Redeeming not withdrawing from a fund: Member exits via High Court

Summary

In MacarthurCook Fund Management Ltd v TFML Limited, the High Court unanimously held that a compulsory redemption of a member’s interest in a managed investment scheme (Fund) by the responsible entity does not constitute a withdrawal from that scheme under Part 5C.6 of the Corporations Act 2001 (Cth) (Corporations Act).

Despite the responsible entity suspending withdrawals in the illiquid Fund, the High Court held that the member was entitled to enforce the terms of their subscription agreement with the responsible entity and require the responsible entity to redeem their interests in the Fund at the agreed redemption price which significantly exceed the current value of the interests.

Background

RFML Ltd (RFML) was the responsible entity of the Fund, an unlisted unit trust which was a registered managed investment scheme pursuant to Chapter 5C of the Corporations Act.

MacarthurCook Fund Management Limited (MacarthurCook) agreed to subscribe for 15 million “Subscription Units” at $1 per unit by entering into three subscription agreements, which all provided that:

“Subject to compliance with any requirements under the Corporations Act and the [Fund] Constitution, during the Subscription Period, Subscription Units held by MacarthurCook must be redeemed by [RFML] for their Issue Price, using funds received by the [Fund] as a result of accepted applications under the [public offer], such redemptions commencing six months from the Subscription Date.” (Redemption Clause)

The Subscription Period was defined to mean a period of 12 months from the Subscription Date for the Subscription Units. The Subscription Date was 1 November 2007 for one tranche of Subscription Units and 3 December 2007 for the remaining tranches.

The Subscription Units constituted a separate class of units of which MacarthurCook was the only holder.

By 29 September 2008, the Fund had received proceeds totalling $12,347,079 as a result of the public offer. However RFML did not redeem any of the Subscription Units and indefinitely suspended all withdrawals from the Fund at that time. TFML Limited (TFML) replaced RFML as the new responsible entity of the Fund and assumed all the rights, obligations and liabilities of RFML.

MacarthurCook commenced proceedings against RFML and TFML alleging breach of contract arising from its failure to redeem the Subscription Units in accordance with the terms of their issue. The value of the approximately 12 million Subscription Units which RFML could have redeemed with the proceeds of the public offer had decreased to approximately $1.5 million.

The key issue turned upon whether the withdrawal provisions in Part 5C.6 of the Corporations Act applied to the redemption of MacarthurCook’s Subscription Units and if so, the implication of applying Part 5C.6 to the terms of the issue of the Subscription Units.

MacarthurCook succeeded at first instance, with the primary judge holding that the withdrawal provisions in the Corporations Act applied to the redemption. The primary judge held that the responsible entity had complied with the ‘requirements under the Corporations Act and the Constitution’ and therefore was in breach of its obligations under the Redemption Clause. The decision was reversed on appeal. Although the Court of Appeal held that the withdrawal provisions applied to the redemption, the Court of Appeal found that RFML did not comply with the requirements under the Corporations Act or the constitution in respect of the redemption. Accordingly, the Court of Appeal concluded that RFML did not breach the Redemption Clause in failing to redeem.

MacarthurCook subsequently appealed to the High Court.

Distinction between redemption and withdrawal

MacarthurCook argued that Part 5C.6 of the Corporations Act did not apply to the redemption of the Subscription Units as it was not a withdrawal from a scheme within the provision’s meaning.  MacarthurCook submitted there was no lawful excuse for RFML not to redeem its units in accordance with the terms of issue.

TFML argued that the Court of Appeal’s reasoning was correct. Interestingly, TFML also argued that even if the withdrawal procedure was complied with, TFML would have breached its duty to act in the best interests of unitholders by redeeming the Subscription Units after suspending withdrawals. The High Court refused to consider this argument, as it had not been raised at first instance.

Although the High Court held that TFML was in breach of its obligation to redeem the Subscription Units, its reasoning differed from the reasoning of both the Supreme Court and the Court of Appeal. Contrary to the Supreme Court and Court of Appeal, the High Court held that Part 5C.6 of the Corporations Act did not apply to the redemption of the Subscription Units.

The High Court held that there was a distinction between a member requesting withdrawal and the responsible entity’s separate contractual obligation to redeem a member’s interests as part of the terms of the issue.

The High Court stated that a withdrawal from a scheme within the meaning of Part 5C.6 of the Corporations Act ‘involves some act of volition on the part of the member’. This interpretation was supported by various features in Part 5C.6, such as references to a member’s ‘right to withdraw’, how the right ‘may be exercised’, and procedures to make a ‘withdrawal request’.  The High Court also gave significant weight to the joint report by the Australian Law Reform Commission and the Companies and Securities Advisory Committee published in 1993 (ALRC Review), which preceded the enactment of the legislative provisions. In respect of withdrawal rights, the ALRC Review identified issues associated with members exercising a choice to exit a scheme, not problems associated with members exiting a scheme otherwise than through the exercise of choice, even when the scheme is not liquid.

Accordingly, the High Court held the redemption of MacarthurCook’s Subscription Units by RFML in accordance with the terms of their issue did not constitute a withdrawal as MacarthurCook exercised no choice in the matter.  Part 5C.6 of the Corporations Act had no application and TFML was obliged to redeem the Subscription Units by paying the public offer proceeds it had received from the Subscription Date.

Implications

When subscribing for interests, members may be able to negotiate contractual redemption rights in addition to the statutory right of members to withdraw from the scheme in accordance with the Corporations Act and the scheme constitution. These may function as alternatives to underwriting arrangements or other equity funding arrangements. However, in entering into these arrangements, the responsible entity should be cognisant of its duties to act in the best interests of members, to treat all members of a class equally and to treat members of a different class fairly in entering into such redemption arrangements and when redeeming member’s interests. Responsible entities should consider the structure of such redemption arrangements so that they comply with their statutory and general law duties.

Where an obligation to redeem a member’s interests arises as a term of the issue of the interests, the responsible entity may not be able to suspend its obligation to redeem in the same way that it is able to suspend its obligation to offer withdrawal rights to members if adverse market conditions arose.

Accordingly, when drafting redemption clauses, the responsible entity must be aware that that the terms of redemption, such as the redemption price and period, may operate in a wide range of potential market conditions.

Hall & Wilcox has experience in advising on novel liquidity solutions for various funds.