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How to Manage and Resolve Disputes Between SMSF Fund Members How to Manage and Resolve Disputes Between SMSF Fund Members - July 2013

How to Manage and Resolve Disputes Between SMSF Fund Members


by Graeme Colley, SMSF Professionals Association of Australia Limited (SPAA)

Released July 2013

Throughout history there have been a number of methods to resolve disputes, some good - most not so good. Initially, in the Stone Age setting I suppose disputes were resolved with physical aggression and the stronger party usually prevailing as the winner. Although I must say the story of David and Goliath is a good lesson to show how cunning and technology have its place, but it seems to be the exception rather than the rule for its time. The duelling technique of dispute resolution which was trendy for much of the previous millennium, from the medieval to the late 1700s, served as an effective method of sorting things out and, if we believe the movie versions, gained the hand of a fair lady. If that practice had continued the spoils to the victor may have ended up with the prize, however, these days comes with it the added bonus of a custodial sentence. The modern day equivalent of the duel is ceremonial and forms part of the Olympics, thus the sport of fencing.

These days we’d like to think we are far more sophisticated and the environment in which disputes are resolved is far more conciliatory than in the past. In many cases we may not decide to pursue the matter due to its trivial nature or that there may be bigger fish to fry in the scheme of things. In other cases the result may be that overall things may work themselves out. However, there are always those who wish to fight on with the argument that ‘it’s a matter of principle’ irrespective of the cost or the ultimate outcome. My past experience saw a number of matters end up in the courts on the basis of ‘principle’ by the individual or entity only to be cut asunder by the court’s decision.

On the basis of principle, family law disputes are probably the ones that come to mind more readily than others due to the emotional issues involved such as access to family members and so on. However, you would think that superannuation disputes don’t come far behind family law issues. This is in view of the growing amount of money saved through superannuation and, for most, it is the largest personal asset apart from the family home.

The resolution of a dispute should not get confused with the payment of compensation that may be made, although many see the size of the financial compensation as what it is all about. Any resolution of a dispute involves a process and at its end reconciliation is made. The final outcome may involve an exchange of rights and property, including cash, between the parties so that they are broadly returned to an equitable position had the dispute not occurred. The exchange of rights may include changes in the behaviour of one or more of the parties.

A dispute is a perceived inequity that involves a matter of fact and degree. Some of us go into crisis mode once an unfairness is perceived at the blink of an eye while others wait until the issue may develop to work out what the real issue is or forget about it altogether and get on with life. Some trustee/members of SMSFs seem to attract disputes, maybe that’s just the way they live while in other funds they never run into problems. Others may start out in peace and harmony and end up with WWIII erupting. What creates the dispute is usually about ignorance of what superannuation is designed to do, misunderstanding how things work or intentionally taking more than one is entitled to.

The main areas involved in the operation of a superannuation fund and whether disputes will arise seem to centre around:

  • Choice of client and whether an SMSF is an appropriate retirement savings vehicle,

  • The members’ understanding of what superannuation is all about,

  • The drafting of the fund’s trust deed and its practical operation,

  • The dominance of one member which results in other members being disadvantaged, and

  • The payment of death benefits and death benefit nominations.

Your experience may add or subtract items from this list and you may see the net being cast much wider for SMSF trustees, members and their beneficiaries. You may include disputes between an adviser and individual fund members as the area where most disputes arise. Others may include disputes with the regulator of SMSFs, the ATO.

Let’s have a look at some of the areas where disputes may arise and what could have been done to assist in preventing the situation that prevailed. First we will have a look at the drafting of the trust deed of the fund and then the relevance of other aspects of the fund operation.

