Resilience without indemnity

This paper was originally presented to the Law Council of Australia Superannuation Conference in Canberra on 11 March 2022, and has been reproduced with permission.

The financial resilience of trustees of many of Australia’s largest superannuation funds has recently come into focus. Changes to the law came into effect from 1 January 2022 which significantly expanded the prohibitions on a trustee indemnifying itself from the trust assets.

These changes meant that superannuation fund trustees would not have been able to use the trust assets to pay any financial penalty imposed under any law of the Commonwealth.?

Where the superannuation fund was a non-commercial (or profit for member) fund that held all (or most) assets in the trust for the benefit of members, this meant that any financial penalty imposed by the Commonwealth government could have made the trustee insolvent.

As a response to this risk of trustee insolvency (not to be confused with fund insolvency), there were a parade of applications made to Supreme Courts in several states seeking judicial advice or judicial intervention endorsing changes to trust deeds which give trustees the power to remunerate itself, or to pay a fee to itself from the assets of the trust.

There are plenty of important legal and policy implications of these applications and the resulting changes to the landscape for superannuation trustees:

• How do the applications and resulting court opinions reconcile with the changes to the law that came into effect from 1 January?
• What protections will be in place for members?
• Is the profit for member model threatened by these changes?
• Are there limits on a power or right to charge a fee from trust assets?
• Once the fees are deducted, what can they be used for?
• Are capital requirements likely to be mandated on trustees in the near future?
• Are trustees likely to be more willing to seek judicial advice in future? Will courts be willing to provide it?

This also comes at a time where APRA has announced proposed new prudential standards which relate to contingency and resolution planning and released a consultation paper seeking to understand how trustees manage financial resources, the role and use of the operational risk financial requirements (ORFR), reserving practices, and protections afforded via insurance to "inform the need for enhancements to the prudential framework to ensure that trustees prudently manage their financial resilience in the best financial interests of beneficiaries."?

The themes and issues concerning financial resilience of superannuation trustees are illuminated in the decisions that were handed down by the courts in November and December and will undoubtedly inform further policy debate in relation to the financial resilience of the superannuation system. Rather than providing a long list of comprehensive case reviews, this article adopts a thematic approach to considering some of the relevant cases through the lens of the key questions noted above.

Diminishing rights of indemnity

The long-standing general law prohibition on a trustee indemnifying itself from trust assets where there has been a breach of trust has been progressively expanded by a creeping process of statutory reform. Section 56 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) has operated to affirm or protect the right of a superannuation fund to indemnify itself from the fund for liabilities which were not as a result of the trustee’s own dishonest, intentional or reckless conduct (even where there may have been a breach of trust).?

Subsequently, the Treasury Laws Amendment (Improving Accountability and Member Outcomes in Superannuation Measures No. 1) Act 2019?and Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Act 2019?saw civil penalties introduced in relation to the section 52 covenants and existing limitations on a trustee’s right to indemnify itself from trust assets for liabilities extended to civil penalties under the SIS Act.

Most recently, the Financial Sector Reform (Hayne Royal Commission Response) Act of 2020 went further to amend:

• section 56 and 57 of the SIS Act to extend the prohibition on indemnification to liabilities arising from a pecuniary penalty imposed on the trustee under any law of the Commonwealth (however, it should be noted that the Hayne Royal Commission made no such recommendation, rather, according to the explanatory memorandum the change was made "in the context of the extension of the Australian financial services licensing regime's coverage over superannuation"); and
• section 766A of the Corporations Act to designate a superannuation trustee service as a financial service, which in effect requires each trustee to hold an Australian financial services license and expands the applicability of the regime to the activities required to operate a superannuation fund, including the exposure to penalties under the regime.?

This extension to include administrative penalties and all laws of the Commonwealth seems to have crossed a threshold at which many trustees were no longer able to accept the risk of incurring a penalty for which it could not indemnify itself. Concern included the risk that relatively minor administrative penalties and infringement notices are issued with little warning.

The Financial Sector Reform (Hayne Royal Commission Response) Act did also include an amendment which requires the Court to “take into account the impact that the fine under consideration would have on the beneficiaries of the entity” when imposing a penalty on a superannuation trustee under the Corporations Act.?However, the breadth of penalties that the sections 56 and 57 indemnity prohibitions apply to much broader than just those imposed by a Court under the Corporations Act, and extends to infringement notices and administrative penalties imposed under any law of the Commonwealth.

