SMSF recent case law developments

Strategies

The body of case law surrounding self managed superannuation funds (SMSFs) continues to build at an alarming rate. Alarming because the case law alerts SMSF trustees and their advisers to the risks that SMSFs present, which in some cases are not present when a superannuation interest is held within an APRA-regulated super fund.

This article, for financial services professionals, groups a number of recent decisions of the various State Supreme Courts by the issue raised, and provides background on earlier decisions on the issue.

In particular, the article examines the development of trustee discretion, binding death benefit nominations, the sole purpose test, complications in becoming an executor or administrator upon death and process and documentation challenges.


1. Trustee discretion

While the trustee of an SMSF may have absolute and unfettered discretion on some issues, many discretions are limited by statutory law and, of course, the terms in the specific trust deed.

For example, the discretion of a trustee to pay the death benefit of a deceased member is limited at law generally to those who meet the definition of ‘dependant’ in the Superannuation Industry (Supervision) Act 1993 (SIS), but the range of individuals may be further limited by the specific trust deed.

The trustee’s discretion to pay a death benefit to anyone within this restricted group was previously considered to be unfettered. For example, the trustee was able to make a benefit payment to themselves and, in many cases,1 did exactly that.

This position was supported by a very early SMSF case, Katz v Grossman,2 where a daughter became trustee and decided (with her husband and co-trustee) to pay the entire death benefit resulting from her father’s death to herself. See the earlier article Supreme challenges in SMSF estate planning for further details. The decision was made despite the deceased’s non-binding nomination to pay the benefit equally to his son and daughter. The court did not disturb the trustee’s decision.

In a 2015 decision,3 the Court of Appeal Division of the Supreme Court of Western Australia heard a claim that the exercise of discretion by an SMSF trustee was in bad faith. The court held that the onus was on the party asserting bad faith to prove it, and that the asserting party had not done that in this case. Moreover, the court found that the decision was not in bad faith.

Most recently in Re Marsella,4 the court set aside a trustee discretion decision to pay a death benefit to the daughter (who was a trustee) of the deceased, and removed the trustees.

The deceased was the sole member of an SMSF established in 2003. The fund’s individual trustees were the deceased and her daughter. The deceased had re-married in 1984, and had two children from a previous relationship (including the co-trustee). At the time of death, the deceased’s interest in the fund was approximately $490,000, but no valid death benefit nomination was (or had been) in place.

The trustees determined to pay the benefit to the deceased’s daughter. The deceased’s husband challenged whether the trustees had acted in good faith and with real and genuine consideration to the interests of the dependants of the deceased.

The court agreed with the husband’s position, and made the following comments:

While it is not the Court’s role to consider the fairness or reasonableness of the outcome of the exercise of discretion and usurp the role of the trustee, the outcome itself, particularly where the result is ‘grotesquely unreasonable’, may form evidence that the discretion was never properly exercised, or was exercised in bad faith. In the circumstances of this proceeding, the outcome of the defendants’ exercise of discretion, that is, the distribution of the entire proceeds of the fund to the first defendant, supports the conclusion that there was a lack of real and genuine consideration.5

The decision in Re Marsella serves as a reminder to SMSF trustees that their duty when making discretionary death benefit decisions is to consider all potential beneficiaries, their relationship with the deceased and their relative financial circumstances. Furthermore, the court noted that even if it accepted that the deceased did not intend the husband to benefit from the fund, it was not open to the trustee to ignore the substantial relationship the husband had with the deceased, and his relatively limited financial circumstances.6

More importantly, trustees are now on notice that the court is willing to set aside a trustee discretion decision exercised in bad faith.


2. Binding death benefit nominations

Four key decisions have been handed down at the State Supreme Court level regarding binding death benefit nomination issues. The 2009 Donovan v Donovan7 decision caused concern in the industry about whether binding death benefit nominations (BDBNs) could be non-lapsing. This doubt arose despite the Australian Taxation Office (ATO) view in SMSFD 2008/3 that SMSFs could offer BDBNs which don’t conform with the requirements in SIS Regulation 6.17A, including the three-year lapsing requirement.

