(c) Knowledge of transactions and loans made prior to appointment as directors
83 The present form of the proposed pleading against the directors is at Exhibit RGJ-4 to Mr Johnston's second affidavit. Paragraph 229 is as follows:
Upon their appointment as a director of MFSIM on 27 February 2007, or at least within a reasonable period thereafter, each of Ms Beale, Mr Whateley and Diamond should have been reasonably familiar with and understood the matters referred to in paragraph 36 above, including:
(a) the Fund's financial statements for the year ended 30 June 2006;
(b) the Fund's financial statements for the half-year ended 31 December 2006;
PARTICULARS
The applicants repeat the particulars at paragraph 36 above.
84 Paragraph 36(b) alleges the directors would have understood 'the financial status of the Fund by regular review of the Fund's financial statements'. Paragraph 230 then deals with what they should have gleamed from the financial statements for the year ended 30 June 2006.
85 In his written submissions, Mr Jackman SC pursued the line that the directors could not have been aware of these transactions, as paragraph 229 alleges, which had, after all, occurred prior to their appointment on 27 February 2007. That argument, however, lost much of its force in light of paragraph 36(b) which makes plain why it is alleged that they became aware of matters antedating their appointment. To the extent that the point was pressed I reject it.
86 In his address, Mr Jackman SC pursued a somewhat different line. The manner in which paragraph 36(b) operated tied the allegations made against the directors to that which could be gleamed from the 30 June 2006 financial statements. These statements were in evidence and the burden of Mr Jackman SC's submission was that a comparison between what was alleged and was contained in the statements revealed the pleading to be untenable. Paragraph 230 contains the allegations in question. It is long and detailed but in substance contains five substantive allegations. I propose to treat each of them separately for the sake of clarity.
87 Paragraph 230(a) alleges:
230. On 27 February 2007 or within a reasonable period thereafter, each of Ms Beale, Mr Whateley and Diamond knew that:
(a) during the financial year ended 30 June 2005, MFSIM made or maintained unsecured loans out of the Fund's property to:
(i) MFS Group Limited in the amount of $62,000,000;
(ii) MFS Pacific Finance Limited unsecured notes in the amount of $5,000,000;
(iii) MFS Optimiser One (formerly MFS Diversified Property Securities Trust) in the amount of $26,073,011;
(iv) MFS Mirage Investment Trust in the amount of $20,000,000;
with a monthly average balance in promissory and unsecured notes of $26,918,221;
PARTICULARS
(1) Each of Ms Beale, Mr Whateley and Diamond was a director of MFSIM.
(2) These loans are recorded as notes, promissory and unsecured notes or debt units in notes 3, 9 and 16 to the Fund's financial statements for the year ended 30 June 2006.
88 The critical part of this allegation is that loans in question were 'unsecured'. This is pivotal to the allegation made subsequently by the applicants (in paragraph 231) that the loans referred to in paragraph 230(a) were not authorised (because they were not secured) and the subsequent allegation (in paragraph 232) that Mr Jackman SC's clients should have known they were not authorised.
89 Mr Jackman SC began with the unsecured loan of $62,000,000 apparently made to MFS Group Limited. Resort to note 16 in the financial statements revealed a section headed 'Investments in Related Parties' under which was an entry which recorded $62,000,000 as having been invested by the Fund in 'MFS Group Notes'. Mr Jackman SC submits that this entry does not say that the investment was unsecured so that the allegation in paragraph 230(a)(i) that there had been an unsecured loan of $62,000,000 to MFS Group Limited was unsupported. Mr Jackman SC submitted that this showed that 'the pleaders made that up'. Furthermore, so he submitted, it was difficult to understand how his clients should have understood merely from reading that entry that the Fund had made an unauthorised loan.
