A radical SMSF approach – part two

Grant Abbott - director of I Love SMSF - continues to examine the possibility of having a multiple member SMSF with a single trustee structure in the second part of this series.

In the first part of my three-part series on a new radical way of running an SMSF I looked at the responsibilities of being a trustee. My argument is that, as advisers, we have been cavalier in setting up SMSFs where all members are trustees or directors of a corporate trustee. For many members, well advanced in age or lacking moderate financial and management skills, the role of trustee is an extremely high competency bar to attain. After all, consider your existing SMSF clients – how would they go sitting a basic SMSF trustee test?

The main focus in the first part was on the financial perils of being a trustee and to that end we looked at section 166(1) of the Superannuation Industry (Supervision) (SIS) Act 1993 and also the commissioner of taxation’s statement on the impact of the section: Practice Statement Law Administration (PSLA) 2020/3 – Self-managed superannuation funds – administrative penalties imposed under subsection 166(1) of the SIS Act.

In PSLA 2020/3, the tax commissioner noted that, quite apart from set administrative fines, that he could also use the following: • issuing a direction to educate, • accepting an enforceable undertaking, • issuing a direction to rectify, • disqualifying an individual and prohibiting them from acting as a trustee of a super fund or as a responsible officer of a corporate trustee of a super fund, • issuing a notice of non-compliance to the fund, and • seeking civil and/or criminal penalties through the courts.

These actions by the commissioner are significant, but can also lead to member compensation laws that catch advisers, auditors and accountants in the compensation for loss or damages trap.

Legal actions brought by members

One of the first things I teach any student is the statutory right to be sued by members of an SMSF where the individual has made a loss as a result of a breach of the laws or fund trust deed by the trustee or their adviser, auditor and/or accountant. I bring the accountants and advisers into the equation because advising on SMSFs is not just all upside – there are plenty of risks as auditors have found out in the last couple of years through negligence actions via the law of equity (a non-statutory law).

It is important to note if you are an SMSF adviser, auditor or administrator, the following legal analysis is probably the most important area under the SIS Act and one that can cause the downfall of an SMSF and all its advisers in quick fashion. So commit the following to heart and make sure all your assets are protected.

Section 54C of the SIS Act deals with a breach of the governing rules of a superannuation fund, including an SMSF. The section provides: (1) A person must not contravene any other covenant contained, or taken to be contained, in the governing rules of a superannuation entity.

This section, designed to safeguard members’ interests in a superannuation fund, is cast wide such that a person (not just the trustee) who must not contravene the governing rules of a superannuation entity would include: • fund trustee, • auditor to the fund, • fund administrator, • legal adviser to the trustee of the fund, • fund insurance agent, • commissioner of taxation, • Australian Securities and Investments Commission representative, • fund accountant, • Australian financial services licensee.

Again, it is important to acknowledge the section applies to a person and not just the trustee. For example, if the trustee of an industry super fund refused to transfer superannuation benefits in a timely manner in accordance with its trust deed, then the directors of the corporate trustee are personally liable and can be sued jointly and severally.

What are the governing rules?

Section 10(1) of the SIS Act provides that governing rules in relation to a fund, scheme or trust means: a. any rules contained in a trust instrument, other document or legislation, or combination of them, or b. any unwritten rules governing the establishment or operation of the fund, scheme or trust.

This means all the provisions of the deed form part of the governing rules of the SMSF. It also includes other documentation regarding the establishment and operation of the fund, including the establishment of a member interest, the commencement of a pension, the creation of an investment strategy, contributions minutes, the investment strategy, the valuation of assets of the fund, binding death benefit nominations (BDBN) and so on.

Application of the law

To see the section in action, let’s look at the issue of investment strategies, which are currently the subject of much discussion by the ATO and auditors alike.

First off, we know the investment strategy of the SMSF forms part of the fund’s governing rules either directly through the fund’s trust deed or the deemed inclusion of fund investment strategy requirements under section 52B(2)(f) of the SIS Act. Importantly, if the investment strategy is not followed, then there is a breach of section 54C of the act. Likewise, if the accountant to the SMSF completes an investment strategy that provides for a 0 per cent to 100 per cent allocation to various asset classes, which does not constitute an investment strategy (see the tax commissioner’s public guidelines), then the trustee and accountant will be in breach of section 54C. This can include the SMSF auditor as well if they do not recognise this as a contravention.