The position was clarified for the industry in the decision in Munro v Munro,8 specifically that BDBNs entered into by members of SMSFs may be non-lapsing, as long as the specific trust deed is constructed appropriately.

Most troubling, however, is the situation that arose which was the subject of the decision in Wooster v Morris.9 Despite a BDBN being ultimately upheld as valid by the court, the intervening decisions and actions of conflicted parties (in particular, the deceased’s second wife) significantly affected the amount the intended beneficiaries (the deceased’s two daughters from his first marriage) ultimately received from the SMSF.

See Supreme challenges in SMSF estate planning for further details of these three cases.

2.1 Narumon

More recently, the Supreme Court of Queensland dealt with a number of SMSF BDBN issues in Re Narumon.10 The case involved a single member SMSF with a corporate trustee. Mr Giles, the SMSF member, held two interests in the fund: a lifetime pension (backed by approximately $3 million of assets) and an accumulation account (approximately $1 million).

Mr Giles passed away on 14 June 2017, aged 80, having been diagnosed as having lost his legal capacity in November 2013. Under an enduring power of attorney (EPoA) made in January 2013, Mrs Giles and Mr Giles’ sister, Mrs Keenan, had held powers regarding his financial matters.

Mr Giles was survived by his wife of almost 19 years, Mrs Narumon Giles, their 16 year old son and four adult children from Mr Giles’ previous marriage.

Although there was minimal evidence, the court ultimately accepted that the lifetime pension was reversionary, and so could continue being paid to Mrs Giles.

The accumulation interest was subject to a BDBN made in June 2013, prior to the medical diagnosis of Mr Giles’ loss of legal capacity. The BDBN sought to bind the trustee to pay his accumulation benefits as follows:

  • 47.5 per cent to Mrs Giles
  • 47.5 per cent to his son, Nicholas Giles
  • 5 per cent to his sister, Mrs Keenan.

The BDBN was stated to lapse three years later, in June 2016. One issue for the court to determine was whether the nomination of five per cent to Mrs Keenan, given she was not a dependant of Mr Giles, affects the validity of the BDBN as a whole.

As the attorneys appointed in the 2013 EPoA, Mrs Giles and Mrs Keenan signed a document in March 2016 purporting to extend the June 2013 BDBN a further three years.

At the same time, they also signed a new BDBN nominating:

  • 50 per cent to Mrs Giles
  • 50 per cent to Nicholas Giles

The ‘new BDBN’ was intended to rectify the invalid part of June 2013 BDBN which allocated five per cent to Mrs Keenan.

Nomination partially invalid

Incidentally, the court agreed with conclusion in Munro v Munro, referred to above.

The court determined that the June 2013 BDBN was valid, except for the part nominating Mrs Keenan. The court adopted a practical and purposive approach, despite recognising it was open to the court to declare the entire nomination invalid.

Extending a BDBN

The court was asked to determine the validity of the extension to the June 2013 BDBN signed by Mr Giles’ attorneys, Mrs Giles and Mrs Keenan, purporting to act under the 2013 EPoA.

The court noted that the SMSF’s trust deed allowed an attorney to sign a nomination for a member where the member was under a legal disability, and also that there was no restriction in the SIS Act or Regulations to prevent that.

The court turned to the Queensland Power of Attorney Act (Qld PoA Act). Although an attorney cannot make or revoke the EPoA principal’s will, the court determined that ‘the exercise of a member’s right…to require the trustee of the fund to pay benefits…in a particular way’ is a financial matter, and not a testamentary act.11

Conflict transactions

The court highlighted that the restriction on an attorney from entering into a conflict transaction without the authorisation of the EPoA principal was an important protective feature in the Qld PoA Act.

Section 73 of the QLD PoA Act provides:

A conflict transaction is a transaction in which there may be conflict, or which results in conflict, between –

(a) the duty of an attorney towards the principal; and

(b) either –

(i) the interests of the attorney, or a relation, business associate or close friend of the attorney; or

(ii) another duty of the attorney.

