The nexus between banks and SMSFs can be problematic
The advent of so-called “stronger super” on January 1, which in many respects is seen as a good thing by people associated with SMSFs and insolvencies, can also be problematic in the nexus between such funds and banks.
This is seen in a recent court case that demonstrates an SMSF’s obligation to operate soundly in return for the contributions it receives. Quite apart from ethical considerations, proper operation of a SMSF will defeat claims, in certain circumstances, to the contributions made to it.
The court’s decision in effect invites directors, trustees and their advisors to be aware that complex legal structures almost inevitably go hand in hand with obligations, that if not met, will be to the serious detriment of the parties involved.
Facts and issues
Businesses are borrowing from banks to make large contributions to their SMSFs. What can happen if such a business goes belly up?
The company in this case was Australasian Annuities Pty Ltd (AA), a financial planning business.
Specifically AA acted as trustee of a family trust, and in that capacity operated as a service entity providing management, administration, accommodation, and staff services to another entity.
Herewith a sequence of events:
- On 7 May 2007, AA signs a facility with Macquarie Bank with a limit of $2.5m. Security for the loan includes a registered first ranking fixed and floating charge over the whole of the assets and undertakings of AA.
- On 17 May the bank advances the money to AA.
- A significant proportion of the $2.5m is contributed by AA to its SMSF (AA having a sole director who has a wife and sons).
- Just over two years later, AA runs into financial trouble and on 29 June 2009 Receivers and Managers are appointed by Macquarie Bank under securities conferred on the bank to protect its loan to AA.
Opening gambit and result
The Receivers and Managers of AA bring a claim in AA’s name against both the SMSF trustee and financial planner who is AA’s sole director. The Receivers and Managers’ aim is to recover as much of the bank’s money as possible. When the financial planner is declared bankrupt, it becomes obvious action can now only be taken against the SMSF trustee.
AA’s first attempt to recover money fails before the Supreme Court in Australasian Annuities Pty Ltd {2013} VSC 543.
AA appeals in the Victorian Court of Appeal – Australasian Annuities Pty Ltd {2015} VSCA 9 (AA 2015).
There are two lines of argument. One holds that the SMSF should be ale to keep the money. The other involves application of a well-established rule that entitles the bank to recover the money.
AA’s Receivers and Managers are attempting to claw back the money. They argue that the trustee of the SMSF has received it “as a volunteer”, a technical term meaning the money should be returned because the SMSF trustee has given nothing in return for the money and therefore must be forced to make restitution by paying it back.
The court’s decision
Good news for SMSFs. In a majority decision, the court ruled that the SMSF trustee did provide valuable consideration in exchange for contributions.
Thus AA’s argument to the contrary failed.
Earlier the High Court in Cook v Benson {2003} HCA 36 held that superannuation funds do provide consideration in exchange for contributions. Although parties in that case had dealt at arm’s length, nevertheless the majority of judges in AA 2015 decided the essence of the High Court’s decision was applicable to their ruling in the Supreme Court of Victoria.
This case makes it clear that the valuable consideration given by a SMSF trustee in exchange for contributions, includes the trustee’s obligation to provide fund beneficiaries with rights and benefits under the fund’s rules.
These include obligation to:
- Give members specified entitlements for their entire lives and also retirement benefits.
- Invest money in accordance with the fund’s investment strategies.
- Credit contributions to an appropriate accumulation account.
- Administer contributions under agreed terms, while maintaining proper accounts and records that are available to members.
AA’s backup argument
When AA elected to fight the opening battle with the “volunteer” argument as its only weapon, it seemed likely this would have lost them the war. However in the final and decisive court battle AA used “knowing receipt” as its big gun, arguing that under this principle the SMSF was certainly liable to return Macquarie Bank’s money.
This was because the SMSF:
- Received property (money), and in misapplying or transferring it, breached fiduciary duty or trust; and
- Did this knowing the misapplication or transfer was a breach of fiduciary duty or trust.
It was not questioned that AA’s sole director was subject to fiduciary obligations.
As to the first matter, it was unanimously agreed the director breached fiduciary duty in borrowing money for his own benefit and that of his wife.
The court found the financial planner (namely the then sole director of AA) facilitated the money’s distribution for his own benefit and certain family members, as though the money was his to use as he pleased.
It was ruled therefore that distribution of the bank’s money received by the SMSF was transferred in breach of fiduciary duty.
As to the second issue, the court decided AA needed to prove the SMSF’s trustee knew the money was received in breach of fiduciary duty.
So to the final act
The trustee comprised four directors of which the financial planner was only one, but obviously the most active.
Accordingly the court had to decide whether this activity represented the “directing mind and will” of the SMSF’s trustee.
A majority of the court’s judges decided that the financial planner was the only active and knowledgeable director instrumental in relevant transactions, that he alone directed and monitored payments to the SMSF, and therefore was indeed the directing mind and will of the SMSF. His knowledge was thus imputed to the fund.
Accordingly the court ruled the SMSF, because of this imputation, knew the bank’s money was received in breach of fiduciary duty, and as a result of this ruling the trustee of the SMSF was liable to pay Macquarie Bank’s money back to the receivers and managers.
For more information, contact Macks Advisory on 08 8231 3323 or visit our office at Level 11, 99 Gawler Place, Adelaide SA 5000.
