12 Jun 2014

Redemption of units from a non-liquid MIS

by Matthew Daley, Mary Konstantopoulos

The High Court clarifies the position in respect of the withdrawal offer provisions for registered managed investment schemes.

A compulsory redemption of a member's interest in a managed investment scheme does not constitute an act of withdrawal under Part 5C.6 of the Corporations Act 2001 (Cth) because it does not involve a voluntary act by the member, according to the High Court of Australia (MacarthurCook Fund Management Limited v TFML Limited [2014] HCA 17).

As a result, if the constitution of the scheme requires the responsible entity to redeem the member's interest in specific circumstances, the responsible entity will only have to comply with the general obligations in the Corporations Act, and not the additional ones in Part 5C.6.

This may lead scheme constitutions to be structured in a way which provides comfort to "seed investors" irrespective of whether the scheme itself is liquid or not liquid.

The non-liquid managed investment scheme

Between 2006 and 2008 RMFL Ltd was the responsible entity of an unlisted unit trust which was a registered scheme. RMFL was eventually replaced by TMFL Ltd, which assumed RMFL's rights, obligations and liabilities as responsible entity.

Under the scheme's constitution, no unitholder could withdraw from the scheme other than in accordance with specific procedures in place for making and dealing with withdrawal requests. These procedures varied depending on whether the fund was liquid or not liquid.

In October 2006 and December 2007, RMFL sought to raise funds through an open-ended public offer of ordinary units in the scheme. It issued what were called "Subscription Units" to MacarthurCook Fund Management Limited under an agreement which required RMFL to redeem the units by a specific deadline from funds received from the open-ended public offer.

On 29 October 2008, RMFL gave notice that it had suspended all "withdrawals" from the scheme. At this point, the scheme was not liquid and RMFL was replaced. Neither RMFL nor its replacement, TMFL, redeemed or purchased the units by the deadline. Proceedings were brought against both RMFL and TMFL because of the failure to redeem the Subscription Units in accordance with the relevant terms of their issue.

The issue for the High Court was whether redemption of the Subscription Units constituted withdrawal from the scheme within the meaning of Part 5C.6 of the Act.

The Corporation Act's protections for a member withdrawing from a non-liquid managed investment scheme

Part 5C.6 of the Act contains specific provisions about withdrawals from a scheme. A responsible entity must not allow a member to withdraw from a non-liquid scheme unless it is in accordance with the scheme's constitution and sections 601KB to 601KE of the Act (section 601KA(3)).

Sections 601KB and 601KE then provide a framework for a responsible entity to offer members an opportunity to withdraw from a non-liquid scheme. These statutory procedures were described by the High Court as "designed to ensure that all members with rights to withdraw have the same practical opportunity to make withdrawal requests and to have those withdrawal requests satisfied."

The High Court finds withdrawal must be voluntary

The High Court held that a member's "withdrawal" from a managed investment scheme has to be voluntary to trigger the protections in Part 5C.6. A member does not withdraw from a scheme just because a responsible entity has performed an obligation to redeem the interest of the member.

Therefore, section 601KA(3)(b) does not apply to the redemption of units by a responsible entity where the units were issued on terms which included an obligation on the responsible entity to redeem them in specified circumstances.

Part 5C.6 does not deal with the situation where units are subject to a compulsory redemption, or where a redemption takes place without any act of the member, because neither involves a voluntary act by the member. There is a difference between an agreement which provides that redemption needs to occur at a specific time and one which allows the member to redeem at a time they choose. There is no volition just because a member chooses to subscribe for units on the terms they are issued upon. It is the latter which is regulated by Part 5C.6.

As a result, the obligation to redeem the Subscription Units had not been met within the time period specified and section 601KA(3)(b) had no application to the facts.

How does the decision in MacarthurCook Fund Management affect responsible entities or fundraising?

As a result of this decision, Part 5C.6 does not impose additional requirements on responsible entities when obliged to redeem under the terms of issue of a class of interests.

There was debate as to whether the Court's analysis would render protections available in this Part void. The High Court made specific reference to other sections of the Act which contain protective provisions which continue to apply, such as section 601FC. This section requires responsible entities to comply with a number of duties, including to exercise a reasonable degree of care and influence, act in the best interests of the member and make sure that all payments from scheme property are made in accordance with the Act and the scheme's constitution.

This decision may also lead scheme constitutions to be structured in a different way. There may be an opportunity for provisions to be added in order to provide comfort to initial investors about the return of their investment, irrespective of whether the fund is liquid or not liquid at the time of redemption.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.