Vol 8 (2011) - Issue 5

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Insolvent Unit Trusts in Australia

The Australian unit trust industry recently experienced financial difficulties. The formal legal process of handling those difficulties has revealed gaps in the Australian regulatory map. This article highlights some of those problems and the government’s response to them.


Background

It is not yet clear whether the sector’s current problems arise from the GFC or whether (and to what degree) they are the result of purely domestic factors. In respect of the latter issue, it is possibly relevant that Australia has, since the mid-1980s, been moving its retirement incomes policy from a largely State-funded one to one in which retirees are encouraged to fund their own retirement, with the state’s resources being reserved for a social safety net. The result has been a significant expansion of retail (or 'Mum and Dad') investment activity, either directly or through the medium of private sector pension funds.

One thing which is clear is that one segment of the sector has been noticeably affected by financial stress: agricultural unit trust schemes. These involve the vending of financial interests in agribusinesses.

As the cases discussed below show, the collapse of these schemes has shown that there are gaps in the Australian regulatory regime for handling the insolvency of unit trusts in general. This is surprising, because the statutory requirements for unit trusts were completely rewritten in 1998, largely in response to the near collapse of the unlisted property trust segment of the unit trust industry in 1991. That statutory regime was extensively reviewed and given a clean bill of health in 2001.

Despite this, the current round of collapses has seen a major increase in litigation in the sector, as liquidators seek court directions on the performance of their duties.

The single responsible entity model

To some degree, the problems arise from the statutory model for unit trusts.

Until the 1998 amendments, unit trusts operated on a system of split responsibility. A trustee held the trust property and a separate manager managed the trust business. As well as holding the trust property, the trustee was responsible for ensuring that the scheme manager properly discharged its duties.

A key change in 1998 was the formal abolition of the split between trustees and scheme managers. In a strictly legal sense, the trustee and scheme manager were abolished and replaced by a single 'responsible entity'. The objective was to overcome the possibility of a 'responsibility gap' between trustees and scheme managers, which could result in defaults in the operation of the trusts. A less important change was the rebranding of unit trusts as 'managed investment schemes'. As a matter of practice, responsible entities are now commonly referred to as 'REs' and managed investment schemes as 'MISs' (a convention which will be followed in this article).

Despite the fact that it is not required by statute, most MISs are structured as trusts. The RE holds the scheme assets on trust and is liable to investors for the operation of the scheme. However, it is common for the management function to be outsourced (although ultimate responsibility remains with the RE).

Chapter 5C of the Corporations Act 2001 (Cth) contains the main provisions governing MISs. Only seven of the 68 sections in Ch 5C deal with insolvency. They effectively provide that a MIS can be wound up in accordance with its constitution (if the constitution contains such provisions) or by order of a court.

The recent round of litigation arising from the collapses of schemes has showed that the legislation does not satisfactorily answer two questions:

– who should actually liquidate an insolvent MIS?

– who should pay for the liquidation?