The Trust Deed and Other Fund Documents

How many of us as advisers, accountants or fund auditors have actually read the trust deed of a client’s SMSF. Then there’s the question of whether the client as trustee or member of the SMSF has read the fund’s deed or at least a summary of it. In practice, there is no requirement to provide a Product Disclosure Statement for an SMSF at the time a member joins the fund or at the time of commencing an income stream. However, it can serve as a valuable educational tool for clients in the short term and for advisers in the longer run to act as a buffer in reducing disputes. The use of a common trust deed for all clients can benefit an adviser and other professionals to enable them to become more familiar with the deed’s operation on a frequent basis. An adviser who has SMSFs with trust deeds that have evolved at different times or drafted by lawyers who seem to come from all walks of life can only lead to confusion and possibly conflict in some cases. Don’t forget the rule that if you can’t understand the provisions of the fund’s trust deed as a professional the client will probably not be able to understand it as well, unless he or she is a lawyer and even then any understanding may be questionable.

In a recent case I came across the trust deed was poorly written and had not been a robust document at the time it was written and was subsequently amended a number of times. The benefit clause was particularly startling. Here is what it said:

3.7 UPON the retirement of a Member from employment with an employer or retirement from all employment a benefit shall be payable as a lump sum.

Note: clause number and the font used in the deed has been changed to conceal its identity.

That was all the deed said about benefits from the fund. It meant that anyone wishing to receive a benefit from the fund was limited solely to a lump sum when they retired from the employer or employment irrespective of their age. Retirement was not defined in the fund’s deed so you must assume it takes its ordinary meaning. There was no provision in the deed stating that SISA prevailed where a conflict arose between the law and the provisions of the deed. However, the saviour in this case was the ability to amend the deed. That has now been done prior to any disputes arising in the fund.

Lost deeds and their replacement

In a small number of cases the trust deed for an SMSF may be lost, stolen or destroyed by flood or fire. While there are no real issues in replacing the original deed with a replacement care should be taken. Appropriate precautions should be implemented in advance to ensure a copy of the executed deed is kept independently of the fund, thus reducing the likelihood of loss. In some cases a copy of the fund’s deed may be stored with the auditing records, particularly if the ATO’s recommendations and Guidance Statement GS009 about the audit of SMSFs are followed closely.

Some administrators with standard trust deeds identify each version of the deed and are able to provide a copy of the standard deed that was provided to the fund. However, any subsequent bespoke amendments to the deed that have not used the legal drafting service provided by the administrator would not usually be available. Trust deeds could also be retained by the fund auditor in some cases.

Of course, in cases where fund trust deeds go missing the nagging doubt when a dispute arises is, what did the original deed really say and, are the trustees making decisions contrary to those provisions.

Provisions in deeds relating to dispute resolution

One question is whether the trust deed of an SMSF should have a provision relating to disputes. You may think this is tempting the inevitable, however, it is there solely as a sensible safety first measure. Many deeds do not have provisions relating to the escalation of disputes or, if they do, may refer in scant terms to the fact that where there is a dispute it is referred to an appropriate dispute resolution mechanism. Some deeds go to a great deal of effort and will refer to the process of how disputes are to be dealt with and the stage at which they are to be referred to the appropriate arbitrator or conciliator, the timing of the referral and the types of matters that can be referred. Whether this is a bit over the top can only history will tell on a fund by fund basis and the crises that may confront it over time.

Issues Relating to Fund Documents and Trustee Decisions

The need to keep fund documents up to date and ensure trustee decisions are relevant and correct has been demonstrated in a number of cases to hit the press over the past few years. The most notable, familiar to anyone who has attended this and other conferences over the past few years1, was about an SMSF where both members of the fund had died and the daughter and her husband ended up as trustees to the detriment of her brother. As a result of the case, amendments were recommended to trust deeds to assist in ensuring the distribution of fund benefits reflect the true wishes of the deceased and wrest power from perceived potential abuse of decisions relating to the fund. While this may work, there may be a number of alternatives which are just as effective as incorporation of specific provisions in the trust deed.

One case that is interesting is the Queensland Supreme Court case of Donovan v Donovan [2009] QSC 26. The case emphasises how important a superannuation trust deed can be and whether a death benefit nomination is binding on the fund trustee. The statements made by the Commissioner in SMSF Determination SMSFD 2008/3 are also relevant. This shows that the provisions of the fund’s trust deed should be flexible enough to allow members to give a direction to the trustee in terms of section 58 of the SISA rather than binding the trustees decision to the much more limited requirements of SIS Regulation 6.17A.

