GFC and the restructure of Managed Investment Schemes

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					F S T       E     B U L L E T I N

GFC and the restructure of
Managed Investment Schemes
The impact of the GFC has resulted in some restructuring activity of Managed
Investment Scheme arrangements. In this edition of FST e-Bulletin, Corporate
Partner, Alan Jessup, discusses some of these restructuring options available.

Internalisation of                              “Top Hatting”                                     Replacing Failed
Management Rights                                                                                 Responsible Entities
                                                It is possible to restructure stapled
One common method of restructuring              arrangements and obtain roll over relief          There have been a number spectacular
has been to internalise management              without causing any public trading trust          failures of responsible entities over the
rights. This refers to the process whereby      issues by what is called “Top Hatting”.           past 12 months. However this does
the responsibility for management of            This is a process where stapled interests         not necessarily mean that there is an
a Managed Investment Scheme (MIS)               are exchanged for interests in a trust. The       issue with the underlying schemes.
through a third party externally owned          reason for stapled interests is to avoid          Unfortunately many schemes have
responsible entity is transferred from that     the public trading trust problems which           been allowed to be wound up in these
external third party ownership to direct        may occur where there is a business being         circumstances when that may not have
or indirect ownership within the same           carried on in conjunction with an eligible        been the best option for investors.
group as the MIS. This is almost certainly      investment business e.g. a retirement village,
done under a stapled arrangement to             property development, private hospitals           Nevertheless there may be some
avoid the MIS becoming a public trading         etc. However by following the appropriate         difficulties to be overcome in order to
trust i.e. the investors will hold units in     procedure it is possible to remove the            prevent the winding up of the underlying
the MIS and stapled shares in either the        complication of a stapled structure with a        scheme although some of these issues
responsible entity or a company which           trust as the “Top Hat” and still retain the tax   have been clarified by some recent cases.
wholly owns the responsible entity.             benefit of the underlying stapled structure.
                                                                                                  Some of the issues to be confronted
The theory is that this will match the          Subject to satisfying certain conditions and in   particularly where a restructure involves
interests of management with the                some instances subject to application to the      the replacement with a new responsible
interests of unit holders and also reduce       relevant Commissioner, in NSW, Qld, ACT,          entity are as follows:
management costs.                               Vic, SA, WA and NT there is what amounts
                                                to an exemption in one form or another for        •   the new responsible entity steps into
Although theoretically, the members             “top hatting” with land rich entities which           the shoes of the former responsible
of the MIS can remove the current               therefore enables this procedure to be                entity which means that there is an
responsible entity at any time if they          undertaken without income tax or stamp                automatic statutory novation, rather
can get the requisite majority and              duty consequences.                                    than a mere assignment, in favour of
therefore the management rights may                                                                   the new responsible entity in respect
appear to have little value, nevertheless                                                             of all rights, obligations and liabilities
some promoters of MIS have extracted                                                                  of the former responsible entity and
considerable value from their MIS by                                                                  apply to all contracts and any other
internalisation of these management                                                                   documents to which the former
rights. This has amounted to millions                                                                 responsible entity was a party subject
of dollars being released to the original                                                             to only the limited statutory carve out
promoters. There seems to have been no                                                                which means that there may be some
difficulty in obtaining valuations to support                                                         difficulty in finding a new responsible
this type of restructure.                                                                             entity to take on the task unless due
                                                                                                      diligence is possible                                               1                                                            August 2010
[ P U B L I C A T I O N                N A M E ]