The changes to ss 56-57 of the SIS Act have certainly increased the likelihood that a superannuation trustee will incur a penalty for which it cannot be indemnified from trust assets. This development sent trustees in search of solutions and initiated the recent series of applications for judicial advice.

On judicial advice

Each state has passed similar legislation (Trustee Acts) which allow trustees to apply to the Supreme Court for an opinion, advice, or direction when in doubt as to a particular course of action on any question respecting the management or administration of the trust property or respecting the interpretation of the trust instrument.?

Like in the cases discussed in this article, a trustee will often seek advice to the effect that it is justified in amending its trust deed where it has formed the view that while amending the trust deed is in the best financial interests of members, the trustee and its directors may have a conflict of interest in making the amendments. In the cases at issue here, the amendments to the trust instrument would create of expand the power for the trustee to charge a fee resulting in the trustee and its directors acquiring a potential financial benefit, which could be at some indirect cost to members.

The advantage to a trustee in obtaining judicial advice is that, if the trustee acts in accordance with the Court’s advice, then the trustee will be considered to have discharged its duty in relation to the proposed course of action (and therefore, cannot be guilty of breach of trust), so long as it has not engaged in any fraud or wilful concealment or misrepresentation in obtaining the judicial advice.

Judicial advice is therefore an important avenue through which a trustee can gain protection from potential risk of a subsequent finding of breach of trust, most relevantly, the risk that amending the trust deed to create or broaden a power for the trustee to remunerate itself from trust assets would be in breach of the trustee’s duty in relation to a possible conflict of interest and duty.

It is not the Court's function to take over the exercise of the Trustee's discretion, assess the commercial wisdom of the Trustee's decision, or tell the Trustee what to do. The question is whether the Court is satisfied that the Trustee's proposed action or exercise of power is proper and lawful.

Unlike most court proceedings, there is often no other party to the proceedings.?However, the Courts may invite amicus curiae (friend of the court) to provide evidence or a contradictor in testing any counter arguments to the advice sought by the trustee. It was common for the Australian Prudential Regulation Authority (APRA) to be invited in this role for many of the applications considered below.

Re QSuper Board [2021] QSC 276.

The first reported application was that made by the QSuper Board to the Supreme Court of Queensland in relation to a proposed amendment to the trust deed that would grant the trustee the power to charge, and retain for its own benefit, remuneration which it determines to be reasonable and to deduct such remuneration from the assets of the fund.

Amending the trust deed in this manner was considered a prospective conflict between the trustee’s duties owed to members and its own interest in amending the deed to create the power to deduct fees.?In such circumstances, the trustee can seek judicial advice to endorse the proposed course of action and provide the amendment with legal protection.

Importantly, the amendment did not seek to give the trustee the right to charge and retain for its own benefit such a fee (the amendment created the power to charge and retain for its own benefit the fee). While the exercise of a power attracts and is subject to duties under the section 52 SIS covenants and general law, the exercise of a right is not subject to these duties (including the recently amended best financial interests duty).

This means that QSuper’s prospective determination and deduction of remuneration for its own benefit would be an exercise of a power that is subject to these duties and protections.

The importance of this aspect of QSuper’s application is evident in Kelly J’s judgement which emphasises the concern that such a provision “might be described as a “blank cheque” indemnification and exemption”.?

Kelly J ruled that the fact that the remuneration power would apply to the possibility of future liabilities, rather than in response to an existing liability, and the possibility that the amount of fees would not correlate to liabilities was determinative in justifying such remuneration to have the effect of extinguishing the liability of the trustee.?

Therefore, the Court did not find that the remuneration power was in effect an indemnity and therefore contrary to the law. In other words, the trustee was not undermining the intent of the changes to the law by amending its deed in this manner. APRA supported this proposition in its submission.

The Court left open the question of how the powers might be exercised in future, and as an exercise of a power, the charging and deduction of such remuneration would be subject to the trustee’s duties at the point at which it is exercised.?

