The recent NSW Supreme Court decision in Basis Capital Funds Management Ltd v BT Portfolio Services Ltd has helped to define the way in which units in registered schemes are issued and redeemed. Although this case is fact specific, the decision points to issues relevant to fund administrators generally and highlights the duties and obligations of responsible entities and their directors.
The Supreme Court's involvement was required so as to resolve competing claims by different categories of investors in the managed funds. Basis Capital Funds Management Ltd (Basis Capital) sought the Court's determination as to the timing of the issuing and redemption of units in two Australian managed investment schemes, the Basis Yield Fund and the Basis Aust-Rim Fund (the Funds) of which it was the responsible entity. The Funds invested in a variety of investments including asset and mortgaged backed securities and high yield corporate credit securities. The investments of the Basis Yield Fund were most at risk.
Applications for units in the Funds were processed by Basis Capital on a monthly basis and requests for the redemption of units were processed on a quarterly basis with the price for application and redemption being calculated on net asset value (NAV) per unit as at the last day of the month and quarter respectively.
The Funds received over $23 million in investment application money in June 2007 (the June Applicants). Once this application money was received, it was placed in an account until units were to be issued in early July after the NAV, as at 30 June 2007, had been calculated. Whilst the units were not actually issued immediately upon receipt of the application money, the application information was entered onto the unit register and a confirmation letter was sent to them which thanked the investor for investing in the fund and advised that they would be informed of the final details of their investment shortly.
A number of redemption requests were received from investors in the Funds for the quarter ending in June 2007(the June Redeemers) which, as with the applications, were to be processed in early July 2007 after the NAV as at 30 June 2007 had been calculated.
In late June 2007, both Funds became adversely affected by the downturn in the credit market as a result of investor concern over the US sub-prime mortgage market. Due to the uncertainty this created, the NAV could not be calculated until late September 2007. As a result, on 16 July 2007 Basis Capital suspended the applications and redemptions of units in the Funds. The June applications and redemptions were therefore not processed and the monies continued to be held on trust by Basis Capital until the Court determined the following two questions at the request of Basis Capital:
- whether the June Applicants could obtain a repayment of their application money (thereby avoiding an immediate loss given the investment was worth much less than when the application was made in June 2007) or whether Basis Capital was required to allocate units to the June Applications based on the NAV calculated in September 2007 (which would benefit remaining investors in the fund); and
- whether the June Redeemers were entitled to be paid out the value of their units as at 30 June 2007.
Were the June Applicants entitled to obtain a repayment of their application money?
The Court was required to address two preliminary questions. Firstly, the point at which new units in the Funds were actually issued to applicants, and secondly if this was not when the applications were received, whether the entry of the applications onto the registry and the sending of a letter confirming the investment resulted in the applicants acquiring a financial product of some kind as defined by the Corporations Act 2001.
The Court determined that units in a fund are not issued until the exact number of units to be issued is calculated (after calculation of the NAV) and this information is entered on the registry. Therefore at the time of the suspension of applications by Basis Capital in June 2007, units in the Funds had not been issued to the June Applicants. The Court did find however that acceptance of an application by a funds manager constituted a binding contract by which the funds manager is obligated to issue units to applicants and that this meant an applicant acquired a "prospective or contingent" interest in the fund which constituted a "financial product".
If this were the end of it, the June Applicants would simply have both their units and an interest in the fund. However, the provisions of section 1017E of the Corporations Act were integral to determining the entitlement of the June Applicants to a refund of their application monies.
The Court held that s1017E(4) requires application monies to be returned to applicants if the financial product has not been issued within one month after receipt of the monies "if it was reasonably practicable to do so". On its face section 1017E(4) is ambiguous but the Court held that it acts so that the issuer can only retain application funds after the one month period if:
- it was not reasonably practical to issue the product; and
- it was not reasonably practical to return the money.
In this situation the Court found that: (1) was satisfied due to the collapse in global debt markets but that there was no obstacle to returning the money to the applicants and therefore (2) was not satisfied. Therefore the June Applicants got their money back.
The Court also found that whilst a financial product had been issued to the June Applicants upon receipt of their applications, that this did not prevent the application of section 1017E and ss(4) in particular because it found that the June Applicants had paid the application moneys to acquire the units rather than an interest in the Funds.
Were the June Redeemers entitled to be paid out the value of their units?
Under the Corporations Act and the constitutions of the Funds, redemption payments were required to be made within 30 days of the redemption date provided that the Fund is liquid. This limit can be extended indefinitely when the Funds are illiquid. The Funds had been liquid when the June Redemptions accrued on 30 June 2007, but had subsequently become illiquid in mid-July 2007 and redemptions suspended, prior to the redemption payments being made. The Court was therefore required to determine whether this subsequent illiquidity affected the June Redeemers entitlement to receive their redemption payments.
The Court found that the June Redeemers' rights to redemption accrued on the redemption date (being 30 June 2007) and that Basis Capital was required to pay the redemption amount within 30 days of this date irrespective of any subsequent illiquidity of the Funds and/or suspension of redemptions. Accordingly the Court found that the June Redeemers were entitled to be paid the value of their units as calculated as at 30 June 2007.
Lessons for Issuers of Interests in Managed Investment Funds
It is important to ensure consistency between constitution provisions and processes applied in practice and breach of s. 1017E is a serious concern - it can attract criminal penalties. It also indicates that timing issues are critical and REs and their directors might need to reconsider methods for raising equity to avoid the potentially problematic impact of s. 1017E.
Implications for Insurers
This case may be fact specific but it demonstrates that the promotion of investor protection was at the forefront of the Court's reasoning and the investor friendly reading of ambiguous legislation will likely be a common theme as cases arising from the credit crisis work their way through the Courts. Should REs and directors face exposure for the type of problems encountered in this case, then this could potentially impact on D&O and other policies.
This is one of the first Australian cases dealing with the impact of the sub-prime crisis and the reach it has for Australia. Insurers may yet see the effects of claims against investment advisors/brokers and research houses for recommending any investments with exposure to these problems.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.