•   however recent case law on the            Trust Mergers                                 Act, 2001 where there was a dispute
    meaning of section 601FS(2)(d),                                                         as to their applicablity to some of the
    which excludes from the statutory         Trust mergers have been undertaken even       Timbercorp schemes.
    novation liabilities for which the        within groups which increase the size of
    former responsible entity could not       funds under management and theoretically      In this case a new responsible entity
    have been indemnified out of scheme       reduce the overall costs of management.       (New RE) had been chosen by members
    property, means that at least in the      Some care needs to be taken to                of three Timbercorp schemes to replace
    case of contractual type schemes          ensure that there are no income tax           the former responsible entity which was
    where liabilities for third party         consequences by taking advantage of the       in liquidation (Old RE).
    contract have to be met out of the        available roll over relief. Also stamp duty
                                                                                            However notwithstanding the
    fees received, such liabilities may not   issues particularly with land rich entities
                                                                                            appointment of New RE as the
    be novated to the new responsible         need to be taken into account. For listed
                                                                                            responsible entity of these three
    entity                                    trusts, Chapter 6 of the Corporations
                                                                                            Timbercorp schemes, the Liquidators of
                                              Act or alternatively the Takeover Panel’s
•   for contractual schemes it may be                                                       Old RE refused to transfer to New RE:
                                              Guidance note on trust mergers need to
    difficult to amend the contracts          be considered.                                •   the scheme agreements with each
    due to some case law on this point
                                                                                                Grower comprising a Sub-Licence
    although query whether this can be        Conversion of MIS to a Company                    and Marketing Agreement, Licence
    circumvented by an amendment to
                                              Due to the GFC, sometimes it is difficult         Agreements and Management
    the Constitution instead
                                              to find funding for MIS structures                Agreements, or
•   where fees are paid in advance,           particularly with contractual based           •   the leases of the underlying land.
    there may be no apportionment of          schemes. One form of restructure that
    these fees according to recent case       may be used to overcome this funding          The Liquidators claimed that each of these
    law, which will therefore mean a          difficulty is to convert to a company         agreements were not scheme property
    new responsible entity will need to       structure by replacing trust interests with   but were entered into by Old RE in its
    be sure that there are appropriate        share interests. This can be popular with     personal capacity. Therefore Old RE was
    amendments to the Constitution            contractual based schemes as it may make      not required to transfer these documents
    to ensure that it is paid for ongoing     additional financing easier and enable        to New RE because property in the same
    work before it accepts such an            further capital to be raised. However         remained with Old RE. Therefore the
    appointment                               there are tax and stamp duty issues to be     provisions in section 601FS and 601FT
                                              considered in such a restructure as well as   that have been found in earlier case law
•   a cascading series of resolutions may     compliance with Corporations Act fund         to have the effect of causing the new
    be required to protect the incoming       raising rules.                                responsible entity to “step into the shoes”
    responsible entity before it consents
                                                                                            of the former responsible entity had no
    to be appointed                           Timbercorp Schemes - Transfer of              application to these three schemes.
•   the liquidator of the former              Scheme Documents and Scheme
                                                                                            The absurdity of this argument was that
    responsible entity may not cooperate      Property                                      was the scheme could not be performed
    as a recent case considered later
                                              The Federal Court recently had to             by New RE as the new responsible entity
    in this bulletin in relation to the
                                              consider the interpretation of sections       because these documents included the
    Timbercorp scheme illustrates
                                              601FS and 601FT of the Corporations           very contracts which made the scheme
    resulting in additional costs to the
                                                                                            work. Further if this argument was
    incoming responsible entity.
                                                                                            correct Old RE would have continued
                                                                                            to have a crucial commercial role in
                                                                                            the Projects despite its removal as the
                                                                                            responsible entity which would have
                                                                                            been a nonsensical result.                                            2                                                        August 2010
This forced New RE to make application             or liability of the former responsible    The Court also found that Old RE
to the Court for orders requiring transfer         entity or a document to which it          and the liquidator had:
of these documents by the liquidators of           was party, is identified as having the
Old RE to New RE pursuant to sections              character of being “in relation to the    •   asserted a position to benefit
601FS and 601FT of the Corporations                scheme”, it is novated to the new             Old RE’s general creditors at the
Act, 2001.                                         responsible entity by force of these          expense of the three schemes
                                                   provisions subject to only limited
New RE was completely successful in its                                                      •   not sought to benefit the estates
                                                   statutory carve out.
claim against the liquidators. The following                                                     of the schemes
key points arise out of this success by        •   Sections 601FS(1) and 601FT(1) of
                                                                                             •   forced New RE to bring the
New RE before the Court:                           the Corporations Act, 2001 also
                                                                                                 proceedings to establish that the
                                                   create the means of ensuring that
The provisions of Division 3 of Pt 5C.2                                                          statutory provisions operated in
                                                   rights to hold, and rights “in relation
of the Corporations Act, 2001 are to be                                                          the manner as found by the Court
                                                   to”, scheme property pass to and
given a broad and purposive construction           vest in the new responsible entity.       •   appreciated that their arguments
as the provisions are designed to protect
                                                                                                 were contrary to the interests of
the members.                                   •   The statutory scheme in Division 3 of
                                                   Ch 5C.2 is clearly intended to apply
•   The words “rights, obligations and             to a change of, and effect a transfer     •   engaged in the litigation as adversaries
    liabilities” as used in Div 3 of Pt 5C.2       between, responsible entities in all          of the new registered entity of
    are be given a broad construction so           situations so as to ensure that the           the schemes rather than seeking
    as to achieve the legislative purpose          incoming responsible entity has the           directions from the Court as to Old
    of facilitating an immediate and               fullest and most effective control            RE ‘s position having regard to the
    seamless change of the responsible             of the whole of the scheme and                potential conflict in its interest that
    entity whenever ASIC records the               scheme property at the instant that           they were advancing and its fiduciary
    new responsible entity’s name in its           s 601FJ gives effect to the change so         duty as the former registered entity
    record of a registered scheme.                 as to ensure that the conduct of the          of the three schemes.
                                                   scheme is not disrupted.
•   The words “in relation to” as used in
                                                                                             The Court therefore ordered the
    section 601FS(1) of the Corporations       •   Therefore the use of the words by         liquidators to pay New RE’s costs
    Act, 2001 are also to be given wide            Old RE “in its personal capacity”         limited to the amount of Old RE ‘s
    and general import and are not to be           in the scheme documents was               assets available for that purpose.
    read down in the absence of some               irrelevant. The effect of the statutory
    compelling reason to do so.                    provisions was that the various
                                                   agreements were automatically
•   The provisions operate as an
                                                   novated to New RE on the recording
    automatic statutory novation, rather
                                                   of the change of responsible entity
    than a mere assignment, in favour
                                                   with ASIC pursuant to section 601FJ
    of the new responsible entity in
                                                   irrespective of any stated capacity of
    respect of all rights, obligations and
                                                   the former responsible entity.
    liabilities of the former responsible
    entity and apply to all contracts and      As a result Old RE and the liquidators
    any other documents to which the           were ordered to execute transfers of
    former responsible entity was a party      all of the above agreements to effect a
    subject to only the limited statutory      novation of those documents.
    carve out. Once a right, obligation                                             3                                                       August 2010
[ P U B L I C A T I O N                 N A M E ]