In the case, Mr and Mrs Donovan (his wife by a second marriage) were also the respective director and secretary of the fund’s corporate trustee. The revised trust deed of Mr Donovan's super fund required a corporate trustee to be bound by a binding death benefit nomination.

A letter was addressed to the corporate trustee that upon his death his superannuation entitlements should be distributed to his legal personal representative for inclusion in his estate assets. On Mr Donovan's death, his daughter by his first marriage, Lynda (who was the beneficiary under his will), brought an application to seek the court's determination that Mr Donovan's nomination was binding on the corporate trustee, which was under the control of Mrs Donovan.

The Court found that the intent of the particular trust deed was to require Mr Donovan's letter to be in the form described in regulation 6.17A(6) of the Superannuation Industry (Supervision) Regulations 1994 (Cth), and so further held that Mr Donovan's letter was not binding on the trustee.

As Mr Donovan's letter was a non-binding death benefit nomination, the corporate trustee was not obliged to distribute his superannuation entitlements to his legal personal representative for inclusion in his estate assets.

The lesson to be learned from this case is that members of externally-managed superannuation funds should check to ensure that any binding death benefit nomination accords with the member’s current wishes on an ongoing basis.

Members of self-managed superannuation funds should:

  • consider the distribution of their assets, in conjunction with their will, to determine the form of nomination to their trustee, or whether the terms of any existing nomination is still appropriate; and

  • review the fund’s trust deed to ensure that a death benefit nomination is made in a way to ensure that any binding nomination which has been made follows the form and manner provided for in the SISA and SIS Regulations.

Unfortunately, in this case the requirement of the fund’s trust deed to satisfy the provisions of SIS Regulation 6.17A was accepted as valid. However, had the provision of section 58 of SISA been used the manner in which the direction was made may have ended up with a different result.

Voting rights and the ability to control the fund

The ability to control a superannuation fund is always a risk. The question arises that if voting is provided under the deed as one member one vote then issues can arise where there is more than two members in the fund. This can happen where family groups wish to have children as members of the fund who may be able to manipulate the fund on the death of one of the parents. It is for this reason that some advisers do not recommend children as members due to the inequity that can result and leave the membership of the fund to just one or two members in the case of a couple.

While it is possible to have trustee voting provisions in the trust deed based on the balance of each member the administration of the fund may prove difficult as the value of the member’s balance may need to be valued prior to any vote. A possible solution to this is to have the voting rights set at the commencement of the year when the balances are valued for other purposes.

He or she who holds the cheque book is king or queen

SMSFs, like most things to do with superannuation, are all about the control of money and its collection, investment and distribution. Where money is involved, particularly if it involves significant amounts, disputes will follow where those who think they have been denied their fair share of the pie have been wronged. Where SMSFs are involved, unlike larger funds, it is the trustee who is invariably the member is able to cut the cake to their advantage.

One recent case where the holder of the chequebook was king was in the matter of Shail Superannuation Fund v Commissioner of Taxation, Re [2011] AATA 940. The lessons to be learned from this is don’t trust your partner with the chequebook if you suspect anything untoward and if you’re left holding the baby as one of the remaining trustees you may end up with more than you bargained for.

The trustees of the Shail Superannuation Fund at the relevant time were Mr Mustafa Shail and Mrs Nuriye Shail. It was understood there were some relationship issues at the time in relation to the couple. Mr Shail transferred $3,460,000 from a cash management account of the fund to a bank account in Turkey in the name of “Mustafa Nail Shail”.

Mrs Shail claimed that she was unaware of the transfer. The Tribunal considered the case on this basis and that Mrs Shail did not benefit from the transaction.

The Commissioner treated the Shail Superannuation Fund as non-complying for year ended 30 June 2005 and imposed various penalties on the fund. By treating the fund as a non-complying fund tax payable for the year ending 30 June 2005 was in excess of $1.5million.

