Source: http://archive.conventuslaw.com/australia-high-court-clarifies-the-law-on-mis-equity-funding/
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Conventus Law » Blog Archive » Australia – High Court Clarifies The Law On MIS Equity Funding.
Australia – High Court Clarifies The Law On MIS Equity Funding.
MacarthurCook Fund Management Limited v TFML Limited [2014] HCA 17.
On 14 May 2014, the High Court of Australia (French CJ, Crennan, Kiefel, Bell & Gageler JJ) handed down judgment in MacarthurCook Fund Management Limited v TFML Limited [2014] HCA 17.
The judgment is significant for the funds management industry as, by clearing up the law on the operation of the withdrawal provisions for managed investment schemes in the Corporations Act 2001 (Cth), it opens up the possibility of novel equity funding and underwriting arrangements.
The account of the facts in this section has been simplified to the matters essential to that which is truly relevant to the decision of the Court.
Before the global financial crisis, MacarthurCook Fund Management Limited entered into a series of identical funding agreements with RFML Limited, the responsible entity of an A-REIT. RFML was subsequently replaced as responsible entity by TFML Limited but as that change is not significant for present purposes, the responsible entity will simply be referred to as “TFML”.
The funding agreements relevantly provided for an equity funding arrangement, pursuant to which MacarthurCook would subscribe for units in a special class, called “Founder Units”. Under the terms of issue, the units were to be redeemed during a specified period of time, out of (and limited to) the proceeds of a public offering being undertaken by TFML. The terms of the issue also provided that TFML’s obligation to redeem was subject to the constitution of the scheme and the Corporations Act.
As it turned out, the units fell to be redeemed during the global financial crisis and RFML gave notice suspending all withdrawals from the fund. At the time of suspension, the fund was not liquid within the meaning of section 601KA(4) of the Corporations Act.
MacarthurCook sued TFML in the Supreme Court of New South Wales for damages for failing to redeem the Founder Units when required. MacarthurCook succeeded at first instance but TFML was successful in the New South Wales Court of Appeal. The High Court then granted MacarthurCook leave to appeal.
TFML’s primary defence to MacarthurCook’s claim was that it did not breach its obligation to redeem because the redemption clause was expressly stated to be subject to the constitution of the scheme and the Corporations Act.
Part 5C.6 of the Act contains a detailed framework for withdrawals from a scheme. In particular, section 601KA(3) provides that a responsible entity must not allow a member to withdraw from an illiquid scheme other than in accordance with the scheme’s constitution and sections 601KB to 601KE.
Sections 601KB to 601KE then spell out a procedure under which a responsible entity of an illiquid scheme may offer members an opportunity to withdraw from the scheme. The responsible entity must make a “withdrawal offer” that specifies a number of things including a period (of at least 21 days) during which the offer will remain open, the assets to be realised to fund the offer, the amount of money expected to be available to fund withdrawals and how withdrawal requests will be dealt with if the requests exceed the money available. Any member wishing to withdrawmust then serve a withdrawal request and if the requests do exceed the available funds then they are to be satisfied pro rata. The responsible entity may also cancel the withdrawal offer before it closes if it is in the best interests of members to do so.
TFML argued that its suspension of withdrawals (which it was empowered by the constitution to do), coupled with the absence of compliance with the procedure mandated by sections 601KB to 601KE (including publication of a withdrawal offer by TFML and service of a withdrawal request by MacarthurCook) meant that there was no breach of the redemption clause in the agreements with MacarthurCook.
The High Court held that, by failing to redeem during the redemption window specified in the funding agreements, TFML was in breach of the terms of issue of the Founder Units and liable to pay damages to MacarthurCook. MacarthurCook’s appeal was therefore allowed with costs.
The Court analysed the nature and structure of the provisions of Part 5C.6 and section 601GA(4) and ruled that a right within Part 5C.6 of a member to withdraw from a managed investment scheme involves “some act of volition on the part of the member” [23].