The 2013 EPoA did not provide authorisation for Mrs Giles and Mrs Keenan to enter into conflict transactions.

The court found that the extension to the June 2013 BDBN was not a conflict transaction as there was no change to the wishes of Mr Giles expressed in the 2013 EPoA.

However, the court found that the ‘new BDBN’, which changed the nominations to rectify the issue of the sister (Mrs Keenan) not being a dependant, was a conflict transaction without the authorisation of the principal, and so was invalid. This meant that the trustee was to otherwise deal with the five per cent that could not be paid to Mrs Keenan.

Key points

Re Narumon is an important clarification of the operation of the laws interacting between SMSF BDBNs and enduring powers of attorney. It indicates that EPoA holders may extend an existing BDBN, but should be wary of altering an existing BDBN if conflict transactions have not been expressly authorised by the EPoA principal.

It is also authority that a partially invalid BDBN may not cause the BDBN to be completely invalid.

Note that the law regarding EPoAs is state-based, so variances in other states may exist.


3. The sole purpose test

The application of the sole purpose test was clarified in the Aussiegolfa12 case, which was heard by a single-judge sitting of the Federal Court in 2017, and subsequently appealed to the Full Court of the Federal Court in 2018.

Aussiegolfa - the arrangement

Mr Benson was the sole member of an SMSF with a corporate trustee, Aussiegolfa Pty Ltd (the Trustee). Mr Benson (via his SMSF), his sister and mother resolved in 2015 to invest in a unit of student accommodation in Melbourne (the Burwood apartment) via a managed investment scheme (DomaCom Fund), operated by DomaCom Australia Ltd (DomaCom).

DomaCom established a sub-fund (the Burwood Sub-Fund) within the DomaCom Fund, the sole asset of which was the Burwood apartment. The Trustee and Mr Benson’s sister each agreed to purchase 25 per cent of the units in the Burwood Sub-Fund, while Mr Benson's mother agreed to purchase the remaining 50 per cent.

Two students, both unknown and unrelated (ie arms-length) to Mr Benson, agreed to lease the Burwood apartment for consecutive periods in 2016 and 2017. In 2017 Mr Benson’s daughter, also a student, agreed to lease the Burwood apartment from February 2018, on very similar terms to the unrelated tenants.

Full Court decision

Following the 2017 Federal Court decision, Aussiegolfa Pty Ltd appealed to the Full Court of the Federal Court, which handed down its decision on 10 August 2018.

Although the main issue for DomaCom was the court’s determination that the sub-fund in the broader DomaCom Fund was a trust in its own right (and hence a related trust), the main development in the law from the Aussiegolfa case is the court’s interpretation of the sole purpose test.

The court noted that several provisions in SIS allow transactions with related parties. For example, listed securities may be acquired from related parties at market value, business real property may be leased to related parties and certain in-house rules contemplate transactions with related parties. The court concluded that a transaction involving a related party, of itself, does not result in a conclusion that the sole purpose test has been breached.13

The court held that the ‘comfort or convenience’ the daughter received by residing in the property was viewed, at best, as an incidental benefit. As the property was leased on arm’s length terms, the court concluded that it was consistent with maintaining the asset for at least one of the core purposes referred to in the sole purpose test.

This is an important development in the way the industry has interpreted the sole purpose test, where previously any benefit conveyed on a related party gave rise to sole purpose test concerns.

However, the development may have limited practical application, as leasing an asset that is not business real property to a related party will result in it becoming an in-house asset, subject to the five per cent threshold.


4. Administrators and executors, and conflicts of interest

Several recent decisions at the Supreme Court level have dealt with the conflict that may arise when a potential beneficiary of a superannuation death benefit accepts the role of administrator or executor of a deceased estate.

McIntosh v McIntosh

The situation in McIntosh v McIntosh14 involved James McIntosh, who died intestate at the age of 40 in July 2013. At the time he was living and being cared for by his mother, Elizabeth McIntosh. He had bipolar disorder and some physical disability.

James had a distant relationship with his father John McIntosh, and although Elizabeth and John had divorced in 1979, their relationship remained acrimonious.