The Court also found that the power would also be subject to the doctrine of powers and must be exercised for the purpose which it was given.?The purpose of the remuneration power is ostensibly one of maintaining financial resilience in the trustee, something the court also held to be “clearly in the best financial interests of members”.?

APRA provided written submissions, which seemed to suggest that documented arrangements governing the future exercise of such a remuneration power would be desirable. APRA expressed a concern that the broad discretion in the remuneration power and absence of any documented policy in relation to its future exercise of the power might not satisfy the duty of prudence and best financial interests of member covenant.?

In advising that the proposed amendments were justifiable and reasonable, the court ruled that the absence of such documented policy should not prevent the amendment from being made.?

The decision was also significant in that Kelly J observed in obiter that changes to the best financial interests duty did more than clarify the existing operation of the law.?It is also cited in the subsequent decisions of similar applications as an authority.

Re Care Super Pty Ltd [2021] VSC 805 and Re Care Super Pty Ltd (No 2) [2021] VSC 854.

Care Super Pty Ltd sought judicial advice in the Supreme Court of Victoria concerning the exercise of an existing power to charge fees for services, not an amendment to the trust deed.?

The trust deed already provided the trustee with the power to remunerate itself from the fund for the bona fide provision of services on such basis as the trustee determines to be fair and reasonable.

The board of the trustee had resolved to endorse the basis for the calculated fee to be deducted and held in a trustee resilience reserve. In determining the amount of the fee, the trustee had focused on a target range or target amount by reference to capital requirements and the risk of statutory liabilities.

Lyons J observed that this management recommendation “did not address or mention the nature or value of the services provided” by the trustee, or any other factor other than the amount necessary for the trustee resilience reserve.?

Ultimately, Lyons J therefore refused to provide the advice sought on the basis that the advice sought wasn’t consistent with the course of action proposed in the board resolution, in that the proposed fee determination was beyond the scope of the existing right conferred by the remuneration clause, and therefore not fair and reasonable administration and operation of the fund.?

Endorsing Kelly J’s ratio in Re QSuper, Lyons J held that “[t]he charging of fees to build up a reserve is conceptually distinct from a provision that would have the effect of exempting or indemnifying a trustee against such liabilities.”?This affirmed the approach that the amendment of deeds, or the deduction of trustee remuneration from the fund are not contrary to the intention of the operation of the changes to ss 56-57 of the SIS Act.

The decision also considered whether shares in the trustee company owned by trustee directors were held personally or were held on behalf of the fund. The Court held that these shares were held personally (beneficially held) by the current director shareholders and were not an asset of the fund. In coming to this decision, Lyons J reasoned that the lack of evidence to the contrary, and limitations on the rights attached to the shares held by directors (restricting the transfer, issue, and dividend rights) were relevant in characterising the shareholding of directors was not trust property.?This may be significant if future law reform suggested by Blue J in AustralianSuper Pty Ltd v McMillan (discussed below) is considered further.?

The decision also provided a neat articulation of the concern about weakening of member protections in allowing such fees to be deducted from trust assets, in that “once such a fee ceases to be a trust asset, the property is property of the trustee in its own right to do with what the trustee sees fit.”?

While the trustee wasn’t successful in obtaining the advice it sought in its initial application, a subsequent application was heard by the Court which did see the advice sought being provided.?

The decision is also notable in that it addresses the construction of the trust instrument where the executed versions of amendments cannot be located.

Re NGS Super Pty Ltd [2021] NSWSC 1694.

The trustee of NGS Super sought judicial advice in the Supreme Court of NSW on the amendment of the existing remuneration power under its deed. The existing remuneration power was considered to be unworkable, giving rise to the application.

In considering whether the proposed amendment was in the best financial interests of members, Henry J adopted the interpretation of Jagot J in APRA v Kelleher that “regard should be had to the interests of both present and future members and the commercial and practical realities of the superannuation industry generally” and that the question is “not what is in the best financial interests of members, but whether the decision of the trustee to consent to the Proposed Amendment is reasonably justifiable on that basis.”?

The Court relied on the Re QSuper decision in providing the desired advice, and also held that the amendment was not inconsistent with the trustee’s duty of care, skill, and diligence and that there was no reason to believe that the power would be exercised for an improper purpose.