Mrs Shail contended that she could not be liable for the breach by Mr Shail as she was unaware the transaction had taken place. In her defence she relied on a number of court decisions to support her case, in particular the High Court decision in Austin v Austin where “it was held that a joint trustee could not be held liable for a breach of trust by a fellow trustee in circumstances where there was no proof of negligence or breach of trust by the first mentioned trustee”.

The Commissioner argued that the significant nature of the offence and the purpose of all members being trustees of a fund under the SISA, requires fund members “to participate equally in the decision making processes of the fund”.

The Commissioner’s decision was supported by the Tribunal which noted that “[a]ny appearance of unfairness to Mrs Shail as an individual should not … obscure the nature of the Fund, the role of trustees or the regulatory regime in which they function”.

You must come to the conclusion that joint signatories may have come to a different conclusion and the fund remain a complying superannuation fund. Although, there would be no barrier to both trustees acting in tandem and absconding with the money.

The power goes to whoever controls the chequebook or does it?

In contrast to the matter in Shail which involved the Commissioner and the compliance of the relevant superannuation fund, the case of Dunstone v Irving [2000] VSC 488 (21 November 2000) was a case where the regulator was nowhere to be seen in the litigation. It shows the issues that may evolve where there are two trustees, related or otherwise, who start out with good intentions but in the end when things turn sour they want their agreed cut of the cake as benefits from the fund rather than what the trust deed said.

The case involved Iverston Pty Ltd Superannuation Fund and its two trustee/members John Dunstone and Chester Irving. The fund was used to provide working capital via an interposed unit trust for a building and construction business they both owned. As part of the arrangement they agreed to make contributions to the fund equal to the maximum permitted by the legislation. This meant that the amount of the contribution made for Dunstone were about twice those for Irving. However, it was agreed that when it came time for the payment of benefits the superannuation fund would be used to ‘equalise’ their entitlements due to business issues external to the fund. This was consistent with the practice of the business where they both were paid the same amount of remuneration.

Under the rules of the fund the member’s statements year by year published the vested entitlement of the member. However, under the terms of the fund’s trust deed the trustee had discretion to pay benefits as they determined. The reason for crystallising the member’s benefits was that Dunstan wished to rollover his superannuation benefit to another fund. He considered his entitlement in the fund was about $1.3 million which was disclosed on the member statements.

Initially, it was agreed to pay the amount on the member statement and would exercise the discretion provided under the trust deed. However, Irving considered the total benefits in the fund should be split equally and prevented payment of the agreed amount from taking place. Dunstan sought damages under s 55(3) of the SISA to order Irving to do all things that would allow the transfer to take place. The final amount awarded considering the possible investment scenario that Dunstan was expected to embark on was about $1.6 million.

Disputes with the regulator

Superannuation disputes involving the ATO as regulator of SMSFs really show that common sense is the best way to progress a case without the fuss, time and expense of going through the legal system. Recent cases have shown the success of the Commissioner with excessive contributions tax assessments as well as the compliance of SMSFs with the SISA and the imposition of penalties. This is despite a few recent cases which have not been decided in favour of the Commissioner (Bronstein, Pabian Park Pty Superannuation Benefits Fund) despite the seriousness of the breaches.

In the case of Pabian Park Pty Ltd Superannuation Benefits Fund (Fund) [2012] AATA 375 the Commissioner had accepted that the fund was a "complying superannuation fund" for a number of years and it received the relevant concessional treatment for taxation purposes.

The Commissioner found that the Fund had breached the SIS Act in 2008 because the loans were 'in-house assets' representing more than 5% of the market value of Fund assets. An undertaking was accepted that the loans would be repaid by 30 September 2009. This did not occur by the date agreed and the Commissioner issued a notice of non-compliance for the 2005/06 financial year. Breaches related to the sole purpose test and in-house asset rules.

The trustees applied to the AAT for further review. However, after 'weighing up all the factors', the AAT set aside the decision of the Commissioner. It was considered that the decision was finely balanced but after considering all the circumstances that the breaches while serious were not wilful.

