Heading off member conflict

ROB LAVERY is senior technical manager with knowIt Group.

The interaction between SMSF members can sometimes result in conflict. Rob Lavery examines this issue and courses of action that can be taken to avoid these situations.

The rules governing the membership of an SMSF are fairly straightforward – all members must be trustees or directors of the trustee company if the fund has a corporate trustee. The rules are slightly different for single-members.

It is the simplicity of an SMSF’s governance structure that leaves it uniquely exposed to the very human issue of conflict. With the prospect of six-member SMSFs once again on the legislative agenda, the likelihood of conflict between trustees is only increasing. So why is conflict likely to arise between SMSF members and how can members and their advisers set up SMSFs to minimise the risks?

Conflict often arises from issues outside the SMSF

It is common for conflict that arises in an SMSF to originate from issues between the trustees outside the fund. From this standpoint, an SMSF created as an extension of an existing relationship, such as one based around a jointly held business, is oft en more prone to conflict between the fund’s trustees.

Dunstone v Irving

In the Victorian Supreme Court case of Dunstone v Irving, a dispute between the fund’s trustees had its origins in a business owned by those trustees. As noted in the ruling:

“The dispute arose as a result of the plaintiff’s (Dunstone) departure at the end of the 1997 calendar year from a construction and development business that the plaintiff and defendant (Irving) jointly operated. The plaintiff wished to roll over his entitlements into another superannuation fund. At the time the fund contained approximately $2.1 million. The plaintiff claimed he was entitled to about $1.3 million, an amount derived in essence from his annual member’s statements. The defendant claimed that the fund should be divided equally. He later also claimed that allowance should be made for certain tax liabilities.”

The defendant, Irving, claimed he and Dunstone had agreed to equalise the benefits drawn from their jointly held business. Superannuation contributions formed part of these benefits to be equalised. Irving extended this unwritten agreement to mean that the benefits payable from their SMSF could be amended to ensure this equalisation. Ultimately, the judge did not agree with Irving and Dunstone remained entitled to his larger portion of the SMSF’s assets.

It also emerged the fund was actually a trading arm of a property development group – in substance the fund was nothing more than a serial property developer and the assets were held mostly in cash to enable the fund to carry out such developments. All in all, it was clearly not in the interests of the members for this matter to be publicly litigated and hence drawn to the attention of the ATO.

The lessons from Dunstone v Irving

Section 17A of the Superannuation Industry (Supervision) (SIS) Act only requires that no member may be an employee of another fund member, unless they are relatives. It does, however, mean business partners, friends and in-laws can join or form an SMSF as long as the maximum fund membership is not exceeded.

While an SMSF can contain business partners and friends, Dunstone v Irving demonstrates it may be a better strategy to confine membership to the immediate family to prevent, or at least limit, the possibility of problems in the future should business relationships turn sour. One lesson the case clearly outlines is that an SMSF should not form part of a business agreement, particularly where the agreement is potentially in conflict with superannuation and trust law.

Dunstone and Irving would have been better off forming their own separate SMSFs and creating a separate nonsuperannuation-funded mechanism for ensuring the benefits each claimed from their business were equal.

When relationships break down

As mentioned above, when relationships between trustees break down, difficult situations can be limited by keeping membership of an SMSF within the immediate family. That said, keeping the fund in the family is not a cure-all for avoiding conflict as was demonstrated in another court case.

Notaras v Notaras

In the New South Wales Supreme Court case Notaras v Notaras, the plaintiff, Basil Notaras, and the defendant, Brinos Notaras, were brothers and the only two members and trustees of an SMSF called the Saraton Superannuation Fund.

Basil sought to remove Brinos as trustee of the fund on the following grounds:

• Brinos sold the fund’s shares and withdrew the proceeds from two bank accounts without consulting his cotrustee (Basil),

• the total amount Brinos had withdrawn was more than he was entitled to as a member of the fund,

• failure to take part in the management of the fund and refusal to sign documents (tax returns and member statements) had placed the trustees in breach of the SIS Act, and

• since the withdrawal, Brinos had a nominal interest in the fund.

As a result of the breaches, the Supreme Court concluded Brinos could be removed as trustee and replaced as trustee under section 70 of the Trustee Act 1925 (NSW).

The replacement trustee was a company, Bazport Pty Ltd, controlled by Basil. The presiding judge, Justice Nigel Rein, commented that to appoint a corporate trustee with such a close connection to Basil would not be appropriate, but under the circumstances, where only Basil had a financial interest as a member of the fund, it was not inappropriate, because Brinos’s interest as a member was nominal only.