New Responsible Entity’s Liability            of the view that the indemnity afforded to       Gains and profits from carried interests
for Third Party Contracts                     the responsible entity under the scheme          held in entities that are or were Australian
                                              documents did not attach to the obligation       managed investment trusts are included
In a recent Federal Court case, the Full      of the former responsible entity to pay to       in the assessable income of the holder of
Bench had to consider whether a new           third party contractor and accordingly, the      the interests. The holder is entitled to a
responsible entity was liable to pay fees     exception provided for in s 601FS(2)(d) and      deduction from losses from such interest
to a third party contractor in relation       s 601FT applied.
to a contract entered into between the                                                         In order to come within these rules the
former responsible entity and that third      Therefore for fee based schemes some of          entity must be a “managed investment
party contractor. There were common           the potential liability that may arise out of    trust”. After some recent amendments
directorships and common shareholdings        the statutory novation principles may not        to this definition, it is now very broad and
between the former responsible entity         be so much of an issue for an incoming           will cover all registered schemes as well
and the third party contractor.               responsible entity.                              as a myriad of unregistered wholesale
The MIS was an olive scheme. As is            Important Taxation Changes for
common with these types of schemes,           Managed Investment Schemes                       There are provisions to relax the rules
the responsible entity is paid a fee out of                                                    for the start up phase and the winding up
which it has to meet all the expenses of      The trustee of an Australian managed             phase.
carrying out its obligations. One of the      investment trust may make a choice that
                                              certain assets of the trust be dealt with        The trust must also not be a corporate
arguments of the new responsible entity                                                        unit trust or a public trading trust.
was that because the amounts payable          under the CGT rules which means gains
to this third party contractor were to be     and losses in relation to those assets will be
                                              treated as being on capital account These
                                                                                               Infrastructure Funds – Consultation
met by the former responsible entity out
                                              assets are:                                      Paper on Improved Disclosure for
of the fees it received from the Growers
rather than out of scheme property, the                                                        Investors
                                              •   a share in a company (including a
liability of the former responsible entity                                                     ASIC has issued a consultation paper
                                                  share in a foreign hybrid company)
under this third party contract was not a                                                      on benchmarks that ASIC is proposing
liability for which the former responsible    •   a non-share equity interest in a             and detailing its expectations regarding
entity was entitled to be indemnified             company                                      disclosure for infrastructure entities.
out of scheme property. Therefore                                                              Although the reason behind this is
the statutory carve in section 601FS(2)       •   a unit in a unit trust
                                                                                               not expressly stated, undoubtedly the
(d) applied and the third party contract                                                       Brisconnections fiasco had something to
was not statutorily novated to the new        •   land (including an interest in land)
                                                                                               do with this release particularly given that
responsible entity.                           •   a right or option to acquire or dispose      the Joint Committee on Corporations and
Although the new responsible entity failed        of an asset of a kind mentioned above.       Financial Services expected some action
at first instance, the Full Bench upheld                                                       by ASIC following this incident. This is
                                              If the trustee does not make a choice that       expected to become a regulatory guide in
this argument. The Court found that           that certain assets of the trust be dealt with
when proper regard is had to the terms                                                         September, 2010.
                                              under the CGT rules, those assets will be
of the scheme documents it was clear          treated as revenue assets and therefore
that the responsible entity was not to be     gains and losses will be dealt with on
remunerated on some sort of hybrid basis      revenue account. It is therefore important
comprising a fixed fee plus reimbursement     for this choice to be made. Generally the
for some or all of the costs incurred by      reason for using a managed investment trust
it in managing the project. It was to be      structure is for the tax advantages of flow
paid a fee (or perhaps two fees) and          through including making the discount
had to pay the operating costs out of         capital gain available to unit holders.
its own funds. Therefore the Court was                                             4                                                          August 2010
[ P U B L I C A T I O N               N A M E ]