The Court then went on to analyse the legislative history of Part 5C.6 and in particular the 1993 joint report by the Australian Law Reform Commission and the Companies and Securities Advisory Committee (entitled “Other People’s Money”). The report was written after a loss of investor confidence following the collapse of many property trusts in the late 1980s following a sharp decline in commercial property values. The thrust of the relevant part of the report was that the then arrangements for exiting illiquid schemes were unsatisfactory and appropriate reform was required to address the problem of, in colloquial terms, “a run for the door”.
According to the Court, Part 5C.6 operates to address the problems identified in the report, namely “problems associated with investors exercising choice to exit a scheme, particularly when the scheme is not liquid; much less problems associated with the performance of duties and exercise of powers by responsible entities” [28].
The Court concluded that the meaning which “best fits the structure and purpose of Pt 5C.6 operating in combination with section 601GA(4)” is one which confines the operation of that part to voluntary withdrawals from a scheme, that is to say where a member “acts so as to result in the responsible entity returning the whole or some part of the member’s contribution” [29]. So, Part 5C.6 does not cover the situation where a member is being compulsorily redeemed under the constitution. Nor does it cover the situation where the responsible entity is performing an obligation to redeem under the terms of issue of the member’s units, which obligation is required to be performed independently of any act of the member.
Perhaps significantly for future cases, the High Court distinguished between situations such as the one in this case, where the obligation to redeem constitutes part of the terms of issue, and situations where a separate or collateral contractual obligation to redeem has been created. In other words, the distinction is likely to be one of substance rather than form and is between what may be said to be the terms of an issue of securities (however documented) and a separate collateral arrangement entered into after the securities have been issued. Nonetheless, there remains ambiguity as to exactly how this distinction is to be drawn in practice—that will no doubt be the subject of future controversy.
In practical terms, the Court has ruled that Part 5C.6 regulates the ordinary rights of a member of a managed investment scheme to withdraw from the scheme but does not cover the situation of compulsory redemptions such as where the constitution of a scheme provides in particular circumstances for a member to be ejected from the scheme. Nor does it cover underwriting or equity funding arrangements pursuant to which the funder’s interests are for a particular term, after which the funder is to be redeemed.
The key element that distinguishes the two situations is that the member wishing to withdraw does so voluntarily. By contrast a compulsory redemption is just that—the member is ejected. So too is an investor for a fixed term. At the conclusion of that term the investor has no option to choose to stay in the scheme but is ejected from the scheme by having its interests redeemed. It is only the voluntary process that is the subject of regulation by Part 5C.6.
One of the concerns addressed by the Court was the usual “floodgates” concern, that is to say whether confining Part 5C.6 in this way enables avoidance behaviour that neuters the protections in the Corporations Act. The Court’s answer was twofold. First, it was said (by reference to the legislative history of Part 5C.6) that the purpose of that Part was not to regulate all withdrawals from a scheme but rather to address the shortcomings in the arrangements that had been in place at the time of the financial crisis of the early 1990s. Secondly, Part 5 of the Corporations Act contains other protective provisions that continue to apply, including the duties imposed on responsible entities by section 601FC. In the words of the Court [32]:
… the responsible entity of a scheme must always exercise a reasonable degree of care and diligence, must always act in the best interests of members, must always treat members who hold interests of the same class equally and members who hold interests of different classes fairly, and must ensure that all payments out of the scheme property are made in accordance with the scheme’s constitution and the Act. The responsible entity is not placed by Pt 5C.6 under any further obligation in the performance by the responsible entity of an obligation to redeem arising under the terms of issue of a class of interests.
The High Court has, in just 13 pages, made a ruling which is of some commercial significance. It clears up an uncertainty about the scope of the withdrawal provisions in Part 5C.6 of the Corporations Act and, by providing certainty, has opened up the prospect of new (and appropriately structured) equity funding and underwriting arrangements.
In so doing the Court has emphasised that the broader duties imposed on responsible entities by the Act will be enforced so that this ruling does not permit, for example, arrangements which discriminate between members.
Hayden Fox, Ashurst
hayden.fox@ashurst.com