Why successor directors are better for SMSF succession planning

November 16, 2016

Gary Chau and Bryce Figot, DBA Lawyers

As with all succession planning discussions, SMSF succession planning being no different, people want to ensure the right people are in control when they die or lose capacity. For this to happen, generally the right mechanisms and structures must be in place well before the person dies or loses capacity. Without the right mechanisms, the wrong people may come into control, and these people may not carry out the person’s wishes or even know how to ensure the person’s wishes are to be carried out.

The solution can be to appoint a successor director.

There is a train of thought that an alternate director may be the solution, but in reality an alternate director has limited usefulness in succession planning.

What is the difference between an alternate director and a successor director?

An alternate director usually indicates the appointment of a temporary director who acts as an alternate to exercise some or all of the appointing director’s powers for a specified period. This appointment usually requires the consent of the other directors.

On the other hand, a successor director is a special company mechanism whereby a director appoints one or more other people who actually step in as fully fledged directors when the first director loses capacity or dies. Special rules in the company constitution are needed to implement successor directors.

Alternate directors

In succession planning, a director may desire that a certain person that they trust ‘steps into their shoes’ when they die or lose capacity. What should this director do to ensure their wishes are put in place? Let’s look at some different scenarios where alternate or successor directors are in place.

Scenario A

John and Sarah are directors of their SMSF’s corporate trustee with one share each. John and Sarah are also the only two members of their SMSF.

Alex is the adult son of John from a previous relationship and has been appointed John’s alternate director. As an alternate director, Alex would be able to attend board meetings on behalf of John and have the same director powers as John.

Sarah also has two daughters from a previous relationship, but neither daughter is involved in the SMSF.

John ultimately wants Alex to take over as a director when he dies or loses capacity.

Years later, John becomes mentally incapacitated and as a result ceases to be a director since the constitution of the company says that the office of the director becomes vacant when a director dies or becomes mentally incapacitated.

Is Alex able to step into the shoes of John?

Unfortunately, the answer is no. On a conservative interpretation of s 201K of the Corporations Act 2001 (Cth) (‘Corporations Act’) (ie, the provision dealing with alternate directors) this section provides that an alternate director can only ever exercise the powers of the appointing director as if the powers were exercised by the appointing director him or herself. Therefore, there is a presumption that the appointing director must monitor their alternate director’s actions. In other words, the monitoring by the appointing director is an essential element for an alternate director to be in place. Hence, on the ceasing of the appointing director as a director of the company, the likely scenario, albeit the conservative view, is that the alternate director also ceases since the appointing director is no longer in a position to monitor their alternate director.

Therefore, in scenario A, Alex would be unable to step into the shoes of John as a director or exercise any powers on behalf of John since John is no longer a director. This is a problem since John originally wanted Alex to step into his shoes as a fully fledged director. Accordingly, the alternate director loses its succession planning usefulness when the relevant event such as death or loss of capacity happens!

Therefore, based on a conservative interpretation of the Corporations Act, what we have in scenario A is a failure of planning where John ceases as a director and Sarah is probably left as the sole director of the company.

Alternate director and enduring power of attorney

It might be suggested that John appoints Alex as his attorney under an enduring power of attorney to prevent scenario A from happening.

Let’s revise our scenario.

Scenario B

Take the same facts as above. John still appoints Alex as an alternate director but this time, John also appoints Alex as his attorney under an enduring power of attorney.

Thus when John loses capacity, Alex, as attorney under the enduring power of attorney, exercises the power attaching to John’s shares and moves to appoints himself as a director of the corporate trustee.

However, to be appointed director, the company constitution requires the consent of the majority of shareholders. Since Alex has one share (ie, John’s share), he will need Sarah (ie, Alex’s step mum) to consent to his appointment to have a majority. There can be other issues too.

At first glance, an enduring power of attorney appears to be a good solution. Here, Alex has the ability to step into the directorship of John to ensure the member/trustee rules under s 17A of the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’) are met. This is allowed under s 17A(3)(b)(ii) of the SISA, which provides that a person who holds an enduring power of attorney in respect of a member can be a trustee or director of the corporate trustee of a super fund in place of the member without causing the fund to lose its status as an SMSF. But unfortunately, Alex does not become a director automatically just by being John’s attorney.

