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Companies and Securities Advisory Committee
Report to the Minister for Financial Services and Regulation
Liability of Members of Managed Investment Schemes
Liability of members of managed investment schemes
Request from the Minister
By letter of 28 June 1999, the Minister for Financial Services and Regulation,
The Hon Joe Hockey MP, requested the Advisory Committee's advice on the
liability of members of managed investment schemes.
The Minister pointed out that, during the Senate debate on the Managed Investments
Bill in June 1998, the Australian Democrats proposed the following amendment
to the Bill to limit the liability of scheme members:
This compares with s 516 of the Corporations Law which provides that in
a corporate liquidation:
In August 1984, the Companies and Securities Law Review Committee (CSLRC) wrote
to the then Ministerial Council requesting a legislative amendment to limit
the liability of all unitholders in public unit trusts, in a similar manner
to what is now found in s 516 of the Corporations Law.
The CSLRC pointed out that the investing public sees the purchase of units
in a public unit trust as analogous to the purchase of shares in a limited liability
company and generally assumes that the limited liability that attaches to shares
in such companies applies equally to units. However, under trust law, each beneficiary
may be proportionately liable to indemnify the trustee (and indirectly the creditors
through their subrogation rights) for any liabilities which are incurred by
that trustee in the exercise of its powers and which could not be met from the
assets of the trust, unless that right of indemnity has been expressly excluded
by the trust deed.1
The CSLRC also recommended that trustees or management companies be obliged
to notify third parties that members of unit trusts have limited liability.
The Ministerial Council subsequently considered the matter. There was some
support for the proposal, based on the analogy between unitholders in a public
unit trust and shareholders in a limited liability company. Those opposing the
amendment argued that the statutory limited liability protection could come
at the expense of innocent third parties. They gave the example of investors
in a timesharing development being preferred over private contractors employed
by the management company to refurbish the premises. They argued that any unitholder
liability should be left to the drafting of particular trust deeds (which might,
for instance, specifically ensure that the rights of the trustee, and therefore
the subrogated rights of creditors, do not extend beyond the assets of the trust).
The legislation could also be amended to oblige promoters to indicate in the
prospectus whether unitholders could be liable under the terms of the particular
In consequence of this difference of view in the Ministerial Council, the CSLRC
proposal was not adopted. Instead, the Ministerial Council decided to defer
the matter pending any judicial decision that directly imposed liability on
unitholders in a public unit trust. The Ministerial Council did not subsequently
consider the matter.
The Harmer Insolvency Report
The Australian Law Reform Commission (ALRC) Insolvency Report (1988)
considered the matter from a different perspective from the CSLRC, namely whether
to exclude the common law right to draft trust deeds to limit the potential
liability of beneficiaries.
The argument put forward in those submissions that supported excluding that
right was that beneficiaries who had gained financially through a trading trust
should have to provide some compensation to creditors if that trust became insolvent.
However, most submissions opposed that common law right being excluded. They
pointed out that beneficiaries, in that capacity, have little, if any, influence
or control over a trustee and thus should not be held personally responsible
for debts incurred by the trustee. These beneficiaries were analogous to shareholders
in limited liability companies.
The ALRC recommended that the common law rights of a beneficiary to have personal
liability excluded under the terms of a trust deed should not be removed.
Collective Investments Review
The ALRC and the Advisory Committee conducted a joint Collective Investments
Review from 1991 to 1993. The Review concluded that it would be unsatisfactory
for the potential liability of investors in public investment vehicles such
as collective investments to depend on the drafting of an individual deed or
constituent document. The Review recommended a statutory provision to ensure
that investors in collective investment [managed investment] schemes have no
personal obligation to indemnify the responsible entity or a scheme creditor
where scheme assets are insufficient to cover scheme debts. Investors' liability
should be limited to any amount unpaid on their investment in the scheme. Submissions
on this matter strongly supported this policy.2
Advisory Committee analysis
In preparing this Report, the Advisory Committee sought the advice of its expert
Legal Committee. It also sought comments from the Investment and Financial Services
Association (IFSA) and the Managed Investments Industry Association. Both Associations
supported the principle of statutory limited liability.