90 There are a number of skeins in this debate which needs must be separated: are unsecured loans 'investments'? What were the duties of the directors in coming to grips with what the Fund was obligated to invest in? What can arguably be drawn from the financial statements? Ultimately, is the applicants' case that the directors should have realised from the financial statements that the Fund had made unauthorised loans to related parties sufficiently arguable to permit it to advance to trial?
91 Starting at the beginning, the authorised investments permitted to the Fund were alleged in paragraph 38(c) to be as follows:
(i) mortgage investments being a loan secured by a registered mortgage over a freehold estate or interest in real property in Australia;
(ii) deposits at call or for a term with any authorised deposit taking institution authorised to undertake banking business ("Bank") as those terms are defined in section 5 of the Banking Act 1959 (Cth);
(iii) bills of exchange (including commercial bills) issued, drawn accepted or endorsed by any Bank or negotiable certificates of deposit issued by any Bank;
(iv) up to 14 December 2005, any mortgage investment scheme that was a registered managed investment scheme, including a managed investment scheme of which MFSIM was the responsible entity;
(v) after 14 December 2005, subject to any exceptions contained in the Act or any ASIC relief (including any ASIC class orders) any managed investment scheme that was a registered managed investment scheme, including a managed investment scheme of which MFSIM was the responsible entity; or
(vi) any investment authorised under section 21 of the Trusts Act 1973 (Qld) which MFSIM considered a prudent investment for the Fund;
92 It is tolerably clear, I think, that (i)-(v) would not embrace the making of unsecured loans to persons other than banks. But it was upon (vi) and its reference to s 21 of the Trusts Act 1973 (Qld) that Mr Jackman SC seized. It provides:
A trustee may, unless expressly forbidden by the instrument creating the trust-
(a) invest trust funds in any form of investment; and
(b) at any time, vary an investment or realise an investment of trust funds and reinvest an amount resulting from the realisation in any form of investment.
93 Mr Jackman SC submitted that this was as broad as one could want.
94 The applicants, on the other hand, submitted that an unsecured loan could not be an 'investment' citing the Privy Council's decision in Khoo Tek Keong v Ch'ng Joo Tuan Neoh [1934] AC 529 at 536 and JD Heydon and MJ Leeming, Jacobs' Law of Trusts in Australia (Butterworths, 7th ed, 2006) at [1804]. Khoo Tek Keong is authority for the proposition that reference to an 'investment' in a testamentary trust does not encompass the making of unsecured loans. That case concerned a testamentary trust with a clause permitting trustees to make 'such investments as they in their absolute discretion think fit'. The trustees lent money without security to 'chetties' (which the Oxford English Dictionary describes as South Indian trading castes). The Privy Council tersely agreed with the Appellate Court for the Straits Settlements that these were not investments within the meaning of the investments clause since there was no security.
95 The learned authors of Jacobs' Law of Trusts think that a power to invest 'if sufficiently widely expressed, may not always require that a security be taken for the funds' and indeed, as they point out, there have been cases where extrinsic evidence has been permitted to show that the reference to 'investments' includes the purchase of shares: Re Mort (1904) 4 SR (NSW) 760; cf. Harris v Harris (No 1) (1861) 54 ER 567.
96 In the same vein, the High Court has described the class of authorised investments contemplated by s 21 as 'very broad': Willett v Futcher (2005) 221 CLR 627 at 635 [26]. The plurality in that case included one of the authors of Jacobs' Law of Trusts above.
97 It is perhaps a source of regret that the parties did not examine this question a little more closely. The history and effect of s 21 is considered three paragraphs after [1804] at [1807] in Jacobs' Law of Trusts. The authors note that the legislation is part of uniform legislation across Australia deriving from the new Part II of the Trustee Act 1956 (NZ) which, in turn, was inserted by the Trustee Amendment Act 1988 (NZ). The authors say of these provisions:
In part, the legislation is a reaction to relatively conservative approaches to the meanings given to the words 'invest' and 'security' in trust instrument investment clauses discussed at [1804]. For that reason it is improbable that in the uniform legislation, unlike what preceded it, the expressions 'invest' and 'investment' will be construed as narrowly as they were in the investment clauses discussed at [1804].