Other cases concerning the compliance of the fund and the imposition of penalties are Olesen v MacLeod [2011] FCA 229; Olesen v Eddy [2011] FCA 13 and AAT Case [2011] AATA 403 Triway Superannuation Fund.

A penalty of $12,500 was imposed for a trustee of an SMSF for the illegal release of benefits in breach of the sole purpose test in Olesen v MacLeod [2011] FCA 229

The facts involved the rollover of a payment of $40,032 in August 2005 and the subsequent withdrawal of $20,028 to settle some legal proceedings for a former client. Further amounts were withdrawn in 2006 and 2007 to meet other financial needs in relation to school fees and due to a relationship breakdown. These contraventions were reported by the fund auditor in 2007 and despite this other amounts were subsequently withdrawn from the fund. In January 2010 the fund was closed and any remaining assets were transferred to a retail superannuation fund. The ATO disqualified the trustee.

The Federal Court held that the trustee had contravened the sole purpose test by the significant number of withdrawals and that financial assistance was provided to the member under section 67 of the SIS Act by using the resources of the fund. The Court imposed the civil penalty of $12,500 due to the seriousness of the breach over a number of years and the deliberate nature of the breach.

A penalty of $15,000 was imposed on an SMSF trustee for the unauthorised early release of benefits in breach of the sole purpose test in Olesen v Eddy [2011] FCA 13

The facts in this case were that an SMSF was established in 2005 and $75,570 was withdrawn from the fund over 2005 to 2008. The auditor of the fund identified the breaches which represented 98% of the fund and referred to as loans to the member. The Commissioner applied to the Federal Court to impose a civil penalty on the trustee. The Court held there was a breach of the sole purpose test because of the multiple withdrawals which were not authorised and also the member had obtained financial assistance to a member using the resources of the fund. In relation to the amount of the penalty took into account the members personal circumstances and other financial pressures surrounding his divorce. But on the other side of the coin there were 160 deliberate contraventions sustained over a sustained period.

The Commissioner’s decision was confirmed by the AAT in AAT Case [2011] AATA 403 Triway Superannuation Fund that the fund should be treated as a non-complying superannuation fund despite the fact that the son of a couple who were all members had taken money from the fund which had been concealed by the parents for five years. In its decision the AAT considered that the breaches of the superannuation standards were particularly serious and that for the Commissioner to treat the fund as complying in the circumstances was inconsistent with the provisions of the SIS Act.

Alternative dispute resolution

Disputes can be resolved without lawyers or court hearings. Alternative dispute resolution methods can provide more control of the outcome and help save time and money. These involve the use of an impartial third person assisting the participants to negotiate. It aims to provide disputing parties with a cheaper, quicker and less adversarial alternative to going to court.

Use of formal ADR is becoming more common in tax and superannuation disputes. This is consistent with wider reforms in the Commonwealth civil justice system, and with the ATO's obligation to act as a model litigant. These approaches include mediation, conciliation, case appraisal and evaluation by an independent party.

Conciliation is the most commonly used technique (57% of tax cases) in the Administrative Appeal Tribunal (AAT). Since 1 July 2008, there have been 235 AAT cases that used these approaches and 94 (40%) were resolved. A further 35 (15%) were partially resolved. Most of the remaining 45% were later resolved or ADR was useful in narrowing the issues for a hearing.

Mediation is the most frequently used ADR technique in the Federal Court. In 2010-11, 18 tax matters were referred for mediation: 16 to internal Federal Court mediators and 2 to external mediators such as barristers. 5 of the 16 cases referred to internal mediators have been completed, of which 4 have been resolved.

When the ATO can settle

The Commissioner's statutory responsibilities as the administrator of the tax and superannuation laws restrict how far the ATO can go in settling disputes. Generally the ATO cannot negotiate liability on a commercial basis - we must settle on a principle basis (that is, what is the tax liability) except in certain limited circumstances under the Code of Settlement Practice. This requires balancing the obligation to collect taxes with the obligation to administer the tax and superannuation system in an efficient and effective way.