The Court held and advised that the trustee was justified in amending the deed to clarify and broaden the purposes and scope of the remuneration power.

Re HEST Australia Ltd [2021] VSC 809.

The trustee of HESTA also sought judicial advice in the Supreme Court of Victoria in relation to proposed amendments to the trust deed which provide the power to deduct a limited fee from the fund.

The proposed new clause would give the trustee the power to “determine that a trustee fee is payable to the trustee if the Trustee Capital Reserve Condition and the Trustee Fee Condition are both satisfied.”?

The Trustee Capital Reserve Condition requires that the balance of the reserve does not exceed 0.125% of the value of trust assets, and the Trustee Fee Condition requires that the aggregate value of such fees in each three year period doesn’t exceed 0.125% of the value of trust assets.

The corporate structure of the trustee as a company limited by guarantee (rather than a private company) was also noted in APRA’s submission. The relevance of this was identified as being that the trustee’s use of any capital accumulated outside the trust would be constrained because its constitution requires that any profits and other income be applied in promoting its objects and precluded it from carrying on activities for the profit or gain of its guarantors.?

This highlighted the existence and importance of such additional protections for members and demonstrates that the “profit for member” model of industry funds doesn’t necessarily need to be diminished by such changes.

In providing the advice sought, Button J reasoned that it would not be in the interests of beneficiaries for the trustee to have no personal capital and to be exposed to the risk of insolvency for relatively minor penalties.?Furthermore, it was held that in addition to the very significant direct costs that insolvency would impose on members, “the inability of a superannuation trustee to put itself in a reasonably secure prudential position was deleterious to the interests of members.”?

The decision also provided useful distinction between reserves held on trust as fund assets and the personal property of the trustee. “There is an important distinction between reserving trust property, and taking property out of the trust and putting it in the hands of the trustee in its personal capacity.”?

The application was differentiated by the inclusion of conditions concerning making certain public disclosures in relation to such fees. The Court provided the advice sought, providing the necessary protection for the proposed amendment.

AustralianSuper Pty Ltd v McMillan [2021] SASC 147.

The trustee of AustralianSuper sought an order to amend the trust deed (rather than seeking judicial advice) from the Supreme Court of South Australia. AustralianSuper’s application was characterised by the presence of a member in the proceedings and the Court's consideration of the potential alternative methods for mitigating the risk of insolvency arising from non-indemnifiable penalties.

The member argued, amongst other things, that the proposed amendment would be rendered void by subsections 56(2) and 57(2) of the SIS Act, which both the Trustee and APRA opposed. After thoroughly considering the purpose and meaning of those sections the Court found that the proposed amendment would not have the effect of indemnifying the Trustee or directors and therefore would not be void.

While the member accepted that "there is manifestly good reason to amend the Trust Deed and clearly such an amendment would be in the best interests of beneficiaries if that risk is thereby mitigated and that risk cannot otherwise be satisfactorily mitigated," he submitted "that the members do not wish to be the ones funding the Trustee's capital in order to mitigate that risk."?In considering the potential for alternative methods of mitigating the risk, the Court noted:?

• AustralianSuper's adoption of extensive risk management policies and practices;?
• AustralianSuper's liability insurance and the indemnities it provides against some penalties but not others, as well as evidence given that insurers are generally not willing to indemnify against criminal offences;?
• there was insufficient time for a captive insurance arrangement to be put in place and the potential of captive insurance beyond the immediate future was relevant to the order;?
• the current share capital of $12 and shares held by the Australian Council of Trade Unions and Australian Industry Group?- a peak national employer organisation and the shareholders unwillingness to contribute additional share capital to create a risk reserve (which the Court recognised as "perhaps unsurprising given that they do not have a financial interest in Aus[tralian]Super (for example, they are not entitled to dividends or a return of capital on winding up))”;?and
• the attractiveness of the possibility of the Fund contributing share capital to the trustee by the issue of a class of shares to be beneficially owned by the Fund. This option is, however, prohibited by the sub-regulation 13.17A of the SIS Regulations, which prohibits the Trustee from investing in itself.?In analysing this option, the Court focused on the difference between a for-profit and a profit-for-member trustee; the bank or other financial institution contributes to the trustee in the former scenario to make a profit whereas in the latter scenario the trustee is "an integral part of the cooperative fund and, at least in the case of industry funds, the trustee is itself a cooperative venture"?and further analysed three sub-options under which this alternative could be achieved. In concluding that "it is not legally possible for the Fund to provide share capital to AusSuper to mitigate the risk of insolvency if a non-indemnifiable penalty is imposed,"?the Court noted that "Commonwealth legislation and regulations intended to increase protection is actually detrimental to the interests of members of superannuation funds."?Blue J also remarked that it was “highly desirable that the Commonwealth reviews its legislation and regulations in the manner suggested in the interests of members of cooperative superannuation funds.”?