It is common for conflict that arises in an SMSF to originate from issues between the trustees outside the fund.

Lessons to be learned from Notaras v Notaras

The Notaras v Notaras case highlights several issues for consideration by both SMSF trustees and their advisers.

An initial source of friction between the brothers was a disagreement over a family-owned property in Maroubra, Sydney – once again, the origin of the conflict was not directly related to the fund itself. Shared business or investment interests within a family are not always a good reason for establishing an SMSF and should be evaluated against a broader range of considerations, such as fund purpose, skills, time and expertise of the participants, as well as having sufficient assets.

In the event of a relationship breakdown between trustees, the trust deed should be a source of guidance as to how decisions can be made in an alternative manner, as well removing and appointing a trustee. This is easier said than done in cases where funds have more than one member as the requirement that all members be trustees cannot be ignored just because one trustee has fallen out of favour. The ability to weight voting rights via the trust deed, or the use of a corporate trustee, may help avoid situations reaching the boiling point seen in Notaras v Notaras.

Justice Rein also commented that attempts had been made to have tax returns and member statements finalised in 2011, but none had been completed since 2008. Thereafter, “no further steps were taken in relation to the finalisation of tax returns and member statements, with a consequence that the trustees of the fund had put themselves in breach of the (SIS) Act”. The lack of understanding by the trustees as to their duties demonstrates the need for SMSF trustees to have capable professionals, such as financial advisers and accountants, on whose advice they can rely.

Blended families invite even greater risk

The failure of jointly owned investments or business ventures are not the only sources of conflict in an SMSF. Situations where there are blended families or multiple children by multiple former or current spouses can be just as prone to conflict.

Marsella v Wareham (No 2)

In the Victorian Supreme Court case Marsella v Wareham (No 2), the children from an SMSF member’s first marriage had to be removed as trustees of the fund.

If thought and effort are not put in ahead of time to prevent conflict, issues can fester and the likely result is a trip to court for the warring trustees.

The SMSF, the Swanston Superannuation Fund, had only one member, Helen Marsella. The fund’s second trustee was the member’s daughter by her first marriage, Caroline Wareham. Upon the death of Marsella, Wareham appointed her brother as the second trustee of the SMSF and paid out the entirety of her mother’s death benefit to herself.

Marsella had no valid death benefit nomination in her SMSF. She had made a nomination more than a decade before her death, however, it nominated her grandchildren as beneficiaries and they were not permissible dependants under superannuation law. When she died, Marsella had a number of potential dependants, including her second husband, her children from her first marriage and her estate. The fund’s trust deed considered the fund’s “beneficiaries” to include dependants with “a mere expectancy to receive payment of a benefit entitlement”. Her will provided specific bequests to her second husband, her children from her first marriage, largely assets acquired from the estate of their father, and cash bequests to her grandchildren.

The court ultimately ruled Wareham and her brother be removed as trustees of the Swanston Superannuation Fund as they had not given genuine consideration to all the beneficiaries of the fund.

Lessons to be learned from Wareham v Marsella (No 2)

Marsella’s SMSF failed to prevent conflict in two major areas:

1. There were no clear instructions relating to payment of her death benefit, and

2. A trustee with a conflict of interest was appointed.

Had the fund’s only member provided clear and binding instructions on the payment of their death benefit, the surviving trustee would not have had any ability to exercise their discretion. A clear, valid death benefit nomination and well-considered trust deed wording are essential in preventing the most common superannuation conflict, that relating to death benefits.

The other issue relates to the member’s choice of a second trustee in a single-member SMSF. While it is hard to know whether there was evidence of conflict between Marsella’s second husband and the children from her first marriage before her death, it should not be surprising that the death of a loved one can heighten any discord between such parties. The fund’s member would have been well advised to engage a second trustee who was not a potential beneficiary upon her death, or using a corporate trustee with provisions in place for unbiased decision-making after her death.

Choose fund members and trustees carefully

Most conflicts between trustees are preventable. By carefully choosing the SMSF’s members and trustees, choosing a deliberately worded and frequently reviewed trust deed and engaging capable professionals, SMSF members can head off conflict before it overwhelms the fund.

If thought and effort are not put in ahead of time to prevent conflict, issues can fester and the likely result is a trip to court for the warring trustees. It is much easier to head off potential conflict ahead of time than it is to stop it once the fights commence.