A guide to company constitutions and SMSFs
Why the constitution of a corporate trustee is important and what should be included in an SMSF constitution.
Firstly, there are many reasons why a corporate trustee is preferable to individual trustees for an SMSF. For example, a corporate trustee has the following benefits over individuals:
- Ease of succession planning and meeting the trustee/member rules;
- Less administration and paperwork to deal with changes to membership (i.e. can change directors without any need to change the trustee of the fund);
- Asset protection;
- Ease of managing overseas members and SMSF residency issues; and
- Lower administrative penalties under s 166 of the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA).
There are also various reasons that the company should be a sole purpose company that only acts in that role as trustee of an SMSF.
Why is a constitution important?
The constitution is the key foundation document for every company. This document regulates the activities of the company including the following:
- Who has the power to appoint and remove directors;
- Who can be appointed or removed as a director;
- How decisions by the company are made including how meetings or resolutions are regulated; and
- What powers the shareholders and directors have.
Where an SMSF has individual trustees, most of these issues would be dealt with under the governing rules of the fund. However, where a corporate trustee is in place, the constitution regulates these issues.
While a company has an indefinite lifespan, there are ongoing legal and practical developments that may render a constitution obsolete. Typically, you should consider reviewing each constitution on at least every 10 years. However, at times there are legislative or other changes that necessitate a more timely update.
We now consider some key points that should be covered in the constitution of an SMSF trustee.
Succession to control
Ensuring the right person is in control at the right time is key to SMSF succession planning. Constitution plays a vital role in ensuring this is managed smoothly and appropriately.
Where a director dies or loses capacity, they will cease to be a director of the company. Without proper prior planning, it may be difficult for a director to be appointed to represent the interests of the director who dies or loses capacity, giving way to uncertainty. In an SMSF context, it is especially important to manage these issues to ensure the trustee/member rules are satisfied and that any directions or nomination regarding death benefits will be followed.
While many believe that a person’s legal personal representative or executor will step into their role as director of a corporate trustee upon their death or loss of capacity, this is not the case. Without prior planning, the decision to appoint a replacement director requires the shareholders’ approval.
A properly drafted constitution can allow for a director to nominate one or more persons to “step into the director’s shoes” and be appointed a director in their own right in the event of the nominating director’s death or loss of capacity. If a constitution allows for successor directors and the relevant documents are completed, a director’s nominated successor director can step in immediately when they die or lose capacity. This provides greater certainty regarding the ongoing control and management of a fund.
Different share classes
It is important that a constitution has the flexibility of issuing different share classes to allow planning for differentiated voting, dividend and capital rights.
In an SMSF context, the issue of a “Guardian” share can be useful to ensure a person can exercise ultimate control of a company and resolve issues that may be subject to a dispute. For example, a constitution can provide that a “Guardian Shareholder” must consent to any decision of both directors and shareholders before the resolution can be passed.
Lower ASIC fees
A company that solely acts as an SMSF trustee is entitled to a substantially reduced annual ASIC fee. It is therefore important to ensure a constitution has flexible and adaptable wording that allows for the reduced ASIC fee to apply, but also allows the company to take on another role — e.g. becoming the trustee of a family discretionary trust, without requiring a variation to the constitution. Some constitutions are hard-wired and a variation is required if the company takes on another role. In contrast, others, like DBA Lawyers’ constitution, has flexible wording that allows other roles to be taken on without any need to amend the constitution.
Use of company in SMSF investment structures
It is also important to remember that a company can be used as part of an investment structure or entity that an SMSF invests in, e.g. where a company acts as the trustee of a unit trust that an SMSF acquires units in.
With an appropriately drafted constitution of the corporate trustee of the unit trust and an appropriately drafted unit trust deed, an SMSF can be a 50 per cent investor in a unit trust with an “unrelated” party without giving rise to in-house assets issues. Naturally, it is important that the constitution used in this scenario is drafted to ensure that it does not allow any particular party to “sufficiently influence” or “control” the company/trust. This would, for instance, preclude the chair having a casting vote or any other point of influence.
Formalities and technology
Many older or poorly drafted constitutions require certain formalities to be complied with in order to perform simple functions. In particular, they may enshrine the use of formalities, such as written notice sent by post. A modern constitution can provide greater flexibility such as allowing meetings and resolutions via technology.
A further example of this is that s 127 of the CA states that a sole director who is also the sole secretary can execute documents for a company. It also states that the section does not limit the ways the company may execute a document. Thus, the constitution should provide greater flexibility by stating that a sole director can execute documents on behalf of a company even when they are not appointed as a company secretary.
A well-drafted constitution from a quality supplier usually has numerous value-added features. In particular, a good company constitution will allow for proper succession planning in an SMSF and provide greater certainty especially in relation to who is in control on the death or loss of capacity of a key person. In contrast, poor-quality constitutions can result in numerous shortcomings, risks and other consequences including costly legal disputes.
Daniel Butler, director, DBA Lawyers