Basis Capital v BT: Investor’s rights to application and redemption monies

A recent decision by the New South Wales Supreme Court in Basis Capital v BT shows that the rights of investors and members in a registered managed investment scheme are highly dependent on the facts, the nature of the financial products offered and the administration and drafting of the constitution and product disclosure statement of the scheme.

The key findings in Basis Capital v BT are that:

• under section 1017E(4) of the Corporations Act 2001 (Cth) (Act), a product issuer may only retain investors’ application monies beyond a one-month time limit if it is not reasonably practicable to issue the product and also not reasonably practicable to return the money, and
• where the scheme’s constitution empowers the responsible entity to suspend redemptions of units where the scheme is liquid and the responsible entity does in fact suspend redemptions, the authority to defer payment of the redemption price is withdrawn when the scheme becomes illiquid as the relevant provisions of the scheme’s constitution cease to operate.

Freehills acted for BT Portfolio Services Ltd as first representative defendant.

Facts of the case

On 16 July 2007, redemptions of units in two managed investment schemes, the Basis Yield Fund and the Basis Aust-Rim Diversified Fund (Funds) were suspended as a result of the disruption of global credit markets. Both Funds had exposure, through a series of offshore vehicles, to structured credit investments adversely affected by the downturn of the United States sub-prime mortgage market.

Basis Capital Funds Management Ltd (Basis) as responsible entity of the Funds announced, by a disclosure notice for each fund, that during the suspension, no applications for the issue of units in the Funds would be accepted.

Basis had received applications for the redemption of units in the Funds and the issue of new units to be effected on 2 July 2007 and it sought declaratory relief from the court to principally determine:

• whether it would be in compliance with its duties under the Act in retaining the application monies of investors who applied for units in either fund in June 2007 (the June Applicants) as assets of the relevant fund, and

• whether unitholders who validly applied for redemption of units to take effect on 2 July 2007 (the June Redeemers) were creditors of the relevant fund and the amount of the redemption proceeds be paid based on the relevant funds’ net asset value as at 30 June 2007.

The timing of the issue of units to the June Applicants

Having regard to the provisions of the constitutions of the Funds and the processes in place in practice, the court determined that the June Applicants were only issued units on 28 September 2007, well beyond the one-month time limit provided for under section 1017E.

The return of investor’s application monies under section 1017E

Section 1017E creates statutory rights and obligations which are superimposed upon the constitutional rights of investors. Under section 1017E(2A), the application monies of the June Applicants were taken to be held in trust by Basis for the benefit of the June Applicants from the time that the payments were received.

Section 1017E(4) imposes a duty on the product issuer to return the money or issue the product within a time limit. The time limit is either before the end of one month starting on the day on which the money was received or if it is not reasonably practicable to do so before the end of that month—by the end of such longer period as reasonable in the circumstances.

The court determined that under section 1017E(4) the product issuer may only retain the money beyond the one-month time limit if it is not reasonably practicable to issue the product and also not reasonably practicable to return the money.

In the circumstances, the court decided that although it was not reasonably practicable for Basis to issue units within the one-month period because of the collapse in global markets, there was no obstacle to returning the money to the June Applicants and Basis was therefore required to return application monies within the one-month period.

The alternative construction whereby the product issuer may retain the money beyond the one-month time limit if it is not reasonably practicable to issue the product or not reasonably practicable to return the money would permit the product provider to retain the money on the basis of its own determination of the practicability of the issuing of the financial product. It was determined that this alternative construction was inconsistent with the literal wording of the section and a construction of 1017E that promotes investor protection.

The issue of a financial product other than units in the Funds

The court determined that each June Applicant received two classes of financial products: units in the Funds and interests in the Funds constituted by the contractual right that arose when Basis accepted the June Applicant’s investment applications by way of confirmation letters.

The court decided that the issue of this additional financial product was irrelevant to the determination as to whether Basis was entitled to retain the June Applicants’ application monies. It was pointed out that section 1017E can only apply where money is paid ‘to acquire’ one or more financial products issued by the product provider and the application forms and the product disclosure statements indicated that the June Applicants paid their application monies to acquire units in the Funds and not a financial product constituted by a contractual right.

Redemptions of units where the scheme is illiquid

Under the Act and the constitutions of the Funds, each member’s right to redeem units depends upon whether the Funds are liquid or illiquid.

The constitutions of the Funds provide that where the Funds are liquid, Basis must satisfy a redemption request by payment of the redemption price within 30 days of the redemption date. If Basis is unable to calculate or pay the redemption price under certain circumstances set out in the constitutions, the period for satisfaction of the request may be extended for as long as the circumstances apply.

The court determined that the June Redeemers applied for redemption of their units when the Funds were liquid. Subsequently, the Funds became illiquid and Basis’ entitlement to defer payment of the redemption price under the constitutions ceased. Consequently, the court decided that as of the date when the Funds became illiquid, the June Redeemers became creditors of the respective Funds in respect of their June redemption requests and that the redemption price was to be calculated on the basis of the net asset value of the Funds as at 30 June 2007.

Closing comments

Three points of interest to come out of this decision include that:

• it is a timely reminder that the provisions of the constitution of a scheme and the processes applied in practice should be consistent. If they are not, any compliance breach should be remedied by either amending the constitution or changing the processes in place

• because of the nature of certain products, applying the principle in section 1017E as interpreted by the court may be problematic and responsible entities may need to reconsider the way certain schemes raise equity. In particular, it is of critical importance that any timing issues relating to the issue of units are resolved, and

• the responsible entities should review their approaches to redemptions and the provisions of scheme constitutions dealing with redemption in light of this decision.

For more information, please contact:

Name : Peter Rowe
Title : Partner
Office : Sydney
Phone : +61 2 9225 5343
Fax : +61 2 9322 4000
Email : peter.rowe@freehills.com

Name : Michael Vrisakis
Title : Partner
Office : Sydney
Phone : +61 2 9322 4411
Fax : +61 2 9322 4000
Email : michael.vrisakis@freehills.com

Name : Anna Sutherland
Title : Partner
Office : Sydney
Phone : +61 2 9225 5280
Fax : +61 2 9322 4000
Email : anna.sutherland@freehills.com