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(May-2002) Trustee Update
Superannuation fund trustees are generally free to make properly considered investments that are consistent with their responsibilities to manage assets soundly for the benefit of fund members. However, the SIS legislation prohibits or limits certain investment practices.
Recent action before the Federal Court highlights the need for trustees investing in commercial loans to be especially mindful of their duties when developing and implementing an investment strategy. Commercial loan investments are intrinsically problematic for trustees due to the potential for conflicts of interest. In addition, the risk associated with a commercial loan must be suitable for the fund’s investment strategy.
In the matter of QLS Superannuation Pty Ltd v Parker & Anor [2002] FCA 196, the Federal Court refused to strike out an action brought by ASIC against the trustees of a super fund for breaches of statutory duty under s 232(4) of the Corporations Law. ASIC’s statement of claim alleged that the four directors of QLS Superannuation Pty Ltd (QLSS), as the corporate trustee of the Law Employees’ Superannuation fund, were liable for failing to exercise a reasonable degree of care and diligence under s 232(4) in relation to investments in commercial loans.
Until April 1997, QLSS invested its trust monies only in institutional managed funds. Subsequently, three of the trustees (the second to fourth defendants) approved a $2.5 million commercial loan, representing 14 per cent of QLSS’ assets.
The loan was introduced by the first trustee defendant, Mr Parker. At the time of the loan’s approval, ASIC claims that the trustees were also aware that one of their two other existing loans of $1 million (also introduced by Mr Parker) was in default.
ASIC’s statement of claim pleaded that the trustees contravened the s 232(4) duty of care and diligence by:
permitting QLSS to undertake a lending business without any documented procedures for assessing the loan applications and lending risks;
failing to employ staff experienced in commercial lending;
failing to seek full disclosure from Mr Parker concerning the nature and extent of his relationship with the loan recipient; and
failing to inform themselves of the results of the required due diligence.
The second to fourth trustee defendants filed a notice of motion with the court seeking an order striking out ASIC’s statement of claim, arguing that the sustainability of ASIC’s case depended upon establishing that the three trustees should not have relied on Mr Parker with respect to the implementation of the $2.5 million loan. They argued that no viable case was disclosed in the statement of claim as ASIC did not, in effect, propose to undertake the burden of establishing that matter.
The court dismissed the defendants’ notices of motion seeking to strike out ASIC’s statement of claim. It found that ASIC’s case could arguably be made out without reliance on Mr Parker’s conduct in respect to the introduction of the $2.5 million loan and the deficient steps he is said to have taken implementing the loan.
According to the court, it was at least arguable that each of the trustees of QLSS were in breach of their statutory duty with respect to the making of the loan, quite apart from any reliance they placed in Mr Parker.
The court indicated that the circumstances that gave rise to an arguable case included:
QLSS conducted a small super fund with assets around $20 million, as such, the $2.5 million loan exposed a substantial part of the fund’s assets to the risks inherent in making commercial loans;
QLSS and the trustees had not established any of the controls and procedures for conducting such an inherently risky business; and
the loan was introduced by Mr Parker to the board, which allegedly knew at the time of approving the loan, that two of the earlier loans were in default.
The court noted that the circumstances pleaded by ASIC were not critical as to whether ASIC had pleaded an arguable case. As a result, the court concluded that there was an arguable case for ASIC to establish a breach of the statutory duty under s 232(4).
The matter serves as a warning to trustees contemplating investments in commercial loans. The regulator has identified commercial loans as an area prone to conflicts of interest and defective procedures for which it will pursue trustees for any perceived deficiencies.
Therefore, trustees determined to undertake such investments need to give detailed consideration to the procedures for devising and implementing commercial loans to ensure they do not breach their trustee duties and are in accordance with the trust deed and SIS requirements.
— Stuart Jones is a tax writer at Australian Tax Practice. E-mail: [email protected]
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