Mrs McIntosh was granted Letters of Administration on 26 November 2013.

The deceased’s estate amounted to approximately $80,000, but James also held interests in three super funds, amounting to approximately $453,000 in total.

Mrs McIntosh successfully applied to the funds for the payment of the death benefits, based on her interdependency relationship with her son.

As a result, Mrs McIntosh was in a position of a potential conflict of interest. As legal personal representative she had a duty under section 52 of the Succession Act (Qld) to get in the assets of the estate. She also had a fiduciary duty not to allow a conflict of personal interest to occur.

The court held that Mrs McIntosh had breached her fiduciary duty in applying for payment of the super death benefits to herself, favouring her own interests to those of the estate. She was ordered to account to the estate for the death benefits.

The potential conflict would not have arisen if valid BDBNs were in place at the time of James’ death. However, given that James had not made a will, it is unlikely in practice that he would make BDBNs.

Mrs McIntosh may have avoided the conflict by removing herself from the role of administrator. Alternatively, she may have notified the court of her intention to apply for payment of the death benefits prior to the grant of Letters of Administration.

Brine v Carter

Brine v Carter15 dealt with the role of executor of an estate and the potential conflict when claiming a superannuation death benefit.

Professor Brine passed away with two interests in the UniSuper fund. His will appointed his three sons (Martin, Matthew and Daniel) and de facto spouse (Norma Carter) as executors.

Ms Carter apparently tried to mislead the other executors regarding whether the super death benefits could be paid to the deceased estate.

One of the sons subsequently learned that one of Professor Brine’s interests ($630,299) was potentially payable to the estate. The four executors met and agreed that Carter should apply personally, as well as the executors applying for payment to the estate. Due to the conflict Carter was resolved from acting as executor on the estate’s application for payment of that benefit.

UniSuper paid both amounts to Carter, so the sons sought a court order for Carter to account for the amount of $630,299 to the estate on the basis of her breach of fiduciary duty.

Brine v Carter affirms that an executor has a duty to maximise estate assets.

A fiduciary generally owes a fiduciary duty not without prior authorisation…

2. to pursue a personal benefit in circumstances in which there is a real or significant possibility of conflict between his or her fiduciary duty and personal interest.

Carter was in a position of conflict. Her appointment as executor did not include authorisation to act in a position of conflict.

But Carter was not liable to account to estate for super benefits as there was no breach of fiduciary duty because the sons had consented to her making a personal application for super benefits.

A different decision may have resulted if the sons had not lodged their competing application.

Brine v Carter shows that if an executor is intended to benefit from a super death benefits payment, then the testator should include an express conflict of interest clause in the will. If there is no conflict of interest clause in the will, then the executor should:

  • consider resigning their position as executor
  • fully inform the other executors and obtain their consent, and/or
  • provide the estate with the opportunity to make a claim.

Burgess v Burgess

Burgess v Burgess16 involved the passing of a father in 2015, survived by his wife and two children. As Mr Burgess died intestate, his wife was granted letters of administration in June 2016. The rules of intestacy provided that Mr Burgess’ estate would be paid to Mrs Burgess and the two children.

The deceased had four benefits in public offer superannuation funds. The court was asked to determine whether there were conflicts with Mrs Burgess’ role as administrator and her application, or potential application, to the trustees of the two of the four super funds for death benefit payments to be made directly to her.

The court made the following comments regarding avoiding the situation presented to it:

First, if he had executed a will, then the undesirable scenario for his surviving family of dealing with an intestacy situation would have been avoided. Preferably, his will would have said in explicit terms that there was no difficulty for his widow, if she was appointed as his executor, in acting exclusively in her own interests by applying to receive personally and receiving the full entitlement to any superannuation fund proceeds.

