Written by Brian Egan
In late 2015, the Federal Court handed down a very interesting first instance decision which offered an extensive analysis of the statutory duties owed by officers of responsible entities of registered managed investment schemes, embodied primarily in s 601FD of the Corporations Act 2001 (Cth). Those duties are fairly closely parallel to the duties owed by company directors and officers generally under the Corporations Act. There are, however, a number of differences, and this decision was (and remains) interesting on that count especially. This was the decision in Trilogy Funds Management Limited v Sullivan (No 2)  FCA 1452, a decision of Wigney J.
The Full Court of the Federal Court has now dismissed an appeal from that decision. The Full Court decision is Sullivan v Trilogy Funds Management Limited  FCAFC 153 (25 September 2017), a unanimous decision by Allsop CJ and Farrell and Gleeson JJ. In this article, we examine how the case came to court and was resolved at first instance and on appeal, and why the decision is so important to directors and officers of responsible entities.
The course of the trial and the appeal
As noted above, the first instance decision contains a careful analysis of the statutory duties owed by officers of responsible entities of registered managed investment schemes. By the time the appeal came to be argued, the emphasis had shifted markedly. The appellants complained that they had not been afforded a fair trial, and argued that they should be accorded a new trial. They contended that they were unfairly required to meet a case which ranged well beyond the pleadings and included unpleaded allegations of “fabricated” documents made without notice in cross-examination. The appellants also contended that the trial judge unfairly made findings against them that they were not given an opportunity to answer. The judgment of the Full Court is therefore almost wholly concerned with the working out of these grounds of appeal, and has little to say in the direct sense about the law relating to the duties owed by directors and officers of responsible entities. The Full Court had no quarrel with the findings of fact and the analysis of the applicable law made by the trial judge, with the exception of certain findings made by the trial judge about one of the appellants, which the appellant did not have an opportunity to address in his evidence. In the Full Court’s view, this involved procedural unfairness. But those findings did not affect the trial judge’s reasons for his conclusions that that appellant had contravened s 601FD of the Corporations Act.
Overall, the Full Court was satisfied that the trial judge’s findings that the appellants contravened the Act were inevitable, as were his Honour’s conclusions that the appellants should not be exonerated from those contraventions in the circumstances of the case. All of this means that the trial judge’s analysis of the applicable law can be taken to have been endorsed unanimously by the Full Court of the Federal Court, and is the more authoritative on that account.
Background — facts and issues
So what happened here?
In the words of the trial judge:
“This is a tale of a rapacious Gold Coast property developer with grandiose plans, a compliant and obliging valuer who lacked independence, and a responsible entity of a managed investment scheme the officers of which appeared unable or unwilling to say ‘no’ to the developer, or to otherwise exercise appropriate care and diligence to ensure compliance with the scheme’s mandated policies and procedures. In the end, the developer failed and the security property was found to be worth many millions of dollars less than both its supposed valuation and the outstanding loan. The scheme and its members were left significantly out of pocket. Did the officers of the responsible entity breach their statutory duties when they approved increases to the developer’s loan facility? Or when they failed to prevent further advances being made to the developer that took the loan well over its approved limit? Are the officers liable to make good any losses arising from any such breaches?”
In the end, the various officers of the responsible entity were found to have contravened their duties under the Corporations Act, to be personally liable for compensation to the tune of many millions of dollars, and were not to be exonerated under the Act. And, as noted, the Full Court largely accepted and endorsed those findings.
The statutory duties — correspondences and differences
The trial judge noted that the duty of care and diligence owed by an officer of a responsible entity under s 601FD(1)(b) of the Corporations Act, corresponds with the general duty of care and diligence owed by officers of all corporations under s 180(1) of the Act. There is nothing new or controversial about that principle. There are, however, some apparent differences. First, while the duty in s 601FD(1)(b) corresponds with the duty in s 180(1), the standard of care under s 601FD(1)(b) will often be higher. This flows from the fact that the relevant officer will be an officer of a responsible entity which is acting as a trustee and holding itself out to the public, and being remunerated, as a professional trustee. There is also the fact that scheme members are particularly vulnerable to potential conflicts of interest. Those potential conflicts are: first, the potential conflict between the interests of the responsible entity in obtaining fees and the interests of the scheme members; and, second, the potential conflict between the responsible entity’s interest in obtaining fees and its duty to act in the best interests of the scheme members and give their interests priority.
As the trial judge pointed out, in determining the degree of care and diligence required of an officer under s 601FD(1)(b), consideration should be given to the fact that s 601FD is concerned with the duties of officers and directors of very specific companies. Responsible entities are not only required to be public companies, they are also required to hold Australian financial services licences and effectively to act as professional trustees.
Regard must also be had to the potential for conflicting duties as recognised in s 601FC(3) and 601FD(2). Those considerations are likely to lead to the need for officers of responsible entities to exercise a higher degree of care and diligence than the standard required of an officer or director under s 180 in respect of a company that does not have the specific features of a responsible entity.
A second difference is that, whereas under s 180(1) the officer’s duty of care and diligence is owed to the company, under s 601FD(1)(c) the officer is required to act in the best interests of the scheme members and, in the event of conflict between the interests of the members and the interests of the responsible entity, to prefer the members’ interests.
Another important difference between s 180(1) and 601FD(1)(b) is that s 601FD(1)(b) does not have any express “business judgment rule”, parallel to s 180(2), which deems the conduct of officers in making business judgments which meet certain specified criteria as having satisfied the relevant duty. Nevertheless, even if the statutory business judgment rule does not expressly apply in the case of s 601FD(1)(b), the court warned that, in considering whether the actions of an officer of a responsible entity which involved a business judgment failed to meet the standard of care and diligence required by s 601FD(1)(b), it is likely that regard would in any event be had to the types of matters referred to in s 180(2) if they existed in the particular circumstances of the case. While the existence of such matters might not operate to deem the s 601FD(1)(b) standard to be met, they would nonetheless be relevant to a consideration of whether the standard was in fact met.
Forensic considerations — how (and how not) to run a case
There is also an important forensic point to be noted about this case, about a tactic adopted by the appellants which in the event backfired on them. On appeal, the Full Court pointed out that, although the responsible entity of the fund, which brought the case against the directors in the first place, did not plead any case of fraud, collusion or wilful blindness, the appellants themselves had raised the issue of their own honesty; they pleaded that they should be relieved from any liability for any contravention of s 601FD because they had acted honestly in all the circumstances of the case. By this pleading, the appellants exposed themselves to scrutiny about the honesty of their actions, and to the possibility (which eventuated) that the trial judge would reject their case that they had acted honestly in all the circumstances of the case. The appellants must have appreciated that this was a significant risk where they had each executed a backdated loan approval document which proved to be crucial in the case. Mention of the backdated loan approval document brings up one final practical comment that arises from this case. It used to be that officers and functionaries of companies and other entities such as clubs and partnerships, who were perhaps less than completely scrupulous about their record-keeping, could with impunity manufacture spurious or fictitious records of minutes and meetings and the like, and backdate them, to give artistic verisimilitude to an otherwise bald and unconvincing narrative. That is not so easy nowadays, given that almost all such records will be created electronically, on a computer. Electronic records, wordprocessor documents, spreadsheets and emails and the like, have metadata, which includes dates and times of creation. As the officers of the responsible entity in this case found to their cost, this can give the lie to the content of transaction documents created well after the actual transactions.
For detailed commentary on the duties and responsibilities of officers of responsible entities, see Australian Company Law Commentary Premium at ¶183-300 and Australian Managed Investments Law & Practice at ¶45-100.