Preserve the intended control of a company using successor directors

Small private companies are widely used to manage and control financial affairs. They can be used as companies in their own right, but they are also commonly used as trustees for SMSFs and other trusts. Whether a company acts as trustee or not, the directors have day-to-day control over the company. Despite the importance of this role, many fail to plan for when a director dies or loses capacity. One planning strategy provided in the DBA Lawyer’s constitution is to appoint successor directors to take the place of a director upon these events.

When does a director lose their office?

Under a typical company constitution, a director automatically loses their office when they die or lose mental capacity. This second circumstance (loss of mental capacity) is often forgotten.

Many think that on loss of mental capacity, a director’s attorney under an enduring power of attorney automatically becomes a director, or can at least ‘stand in the shoes’ of the director and exercise director rights. This is not correct (see Saad v Doumeny Holdings Pty Limited [2005] NSWSC 893). Similarly, on the death of a director, the executor of the deceased director’s will does not automatically become a director or ‘stand in the shoes’ of the deceased to exercise director rights.

Many also believe that the trustee-member rules applying to SMSFs mean that a member’s legal personal representative becomes a director in their place upon death or loss of capacity. This is not correct (see Dawson v Dawson [2019] NSWSC 826).

The question is then, where does this leave companies when there is a failure to plan for succession to control? The following example illustrates a common scenario.

Sue remarries and her new spouse Adam becomes a member of her SMSF. Each of them is now a director of the corporate trustee and each holds one share.

Sue loses capacity – she will no longer be a director of the trustee company. Sue had appointed her daughter Nikki as her attorney under an enduring power of attorney. Nikki wants to be a director of the trustee to ensure that Sue’s superannuation is managed appropriately.

However, as Sue’s attorney, Nikki would only have (at most) the voting power in respect of the share that Sue owned personally (ie, one out of the two shares issued). If Nikki wants to be voted in as a director, she needs the majority of the shareholders to agree. This may prove difficult if Adam is not willing to have Nikki step in as a director.

The above can be a very stressful, dysfunctional or even litigious scenario, and can result in the wishes of the director who has died or lost capacity being ignored.

How do successor directors offer a solution?

The use of successor directors is a strategy to address the example above. Under a successor director mechanism, a director is able to appoint one or more persons to step in and become a director in their own right in the event of the original director’s mental incapacity or death (or other chosen event).

If Sue’s company constitution had allowed for successor directors and the relevant documents were completed, Nikki could have immediately stepped in as a director when Sue lost capacity. Adam’s consent would not have been needed.

Director identification numbers (DINs)

The introduction of DINs has created an additional requirement for a person to satisfy before becoming a director. Broadly, a person must apply for a DIN before becoming a director.

Due to this requirement, the DBA Lawyers constitution is drafted in such a way that, in the event that a person does not have a DIN, their appointment will be delayed until they have applied for a DIN. If a person already has a DIN, their appointment will not be delayed.

Thus, any successor director without a DIN must be aware of this requirement and should be prepared to apply for a DIN at short notice when a succession event occurs. Accordingly, it can be worthwhile ensuring that any intended successor director is already a director of another company (eg, the trustee of a family trust) so that no delays occur.

Conclusion

Naturally, successor directors are not the only thing to consider in planning for succession to control a company, an SMSF or a trust. The shareholding in a company, the company constitution, the SMSF or trust deed (including trustee appointment powers), the relevant individuals wills and powers of attorney will all play an important role. By planning for succession to control a company or trust, a lot of time, costs and stress can be avoided.

Related articles:

• Hefty penalties for director identification number (DIN) issues — changes needed by advisers
• Company constitutions and SMSFs
• Not all companies are created equal
• Planning your exit: a guide to SMSF succession planning — Part 1
• Planning your exit: a guide to SMSF succession planning — Part 2

*           *           *

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2001 (Cth).

Note: DBA Lawyers presents monthly online SMSF training. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.

By Shaun Backhaus ([email protected]), Senior Associate, DBA Lawyers

DBA LAWYERS

17 February 2023