The Committee thanks Pamela Hanrahan, Senior Lecturer in Law, University of
Melbourne and Special Counsel, Arthur Robinson & Hedderwicks, for her very
useful comments on an earlier draft of this Report.
The need for law reform
The Advisory Committee considers that the common law creates some uncertainty
about when, and how, it is possible to ensure that investors in managed investment
schemes are protected against unlimited liability. This legal uncertainty is
not in the interests of creditors or members. Creditors do not currently rely
on having access to the personal wealth of scheme members. This uncertainty
could also increase the costs of fundraising and thereby have a negative impact
on the Australian economy.
The Advisory Committee supports the general principle that passive investors
should have similar protections against liability, whether they invest in managed
investment schemes or in limited liability companies. In many respects, these
investors are already treated in a similar manner under the Corporations Law.3
The question is whether all managed investment schemes should provide limited
liability and in what manner.
Types of schemes
There are various types of managed investment schemes under the Corporations
registered schemes. A scheme must be registered if it has more
than 20 members, is promoted by a person who is in the business of promoting
managed investment schemes or is subject to an ASIC requirement that it be
ASIC-exempt schemes. ASIC may exempt schemes that may otherwise
be required to be registered. ASIC has exercised its power both by class order5
and on a case by case basis6
other unregistered schemes. These schemes are those that do
not require registration because there are fewer than 20 members, or all interests
in the schemes that have been issued are excluded from the fundraising requirements.7
What schemes should have limited liability
There are various rationales for giving limited liability to shareholders of
companies, which apply equally to members of managed investment schemes.
Limited liability encourages the economic activity of companies and schemes
by separating investment and management functions and shielding investors from
any loss in excess of their original contribution. This also decreases the need
for shareholders or members to monitor the managers of entities in which they
invest, given that limited liability shields them from the consequences of the
actions of those managers.
In companies, this separation of functions is achieved by excluding shareholders
from the day-to-day running of the company.8
Similarly, one of the hallmarks of any managed investment scheme is that members
do not have day-to-day control over the operation of the scheme.9
This is an argument for extending limited liability to members of all managed
investment schemes, whether registered or not.
The Advisory Committee considers, however, that any statutory provision granting
limited liability should only apply to registered and ASIC-exempt schemes.
The definition of managed investment scheme contemplates the possibility of
particular members having the right to give directions.10
Limited liability should not shield those members from the consequences of giving
these directions. However, all registered schemes must be operated by a licensed
responsible entity, which must be a public company.11
Any member who is actively involved in controlling the affairs of a managed
investment scheme through the giving of directions could be a "shadow director"
of the responsible entity12 and be subject
to the personal liabilities of a director, for instance, for any insolvent trading
by that responsible entity.13 Therefore,
extending limited liability to members of registered schemes, qua members, would
not create an avenue for those who control these schemes to avoid liability
for their actions.
Members of ASIC-exempt schemes should also have the protection of limited liability.
To exclude these schemes may discourage some schemes from seeking an ASIC exemption.
ASIC could take this factor of limited liability into account when considering
applications for, or the terms of, any exemption.
The Advisory Committee considers that there should be no change to the existing
common law for members of unregistered schemes. These schemes can adopt structures
that do not have a public company responsible entity. However, confining any
statutory limitation on liability to registered schemes and ASIC-exempt schemes
may result in fewer unregistered schemes being floated.
Promoting market efficiency and encouraging investment diversity
Limited liability promotes the liquidity and efficient operation of securities
markets, as the wealth of each shareholder or member in a listed entity is irrelevant
to the trading price of its securities. This allows the securities to be freely
traded, as their price is set by factors other than their owners' wealth.
Limited liability also permits investors to acquire securities in a range of
companies or managed investment schemes. This would be impractical for many
investors if the principle of unlimited liability applied and they could lose
all or most of their personal wealth through failure of one entity in which
These rationales for conferring limited liability on shareholders of companies
apply equally to members of registered and ASIC-exempt managed investment schemes.
Types of member liability
A company limited by shares is formed on the principle that each shareholder
is liable during the life, as well as upon the liquidation, of the company only
for the amount (if any) unpaid on the shares held by that person.14
No further pre-liquidation or post-liquidation liability may be imposed on a
shareholder without that person's consent.15
Members of managed investment schemes have potentially broader liabilities.
