High Court decides Prime Trust directors breached their duties

Late last year the High Court of Australia found that four former directors of the failed Prime Care and Aged Care Property Trust (the Prime Trust) had breached their duties, as a result of decisions made by the board in 2006¹. The directors were Mr Bill Lewski, Dr Michael Wooldridge, Mr Mark Butler and Mr Kim Jaques.

The High Court’s decision contains important reminders for public company directors on how they should conduct themselves in the boardroom, including:

• Directors should put the interests of investors ahead of their own interests if there is a conflict of interest;
• As a general rule, a director should absent themselves from the board’s deliberations on a matter in which they have a material personal interest;
• Directors need to deal properly with an obvious conflict of interest of another director; and
• Directors need to be careful when relying on unusual or equivocal legal advice.

The rise and fall of the Prime Trust

The Prime Trust was an ASX-listed trust that owned retirement villages in Queensland, New South Wales and Victoria. Listed in 2007, it collapsed in 2010 and investors lost around $550 million.

Following the collapse, ASIC investigated the conduct of the responsible entity of the Prime Trust, Australian Property Custodian Holdings Ltd (APCHL), and the management of the trust.

Subsequently, in August 2012, ASIC commenced proceedings in the Federal Court against APCHL and former directors.

ASIC’s proceedings focused on an amendment to the constitution of the Prime Trust before listing to permit the payment of new fees to APCHL in its personal capacity.

Federal Court decisions

In December 2013, the Federal Court decided that APCHL had breached its duties as responsible entity, primarily because of the payment of a $33 million listing fee from the Prime Trust to APCHL in its personal capacity, and that the directors had also breached their duties². The court imposed pecuniary penalties on the directors ranging from $20,000 to $230,000 and disqualified the directors from managing corporations for periods ranging from two years and three months to 15 years.

The directors appealed to the Full Court of the Federal Court³. The Full Court decided that the primary judge erred because, although the board’s decision to amend the constitution of the Prime Trust to allow payment of the listing fee was invalid, once the amendment was lodged with ASIC it had “interim validity” until set aside by a court. The Full Court considered that the directors were entitled to act in accordance with the amended constitution that they honestly believed existed when they decided to pay the listing fee to APCHL.

Following that decision ASIC appealed to the High Court.

The $33 million listing fee

Since it issued its first prospectus in 2001, it had been the intention of APCHL to list the Prime Trust. By June 2006, it was likely that the Prime Trust would list on the ASX by the end of 2007.

The liability of the directors of APCHL stemmed from a decision made by the board in 2006 to amend the constitution of the Prime Trust to introduce substantial additional fees payable to APCHL in its personal capacity, being:

• A listing fee, to be payable if the Prime Trust was listed on the ASX;
• A removal fee, to be payable if APCHL was removed as responsible entity of the Prime Trust; and
• A takeover fee, to be payable if the Prime Trust was subject to a takeover.

The Prime Trust was listed on the ASX in August 2007. Just before then the board resolved to pay the listing fee. A listing fee of approximately $33 million was paid to APCHL in two tranches in 2007 and 2008. The Federal Court found that Mr Lewski received the benefit of the fee, as APCHL was controlled by persons and entities associated with him.

Incidentally, the High Court said that the description of the payments as “fees” was a euphemism as none was a payment  for any additional obligation on APCHL or the directors, nor was any a payment for any additional benefit to members.

Power to amend constitution

The constitution of the Prime Trust contained two clauses governing amendments to the constitution.

The first clause allowed the responsible entity (RE) to amend the constitution provided that the amendment was not in favour of or did not result in any benefit to the RE. The second clause provided that any amendment was required by the constitution to comply with the Corporations Act. The Corporations Act allows the RE to amend the constitution if the RE reasonably considers the change will not adversely affect members’ rights. Otherwise, the amendment must be made by special resolution of the members of the trust.

The board had legal advice that offered two interpretations of the power to amend the constitution, without advising which interpretation should be preferred. The first interpretation was that both clauses had to be complied with. The second interpretation was that only the second clause had to be satisfied. The board adopted the second interpretation and formed the view that the amendments did not adversely affect members’ rights. The High Court found that the board gave scant or no consideration of the uncertainty deriving from the legal advice and did not consider whether to seek unequivocal legal advice or a judicial direction.

The High Court’s decision

The High Court found that:

• (Right to due administration of the trust) The members of the trust had a right to the due administration of the Prime Trust in accordance with the existing constitution. Although the RE had statutory power to amend the constitution, it could only do so if, considered reasonably, the amendment would not adversely affect the members’ rights. Otherwise, member approval must be obtained.  Each of the board resolutions to amend the constitution to introduce the new fees and to lodge the amendments with ASIC adversely affected the members’ rights;
• (No concept of “interim validity”) The concept of “interim validity” of an unlawful amendment to the constitution of a registered scheme once lodged with ASIC (until set aside) is not supported by the text of the Corporations Act, nor by the protective purpose of the statutory provisions that regulate the power of the RE to amend the constitution; and
• (Directors breached a number of duties) The directors had breached a number of duties, including:
  • (negligence duty) the duty to act with reasonable care and diligence, as they did not consider the nature or propriety of the introduction of substantial, additional, effectively gratuitous fees and they did not resolve the uncertainty deriving from the equivocal legal advice about the power to amend the constitution to introduce the fees;
  • (loyalty duty) the duty to act in the best interests of members of the Prime Trust and to give priority to the interests of members over their own interests, as the directors should have voted against the resolution to lodge the amended constitution with ASIC in order to prioritise the members’ interests in having APCHL comply with the constitution over the conflicting interest of APCHL in receiving the fees. It was not sufficient that the directors acted honestly, having regard to the belief that the constitution had been amended; and
  • (compliance duty) the duty as a director of an RE to ensure that it complied with the Corporations Act and the constitution, as they failed to ensure that APCHL complied with the provisions governing amendments to the constitution and failed to ensure that APCHL complied with the related party provisions of the Corporations Act when it paid the listing fee.

What next?

The Prime Trust proceedings are not over as the High Court ordered that the matter be remitted to the Full Court of the Federal Court for determination of penalties and disqualification orders to be imposed on the directors.

This article was written by Cameron Jorss, Partner.

¹Australian Securities & Investments Commissions v Lewski [2018] HCA 63
²Australian Securities & Investments Commission v Australian Property Custodian Holdings Limited [2013] FCA 1342
³Lewski v Australian Securities & Investments Commission (2016) FCR 200