Addressing SMSF deed defects

SMSF deed deficiency

An SMSF deed is only as strong as the weakest variation that has been made but there are ways to repair a past deficiency.

It is very common for an SMSF to be commenced by a deed of establishment. Then, when the governing rules need to be updated, this typically is done by way of a deed of variation. The deed of establishment, in conjunction with the deeds of variation, including any change of trustee documents, are sometimes then referred to as the ‘chain’ of deeds.

The metaphor of a chain is used because a chain is only as strong as its weakest link. This begs five questions: Why does a strong chain of deeds matter? What if it the most recent SMSF deed is fine, but a prior deed has a deficiency? What constitutes a deficiency? What are the implications of a deficiency? What can be done to fix a deficiency?

In this article, we consider the answers to all five questions.

Why does a strong chain of deeds matter?

Many people are surprised the common law defaults to preventing many ‘standard’ things they wish to do in respect of their SMSFs.

For example, at common law a binding death benefit nomination (BDBN) is invalid. This is because at common law a trustee must not allow its discretion to be exercised by someone else (for example, a member). Naturally, a discretion includes how and to whom to pay a superannuation death benefit.

Furthermore, at common law, a trustee may not pay superannuation death benefits to themself or itself. This is because at common law a trustee must not allow a conflict of interest. Therefore, at common law, a trustee may not pay a deceased member’s superannuation death benefits to a director of that trustee. This is the case even if the director was the deceased’s spouse.

No legislation overrides the common law in regards to the above issues. Instead, it is the governing rules, as contained in the chain of deeds, that overrides the common law.

Trustees who act in a conflicted manner or in bad faith, particularly where there are uncertainties regarding the chain of deeds and/or the validity of say a BDBN, can suffer severe negative implications. For example, SMSF trustees’ decisions to pay superannuation death benefits can be reversed and SMSF trustees and their directors can be held liable to personally pay resulting significant legal costs. SMSF cases Wareham v Marsella and Wooster v Morris provide illustrations.

Accordingly, only when there is a perfect chain of deeds can a trustee have complete confidence to, for example, follow a BDBN and/or pay superannuation death benefits to themself/itself.

What if the most recent deed is fine, but a prior deed contains a deficiency?

The chain metaphor is very helpful in answering this question. A deficiency in any of the fund’s deeds causes concerns, in the same way any weakness in any link in a chain weakens the whole chain.

This was illustrated in Re Narumon Pty Ltd. One issue in this case was that a purported 2007 deed of variation was signed by a person who was described as a company’s ‘authorised representative’. That person did not state he was signing in his capacity as director and secretary of the company, which he was. Consequently, the purported 2007 deed of variation was held to be invalid. This then resulted in a subsequent 2014 deed of variation being invalid.

What constitutes a deficiency?

Naturally, a lost SMSF deed constitutes a deficiency. However, many other issues can cause problems too. As Re Narumon Pty Ltd illustrates, mis-describing a signatory can cause a deficiency.

Being able to only find an unexecuted copy of a deed can cause a deficiency. Being able to only find a photocopy or a PDF of a signed deed, but not having the original version, can also cause a deficiency. These issues arose in M & L Richardson Pty Limited and Sutton v NRS(J) Pty Ltd. In both cases court orders were required before the trustees were properly authorised to administer the trusts pursuant to the governing rules in the unexecuted and photocopied deeds respectively.

What are the implications of a deficiency?

Where there is any deficiency, if a trustee continues to act (for example, pay out superannuation death benefits), the trustee might not be properly authorised to do so. If challenged, any decision to pay superannuation death benefits might be reversed and the trustee might be replaced and be personally liable for both parties’ losses and legal fees.

What can be done to fix a deficiency?

There are many ways to attempt to address a deficiency and one popular way is to make a SMSF deed with as many parties to it as possible. It is certainly better than doing nothing. However, it is far from providing complete certainty.

The Rolls-Royce of solutions is to obtain a court order confirming what the fund’s governing rules are. However, the only certainty in making a court application is that it will be complex and time consuming and therefore expensive. A court might also decide not enough effort has been made and decline to make any order. Such was the case in Barry McMahon Nominees Pty Ltd.

There is a third option: commence a brand new SMSF and roll the benefits to the new fund. Naturally, there are all sorts of costs, tax issues to consider and administrative difficulties in doing this. Indeed, some assets may not be capable of being rolled over, such as unlisted securities and residential property. However, this option typically gives the greatest certainty.

This third option is often overlooked. While not all funds with deficiencies should implement this third option, they should at least be made aware of the risks if they do not do so.

Daniel Butler is a director and Bryce Figot special counsel at DBA Lawyers.

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