17 Mar 2009
Not as easy as it looks: Replacing a responsible entity of an A-REIT
by Nicholas Mavrakis, Michael Legg, John Moutsopoulos
The key Corporations Act requirements for a member-instigated replacement of a responsible entity present important stumbling blocks or defences to the replacement of a responsible entity.
The global financial crisis has changed the investment landscape by significantly reducing the value and/or investment performance of property trusts, so that members either cannot sell as their schemes are illiquid or to sell is to incur a substantial loss. It has also increased the likelihood that members will seek to remove a responsible entity and replace it with another.
How one goes about replacing a responsible entity however is another question, as there is some uncertainty about the steps set out in the Corporations Act 2001 (Cth). Likewise, a replacement responsible entity should be wary about taking over a scheme it knows little about, and undertake a due diligence process to obtain information about the scheme, including its finances, investments and material contracts.
Corporations Act requirements for members to replace a responsible entity
Chapter 5C of the Corporations Act was introduced in 1998 to regulate managed investment schemes, including providing for a "responsible entity" to operate the scheme and perform the functions conferred on it by the scheme's constitution and the Corporations Act.
The members' power to remove the incumbent responsible entity and choose a new responsible entity is drawn from section 601FM(1). The relevant meeting procedure that applies is to be found in Division 1 of Part 2G.4 and the scheme's Constitution. Sections 601FM (2) and (3), while primarily ministerial provisions for advising ASIC of a change to the replacement entity so that the change can be achieved through amending the register, also require the replacement responsible entity to give written consent.
Consent and a replacement responsible entity
The ramifications of members removing a responsible entity, but not choosing a company to be the new responsible entity that consents, are provided for in section 601NE:
"The responsible entity of a registered scheme must ensure that the scheme is wound up ... if: ... the members pass a resolution removing the responsible entity but do not, at the same meeting, pass a resolution choosing a company to be the new responsible entity that consents to becoming the scheme’s responsible entity."
There are however two possible interpretations of sections 601FM and 601NE(1)(d) in relation to the timing for when consent of a replacement responsible entity must be given.
On one view, the plain text requires that the consent of a replacement responsible entity must be given at or before the meeting where the resolution removing the incumbent responsible entity was passed. If consent is not given the incumbent responsible entity "must ensure that the scheme is wound up".
The other interpretation draws on the purpose of the section and Parliament's intention to facilitate the removal of a responsible entity. Under that interpretation, a replacement responsible entity is chosen at the meeting, but consent can be subsequently supplied within a reasonable time.
Why due diligence?
Under section 601FS, if the responsible entity of a registered scheme changes, the new responsible entity acquires the rights, obligations and liabilities of the former responsible entity in relation to the scheme. There is also a form of statutory novation of the former responsible entity's contracts to the replacement responsible entity under section 601FT, and section 601FC(2) provides that the responsible entity holds the scheme property on trust for scheme members.
A replacement responsible entity may understandably be reluctant to agree to take on the responsible entity role until it can examine material contracts to ascertain the effect of these sections upon it. This includes whether:
- there are limitation of liability clauses in the material contracts limiting the responsible entity's liability to the assets of the trust, thus protecting the responsible entity's personal assets;
- the existing responsible entity has given charges or indemnities which would bind the replacement responsible entity:
- there are any "poison pills" such that a change of responsible entity may be an event of default or give the counterparty to material contracts other rights that are disadvantageous to the scheme or its responsible entity.
However, an incumbent responsible entity is under no statutory obligation to facilitate due diligence by a proposed replacement. Indeed section 601FR only requires a former responsible entity to give reasonable assistance to the new responsible entity once the change of responsible entity has occurred.
The consent at the same meeting requirement and due diligence
If consent is required at the meeting where the resolution removing the responsible entity was passed, but due diligence cannot occur beforehand, then it may be very difficult to find a replacement responsible entity, or convince members to vote in favour of replacement.
Alternatively if the incumbent is removed and the replacement responsible entity is unable to conduct the necessary due diligence to be able to provide consent, the scheme will be forced into winding-up.
The key Corporations Act requirements for a member-instigated replacement of a responsible entity, sections 601FM and 601NE(1)(d), therefore present important stumbling blocks or defences to the replacement of a responsible entity, depending on whether an entity is seeking to become a replacement responsible entity or defending itself from motions to replace it.
Bringing or defending a motion to replace a responsible entity therefore requires careful planning with legal input at an early stage.