Depending on the type of scheme and the terms of its constitution, scheme members
could be liable (in addition to the cost of their units) for:
pre-liquidation liabilities, that is, levies or other payments
imposed during the life of the scheme in accordance with the scheme constitution16
post-liquidation liabilities, that is, debts to scheme creditors
that remain outstanding upon the liquidation of the scheme.
The Advisory Committee considers that there should be no interference with
any right to impose levies, charges or other forms of pre-liquidation liabilities
on scheme members pursuant to a scheme's constitution. Various schemes may depend
on imposing periodic levies or charges to achieve their objectives. Any liability
for these unpaid amounts should remain, even where the scheme subsequently goes
into liquidation. Statutory limited liability for managed investment schemes
should only apply to other debts arising in the context of a scheme's liquidation.
Policy options for introducing limited liability
Managed investment schemes may be structured in various ways, including as
trusts, full or limited partnerships or contractual arrangements. The constitution
of these schemes could take one of four possible approaches to limited liability
in the context of their liquidation:
limited liability schemes, which seek to provide that, upon
the winding up of the scheme, members will have no obligation to contribute
(beyond any capital amount still outstanding on their units)
indeterminate liability schemes, which make no reference to
member liability upon the winding up of the scheme
specific liability schemes, which provide that, upon the winding
up of the scheme, members will have an obligation to contribute in specified
circumstances or pursuant to the exercise of specific powers in the constitution,
but not otherwise
unlimited liability schemes, which, either expressly or by
the inherent nature of the scheme (for instance, a full partnership), provide
that, upon the winding up of the scheme, members shall have unlimited liability
for all the scheme debts not covered by the liquidation of scheme assets.
The Advisory Committee has considered a number of possible alternative statutory
approaches for registered and ASIC-exempt schemes (eligible schemes).
Disclosure obligation only. Under this option, there would
be no statutory provision concerning limited liability for eligible schemes.
Instead, the Corporations Law would oblige the responsible entity to inform
members by an express statement in the constitution, and in any fundraising
document, of the extent to which the scheme into which they are entering gives
members limited liability and how that is achieved. For instance, for eligible
schemes that operate through a trust structure, the terms of the trust deed
may expressly deny the trustee any right of indemnity against the trust beneficiaries.
The effectiveness of any limited liability provision in a scheme constitution
would depend on the drafting of that provision and any relevant common law
principles. Third parties would have to rely on their own interpretation of
any relevant clause to determine their likelihood of recovery against members.
Also, it would be difficult to determine whether or how to impose a disclosure
obligation when interests in managed investment schemes are transferred.
Limited liability if expressly adopted. Under this option,
the Corporations Law would contain a provision conferring limited liability
on members of an eligible scheme on the winding up of that scheme, in the
same manner as shareholders of a company, if the scheme constitution expressly
adopted that provision. This option may be difficult to apply to specific
liability schemes, given that such schemes could at best only partially adopt
limited liability (that is, limited liability in any circumstances not covered
by specific liability).
Limited liability, except to the extent of any contrary scheme
provision. Under this option, the Corporations Law would confer limited
liability on members of an eligible scheme on the winding up of the scheme,
in the same manner as shareholders of a company, except to the extent that
the inherent nature of the scheme (for instance, an ordinary partnership)
or any scheme provision imposes any form of liability on members of the scheme
beyond their initial contribution.
The Advisory Committee supports the third policy option. It gives the greatest
level of protection to passive investors in eligible schemes by ensuring that
they have limited liability unless a scheme inherently precludes limited liability
or specifically chooses to exclude that protection, in whole or part. This statutory
protection should apply to all eligible schemes, whether or not listed on the
ASX. There are many unlisted managed investment schemes involving public participation.
Consequential policy matters
Several consequential policy issues arise for eligible schemes in implementing
the principle of limited liability.
Identifying limited liability schemes
A company limited by shares must have "Limited" or "Ltd"
at the end of its name.17 This informs
both investors and creditors that shareholders in those companies have limited
liability during the life, as well as upon the liquidation, of those companies.