To become a director, under most constitutions, Alex must actually take the necessary steps to be appointed as a director and can only be appointed with the consent of a majority of shareholders or directors, ie, Sarah. This would then lead to the following queries:

  • Would Sarah consent to the appointment?
  • Does the company’s constitution allow a vote at a shareholders’ meeting using a proxy or by an attorney under an enduring power of attorney.

The other downside to an enduring power of attorney is that it ceases immediately when John dies. An attorney can only act for the donor while the donor is alive. In other words, the enduring power of the attorney only confers Alex the power to act on John’s behalf while John is alive, but ceases immediately on John’s death.

If John dies in scenario B, all sorts of other questions arise, such as:

  • Did John pass his shares in the company to Alex in his Will?
  • What is the relationship between Alex and Sarah? Do they get along with each other?
  • Does Sarah intend to admit her two daughters as members of the SMSF (and also as directors of the company)?

Accordingly, without the right mechanisms, the wrong person will come into control of the SMSF.

In scenario B, Sarah is in control of the SMSF. If Sarah is not on good terms with Alex, she can, as a sole director (and as 50% shareholder), refuse to allow the appointment of Alex as a director.

It would have been simpler if John had appointed Alex as a successor director from the start.

As a note, enduring powers of attorney should not be discounted completely. They are certainly very useful while the donor is still alive, particularly when the donor is unable to exercise their powers when they lose capacity. However, until they are appointed as a director, an attorney under an enduring power of attorney may not have any director powers or control in the corporate trustee.

Successor directors are better than alternate directors

This is the preferred scenario for succession planning; namely John appoints Alex as a successor director from the start.

Scenario C

Take the same facts as scenario A. This time, John appoints Alex as a successor director, instead of alternate director. John also appoints Alex as his attorney under an enduring power of attorney.

When John loses capacity, Alex, as successor director automatically becomes a director of the corporate trustee (and there is no need to appoint Alex by a majority of the members).

In this scenario, Alex automatically becomes a director in place of John without needing to get Sarah’s approval. Here, John’s wish is fulfilled as both Alex and Sarah would be directors on John’s death or when he loses capacity.

Issues with appointing an alternate director

On a conservative interpretation of the Corporations Act, an alternate director will cease immediately upon the ceasing of the appointing director (ie, they lose capacity or die).

While the Corporations Act is silent on when an alternate director ceases, the better view is that where the appointing director ceases, the alternate director would also cease.

On reading s 201K of the Corporations Act, the alternate director provision, it provides that a director, with the approval of the other directors, can appoint a person to exercise some or all of the director’s powers for a specified period. The words ‘specified period’ in the provision suggest that an alternate director is only ever meant to be a temporary appointment (ie, where a director cannot attend meetings for a short period of time).

Further, the section provides that ‘when an alternate exercises the director’s powers, the exercise of the powers is just as effective as if the powers were exercised by the director’. This suggests that there is an ongoing responsibility of the appointing director to monitor their alternate director.

How is a successor director appointed?

To appoint a successor director, check the company constitution to see how a successor director is appointed. In all likelihood, most constitutions will be silent on successor directors. If a constitution is silent on successor directors, it isn’t the end of the line. The members of the company can pass a special resolution (plus satisfy any further requirement to pass a special resolution if specified in the existing company constitution) (s 136 of the Corporations Act) to adopt a new constitution with the relevant successor director provisions.

A special resolution is a resolution that is passed by at least 75% of the votes cast by shareholders who are entitled to vote on the resolution.

Once the successor director provisions are in the company’s constitution, the appointing director can appoint their successor director in line with those provisions. The successor director must of course consent to this appointment.

It is important to note that successor directors do not automatically mean a fund will continue to be an SMSF indefinitely. Generally, to fall within this definition, each member must be a trustee or a director of the corporate trustee of the fund. However, the SISA allows a fund to still meet the definition of an SMSF in certain other circumstances.

The DBA Lawyers company constitution facilitates successor directors, and comes with a blank template form for the appointment of successor directors.

Note: DBA Lawyers hold SMSF CPD training at venues all around. 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.

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