There are seven benchmark categories         Agribusiness Schemes – Consultation              •   Annual reporting to members namely
against which disclosure is to be made.      Paper on Improving disclosure for                    the requirement of the responsible
Issuers of these products are required to                                                         entity of the agribusiness MIS to make
address the disclosure benchmarks on
                                             retail investors                                     a commitment to members of each
an “if not, why not” basis which means       Similarly to infrastructure schemes, ASIC            scheme to disclose at least annually
stating that the scheme either meets         has issued a consultation paper which is             relevant information about the
the benchmark or does not meet the           expected to become a regulatory guide                performance of the agribusiness
benchmark (and explaining how and why        in September 2010, that sets benchmarks              MIS and its assets
the issuer deals with the business factors   against which disclosure is to be made for
or issues underlying the benchmark in                                                         •   Responsible entity financial position
                                             agricultural MIS no doubt due to the major
another way). This disclosure against                                                             and use of funds raised which
                                             recent collapses investigations into which
benchmarks is required to be made in the                                                          addresses the financial position of the
                                             have revealed some issues surrounding
PDS, in ongoing disclosures as material                                                           responsible entity and how the funds
                                             disclosure to investors in these schemes.
changes occur and supported in, and not                                                           raised will be used
undermined by, advertising material.         ASIC has developed 10 benchmarks with
                                                                                              •   Qualifications of experts which
                                             respect to which ASIC expects agribusiness
The 7 benchmark categories are:                                                                   addresses the independence and
                                             MIS operators to comply and to disclose
                                                                                                  relevant qualifications of the experts
                                             against the benchmarks on an “if not,
•   Corporate structure and                                                                       engaged by the responsible entity
                                             why not basis. However the “if not, why
                                             not” approach does not require that a            •   Related party issues which addresses
•   Funding                                  benchmark be complied with but does                  how the responsible entity uses
                                             require the product issuer to explain why            related parties to provide services to
•   Assumptions and sensitivity analysis     the benchmark is not complied with.                  the agribusiness MIS and the process
                                                                                                  by which entities are appointed to
•   Valuation policy                         The 10 Benchmarks are:
                                                                                                  provide these services
•   Distribution policy                      •   Fee structures namely how the
                                                                                              •   Land, licences and water-related
                                                 responsible entity structures the fees
•   Withdrawal policy                                                                             issues which addresses ownership of
                                                 it charges members of the agribusiness
                                                                                                  land, licences and water to be used
•   Portfolio diversification                    MIS
                                                                                                  by the agribusiness MIS
                                             •   Track record of the responsible entity in
                                                                                              •   Third party financing arrangements
                                                 operating agribusiness MISs namely how
                                                                                                  which addresses the use of third
                                                 successful agribusiness MISs previously
                                                                                                  party finance to fund the payment
                                                 marketed by the responsible entity have
                                                                                                  of fees payable by members of the
                                                                                                  agribusiness MIS
                                             •   Responsible entity or other group
                                                                                              •   Replacement of responsible entity
                                                 company ownership of interests in
                                                                                                  which addresses the risk of the
                                                 scheme namely the initial ownership
                                                                                                  structure of the scheme frustrating
                                                 interest that the responsible entity and
                                                                                                  or preventing the appointment of a
                                                 its related entities intend to have in the
                                                                                                  replacement responsible entity.
                                                 agribusiness MIS                                           5                                                          August 2010
    [ P U B L I C A T I O N                                 N A M E ]

