Dealing with trustee incapacity before it’s too late

With the increased longevity of SMSF fund members comes the question of how to deal with trustees who have lost their mental capacity.

SMSF practitioners have to consider the possibility that at some point one or more of the trustees/members of a fund might lack mental capacity to handle their role. The answer lies in making sure the structures are correct from the very beginning rather than trying to fix things when it may be too late.

Incapacity can be of two types – physical or mental. It is mental incapacity that most often results in the lack of legal capacity.

For a mentally incapable trustee who is still alive, there are only two persons who can stand in their place as a trustee or director of the corporate trustee: their personal trustee/guardian or their enduring attorney.

Before appointing an alternate trustee for a member with mental incapacity, the trust deed of the fund should be checked for provisions that may be relevant. The deed cannot, however, contradict the provisions of s.17A of the SIS Act.

Scenario one: Individual trustee incapacity where no planning has occurred

If a member/trustee becomes mentally disabled with no enduring guardian, not only are they automatically unable to act as a trustee of the fund but they cannot grant an enduring power of attorney.

The only other person who can therefore act on their behalf is their personal trustee/guardian of their estate.

In the absence of either an enduring attorney or a personal trustee/guardian it would be necessary to either wind up the fund, convert the fund to a small APRA fund or roll out the person’s superannuation benefit to an APRA-regulated fund. Ironically, the selection of that APRA-regulated fund may need a personal trustee/guardian anyway.

Scenario two: Planning for individual trustee incapacity

Each individual trustee of the fund should grant an enduring power of attorney so that the attorney can take over as the trustee of the fund in their place in the event of legal disability.

The fund deed must allow the appointment of the enduring attorney as trustee to happen. It is not enough that the SIS Act says that the fund will still be an SMSF if the member’s attorney is the trustee.

The member must cease to be a trustee. This does not occur automatically as a result of mental incapacity, even though they are disqualified, so the governing rules of the fund should make it so.

The enduring attorney performs the role as trustee in their own right and not as agent for the member. A person can be the enduring attorney of more than one member at a time. A member can appoint another member as their attorney.

The enduring attorney must not be a disqualified person and must sign a trustee declaration within 21 days of appointment.

Scenario three: Planning for incapacity of director of corporate trustee

Each director of a corporate trustee should grant an enduring power of attorney so that the attorney can act for the director of the corporate trustee.

But note this is not enough by itself. More is needed because directorship is not property but rather an office and cannot be simply transferred to an enduring attorney.

Mental incapacity does not necessarily mean the member immediately and automatically ceases to be a director of the corporate trustee.

If the legal personal representative is appointed as an alternate director they can only hold that office while the appointing director is also a director.

The basic question is: should the attorney be appointed as the alternate director of the member/director or as a substitute director in their own right? Both are possible and the answer depends on whether mental incapacity automatically removes the member as a director.

If yes then their attorney will need to be a substitute director. If no then the attorney can be an alternate director for the incapacitated director who can remain theoretically on the board.

Scenario four: Incapacity of a director of a corporate trustee where no planning has occurred

Assume that the member and director of a corporate trustee becomes mentally incapable and no planning has occurred to deal with that situation. The member/director has not appointed an enduring attorney.

In such a circumstance only the personal trustee/guardian of the estate of the incapacitated member is eligible to be the director of the corporate trustee for the purposes of the SIS Act regardless of what might be allowed or required by the trust deed of the fund or the constitution of the corporate trustee.

Good planning would prevent the need for a cumbersome application for the appointment of a legal guardian.

Peter Townsend is the principal at Townsend Business and Corporate Lawyers.

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