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Why admit a conditional member in an SMSF?

Shaun Backhaus & Daniel Butler, DBA Lawyers
31 May 2022 — 3 minute read

If the relationship between SMSF members falls apart, seeking to remove a member from the fund can prove difficult and expensive. Conditional membership can assist with an exit strategy.

This is important to consider before admitting a new member especially a child or a second/subsequent spouse.

With a DBA Lawyers’ SMSF deed, new members can be admitted on a conditional basis as it has all the relevant powers. Further, we can assist with a special suite of documents that can be tailored to also include any special conditions that you want.

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Who is a conditional member?

The DBA Lawyers’ SMSF deed authorises the trustee to, upon on an ‘exit event’ occurring, remove a conditional member from the fund. This includes:

  • Rolling over their benefit to the member’s nominated or default fund; or
  • Paying out the member’s benefit if they have satisfied a relevant condition of release,

One or more exit events can be specified, eg, on the divorce or separation of a couple who are members of the fund.

ATO statistics suggest that around 70% of SMSFs are two member funds and anecdotal evidence suggests the vast majority of these members in around 420,000 SMSFs (600,000 SMSFs x 70%) would be in a married, de facto or spousal relationship. The total number of divorces granted in 2020 in Australia was 49,510.

Assuming there is no spousal relationship, conditional membership can still be appropriate for other potential members such as children or other family members, relatives or friends and especially business ‘partners’.

Why is conditional membership useful?

A member’s consent is required prior to removing them from the fund. Obtaining this consent in contentious circumstances can prove quite difficult and costly and may take years to resolve. However, with conditional membership, consent is obtained when the ‘conditional’ member is first admitted as a member to the fund. This means that on the occurrence of one or more exit events, the SMSF trustee can remove the member.

We are aware of numerous disputes (where conditional membership documents were not in place) where the departing member claimed payments well above their account balance before they agreed to exit the fund. In one case, the departing member demanded a substantial sum of cash from the other member (outside the fund) to ‘clinch’ the deal.

What conditions or exit events are typically appropriate?

There are a range of exit events that could be considered for giving rise to a right to remove a member, including:

  • Divorce or separation (in the case of a de facto relationship);
  • As the member(s) with the majority account balance determine;
  • Material disagreement which is not resolved within 30 days; 
  • Where business associates share the same SMSF and:-
    • Their business relationship ceases; or
    • There is a triggering event under the buy-sell (or equivalent) agreement; or
  • Any significant legal dispute between the parties that is not resolved within a specified time.

Conditional membership can assist if a current SMSF member wants to admit, say, a second/subsequent spouse or a child and also wants the flexibility of removing them if a dispute or relationship breakdown ever arises.

Naturally, a binding financial agreement (BFA) is also highly recommended if a spousal relationship exists as the family court has broad powers to make orders that may cover an SMSF trustee and third parties to the relationship. Note the family court also has power in relation to a de facto relationship. The BFA should also deal with who gets to stay in the SMSF in the event of a marital or de facto relationship breakdown.

Key steps for admitting a conditional member

Broadly, the following steps should be followed:

  • Before embarking on this strategy we recommend that the SMSF trustee has the fund’s document trail reviewed by an SMSF lawyer and obtains advice to ensure the advantages, disadvantages and risks of conditional membership are properly understood.
  • Ensure the SMSF deed has relevant powers (eg, the DBA Lawyers’ SMSF deed includes such power).
  • The SMSF trustee company should have a constitution that contains appropriate wording that allow the removal of the conditional member as a director and shareholder of the company (eg, the DBA Lawyers’ constitution includes appropriate wording).
  • The conditional member obtains their own independent advice (including accounting, legal and financial product advice).
  • Where a spousal relationship exists, a BFA is prepared which may be designed to cover all assets or be more specific to key assets and to cover the SMSF.
  • Further points to consider are covered in our newsfeed articles below. We recommend you especially review the first article below.

Conclusion

Unless carefully and properly implemented with quality documentation and qualified and expert legal assistance, conditions sought to be imposed on admitting a member may be readily avoided or side stepped. 

By Shaun Backhaus, senior associate, and Daniel Butler, director, DBA Lawyers

Why admit a conditional member in an SMSF?
daniel butler shaun backhaus smsf
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