The Court went on to decide that despite the above measures, the trustee was still substantially exposed to a risk of insolvency resulting from the imposition of significant penalties and therefore there was good reason to vary the Trust Deed and the variation is in the best interests of beneficiaries.?

The decision also anticipates that capital requirements are likely to be imposed, as per APRA’s financial resilience discussion paper. The Court referred to APRA's Financial Resilience Discussion Paper and the importance of building a financial contingency reserve on the trustee's balance sheet to meet non-indemnifiable penalties.?

The Court also noted the lack of an APRA policy position on the manner in which a fee should be charged to build trustee capital, but later highlighted the potential for APRA to issue prudential standards addressing the charging of fees as related to financial resilience of trustees.?Read collectively, the Court's statements may indicate that APRA is considering requirements for the building and maintaining of a financial contingency reserve and also issuing a prudential standard that governs how fees can be determined and deducted from the trust property to fund such a reserve.

In exercising its power under section 59C of the Trustee Act 1936 (SA), the Court amended the trust deed of AustralianSuper to affirm that the shareholders of the trustee have no right to a dividend or other payment on winding up. The Court also made the amendment to allow for the created of a Trustee Risk Reserve and power to deduct a Trustee Risk Reserve Fee.?

Re United Super Pty Ltd [2021] NSWSC 1679.

The trustee of Cbus sought judicial advice that it was justified in amending the trust deed to charge a fee for acting as trustee that, amongst other things, is calculated as a percentage of the net assets of the fund.

The trustee had an existing general remuneration power, linked to providing services. This means the remuneration should be fair and reasonable as it relates to the services. The Trustee was concerned with the generality of the power and determined that it was in the best financial interests of members that the power be clarified.

The proposed amendment narrows the power:

• "to impose a trustee fee in an amount equivalent to up to 0.10% of net assets of Cbus (as at the end of the previous biennial period) across successive periods of two financial years (Biennial Limit)."?
• "The power to levy the trustee fee would be suspended for as long as and to the extent that the amount of capital held by the Trustee exceeds an amount equal to 0.14% of the net assets of Cbus or such other maximum amount of trustee capital as the applicable law requires or a regulator permits, recommends, requests or directs the Trustee to hold (Aggregate Cap)."?
• "The Biennial Limit and Aggregate Cap will be reviewed by the Trustee every four years to ensure they remain fair and reasonable and, if they are not, the Trustee must amend them to reflect what it considers to be fair and reasonable amounts."?

The application was successful, and while narrowing the power to be subject to the Biennial Limit and Aggregate Cap, it also adjusts the purpose of the power to be broader than the power to remunerate in relation to services provided by the trustee.

Re LGSS Pty Ltd [2021] NSWSC 1613.

The Trustee of the Local Government Super fund sought judicial advice in the Supreme Court of New South Wales to the effect that the Trustee was justified in amending its trust deed to charge a fee for acting as trustee, "providing the Trustee with funds to be utilised to build up a pool of personal capital for the purpose of reducing the exposure of the Trustee and the directors of the Trustee for personal liabilities, including pecuniary penalties imposed upon them in the course of their duties."?

APRA did not formally appear at the hearing, but subsequently filed submissions, as amicus curiae. Importantly, in its submissions APRA submitted that the trustee's decision-making process should reflect the requirements contained in the statutory covenants – importantly the duty to act in the best financial interests of members and to exercise the same degree of care, skill and diligence as a prudent superannuation trustee; and a " central issue in that decision-making process ought be whether the proposed solution is proportionate and appropriately tailored to the problem."?

Pertinent to the court's decision on whether to provide the advice were the following facts:?