    For further information contact:                                                                                                                  Contact us
    Alan Jessup - Partner
    +61 2 9253 9911                                                                                                                                   Sydney                                                                                                                      Level 23
                                                                                                                                                      Governor Macquarie Tower
                                                                                                                                                      1 Farrer Place
                                                                                                                                                      Sydney NSW 2000
    Dahnia Mithiran - Senior Associate                                                                                                                DX 10216, Sydney Stock Exchange
                                                                                                                                                      t + 61 2 9253 9999
    +61 2 9253 9986                                                                                                                                   f + 61 2 9253 9900
    Aaron Chan - Associate                                                                                                                            Level 24
                                                                                                                                                      385 Bourke Street
    +61 2 9253 9988                                                                                                                                   Melbourne VIC 3000                                                                                                                        GPO Box 2105
                                                                                                                                                      Melbourne VIC 3001
                                                                                                                                                      DX 30829, Collins Street
                                                                                                                                                      t + 61 3 8665 5555
                                                                                                                                                      f + 61 3 8665 5500

                                                                                                                                                      Level 9
                                                                                                                                                      239 George Street
                                                                                                                                                      Brisbane QLD 4000
                                                                                                                                                      GPO Box 3134
                                                                                                                                                      Brisbane QLD 4001
                                                                                                                                                      DX 105, Brisbane
                                                                                                                                                      t + 61 7 3220 7777
                                                                                                                                                      f + 61 7 3220 7700

                                                                                                                                                      167 Flinders Street
                                                                                                                                                      Adelaide SA 5000
                                                                                                                                                      GPO Box 65
                                                                                                                                                      Adelaide SA 5001
                                                                                                                                                      DX 102, Adelaide
                                                                                                                                                      t + 61 8 8205 3333
                                                                                                                                                      f + 61 8 8205 3300


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or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions
resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. PB005 0810

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