For example, settlement may be appropriate if the cost of litigating is out of proportion to the possible benefits, including the prospects of success and the likely award of costs. On the other hand, it would generally be inappropriate to settle where the outcome would be contrary to policy reflected in the law or would involve inconsistent treatment for taxpayers.

In addition to the ATO there are a number of other alternative dispute resolution arrangements such as the Superannuation Complaints Tribunal and the Financial Ombudsman Service. These are covered in the Attachment to this paper.

As you can see from this paper disputes between fund members, irrespective of whether they involve family members, friends or business associates are difficult things to handle.  The best practice is prevention of disputes rather than cure. This can be initiated at the time of the initial fund set up, prior to the issue blowing out of all proportion and dealing with the financial consequences of any resolution that is reached.

ATTACHMENT

Formal Complaint Resolution

Superannuation Complaints Tribunal

In relation to superannuation the resolution of disputes is a formal process in terms of the Superannuation Industry (Supervision) Act 1993 (SIS Act). Section 101 of the SIS Act which requires trustees of a superannuation fund, with the exception of an SMSF, to establish a complaints mechanism and deal with complaints as required (sections 64A and 101). Where resolution of the complaint cannot be made the matter can be referred to the Superannuation Complaints Tribunal (SCT) for review. The SCT can review complaints about decisions and conduct of trustees of APRA regulated funds, approved deposit funds, life company providers and retirement savings account providers. This can include complaints about superannuation, life insurance and whether the trustee has acted reasonably in relation to the relevant decision.

Types of complaints considered by the SCT include:

  • Errors in annual statements,

  • A belief that a death benefit was paid or may be paid to the wrong person or people,

  • An unreasonable delay in a payment,

  • A miscalculation of a benefit, payment, or commutation,

  • A refusal to approve a claim for a disability benefit,

  • Misrepresentation about the terms and conditions of the policy,

  • Error in information provided by a Superannuation Fund Trustee to the ATO for superannuation surcharge purposes,

  • For RSA, a refusal to approve a claim for a disability benefit (including benefits where the insurance premium is paid from the RSA),

  • A superannuation provider's conduct in administering the splitting of a superannuation payment between spouses in accordance with a binding agreement or Family Court Order under the family law legislation.

The SCT is unable to handle a complaint unless:

  • It has been considered by the internal complaints arrangement established by the fund or where it hasn’t been considered within 90 days of lodging the complaint,

  • Complaints relating to the management of a fund such as the fund’s investment performance or the general level of fees and charges.

  • A complaint against an employer that is not a trustee of the fund, such as the failure to pay contributions.

  • A complaint about a life insurance product that non-superannuation annuity or superannuation product such as life insurance. This is the responsibility of the Financial Ombudsman Service,

  • Complaints against financial advisers who are not acting as agents of a superannuation provider,

  • Complaints about matters that are the subject of court proceedings,

  • Complaints that are lodged after 28 days of a decision being made or after the time no response has been received,

  • Actions before funds became regulated,

  • Personal superannuation policies,

  • Some public sector superannuation fund complaints, and

  • Funds that are not regulated.

Financial Ombudsman Service

The Financial Ombudsman Service (FOS) has the role of resolving disputes between consumers, including some small businesses, and member financial services providers. Membership of the Financial Ombudsman Service is open to any financial services provider carrying on business in Australia. As a free service to consumers of financial products FOS is considered as an alternative to the court system and there is no requirement to obtain legal advice when lodging the dispute.

The dispute resolution processes of FOS cover financial services disputes including banking, credit, loans, general insurance, life insurance, financial planning, investments, stock broking, managed funds and pooled superannuation trusts. Estate planning, estate management and trustee services are also included in the FOS dispute resolution responsibilities.

In a similar way to the SCT providers of financial, insurance or investment products or services that are members of the FOS have an internal dispute resolution process. Where the complainant is not satisfied with the response from the internal resolution process, FOS provides conciliation or investigates the dispute and issues a decision which is binding on the financial services provider.Bottom of Form

FOOTNOTES

  1. I have not provided any references to this case as it has been overworked on the conference circuit but I’m sure you are familiar with it (Katz v Grossman).