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Alternate directors in the SMSF context

Alternate directors in the SMSF context

Christian Pakpahan & Daniel Butler
11 January 2019 — 8 minute read

How does the option of a director nominating an alternate director compare with nominating a successor director in the context of an SMSF?

We also provide a brief comparison table below to support our view that alternate directors are not of much value in an SMSF context and indeed can give rise to a number of risks; especially from an SMSF succession planning viewpoint. We commence by explaining what each concept is and then discuss how they apply in an SMSF context.

Note that, for simplicity, we will discuss the role of an alternate or successor director in the singular below even though in practice there may be more than one of these acting at the same time.

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The role of an alternate director

Generally an alternate director is a person who can step in as a director to exercise some or all of the appointing director's powers for a specified period or on a temporary basis. For example, a director who is unable to attend a directors’ meeting or to their duties while they are overseas can appoint a person to act for them as their alternate director for the relevant period.

Under the Corporations Act 2001 (Cth)(CA), a director may appoint an alternate director to exercise some or all of the appointing director’s powers for a specified period. The exercise of a power by an alternate director is just as effective as if it was exercised by the appointing director. Section 201K of the CA is a replaceable rule in relation to the appointment of an alternate director and each constitution should therefore be checked to determine whether an alternate director role exists and what rules govern that role.

Broadly, the powers that an alternate director can exercise are only powers that can be exercised by the appointing director at that point in time. The appointing director should carefully monitor their alternate director’s activities to ensure the alternate director is acting appropriately.

Note that an alternate director’s appointment ceases when the appointing director ceases to be a director. This is particularly relevant where the appointing director loses capacity, e.g., due to loss of mental capacity. Many incorrectly assume that an alternate director can continue to act under the CA despite the appointing director’s loss of capacity. Moreover, generally under many constitutions, a director is automatically removed upon the loss of capacity, so an alternate director would also be removed upon loss of capacity where the constitution is drafted to remove a director on loss of capacity. Thus, an alternate director gives limited succession value to a director.

Furthermore, an attorney under an enduring power of attorney is also not entitled to act for a director as the legislation relating to powers of attorney is state based whereas the CA is Federal legislation. Further, the performance of a director’s office is a director’s own personal responsibility as stated at paragraph 17 in Saad v Doumeny Holdings Pty Ltd [2005] NSWSC 893:

[17] … For a power of attorney is not available for the performance of a duty of a director’s office which is his own personal responsibility as a director:  Mancini v Mancini (1999) 17 ACLC 1570 at 1577 – 1578, per Bryson J. …

SMSF residency and alternate directors

The ATO have indicated that alternate directors can be used as a tool to satisfy the central management and control (‘CMC’) test for SMSF residency purposes where an SMSF member is planning to move overseas.

Firstly, a member can appoint an Australian resident as their attorney under an enduring power of attorney and this authorizes the attorney to then be appointed as an alternate director under s 17A of Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’). This step is typically taken so that an SMSF can continue to maintain its CMC in Australia via the alternate director(s) making strategic decisions here to seek to satisfy the fund to satisfy the definition of an Australian superannuation fund (see extract from SMSFR 2010/2 below).

The alternate director can then exercise their power in Australia while the relevant appointing director/member is overseas. However, with an alternate director there may be ambiguity as to whether the overseas member is still an active director undertaking strategic and ongoing day to day operational decisions for the SMSF during the period that the alternate director is ‘stepping in’ for that appointing director. For example, the appointing director may still reformulate the SMSF’s investment strategy while they are overseas. The alternate director must also not act as a ‘puppet’ for the appointing director, otherwise the CMC may still be considered to reside in Australia. CMC is a factual test and not simply a matter of having the correct paperwork.

Indeed, in many SMSF arrangements that we have come across over the years, there is a real risk that the mum and dad directors who are overseas are still actively involved in some way at a strategic level with the people they have appointed in Australia to satisfy the fund’s CMC test. As discussed above, where an alternate director is used, it is not always clear who is acting when and who is doing what. Thus, we would not recommend an alternate director be appointed for this purpose and for the other reasons outlined in this article. Accordingly, we recommend that the overseas director be removed completely before departing Australia and their attorney act as their director of the SMSF corporate trustee in their place. This removes the uncertainty of who is acting when as mentioned above.

Before discussing this topic, we would like to note that for an SMSF to continue to satisfy the definition of SMSF outlined in s 17A of the SISA, there should be an appropriate attorney appointed by the director under an enduring power of attorney in respect of the relevant appointee.