Secondly, if the man had signed and presented a binding nomination document to the trustees of the four superannuation funds in which he held entitlements (including any life benefits), then such an instruction would ordinarily have bound the trustee to distribute those funds, say, on a 100% basis to his widow…17

The court was satisfied that Mrs Burgess had been acting in the best interest of the children.18 However the court noted:

The nature of an administrator's fiduciary position is such that it requires the fiduciary's undivided loyalty in pursuing exclusively the interests of beneficiary parties - to the exclusion of all other rival interests…19

The interests of a deceased estate require a 'champion' who cannot be seen (even if they are not) to be acting half-heartedly, or with an eye to achieving outcomes other than an outcome that thoroughly advances the interests of the estate - to the exclusion of other claimants.20

Despite the difficulties the decision would cause Mrs Burgess, the court felt compelled to require Mrs Burgess to account to the estate for the $338,607.33 already paid by one of the super funds.

Gonciarz v Bienias

The decision in Gonciarz v Bienias21 involved an application by the spouse of the deceased to be removed as administrator of the deceased’s estate to avoid the conflict of interest in applying for payment of the deceased’s superannuation death benefit ($541,412.20).

The court approved her removal as administrator, and allowed the appointment of an independent, experienced and reputable legal practitioner in her place.

The court noted that the case:

highlights the importance of making wills and making binding beneficiary nominations in respect of superannuation benefits22

and:

By accepting the grant of administration the plaintiff was obliged to subordinate her claim to the death benefit to that of the estate.23

The decision demonstrates that it is possible to be removed as administrator to avoid the conflict position.


5. Process/documentation challenges

An emerging trend in SMSF litigation appears to be in the area of challenges to process and documentation details. The two following cases, although unsuccessful, highlight the lengths some parties may be willing to go to upset a death benefit payment.

Perry v Nicholson

In Perry v Nicholson24 a dispute arose between a de facto spouse and the daughter of the deceased from a previous marriage regarding the validity of a BDBN.

The focus was on the replacement of trustee process which occurred more than 18 months prior to the death of the SMSF member in early 2017.

The daughter disputed the validity of her removal as individual trustee. Although the court found several deficiencies in the documentation and process, it resolved the issue pragmatically, noting that the minutes of the meeting, signed by all three parties, “…properly read, constitute a removal of the applicant as trustee of the Fund”.

Cantor Management Services Pty Ltd v Booth

Cantor Management Services Pty Ltd v Booth25 involved a BDBN which stipulated payment of death benefits to the Legal Personal Representative.

A dispute arose regarding the validity of the BDBN, allegedly as it had not been given to the trustee as required by the deed.

The court held that the BDBN was ‘given’, as the practice of serving documents on entities at their registered office is now well established, and this specific BDBN had been served in that manner.


Summary comments

An ever-increasing body of law now surrounds SMSFs. It is important that prospective and existing SMSF trustees and their advisers are aware of the developments and follow the trends.

In most cases, the issues litigated are pertinent only to SMSFs, and generally will not arise in APRA-regulated superannuation funds. As such, litigation risk is a very relevant additional consideration for SMSF trustees and their advisers.

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1 See for example, Katz v Grossman [2005] NSWSC 934, Donovan v Donovan [2009] QSC 26, Munro v Munro [2015] QSC 61, Wooster v Morris [2013] VSC 594, Ioppolo v Conti [2015] WASCA 45, Re Marsella; Marsella v Wareham (No 2) [2019] VSC 65 

2 Katz v Grossman [2005] NSWSC 934

3 Ioppolo v Conti [2015] WASCA 45

4 Re Marsella; Marsella v Wareham (No 2) [2019] VSC 65

5 Ibid, 51

6 Ibid, 52

7 Donovan v Donovan [2009] QSC 26

8 Munro v Munro [2015] QSC 61

9 Wooster v Morris [2013] VSC 594

10 Re Narumon Pty Ltd [2018] QSC 185

11 Ibid, 69

12 Aussiegolfa Pty Ltd v Commissioner of Taxation [2018] FCAFC 122

13 Ibid, 176

14 [2014] QSC 99

15 [2015] SASC 205

16 [2018] WASC 279

17 Ibid, 15-16

18 Ibid, 82

19 Ibid, 83

20 Ibid, 85

21 [2019] WASC 104

22 Ibid, 38

23 Ibid, 39

24 [2017] QSC 163A

25 [2017] SASCF 122