• The Trustee has eight shares on issue (four "Employer Class Shares" held by the Local Government NSW, the peak body for NSW councils, and four "Member Class Shares held by individuals for, or who are otherwise Union or Association representatives) and $8 in share capital;?
• "The Trustee’s Constitution contains limitations on the entitlements of the shareholders (reflecting that the Fund operates on a profit-to-member model, rather than to generate profit for shareholders), including that: the directors are prohibited from declaring or determining a dividend or applying any portion of the Trustee’s capital or income to be paid or transferred, directly or indirectly, in any way to a shareholder (cl 21.1); and, in the event that the Trustee is wound up, any assets remaining after the satisfaction of the Trustee’s debts and liabilities must not be paid or distributed among shareholders (cl 22.1)."?
• "The proposed amendment to the Trust Deed would empower the Trustee to impose a Trustee Fee in an amount equivalent to up to 0.04% per annum of the net assets of the fund (Annual Limit). In addition to the Annual Limit to the amount of the Trustee Fee that could be charged, the power to levy a Trustee Fee would be subject to a cap on the amount of personal capital the Trustee could accumulate out of the proceeds of the Trustee Fee (Cap on Target Capital). The Cap on Target Capital is to be set initially at an amount equal to 0.08% of the net assets of the fund or such other maximum amount (if any) of Trustee capital as the applicable law requires or a regulator permits, recommends, requests or directs the Trustee to hold. Once the Cap on Target Capital is reached, for as long and to the extent that the amount of Trustee Capital held does not drop below that amount, the power to levy the Trustee Fee would be suspended."?
• "The Trustee Capital would be held by the Trustee solely for the purpose of enabling the Trustee to discharge its duties as Trustee of the Fund," and the restriction contained in the Constitution referenced above would continue to apply.?

The Trustee submitted that "idiosyncrasies of the Fund" – the Treasurer is vested with the power to appoint a replacement trustee – "make the loss of the Trustee additionally undesirable" and the impact of a successor fund transfer on the obligations of participating employers to continue contributing to the defined benefit divisions.?

The trustee also sought alternative relief under the inherent jurisdiction or, alternatively, under the expediency jurisdiction, in the event that the Court did not agree to the judicial advice application under the Trustee Act. With respect to the former, the Court noted that even where the trust deed does not allow for remuneration of the trustee, the Court in its inherent jurisdiction may allow remuneration in a proper case, and with respect to the latter rather than granting authority to amend the trust instrument, the "order should confer (and be the sole and direct source of) the powers which then supplement and, as necessary, override the content of the trust instrument."?

Re Maritime Super Pty Ltd [2021] NSWSC 1614.

The Trustee of Maritime Super sought similar advice as above – that it is justified in amending the trust deed to charge a fee for acting as trustee – in the Supreme Court of New South Wales. The limits on the fee power include the imposition of a fee in an amount equivalent to p to 0.30% of the net assets of the Fund for each successive period of three financial years, subject to a cap on the amount of personal capital the Trustee could accumulate out of the proceeds of the Trustee fee equal to 0.50% of the net assets of the fund or such other maximum amount of capital as required by the law or regulators.

The Court considered the fact that the Fund's MySuper product had failed the performance test and taken steps to identify and rectify the deficiencies in performance, and "a particular matter as to which the Trustee has received advice as to the potential consequences which might flow therefrom (including imposition of a financial outcome against the Trustee but also the possibility of non-financial outcomes)" alongside the Trustee's submission that the potential associated consequences do not derogate from the Trustee's position that the amendments "promote the beneficial administration of the Fund," and the Trustee's "view that the amendment is in the best interests of members."?

In opining that the Trustee was justified in amending the trust deed, the Court accepted "the amendment will not provide the Trustee with a private profit able to be utilised for the benefit of shareholders, noting that the Trustee's Constitution precludes shareholders from receiving any dividend or return of capital and precludes the distribution of capital to shareholders on a winding up of the Trustee."?

Re Motor Trades Association of Australia Superannuation Fund Pty Ltd [2021] NSWSC 1672.

