Replaceable rules

7.122  To address some of the challenges of effecting a desired succession in the event of a legal disability, in the Discussion Paper the ALRC asked whether the SIS Act should be amended to set out the steps that are to be taken when a trustee or director of the corporate trustee has suffered a legal disability.^[129] The ALRC considered that these legislative parameters could provide a safety net in the event that the trustee has not already put in place an effective succession plan. This recommendation responds to that question.

7.123  Recommendation 7–2 would provide a mechanism for ensuring that a person’s enduring attorney is able to step in as a trustee/director where this was provided for in the enduring document. It would overcome deficiencies in the trust deed and company constitution that would otherwise prevent the attorney taking that role. It would also override the ability of the remaining trustee(s)/directors to thwart the appointment of the enduring attorney as trustee/director.

7.124  Under the Corporations Act 2001 (Cth) a company may choose how its internal governance structures are derived.^[130] They can be: a constitution; replaceable rules; or a combination of both. A company’s constitution is a contract between: the company and each member; the company and each director; the company and the company secretary, and a member and each other member.

7.125  Replaceable rules are set out in s 141 of the Corporations Act and can be ‘replaced’ by the provisions of a company’s constitution. These 42 rules govern a range of matters relating to how the company:

• appoints and removes its directors;

• passes directors resolutions;

• conducts directors meetings;

• organises members meetings;

• remunerates directors;

• transfers shares; and

• pays dividends.

7.126  Where it is agreed that the replaceable rules will apply in full or in part with respect to a company, the replaceable rules operate contractually in the same way as a constitution. That is, a breach of the replaceable rules gives rise to an action for breach of contract whereby shareholders may seek a court order requiring compliance with any replaceable rules. A breach of the replaceable rules cannot lead to a prosecution for breach of the Corporations Act.

7.127  By drafting Recommendation 7–2 as a ‘replaceable rule’, individual autonomy and choice are retained, as individuals have the ability to ‘replace’ the rule and rely on the primacy of their trust deed/corporate constitution, particularly where those have been drafted as part of complex estate planning arrangements.

7.128  The ‘replaceable rule’ would be subject to the ordinary consent requirements for becoming a director and trustee. That is, the enduring attorney would have to consent to becoming a director/trustee and thus the appointment would not be immediate on the activation of the enduring power of attorney.

7.129  The replaceable rule would apply on the successful application for the fund to become a registered SMSF with the ATO, unless expressly overruled by the provisions of the trust deed and corporate constitution. Appropriate transitional arrangements would need to be in place to enable SMSF trustees and members to consider whether the replaceable rule should apply and, if not, amend their documentation accordingly. The legislation would need to allow, with appropriate safeguards, for SMSF members to alter the fund documentation in the event that all members agree that a change to the applicability of the replaceable rule is required.

7.130  The recommendation would overcome concerns that significant numbers of SMSF are created with off-the-shelf documentation that has not been crafted to meet the estate planning and succession objectives of their members. It would also overcome problems created by the misperception that the law ‘requires’ rather than ‘permits’ an attorney under an enduring power to become a trustee/director. Ultimately, this would address the risk of elder financial abuse where a person other than the attorney, (being the chosen person to manage the older person’s finances on loss of decision-making ability) is able to control the funds in the SMSF.

Balancing prescription with protection

7.131  Recommendation 7–2 strikes a balance between being overly prescriptive in legislation and (limiting the fetter on SMSF trustees) while also offering protection for SMSF members who may not appreciate the complexities of planning for loss of decision-making ability in the context of their SMSF.

7.132  The idea expressed in the Discussion Paper, that the SIS Act should be amended to set out in legislation the steps that are to be taken when a trustee or director of the corporate trustee suffers a legal disability, received mixed views in submissions.

7.133  The GRC Institute supported the proposition that succession events be set out in legislation:

We agree that there should be certain arrangements for loss of capacity. Many modern trust deeds that set up these arrangements do have these provisions, but a modification to the SIS Act incorporating additional clauses in these deeds would be appropriate.^[131]

7.134  Similarly, FINSIA supported the proposition and suggested that ‘[t]his is particularly important for unadvised persons with SMSFs that are using off-the-shelf products’.^[132]

7.135  CPA Australia also offered qualified support noting that there was ‘scope to prescribe certain arrangements for the management of self-managed superannuation funds in the event that a trustee loses capacity’.^[133]

7.136  The need for flexibility was emphasised by the Law Council of Australia:

The Law Council considers that ‘hard wiring’ a particular course of action may be counterproductive and give rise to inappropriate results. For example, a member may have a legal personal representative but there may be reasons why having that person appointed as a trustee or trustee director in place of the member would be inappropriate in the particular circumstances. Equally, the compulsory transfer of a member’s interests might give rise to adverse tax results or might unduly disadvantage the remaining member/s of the self-managed superannuation fund.^[134]

7.137  Similarly, the SMSFA and Financial Planning Association of Australia emphasised the importance of member education rather than prescribing certain succession events in legislation.^[135]

7.138  The ALRC agrees that education and awareness raising are important, but suggests that the complexity in this area may militate against their effectiveness as the only solution. As set out above, the law regarding SMSFs is highly complex and the legal arrangements for succession on suffering a ‘legal disability’ requires careful procedural steps be taken. While many individuals with SMSFs are highly educated and sophisticated investors, and many retain specialist advisers, there are over 1.1 million individuals who are members of an SMSF, suggesting a breadth of financial expertise. Many SMSFs have relatively small balances, suggesting not all SMSFs members would be availing themselves of specialist advice. Accordingly, the ALRC considers that this recommendation strikes the right balance, providing a mechanism to overcome deficiencies in documentation and understanding, while providing freedom to develop sophisticated estate planning strategies.

7.139  The ALRC agrees that a ‘one size fits all’ approach to succession events in the event of a legal disability is inappropriate and undesirable, given the diversity of SMSFs in Australia. As a result, the recommendation is drafted as a ‘replaceable rule’ that provides a simple mechanism for an enduring attorney to step in as trustee/director while retaining the ability of SMSF members to chose alternative courses of action if this would not be a suitable outcome.

7.140  Another reason for drafting the recommendation as a ‘replaceable rule’ is that, while SMSFs are most likely to be funds held by a couple or single member funds, they can be funds with up to five members, who may not be related. In the latter circumstance, the ALRC envisages that the replaceable rule is less likely to be appropriate with members unlikely to accept a situation where, irrespective of the trust deed and corporate constitution, a member’s enduring attorney can step in if a member suffers a legal disability. In such circumstances, it may be that the nature of the contractual and fiduciary relationships are carefully calibrated in the SMSF documentation and the replaceable rule would upset these arrangements. Alternatively, an individual may not wish their enduring attorney to step into that role of director/trustee and wishes to replace the rule and require that their interest in the fund be paid out or transferred to an APRA-regulated fund on loss of decision-making ability.^[136]