The SIS Act’s Weapon of Mass Destruction -Navigating the Minefield of Personal Liability
A relatively unknown statutory provision buried within the operating standards of the superannuation laws is section 55 of the SIS Act. This provision is relatively untested as to its scope and for an unsuspecting client or adviser, involved with the management of a superannuation fund, it has the potential power, shall we say, of a weapon of mass destruction (WMD) that can be deployed in the hands of a litigation lawyer and more insidious than those other weapon apparently lurking somewhere in a Bagdad bunker.
The effect of section 55 is to impose personal liability on any person who is engaged in a contravention of the mandatory covenants that are imposed into each superannuation fund deed, and which cause another person any loss or damage as a result of the conduct of that person. In those circumstances, the other person “may recover the amount of the loss or damage by action against that other person or against any person involved in the contravention” [emphasis added]. It is the potential breadth and depth of personal liability, particularly for
clients and their advisers of SMSFs that this article attempts to fathom.
The starting point to this enquiry is to determine the mandatory covenants that section 55 imposes liability for loss and damage. In the context of a self-managed superannuation fund (SMSF), these mandatory covenants are expressed to be the existing rules of the fund contained in the trust deed and those covenants imposed under section 52B and 52C of the SIS Act (“section 52 covenants”). These section 52 covenants are broadly drafted to include the following common law duties:
(a) to act honestly;
(b) to exercise care, skill and diligence as a prudent superannuation trustee would exercise in relation to an entity of which it is a trustee and on behalf of the beneficiaries of which it makes
(c) to perform the trustee’s duties and exercise the trustee’s powers in the best interests of the beneficiaries;
(d) to not act with a conflict of interest between the duties of the trustee and the beneficiaries,
(e) to act fairly in dealing with classes of beneficiaries within the fund;
(f) to keep the money and other assets of the fund separate from any other money and assets,
(g) not to enter into any contract, or do anything else, that would prevent the trustee from, or hinder the trustee in, properly performing or exercising the trustee’s functions and powers; (h) to formulate, review regularly and give effect to an investment strategy for the whole of the fund having regard to risk, investment composition, liquidity, discharge of current and future liabilities, and adequate diversification for each beneficiary.
(i) To formulate, review regularly and give effect to an insurance strategy for the benefit of beneficiaries of the fund that addresses levels of cover and premiums
The range of people, therefore affected by section 55 liability include: –
• Clients who are trustees of SMSF’s
• Clients who are directors or corporate trustees;
• Accountants carrying out taxation or administration services to SMSF’s;
• Financial planners advising trustees on SMSF portfolio investment;
• SMSF property managers;
• Actuaries, and
• Anyone else who causes or contributes to the cause of loss by a contravention.
It should also be noted that for clients who are trustees, the operation of section 55 is in addition to other duties imposed under general trust law and the Corporations Act for
company trustees. Advisers often consider that while they are providing services to trustees, it is the trustees who are ultimately liable for decisions that are made, however, the scope of section 55 would purport to extend responsibility to advisers where they are in any way “involved in a contravention” that contributes to the cause of financial loss to another person either directly or indirectly.
Section 55 contains a defence (ss (5)) to anyone affected by the loss suffered from a failed investment, but this defence is only available if they have complied with all of the section 52 covenants above, including the fund’s documented investment strategy. Section 323 of the SIS Act also provides a defence to proceedings under section 55 but only if the contravention was due to a “reasonable mistake” or “reasonable reliance on information supplied by another person”, or by the “default of another” or “by some other cause beyond the defendant’s control”.
“Another person” in this context does not include a “servant or agent of the defendant”. In other words, for a trustee who makes decisions, they cannot rely on information that has been provided to them by their accountant or financial adviser, for example, even if it was reasonable to rely on that information. Further, whether information from another source is “reasonable”, is assessed objectively by a court.
In a recent case of Kelaher (1), handed down in September of this year, the court held that the obligations of section 55 cannot be overruled by contrary powers in the trust deed and trustees cannot be indemnified from the assets of the fund for any liability. Since the introduction of the SIS Act in 1993, there has been only one reported SMSF case involving a section 55 liability claim, and that is a November 2000 case of Dunston-v Irving (2). The few reported cases on section 55 relate to large industry, employer or retail funds involving TPD claims. Dunston -v Irving was a business SMSF and a dispute between two business owners, one of which argued that the SMSF balances should be “equalised” due to an apparent agreement. While section 55 was raised, its scope or operation was never canvassed by the court because it found that there was no evidence of an equalisation agreement.
