Frozen funds and redemption disputes: emerging litigation risks for open-ended MISs
Open-ended managed investment schemes are a cornerstone of Australia's funds industry, often advertising periodic redemption windows while deploying capital into assets that may not be readily realisable.
Increasing scrutiny is being placed on whether liquidity arrangements and investor expectations are aligned, especially in sectors such as private credit. The private credit market has surged to over $200 billion in assets under management, while it is only recently experiencing its first significant credit cycle stress, bringing these issues in focus.
Here we explore the emerging litigation risks that face open-ended fund operators when redemption requests are suspended.
Need to know
A managed investment scheme is only considered liquid if at least 80 per cent of its assets are realisable at market value within the timeframe set by its constitution to satisfy withdrawal requests. If the scheme is not liquid, members can only exit through a formal withdrawal offer under the Corporations Act.
ASIC's recent surveillance found that just two out of eight wholesale private credit funds performed stress testing as part of their liquidity risk management.
When redemptions are suspended, responsible entities (REs) may face potential claims for misleading disclosure, breach of the duty to act in members' best interests, and unfair treatment of exiting versus remaining investors.
Practical steps REs can take include regularly stress testing liquidity, ensuring clear and accurate disclosures, maintaining robust asset valuation processes, and actively communicating with investors regarding redemption arrangements and potential risks.
The RE's ongoing duties during a freeze
A freeze on redemptions does not suspend the RE’s obligations. The RE must continue to exercise its powers in the best interests of members under section 601FC(1)(c) and treat members of the same class equally under section 601FC(1)(d).
This creates tension: if the fund allows selective withdrawals just for members suffering financial hardship without relief under ASIC Instrument 2020/778, this will constitute a breach of the Corporations Act. The board must also actively consider whether restructuring or winding up the scheme is in members' best interests, rather than maintaining the freeze indefinitely. For property funds, this may require selling an asset when market conditions are unfavourable, potentially leading to insolvency consequences for the fund or its directors.
Where disputes arise
- Misleading disclosure about liquidity. In Report 820 Private credit surveillance report: Retail and wholesale surveillance (Report 820), ASIC identified that many private credit funds marketed themselves as offering regular redemption windows while investing predominantly in illiquid, long-dated loans. Where a fund promotes periodic liquidity, but its underlying assets have maturities extending well beyond the redemption period, there is a disconnect that could ground a claim for misleading or deceptive conduct. The risk is heightened where ‘as if complete’ property valuations overstate asset realisability. Liquidity windows also occur through periodic capital raises or partial sale of assets. However, if market conditions are uncertain or unfavourable for a sale, then those liquidity windows may not be offered. Disputes also sometimes arise where investors believe an asset should be sold, particularly where the disclosure contains representations on typical hold periods, exposing REs to potential action from unhappy investors.
- Delayed valuations and unfair exit pricing. In Report 820, ASIC found that many funds lacked effective separation between the investment committee approving loans and the representatives responsible for valuing those assets. In one case, a fund delayed marking down a distressed asset by three months after receiving a third-party valuation opinion. Investors who redeemed during the overvaluation period received more than their entitlement, while remaining investors bore a disproportionate loss.
- Distributions paid from capital. In property construction funds, distributions are often paid from investor capital rather than underlying cash flows. Where this is not disclosed and the fund is subsequently frozen, investors may argue reported returns were misleading and they relied on those returns in deciding not to redeem earlier.
Investor remedies
Investors in a frozen fund may pursue statutory compensation under section 601MA for RE conduct contravening the Corporations Act, void their investment contracts under section 601MB where disclosure was materially deficient, seek winding up under section 601ND, or lodge a complaint with the Australian Financial Complaints Authority. They may also pursue other statutory causes of action, such as a claim for misleading or deceptive conduct, and take action under the fund’s constitution, the Trusts Act and general law.
Six practical steps for REs
REs operating open-ended funds should take the following steps:
Stress test liquidity to model scenarios where multiple investors simultaneously request redemptions and asset realisability deteriorates.
Review disclosure to ensure redemption terms, liquidity gates and suspension circumstances are clearly described.
Ensure valuation independence – valuation committees should be separate from investment committees, with policies specifying impairment triggers.
Disclose the source of distributions prominently where they are paid from capital.
Document freeze decisions – the board's deliberations and the basis for the liquidity assessment will be the RE's first line of defence.
Engage with ASIC early about available relief options, including hardship withdrawals.
The regulatory framework governing redemption suspensions is well-established but has not been tested at scale in the current market. REs that can demonstrate rigorous liquidity management, independent valuations, clear disclosure and good faith decision-making will be best placed to defend claims. Those that relied on loose disclosure or delayed valuations may find themselves exposed to investor claims, regulatory action, or both.
If you have any questions about implementing these steps, or require tailored advice on responding to liquidity challenges, please reach out to Elizabeth Vorbach or a member of the HW Funds team. We are ready to assist REs in navigating regulatory obligations and ensuring robust fund management practices.
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