(Footnotes omitted).
98 Paragraph [1804] is, of course, the paragraph relied upon by the unit holders and contains the reference to Khoo Tok Keong. I have not considered myself any of the materials to which the learned authors of Jacobs' Law of Trusts refer to ascertain whether the asserted legislative intention is borne out. However, Edelman J did consider the matter in Perpetual Trustee Company Ltd v Cheyne [2011] WASC 225. His Honour said this at [53]-[55]:
53 Section 17 is a provision which falls within pt III of the Trustees Act [1962 (WA)] which is entitled "Investments". The word "investment" is not defined anywhere in the Act. Section 17 was introduced by the Trustees Amendment Act 1997 (WA) s 6. It has been suggested that it was introduced, in part, as a reaction to conservative approaches to the meaning of "investment" at common law: Heydon JD & Leeming M, Jacobs' Law of Trusts in Australia (7th ed, 2006) 426 [1807]. An example of the previous common law approach is the decision in Khoo Tek Keong v Ch'ng Joo Tuan Neoh [1934] AC 529. In that case the Privy Council held that an unsecured loan was not an investment.
54 Section 17 has plainly expanded the definition of "investment" beyond the previous common law approach to include, for example, unsecured loans. But there is nothing in s 17, or pt III, which contemplates extending the meaning of "investment" beyond the boundaries of cases involving exchange, or purchase: see the definition in Re Wragg [1919] 2 Ch 58, 65 (Lawrence J).
55 The other provisions in pt III also clearly contemplate this core meaning of investment. For instance, s 18(3) imposes a requirement upon a trustee to review the performance of trust investments at least once a year. The assumption underlying this provision is that something will be received by the trustee in exchange for the disposition of trust funds. Similarly, s 19(1)(b) refers to a duty not to invest trust funds in investments which are speculative or hazardous. Section 26C refers to setting off losses against gains made by trust investments, again contemplating that an investment will involve an exchange. Other sections give examples of investments, all of which include receipts of something in exchange by the trustee which forms part of the trust fund: eg s 24(1) (a dwelling house); s 26 (a debt secured against property); s 26D (housing loans).
99 The first sentence of [54] will at some stage have to be confronted by the applicants. At the moment, however, the state of the law about s 21 does not require that I draw the conclusion that the claim is untenable. The ratio decidendi of no case requires the conclusion that s 21 permits unsecured loans; Jacobs' Law of Trusts and Willett indicate that s 21 is broad but that does not answer the question; Edelman J, in obiter, believes s 21 does extend to unsecured loans. For myself, the views of Edelman J appear to be preferable but the proper resolution of the question would require a consideration of the statutory history which no party attempted and which would be inappropriate in an application such as the present.
100 I proceed therefore on the basis that the applicants should be permitted to advance an argument that the Constitution of the Fund did not permit unsecured loans to persons not being banks.
101 What then of the second matter - what were the duties of the directors in relation to the authorised investments of the Fund? Mr Hutley SC referred me to s 601FD(1) of the Corporations Act which provides relevantly that Mr Jackman SC's clients were bound to 'take all steps that a reasonable person would take, if they were in the officer's position, to ensure that the responsible entity complies with:…(iii) the scheme's constitution'. Paragraph 35 of the proposed pleading invokes this provision to allege the existence of such a duty.
102 It followed, so Mr Hutley SC submitted, that Mr Jackman SC's clients should have known that unsecured loans to entities such as MFS Group Limited were not permitted. That brings one, perhaps at length, back to the question of what may legitimately be drawn from the financial statements. Mr Jackman SC says that it is not reasonable to expect that directors in the position of his clients should have realised from a mere reference to 'MFS Group Notes' of $62,000,000 that the Fund had engaged in unauthorised investments or even that the notes were unsecured.