The Trustee of Spirit Super sought judicial advice in the Supreme Court of New South Wales that it would be justified in amending the trust deed to provide for a remuneration power to enable the Trustee to be paid a fee for acting in the role of Trustee and, in the alternative, sought an order under the relevant Trustee Act 1925 (NSW) or the Court's inherent jurisdiction that a power to pay a fee be conferred on the Trustee.

The Court noted that the Trustee's Constitution provides that "[s]hares in the Trustee can only be held by the directors, who hold them on trust for the benefit of members of the Fund."?This varies from the way in which shares are held in other cases. For example, it was noted in the CareSuper case that directors hold shares in the trustee beneficially and are not an asset of the fund.

In both instances, however, the shareholders have limited rights as related to the transfer of shares – only to be held by a director or nominating organisation (or its representative who is accepted by the Board); and no rights to dividends or distributions of any surplus assets. In advance of seeking advice on the Trust Deed amendment, the Spirit Super Trustee amended its Constitution further "to ensure that the capital accumulated by levying the proposed Trustee Fee, once held by the Trustee in its personal capacity, will be used for constrained purposes that ultimately support the members' best interests."?

The Court granted the Trustee's application, recognising amongst other things, that "[i]t is apparent that changes to the regulatory and enforcement environment have led to a material increase in liabilities and financial risks facing the Trustee and, as a consequence, to the Fund's members" and the "purpose of the Proposed Amendments… is to enable the Trustee to continue functioning in the context of heightened risks of insolvency and to secure the competent administration of the Fund."?

Conclusions

How do the applications and resulting court opinions reconcile with the changes to the law that came into effect from 1 January?

Each decision recognised that the charging of a fee to build up trustee capital to mitigate the risk of insolvency is not prohibited by subsections 56(2) and 57(2) or the SIS Act more generally. Subsections 56(2) and 57(2) in effect prohibit the indemnification of trustees and their directors out of trust assets for non-indemnifiable penalties as identified in those subsections. Building up capital out of trust assets over time does not have the effect of indemnification.

As recognised by Button J in Re HEST Australia Ltd, "[t]he mere inclusion of a power to charge such a fee goes no further than that; the charging of a trustee fee does not involve the trustee in exercising any right of recoupment or exoneration against trust assets to meet a liability, whether crystallised or even contingent. Nor does a rule providing a fee charging power involve the trustee in reserving trust assets as against beneficiaries in support of its equitable lien or charge.”?

When it uses its personal assets, the trustee will not be exercising a right of recoupment or exoneration against trust assets, nor will it be exercising a right of indemnity against the trust fund." Relevantly, Button J also noted:

Parliament enacted provisions addressed to rules which govern (relevantly) the operation of the ‘fund’.?It did so in the context of a legislative regime which permits the charging of fees by trustees which go beyond cost recovery.?What Parliament did not do was to legislate constraints on what trustees can do with assets they personally accumulate from charging fees, or prohibit the charging of fees that may allow a trustee to build a personal fund which may, amongst other uses, be applied to meet penalties.?

Similarly, Henry J in Re Motor Trades Association of Australia Superannuation Fund Pty Ltd recognised that albeit the fact that the legislative amendments to limited indemnity from trust assets "might disclose a legislative intention that trustees of superannuation funds are to bear in their personal capacity the financial cost of the expanded range of liabilities to which they may become subject," and that "the SIS Act recognises that the earning of an administration fee that goes beyond cost recovery by [a] superannuation trustee is permissible."?

What protections will be in place for members?

In most cases, the trust deed amendments do not introduce an unlimited remuneration power for the trustee. Rather, the amendments contain requirements that:

? the fee charged is fair and reasonable; and

? the fee charged does not exceed a threshold cap as a percentage of trust assets; and?

? the fee can only be charged where the personal assets of the trustee do not exceed a specified amount (again as a percentage of trust assets).?

The above requirements ensure that members are protected from the possibility that a trustee may charge excessive or unnecessary fees for its own use (or for distribution to its shareholders) while at the same time protecting members from the consequences that may arise in the event of an insolvent trustee.?

In addition, the remuneration power does not excuse trustees from the statutory covenants under the SIS Act; in particular the duty to act in the best financial interest of members when determining what fee to charge and exercising the care, skill and diligence of a prudent superannuation trustee.?

Is the profit for member model threatened by these changes?