Getting down into the weeds a bit further, consider an investment strategy that provides for 60 per cent to 80 per cent of the SMSF’s investments to be in equities and 30 per cent to 40 per cent allocated to cash. Now if the fund trustee sells the equity portfolio down to purchase residential property, without amending the investment strategy, then a breach of the governing rules will have taken place.

Likewise, if the trust deed of the fund is old and only allows an allocated pension to be taken by a member under SIS Regulation 1.06(4), and this could apply to all deeds drafted before 2007, then the payment of an account-based pension under SIS Regulation 1.06(9) would breach the governing rules of the fund, notwithstanding that it is allowed under the superannuation laws. The action would contravene the SMSF deed and that is a section 54C breach.

Further, if the SMSF trust deed provides that any BDBN must be in accordance with the SIS Act, as the rules relating to BDBNs in section 59 do not apply to SMSFs, then if the fund is a regulated SMSF, the nomination cannot be binding. The deed would need to have its own policy on what is an effective BDBN. No policy and no binding nomination.

Now comes the fun part – who can get sued, who can be a party to the suit and for how much?

Section 55(3) of the SIS Act is pivotal and provides as follows (3) Subject to subsection (4A), a person who suffers loss or damage as a result of conduct of another person that was engaged in in contravention of subsection 54B(1), 54B(2) or 54C(1) may recover the amount of the loss or damage by action against that other person or against any person involved in the contravention.

The three keys are: 1. A person (see above) has contravened section 54C by breaching the fund’s deed, documents relating to the fund, such as pensions, investment strategies, death benefit nominations or the laws relating to SMSFs. 2. A person has suffered a loss or damages because of the breach by the person in 1 above. 3. The person suffering the loss has standing under the SIS Act (a statutory action) to commence an action to recover those losses and damages, which will need to be ascertained by a court of competent jurisdiction.

It must be recognised this is not a negligence claim and there is no defence. Simply show someone, be it a trustee, accountant, auditor or lawyer, has breached the fund’s governing rules and that your client has suffered a loss as a consequence of the breach and then head to court to recover the loss or damages suffered. Deadly simple in its perfection.

Section 55(3) of the act showed up in Dunstone v Irving [2000] VSC 288. In that case, the plaintiff Dunstone was suing the trustees of the fund for not paying his superannuation benefits as required under the fund’s deed. His business partner, Irving, was upset Dunstone’s super balance was twice the size of his. The case found its way to the Supreme Court of Victoria 20 months after the request for payment of superannuation benefits was made, thereby depriving Dunstone of his superannuation monies for the period, as well as any investment gains over the deprivation period.

Justice Hansen in his judgment noted:

"141. The plaintiff sought a declaration as to his entitlement in the fund and it is appropriate to grant it. That was $1,365,478 as at 23 February 1998.

"142. In view of the history of this matter I will also order that within a limited period, which Mr Garde suggested be in the order of 30 days, the defendant do all things necessary to effect a transfer to or at the direction of the plaintiff of the amount to which he is entitled.

"143. The other aspect of relief is a claim for damages, being the loss suffered by the plaintiff as a result of not having the use of his entitlement. The plaintiff sought damages either under s 55(3) of the SIS Act or on account of the defendant’s breach of his obligations as trustee. Mr Berglund did not address a submission as to the basis on which damages, or an award of compensation in equity for a breach of trust, might be awarded, and in view of the conclusions I have reached it is unnecessary to do so. I have accepted the evidence of the expert Romic in relation to calculations.

"I also accept his opinion that, in effect, $1,614,340 is a conservative estimate of what the plaintiff’s entitlement would be worth as at 30 April 2000. This amount, being what the plaintiff would have obtained in a balanced fund, is less than the $1,692,974 he would have achieved if he invested the entitlement as he stated he would have, but in my observation the plaintiff is a cautious man and the return from investment in a balanced fund is more reflective of the likelihood of investment he would have made."

Given all of the above, is there any wonder a member of an SMSF might be reluctant to take on the responsibilities of acting as a trustee as well. However, section 17A(3) of the SIS Act provides an opportunity to avoid these potential trustee pitfalls and presents a path to the new way of running an SMSF. This will be covered in the next part of this series.

Legal actions brought by members One of the first things I teach any student is the statutory right to be sued by members of an SMSF where the individual has made a loss as a result of a breach of the laws or fund trust deed by the trustee or their adviser, auditor and/or accountant. I bring the accountants and advisers into the equation because advising on SMSFs is not just all upside – there are plenty of risks as auditors have found out in the last couple of years through negligence actions via the law of equity (a non-statutory law).