The advantages of conditional membership in an SMSF

May 4, 2016

The advantages of conditional membership in an SMSF

There can be compelling reasons why one might want to share a self managed superannuation fund (SMSF) with others. However sharing an SMSF with a spouse (especially a second or subsequent spouse), children, siblings, in-laws, friends or business associates can involve a risk that at some stage there may be a breakdown in the relationship. Have you ever thought what happens when this occurs?
Indeed, it’s critical that SMSF members cooperate effectively and manage the fund smoothly. This is of prime concern to the member(s) who have the majority account balance(s) in the fund, and who may seek to extricate themselves from a potentially messy legal wrangle. Unfortunately, the law does not adequately provide for such situations.
A certain legal ‘war story’ can serve to illustrate the above problems that occurred in a mum and dad SMSF. The facts in Triway Superannuation Fund v FCT [2011] AATA 302 involve the Triway Superannuation Fund being created and money was transferred to it upon advice given to its trustees by people introduced by the son. The son had a drug addiction and squandered all of his mum and dad’s SMSF retirement savings. The fund was rendered non-complying. The son and his mum and dad, with assistance from their tax agent, assisted to conceal their son’s contraventions for five years until they were discovered during an ATO audit.
Assuming the parents wanted to remove the son from the Triway Superannuation Fund, they did not have a clear right to do so as they would have required their son’s consent. The Triway decision is an unfortunate but good example of how conditional membership can be beneficial. There are numerous other instances listed below where conditional membership can be invaluable.
Removing trustees and members
So how can a member be removed from an SMSF? The starting point is that it depends on the particular SMSF deed and related documentation.
Under DBA Lawyers SMSF deed, the members with the majority account balance can appoint or remove a trustee. This weighting of votes by account balance is particularly advantageous in situations like the Triway case. This means that the member(s) with the majority account balance can remove a person or company as a trustee.
Many other SMSF deeds provide the power to the trustees or to the members by headcount. With the vast bulk of SMSFs having two members, this could easily result in a stalemate.
In addition to being removed as a trustee or director of a corporate trustee, the SMSF deed must also be examined for the provisions relating to the removal of a member. Most SMSF deeds do not provide any power for a trustee to remove a member once a falling out has occurred.
Conditional membership
Under the DBA Lawyers SMSF deed, express provision is made to admit members on a conditional basis. The DBA Lawyers SMSF deed allows a ‘conditional’ member to be paid out (if they have satisfied a relevant condition of release) or rolled out to another superannuation fund upon the occurrence of a specific event or upon a specified time.
For example, if a member wanted to admit their second spouse as a member but wanted the flexibility of paying or rolling their spouse’s balance in the event of a relationship breakdown, then this event could be specified as one of the conditions on which the second spouse would be removed from the fund.
The ‘conditional’ member’s consent would operate such that, upon the occurrence of one or more specific trigger events, the SMSF trustee can use the consent to remove the member and pay their benefit (if a relevant condition of release is satisfied) or transfer their benefit to another complying superannuation fund.
Conditional membership therefore operates similarly to an insurance policy – you don’t want to have to use it, but if the day comes when you need to, you’ll be very glad that you had the foresight to put it in place.
What type of conditions may be placed on a ‘conditional’ member
There are a range of examples that can be considered for giving rise to a right to remove a member, including:

  • divorce or separation in the case of a de facto relationship;
  • a member fails to attend to their usual trustee/director duties including attending at least 4 trustee/director meetings;
  • 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;

  • as the member(s) with the majority account balance determine; or
  • any legal dispute between the parties

SMSF documentation
Naturally, appropriate related documentation including disclosures and trustee resolutions should be prepared to document the member’s admission and any special conditions that apply.
Under most other supplier’s SMSF deeds, however, it is difficult to remove a member without first obtaining the member’s written consent. Regulations 6.28 and 6.29 of theSuperannuation Industry (Supervision) Regulations 1994(Cth) (‘SISR’) provide that a member’s benefit in a fund must not be rolled over or transferred from the fund unless that member has given the trustee the member’s written consent to the rollover.
Therefore, unless the member provides prior written consent to being paid or rolled out, as appropriate, the SMSF trustee cannot simply ‘remove’ the member’s entitlement from the fund. As you would be well aware, consent may be impossible to obtain where there has been a falling out, especially in the case of a divorce, separation or legal dispute.
The key strategy that pre-emptively addresses this issue is conditional membership. Here the existing member(s) with the larger account balance obtains the informed written consent before the new member is admitted in both their capacity as a member and trustee. Appropriate disclosure is made that the new member may be removed as both a member and trustee of the fund.
Corporate trustees
In the case of a corporate trustee, the person also needs to consent to their removal as a director. This requires the constitution to be examined to determine what is required to remove a director.
Under the DBA Lawyers’ SMSF deed, the member(s) with the majority account balance can, if needed, remove a corporate trustee. However, typically the shareholders of a company can hire and fire the directors. Thus, those with the majority of voting shares already have this power. Therefore the member(s) admitting a ‘conditional’ member do not need to issue any shares in the company to such a new conditional member. This is the more efficient approach rather than having to replace the corporate trustee and go through all the paperwork of transferring assets, etc, to a new trustee company.
Moreover, there is no legislative requirement for a member to have any shares in a company that acts as an SMSF trustee.
Removing a member without a conditional membership strategy
In the event the SMSF deed does not expressly provide for conditional membership, the member(s) may need to apply to the court (typically the Supreme Court) for intervention. Courts are generally reluctant to intervene in such situations unless the member has contravened the law, eg, the drug addict son in the Triway case above who was a trustee and had access to the fund’s bank account. However the time, cost and inconvenience associated with legal action are likely to be very substantial.
Thus, unless there is some substantive breach of the trustee or director duties committed by the member that needs to be removed, the court may not provide any practical solution. In these cases, there is the prospect of the SMSF being placed in a precarious position while the parties seek to resolve their differences. Typically, during these periods, the parties do not cooperate with each other to ensure the fund is compliant and often the tax and regulatory returns and other compliance matters are not attended to in a timely manner. This can result in numerous penalties and potentially non-compliance. While this can disadvantage all members, it impacts more on those with the greater account balance. Naturally, fairness dictates that the member(s) with the greater account balance should have greater say in the running of an SMSF.
An SMSF deed that allows for conditional membership, together with appropriate supplementary documentation including a company constitution, can provide members with greater peace of mind. Having a conditional membership strategy in place should minimise the opportunity for costly and uncertain disputes that will place the SMSF and its members at significant risk.

For more SMSF advice, please contact us at Leenane Templeton on 02 4926 2300

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.
Article written and provided for by DBA Lawyers for use by Leenane Templeton.


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