fund's constitution, it must ensure that it has fully:
- informed itself of its members' rights;
- satisfied itself that members' rights will not be adversely affected; and
- documented evidence supporting its state of mind in finding that members' rights are not being adversely affected by the amendment.