103 The difficulty with this submission is the height at which it must be pitched in order to succeed. The present question is not whether the applicants' allegations are correct but whether they are triable. Once that is appreciated, as I think it must be, I am not prepared to say that one could not accept that the references to the 'MFS Group Notes' could not have indicated to a director complying with his or her duties under s 601FD(1) that there was a problem. If that be right then it must follow that Mr Jackman SC's volley against paragraph 230(a)(i) must be rejected.
104 A different argument was then advanced against paragraph 230(a)(ii) and its reference to $5,000,000 of unsecured notes in MFS Pacific Finance Limited. The financial statements in its case do refer to there being $5,000,000 in 'MFS Pacific Ltd unsecured notes' making impossible a suggestion that the accounts did not suggest an unsecured advance. Mr Jackman SC's point here was that they appeared under a heading describing them as 'Investments'. For reasons I have already given I do not accept, at the level of a pleading debate, that the contention that unsecured loans were not authorised is untenable. In the same way I do not accept that the directors can unarguably be said to have complied with their duty under s 601FD(1) by seeing the word 'investment' and thereafter eschewing reading any further.
105 Insofar as paragraph 230(a)(iii) was concerned, Mr Jackman SC submitted that the financial statements merely recorded an amount of $26,073,011 in the name of MFS Diversified Property Securities Trust which was not said to be unsecured. I reject this submission for the same reasons I have given in relation to paragraph 230(a)(i). Mr Jackman SC made a similar submission in relation to paragraph 230(a)(iv) which I reject for the same reasons. Before departing from paragraph 230(a) for the enticements of paragraph 230(b) he made a final parting submission that the reference to the 'monthly average balance in promissory and unsecured notes of $26,918,221' had to be understood as referring to the promissory and unsecured notes on p 24 of the financial statements and resort to it showed that they appeared under the heading 'Investments'. For reasons I have already given I reject this argument. The same submissions were made in relation to paragraph 230(c) and I reject them for the same reasons.
106 I move then to the submission put against paragraphs 230(b) and 230(d), which alleged loans and investments with related parties. With one exception these were identical to those made in relation to paragraph 230(a) and should be disposed of in the same way. There is no need to set them out in that circumstance. The one exception is that an additional submission was made that the section of the financial statements dealing with related party transactions contained, on p 28, the statement 'All transactions with related parties are conducted on normal commercial terms and conditions' so that any director reading the financial statements would have understood all of the related party transactions to have been arm's length transactions. This mattered because s 210 of the Corporations Act (as modified by s 601LA so as to apply to managed investment schemes) had the effect that member approval was not required even though the transaction was with a related party.
107 The applicants submitted that s 210 only dispensed with member approval in such a case if the terms of the transaction, to use the language of s 210, 'would be reasonable in the circumstances if the public company or entity and the related party were dealing at arm's length' - I do not think this is really an answer to the point. But, in any event, if the applicants be correct that unsecured loans are unauthorised the issue of their also being related party transactions is a distraction. The allegation in paragraph 230 operates even if the loans were made to unrelated parties. Perhaps more importantly, although the reference to the transaction being on ordinary commercial terms will no doubt assist the directors' defence, I do not think it necessarily defeats the applicants' case that the directors breached their duties under s 601FD. A critical question at trial will involve the extent to which the directors either read the financial statements or were entitled to rely upon them. They may well be on the correct side of that debate ultimately but whether that will be so will turn on the true status of the financial statements in the life of this Fund and that will require a great deal more knowledge about its operation than is available on a pleading debate. In those circumstances, I do not accept Mr Jackman SC's submission. It was also submitted that the accounts had been audited. I do not regard the fact that the accounts were audited as making the applicants' claims untenable.
108 The same points were made about paragraph 230(e) although it related to the financial statements for the half-year ending 31 December 2006. I reject those submissions for the same reasons.