What to do about defects in SMSF deeds: a chain is only as strong as its weakest link

It is very common for an SMSF to be commenced by a deed of establishment. Then, when the governing rules need to be updated, this typically is done by way of a deed of variation. The deed of establishment, in conjunction with the deeds of variation including any change of trustee documents, are sometimes then referred to as the ‘chain’ of deeds.

The metaphor of a chain is used because a chain is only as strong as its weakest link. This begs five questions: Why does a strong chain of deeds matter? What if it the most recent deed is fine, but a prior deed has a deficiency? What constitutes a deficiency? What are the implications of a deficiency? What can be done to fix a deficiency?

In this article, we consider the answers to all five questions.

Why does a strong chain of deeds matter?

Many people are surprised that the common law defaults to preventing many ‘standard’ things they wish to do in respect of their SMSFs.

For example, at common law, a binding death benefit nomination is invalid. This is because at common law a trustee must not allow its discretion to be exercised by someone else (eg, a member). Naturally, a discretion includes how and who to pay a superannuation death benefits to.

Furthermore, at common law, a trustee may not pay superannuation death benefits to itself. This is because at common law a trustee must not allow a conflict of interest. Therefore, at common law, a trustee may not pay a deceased member’s superannuation death benefits to a director of that trustee. This is the case even if the director was the deceased’s spouse.

No legislation overrides the common law in regards to the above issues. Instead, it is the governing rules — as contained in the chain of deeds — that overrides the common law.

Trustees who act in a conflicted manner or in bad faith, particularly where there are uncertainties regarding the chain of deeds and/or the validity of say a binding death benefit nomination, can suffer severe negative implications. For example, SMSF trustees’ decisions to pay superannuation death benefits can be reversed and SMSF trustees and their directors can be held liable to personally pay significant legal costs. See, for example, such well-known SMSF cases as Wareham v Marsella [2020] VSCA 92 and Wooster v Morris [2013] VSC 594.

Accordingly, only when there is a perfect chain of deeds can a trustee have complete confidence to, for example, follow a binding death benefit nomination and/or pay superannuation death benefits to itself.

What if the most recent deed is fine, but a prior deed has a deficiency?

The ‘chain’ metaphor is very helpful in answering this question. A deficiency in any of the fund’s deeds causes concerns, in the same way that any weakness in any link in a chain weakens the whole chain.

This was illustrated in Re Narumon Pty Ltd [2018] QSC 185. One issue in this case was that a purported 2007 deed of variation was signed by a person who was described as a company’s ‘authorised representative’. That person did not state that he was signing in his capacity as director and secretary of the company (which he was). Consequently, the purported 2007 deed of variation was held to be invalid. This then resulted in a subsequent 2014 deed of variation being invalid.

What constitutes a deficiency?

Naturally, a lost deed constitutes a deficiency. However, many other issues can cause issues too. As Re Narumon Pty Ltd [2018] QSC 185 illustrates, mis-describing a signatory can cause a deficiency.

Being able to only find an unexecuted copy of a deed can cause a deficiency. Being able to only find a photocopy or a PDF of a signed deed, but not having the original version, can also cause a deficiency. See respectively M & L Richardson Pty Limited [2021] NSWSC 105 and Sutton v NRS(J) Pty Ltd [2020] NSWSC 826. In both these cases court orders were required before the trustees were properly authorised to administer the trusts pursuant to the governing rules in the unexecuted and photocopied deeds respectively.

What are the implications of a deficiency?

Where there is any deficiency, if a trustee continues to act (eg, pay out superannuation death benefits), the trustee might not be properly authorised to do so. If challenged, any decision to pay superannuation death benefits might be reversed and the trustee might be replaced and be personally liable for both parties’ losses and legal fees!

What can be done to fix a deficiency?

There are many ways to attempt to address a deficiency. One popular way is to make a deed with as many parties to it as possible. This is a service that DBA Lawyers offers (https://www.dbalawyers.com.au/smsf-deed-update/). It is certainly better than doing nothing. However, it is far from providing complete certainty.

The ‘Rolls Royce’ of solutions is to obtain a court order confirming what the fund’s governing rules are. However, the only certainty in making a court application is that it will be complex and time consuming and therefore expensive. A court might also decide that not enough effort has been made and decline to make any order. See for example Barry McMahon Nominees Pty Ltd [2021] VSC 351.

There is a third option: commence a brand new SMSF and roll the benefits to that new SMSF. Naturally, there are all sorts of costs, tax issues to consider and administrative difficulties in doing this. Indeed, some assets may not be capable of being rolled over such as unlisted securities and residential property. However, this option typically gives the greatest certainty.

This third option is often overlooked. While not all funds with deficiencies should implement this third option, they should at least be made aware of the risks if they do not do so.

Related articles:

• Advantages of the DBA Lawyers SMSF deed (2021-22)
• SMSF deeds: how does your supplier rate?
• Honey, I lost the deed!

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Note: DBA Network Pty Ltd provides regular SMSF Online Update webinars. 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 Daniel Butler ([email protected]), Director, and Bryce Figot ([email protected]), Special Counsel, DBA Lawyers

23 July 2021