While the changes, in isolation, may be viewed or portrayed as threatening the profit to member model, as noted in the decisions discussed above, the constitutions of the trustee generally provide that the income and property of the trustee must solely be applied for the operation of the fund and the trustee's capacity as trustee.

Additional limitations also typically prohibit directors from declaring a dividend or applying any portion of the trustee's capital or income to be paid to a shareholder. Similar limitations on the rights of shareholders to receive any dividend would also generally apply if the trustee were to be wound up.

Such protections under a trustee’s constitution aren’t uniform, and while such protections exist in the cases considered here, it isn’t necessarily so. The profit to member model therefore remains intact, to the extent that trustee constitutions carry no right to dividends to shareholders for their own benefit.

Are there limits on a power or right to charge a fee from trust assets?

In addition to the self-imposed quantum limits imposed by the remuneration power amendments (caps as discussed above), the covenants in Section 52 of the SIS Act apply alongside any general law obligations.

Specifically, the trustee continues to have an obligation to: act honestly; exercise the same degree of care, skill and diligence as a prudent superannuation trustee would exercise; exercise powers in the best financial interests of beneficiaries; where a conflict exists give priority to the duties to and interests of beneficiaries; and to act fairly amongst classes of beneficiaries.

There also appears to be a possibility that APRA will consult on the development of prudential standard or guidance in relation to the determination and deduction of fees from the fund which are to be paid to the trustee. Such a measure would be also significant for trustees that operate on a for-profit or commercial basis, where fees and remuneration are paid to the trustee on a similar basis.

Once the fees are deducted, what can they be used for?

Trustees will generally have discretion on what the fees can be used for once they form part of the trustee capital, subject to specific limitations. As noted by APRA in its submissions to the relevant courts, trustees are "restricted in [their] use of funds to some degree" in that the trustees are Australian companies, the purpose of which is to act as trustee of the relevant fund and in most instances the constitution of the trustee provides that income and property of the trustee can only be used towards the object of the trustee and should not be paid to shareholders. The Corporations Act further limits the scope of indemnities given and insurance paid for by companies.?

Additionally, the directors of the trustee as directors of an Australian company have general law and statutory duties to act in good faith and in the best interests of the trustee. Importantly, the use of assets held personally by the trustee on its own balance sheet (and not on trust as fund assets) would not be subject to the SIS covenants in the same way that these covenants apply to the exercise of powers and performance of duties in relation to the fund assets.

Are capital requirements likely to be mandated on trustees in the near future?

APRA's Discussion Paper Strengthening Financial Resilience in Superannuation and the Courts' comments emphasising APRA's ability to issue prudential standards addressing the manner by which a fee is charged for the purpose of building financial resilience, indicate that APRA may be considering requirements for building and maintaining a contingency reserve and also issuing a prudential standard that governs how fees can be determined and deducted from the trust property to fund such a reserve. This could take the form of a prudential standard and guidance.

The House of Representatives Standing Committee on Economics public hearings on 10 February 2022 discussed issues related to the section 56-57 related proceedings. In response to questioning by the committee about the possibility of capital or reserve held to satisfy the operational risk financial requirement being used to pay penalties, the APRA Chair indicated that “another idea would be to repurpose of the ORFR to hold the risk reserve within it, because that would give APRA greater touch points of control.”?Currently, section 56(2A) expressly prohibits the use of trustee capital or fund reserves managed and maintained by the trustee to cover the operational risk of the entity to indemnify the trustee for liabilities arising from such penalties.

Alternatively, a new standard RSE licence condition requiring that trustees maintain such a contingency reserve outside the trust, would be likely to be a more appropriate approach to mandating such a requirement.

Are trustees likely to be more willing to seek judicial advice in future? Will courts be willing to provide it?

The judicial opinions stemming from the applications discussed above are important for the expansion of superannuation specific case law, which remains sparce. While one cannot predict the exact impact this stream of judicial advice applications and the courts' expediency in providing an opinion will have on trustee willingness to seek judicial advice, it is unlikely that we will see a significant increase in judicial advice applications.

Seeking judicial advice is however costly, time consuming and trustees are limited in the issues on which they can seek judicial advice – questions respecting the management of the trust property or respecting the interpretation of the trust instrument.