What happens when SMSF trustees don’t agree?
A recent NSW Supreme Court case highlights the importance of appropriate trustee combinations as well as strategic mechanisms that assist when trustees don’t agree, according to David Oon and Daniel Butler from DBA Lawyers.
The last thing on the mind of most new self-managed superannuation fund (SMSF) trustees is what might happen years down the track when they are unable to agree with their fellow trustees.
Unfortunately, a number of things can sometimes go wrong with an SMSF's management.
This article considers several thorny issues and a number of preventative steps.
Unwise combinations in the office of trustee — Notaras v Notaras
Often, as two or more people's affairs intermingle (usually because they are family or business partners), the natural desire may be to start an SMSF to act as a vehicle to hold assets such as real property.
Of course, there is nothing inherently wrong with this.
No relationship is immune from conflict. However, some combinations of trustees are more unwise than others.
This is illustrated well by the recent New South Wales Supreme Court decision of Notaras v Notaras [2012] NSWSC 947 (‘Notaras').
The facts of Notaras are hinted at by the case title, representing an unfortunate dispute between two brothers. The plaintiff (Basil) was the brother of the defendant (Brinos).
Both were the only trustees and members of an SMSF.
By 2011, relations between the two had soured over a separate property dispute that also reached the Supreme Court of New South Wales, which was decided in favour of Basil.
In December 2010, Brinos had made withdrawals of over $220,000 from the SMSF's bank accounts. This was $57,839 more than Brinos was entitled to as a member.
Subsequent to the withdrawals, the SMSF's accountant (who was also Basil's wife) sent a letter to Brinos, including tax returns and member statements that needed signing.
Brinos returned the documents without signing them.
While the judge in the case (Rein J) did not explicitly find that Brinos refused to sign them (partly because Brinos had not been expressly asked to do so in the letter), his Honour found (at [7]) that the ‘net effect…was that no further steps were taken… with a consequence that the trustees of the Fund [had] put themselves in breach of the Act'.
Basil sought an order (pursuant to s 70 of the Trustee Act 1925 (NSW)) that Brinos be removed as a trustee and replaced with a company.
The company, Bazport, had Basil as the sole director and shareholder. Other states and territories usually confer similar powers on courts (eg, s 48 of the Trustee Act 1958 (Vic)).
The order was granted. This was an unusual outcome in that it contemplated the trustees of the Fund becoming both Basil, as well as his company Bazport. Because Rein J still considered Brinos to be a member despite having only a ‘nominal interest' ([12]), his Honour noted that Basil and Bazport would be seeking permission from the ATO to have the SMSF exempt from the relevant requirements of the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA').
That is, an exemption would be sought from the requirement that each member is a trustee or a director of the corporate trustee.
The eventual result of Basil's request to the ATO will probably not be made public.
What is quite certain, however, is that the exercise of resolving the dispute via the Supreme Court was likely to have been time-consuming and quite costly.
The case therefore shows that one should think carefully before starting an SMSF along with a family member, especially where there are shared business interests.
Further, there are other relationships that may present a higher degree of risk that a dispute will arise.
These include: parent—child SMSFs, SMSFs with in-laws and SMSFs shared between business associates.
Decision making — must it be unanimous?
Related to the issues raised by Notaras is the topic of trustee decision-making.
There is a general law principle that, where joint trustees are appointed, they must act unanimously.
This was affirmed by Kaye J in Beath v Kousal [2010] VSC 24 [18] (12 February 2010). This means that it is near impossible to make decisions if joint trustees do not agree.
However, this general position can be modified by the governing rules (usually annexed to the trust deed) providing that decisions can be made in some other manner.
For example, deadlocks in trustee decisions could be broken if the governing rules provide that votes are weighted according to the member balance that each trustee has (if any). Not all governing rules will provide for this.
Removal of a trustee
A pertinent question to ask in the case of SMSFs where trustees cannot agree is: can the trustee be removed, other than by a court?
In order to avoid a costly court process and likely time delays, a properly drafted trust deed and governing rules can provide for a procedure by which a trustee can be removed, and a new one appointed.
An appropriate process may be that the member or members who have greater than half the total account balance are able to appoint a new trustee and remove an existing one.
Again, not all governing rules are the same, and many will not provide for this.
Interestingly, Notaras did not contain any discussion of the trust deed or governing rules of Basil and Brinos' SMSF.
It appears that under the governing rules of Basil's SMSF, he did not have adequate power to remove Brinos, despite Basil clearly being the member with the majority account balance.
Additionally, the governing rules also determine whether the power to hire and fire a trustee (ie, the appointor power) comes with fiduciary obligations attached, such as the obligation to exercise the power in good faith (Berger v Lysteron Pty Ltd [2012] VSC 95).
Unless the rules provide that the power does not have to be exercised in good faith, the decision to remove and appoint a trustee may be subject to attack on various grounds.
Accordingly, to protect the interests of the members with the majority of benefits, governing rules should ensure that the appointor power can be exercised without associated fiduciary duties (these duties would be similar to those of a trustee). Few governing rules will provide for this.
Forcibly removing a member
A trustee who cannot agree with fellow trustees is also likely to be a member of the SMSF. This individual may not reply to correspondence and may generally refuse to participate in management of the SMSF. The question then arises: is it possible to forcibly remove the person as a member?
The governing rules can provide for a mechanism to remove a member.
However, the larger hurdle is the requirements under the regulations, where, broadly, prior consent of the member to be removed is required. Of course, this may be impossible to obtain where there is a falling out.
Going forward, a strategy for SMSFs to consider to overcome this potential impasse is for the member with the larger account balance to obtain a signed consent up-front from the other member (in their capacity as both trustee and member) that, upon the occurrence of certain events (eg, disagreement about a material SMSF decision, relationship breakdown or legal dispute), the trustee can remove the other member from the fund and transfer their benefit to another complying superannuation fund.
Another option for a person ‘stuck' in an SMSF with a trustee/member who will not cooperate is to remove themselves from that fund (and roll over funds into a new SMSF).
However, legally and (sometimes) practically, this itself may require the consent of the other trustees (for example, authority to deal with the bank).
Conclusion
The problem of an uncooperative trustee can prove extremely difficult due to the law of trusts, as well as laws protecting the interest of members of superannuation funds.
This can be made more difficult by documents that do not confer strategic powers.
In closing, a wise initial step is to consider carefully with whom to share an SMSF.
Further, strategically drafted trust deeds and governing rules, as well as good initial planning, can assist to cure problems, or better yet, prevent them.
Lastly, for those already part of an SMSF, it is worth considering whether the current structure is prone to problems, and whether a restructure would be worthwhile.
By David Oon is a lawyer and Daniel Butler director with DBA Lawyers.
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