The Advisory Committee considers that schemes that limit the liability of their
members in whole or in part on liquidation should be noted through some appropriate
identifier to be stipulated by the Corporations Law. The aim would be to put
creditors on notice, without attempting to provide detailed information or advice
on the extent of limited liability. This would be in addition to the information
that outsiders, particularly creditors, will be able to obtain through Australian
Business Numbers (ABNs), which all business entities, including schemes, will
be required to have from 1 July 2000.
The Committee also considers that any fundraising document for a managed investment
scheme should indicate prominently the nature of any pre-liquidation or post-liquidation
liabilities of its members.
The constitution of any registered managed investment scheme may be amended
by special resolution of its members.18
The Advisory Committee considers that the members of any eligible scheme should
be permitted, by special resolution, to amend the constitution to increase the
liability of future members and those existing members who consent in writing.19
The Advisory Committee has considered whether an eligible scheme that has specific
liability or unlimited liability provisions should be permitted to reduce or
eliminate that liability for existing and future members. The Committee supports
schemes having this right, subject to approval by scheme members and protection
of existing creditors. This could be achieved through the following procedure:
a special resolution by scheme members to alter the scheme constitution
to reduce or eliminate liability
a statement signed by the directors of the responsible entity setting
out the reasons for their opinion that the reduction or elimination of liability
would not materially prejudice the scheme's creditors, and
approval by ASIC, taking into account the position of creditors.
The Advisory Committee does not support additional requirements such as the
consent of all creditors or leave of the court. These could considerably increase
the cost and time in reducing liability and, in effect, give a veto to any creditor.
However, the Committee considers that the directors of the responsible entity
should be personally liable in the event that creditors are prejudiced by the
reduction or elimination of liability.
Protection of creditors when members withdraw from a scheme
The increasing tendency for managed investment schemes to borrow funds against
scheme assets points to the growing importance of creditor protection.
The Advisory Committee considers that the creditors of managed investment schemes
should be protected through a provision similar to that found for reduction
of capital or buy-backs by companies. Any right of members to withdraw from
a scheme under a withdrawal offer should be made subject to a requirement that
it "does not materially prejudice" the ability of the responsible
entity to pay the existing scheme creditors from the remaining scheme assets
for any debts for which scheme creditors have rights against scheme assets.20
That requirement should apply to any withdrawal offers made after the amending
legislation has come into force.
Creditors of managed investment schemes, like creditors of a company that is
buying back shares, should have the right, where appropriate, to seek an injunction
to prevent a withdrawal offer.21 Likewise,
the directors of a responsible entity should be personally liable if the scheme
is or becomes insolvent in permitting withdrawals by investors.22
However, creditors should not be entitled to pursue former members for return
of funds paid to them in withdrawing from the scheme.
The Advisory Committee considers that this creditor protection provision should
apply to all schemes that permit members to withdraw, whether or not the proposals
for introducing statutory limited liability proceed.
Attached is a letter of advice from Treasury of 2 December 1999 dealing
with the possible tax implications of introducing statutory limited liability.
Recommendation 1. Limited liability of members
The Corporations Law should provide that:
members of all registered managed investment schemes and ASIC-exempt
schemes (eligible schemes) have limited liability for scheme debts that remain
outstanding on the winding up of the scheme, in the same manner as shareholders
of a company limited by shares, except to the extent that the inherent nature
of the scheme or any scheme provision imposes any form of liability on members
of the scheme beyond their initial contribution
eligible schemes that limit the liability of their members in whole
or in part on liquidation should be noted through some appropriate identifier
to be stipulated by the Corporations Law
any fundraising document for an eligible scheme that imposes any form
of liability on members during the life or on the liquidation of a scheme
must prominently note and explain the level of liability
members of an eligible scheme may by special resolution amend its
constitution to increase the liability of future members. Each existing member
should only be bound by that amendment with that person's consent
an eligible scheme may reduce or eliminate the liability of its members
by the following procedure:
a special resolution by scheme members to alter the scheme constitution
to reduce or eliminate liability
a statement signed by the directors of the responsible entity
setting out the reasons for their opinion that the reduction or elimination
of liability would not materially prejudice the scheme's creditors,
approval by ASIC, taking into account the position of creditors
the directors of the responsible entity of an eligible scheme should
be personally liable in the event that creditors are prejudiced by any reduction
or elimination of liability.