SMSFR 2010/2 says

  1. In order to comply with subparagraph 17A(3)(b)(ii), the legal personal representative must be appointed as a trustee of the SMSF, or a director of the corporate trustee of the SMSF. The member must cease to be a trustee of the SMSF or a director of the corporate trustee except where the legal personal representative is appointed as an alternate director
  2. A member who is a director of the corporate trustee may also appoint their legal personal representative holding an enduring power of attorney as an alternate director in their place in accordance with the corporate trustee's constitution or section 201K of the Corporations Act. If the legal personal representative is appointed as an alternate director, he or she must be so appointed in their own right and not as the member's agent. In addition, the terms of the appointment must only empower the legal personal representative to act as a director when the member is not performing those duties themselves. The member is not removed from the position of director in these circumstances.

Accordingly, the terms of the appointment in the enduring power of attorney documentation would need to contain specific wording for the alternate director to satisfy the ATO’s criteria. Typically power of attorney documents do not cater for this.

Thus, from an SMSF residency context, an alternate director is not a sound strategy and for those that have alternate directors we would recommend that a review be undertaken to adopt a better strategy. Where a member’s legal personal representative is a SMSF director, that director should be a valid enduring power of attorney in respect of the member.

The problems with solely relying on an enduring power of attorney and alternate directors for succession planning

Consider the following example.

Example 1

Jacob and Rachel are SMSF's directors with one share each in the trustee company and the only two SMSF members.

Simon is the adult son of Jacob from a previous relationship and has been appointed Jacob's alternate director. As an alternate director, Simon would be able to attend board meetings on behalf of Jacob and have the same director’s powers as Jacob. Jacob also appoints Simon as his attorney under an enduring power of attorney.

Rachel also has a daughter from a previous relationship, but the daughter is not involved in the SMSF.

Jacob ultimately wants Simon to take over as a director when he dies or loses capacity.

Years later, Jacob becomes mentally incapacitated and as a result ceases to be a director since the constitution of the company states that the office of the director becomes vacant when a director dies or becomes mentally incapacitated.

As discussed above when Jacob loses capacity Simon would cease to be an alternate director. However, if the constitution is appropriately worded, Simon as attorney under the enduring power of attorney can exercise the power attaching to Jacob’s shares and seek to appoint himself as a director of the corporate trustee.

Unfortunately to be appointed director, the company constitution would generally require the consent of the majority of shareholders. If this case, since Simon has one share (ie, Jacob’s share), he will need Rachel (ie, Simon’s step-mum) to consent to his appointment to have a majority vote. 

This would then lead to the following queries: 

  • Would Rachel consent to the appointment?
  • Does the company’s constitution allow a vote at a shareholders’ meeting using a proxy or by an attorney under an enduring power of attorney?

The other downside is that an enduring power of attorney ceases immediately when Jacob dies. An attorney can only act for the donor while the donor is alive. In other words, the enduring power of the attorney only confers Simon the power to act on Jacob’s behalf only while Jacob is alive, but ceases immediately on Jacob’s death.

If Jacob dies in Example 1, all sorts of other questions arise, such as:

  • Did Jacob pass his shares in the company to Simon in his Will?
  • What is the relationship between Simon and Rachel?
  • Does Rachel intend to admit her daughter as a member of the SMSF and also as director of the company?

Accordingly, without the right documents and strategy in place, the wrong person may gain control of an SMSF.

In Example 1, Rachel is in control of the SMSF. If Rachel is not on good terms with Simon, she can as a sole director (and as a 50% shareholder) not vote in favour of appointing Simon as a director.

It would have been much simpler if Jacob had appointed Simon as a successor director from the start. We explore why a successor director is better than an alternate director in part 2 of this series in the new-year.

Can an alternate director be held liable?

Finally, in relation to an alternate director’s liability, we note that in Playcorp Pty Ltd v Shaw (1993) 10 ACSR 212 it was broadly held that an alternate director would have no legal status when the appointing director is present (subject to the company’s constitution and the alternate director’s status in other capacities). Accordingly, where the appointing director is present and making decisions the alternate director would typically not be held liable for those decisions.

However, in Doyle v Australian Securities & Investments Commission [2005] WASCA 17 it was emphasised that, broadly speaking, a person who is an alternate director is in a similar position to a director in the context of the duties owed and the standard expected of the director in all respects. Accordingly, an alternate director should be mindful of their duties and obligations under the CA and as a director of an SMSF trustee under the SISA before they accept their appointment as a contravention may result in significant penalties or other legal consequences.

Christian Pakpahan, Lawyer and Daniel Butler, Director, DBA Lawyers

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