So, you might ask, “how could I ever become responsible to another person under section 55 of the SIS Act?” In light of the little judicial guidance on section 55 as it applies to SMSFs, this is a very good but very uncertain question, particularly when section 55 has been so broadly drafted into the SIS Act and undefined as to its scope of operation.
However, given the recent spate of cases involving disputes over the payment of death benefits in the last ten years, the writer foreshadows that it is only a matter of time before section 55 will be more aggressively deployed as a sword, to claim compensation in any one or more of the following circumstances:
1. A disappointed beneficiary making a claim against a client or adviser because they have suffered the loss of benefit due to an incomplete or defective death benefit nomination and a trustee exercising a discretion that is not in their favour; [contravention: s.52B(2)(b) & (c)]
2. The outcome of 1 above because of an earlier defective deed upgrade, prescribing a different form of Binding Death Benefit Nomination; [contravention: s.52B(2)(b) & (c)]
3. The outcome in 1 above because of an earlier defective chain in documents changing the trustee of the fund; [contravention: s.52B(2)(b) & (c)]
4. A loss with an investment of the fund that is not contemplated by the fund’s investment strategy or one which does not address liquidity, risk or investment diversification; [contravention: s.52B(2)(f)]
5. Members of an SMSF that are separating for matrimonial purposes and one of them claims to have suffered loss in the value of a share portfolio or other investment because it is outside the asset allocation bands in the investment strategy; [contravention: s.52(6)]
6. The exercise of a power or discretion by a trustee that is found invalid because of a conflict of interest or because it was made in bad faith and without genuine consideration being
given to all members; [contravention: s.52B(2)(a), (b) & (c)]
7. A trustee decision regarding an investment which fails. While it is within the investment strategy of the fund, the trustee decision was not properly made in accordance with the
rules of the fund. [contravention: trust deed provisions regarding trustee meetings and quorum]
8. A single member of a fund has a terminal illness but is not advised to cash in the fund before death. The member subsequently dies, and the fund beneficiaries/estate pays $285,000 in death benefits tax that could have been avoided. [contravention: s.52B(2)(b) & (c)]
9. A business SMSF holds a factory property secured by a loan (LRBA). There are two business owner members, and one member dies. The trustee failed to put into effect life insurance on the member’s life or consider the risk of death in the fund’s investment strategy. As a result, the factory property has to be sold to pay out the deceased member’s death benefits, incurring a loss to the
surviving member who has to relocate the underlying business. [contravention: s.52B(2)(b) & SISAR 4.07E]
So, by now, I imagine, you are sitting somewhere between despair and apathy and wondering how all of this affects you. However, the fact of the matter is that there are over 600,000 SMSF’s in Australia holding more than $750 billion as part of a $2.9 trillion superannuation pot. With the massive buildup of wealth in the SMSF sector, there is inevitably going to be more disputes relating
to SMSF assets than ever before, and this is forecast to continue. For clients, this means in practical terms that you need to have a consistent and accurate document trail that is regularly reviewed by an SMSF specialist professional. The cost of this exercise is far outweighed by the potential legal costs of a dispute. For an adviser, it is essential that you “risk manage” your work in this sector
and for liability purposes, outsource SMSF related activities beyond tax and administration, particularly in relation to the preparation of death benefit nominations. With the advent of the 2017 superannuation reforms which require careful management of excess transfer balances on death, coupled with the introduction of the “best interest duty” which is yet to be judicially tested, it is
inevitable that an accountant or financial planner will be sued under section 55 of the SIS Act for which professional indemnity cover is unlikely to be granted.
It has been wisely said: – “If you know the enemy and you know yourself you need not fear the results of a hundred battles” : Sun Tzu
(1) Australian Prudential Regulation Authority -v- Kelaher  FCA 1521 (see para 20-22)
(2) Dunstone -v- Irving  VCS 488
The material contained in this publication is general reading only information and does not constitute advice on the subject
matter. While every effort has been made to ensure accuracy, you should not rely on the information provided without
seeking professional specialist SMSF advice on your individual needs and circumstances and the relevance and
appropriateness of the ideas and strategies mentioned. No representation is given, warranty made or responsibility taken
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