Recommendation 2. Withdrawal from a scheme: creditor protection
The Corporations Law should be amended to provide that any right of members
to withdraw from a managed investment scheme under a Part 5C.6 withdrawal
offer is subject to a requirement that it "does not materially prejudice"
the ability of the responsible entity to pay the existing scheme creditors from
the remaining scheme assets for any debts for which scheme creditors have rights
against scheme assets. That requirement should apply to any withdrawal offers
made after the amending legislation has come into force.
Creditors of managed investment schemes should have the right to seek an injunction
to stop a Part 5C.6 withdrawal offer. Also, the directors of a responsible
entity should be personally liable if the scheme is or becomes insolvent in
permitting withdrawals by investors.
1 Hardoon v Belilios  AC 118. The principle
of proportionate liability of beneficiaries was applied in JW Broomhead
(Vic) Pty Ltd (in liq) v JW Broomhead Pty Ltd (1985) 3 ACLC 355,
9 ACLR 593. McLean v Burns Philp Trustee Company Pty Ltd (1985)
9 ACLR 926 also confirmed that the potential personal liability of beneficiaries
for the debts of a trust could be excluded by a clause which limited the trustee's
right of recourse to assets of the trust, except where this would be contrary
to public policy. However, the Court held that a clause in the deed of a public
unit trust which excluded the trustee's right of indemnity against the beneficiaries
was not contrary to public policy.
2 Collective Investments: Other People's Money
vol 1 (1993) para 11.37.
3 For instance, there are parallel provisions for shareholders
and scheme members concerning the conduct of meetings: compare Parts 2G.2
and 2G.3 (shareholder meetings) and Part 2G.4 (meetings of members of registered
managed investment schemes).
4 s 601ED.
5 Examples of schemes exempted from registration by
class order include:
foreign schemes (Policy Statement 136.3)
strata management rights schemes (Policy Statement 140)
managed discretionary accounts (Policy Statement 136.34)
participating property syndicates (Policy Statement 136.34)
some mortgage schemes (Policy Statement 144)
various exemptions carried over from the previous law (Policy Statement 136.46).
6 The case by case exemptions from registration include
"closed prescribed interest schemes" (Policy Statement 135.3 ff)
and instances where there is serious doubt about whether the scheme is a managed
investment scheme (as defined in s 9), but ASIC will grant relief to provide
7 s 601ED.
8 The division of functions between management and
shareholders in corporate decision-making is outlined in Chapter 1 of the
Advisory Committee Discussion Paper Shareholder Participation in the Modern
Listed Public Company (September 1999).
9 Para (a)(iii) of the s 9 definition of
"managed investment scheme" provides that "the members do not
have day-to-day control over the operation of the scheme (whether or not they
have the right to be consulted or to give directions)".
11 s 601FA.
12 The s 9 definition of director includes any
"shadow director", namely any person in accordance with whose instructions
or wishes the directors are accustomed to act.
13 s 588G.
14 s 9 definition of "company limited by
shares". A shareholder could be subject to additional liability under the
terms of a separate contractual arrangement, for instance, a personal guarantee
for debts of a company. However, this is not an exception to the principle of
limited liability, but an example of the right of persons to bind themselves
by separate agreement.
15 For instance, all shareholders of a company limited
by shares or guarantee must approve that company changing to an unlimited liability
company: s 163(2)(c). Also, a shareholder, except by written consent, is
not bound by any modification of the company's constitution that purports to
increase shareholders' liability to contribute to the share capital or otherwise
pay money to the company: s 140(2)(b). Upon liquidation, shareholders need
not contribute more than the amount (if any) unpaid on the shares they hold:
16 The right of a responsible entity to impose levies
on scheme members pursuant to the terms of the scheme constitution is commonplace
in agricultural and various real estate schemes.
17 ss 148, 149.
18 s 601GC(1)(a). The responsible entity may
also amend the constitution where the change would not adversely affect members'
rights: s 601GC(1)(b).
19 cf s 140(2)(b).
20 cf s 256B(1)(b), s 257A(a). In a trust
arrangement, a creditor's right of recovery against scheme assets is through
subrogation to the responsible entity's right of indemnity from the scheme assets.
The responsible entity's indemnity right is regulated by s 601GA(2).
21 cf s 256E referring to s 1324.
22 cf s 256E, referring to ss 588G and 1317H.