The Best Financial Interests Duty - What does the new super duty actually require?

Our last article on this topic canvassed the new best financial interests duty (BFID) in some detail (link here), particularly the breadth of the duty and how it impacts on delegations. We touched on the reach of the new duty in terms of whether it is a subjective test, an objective test and/or an outcomes-based test.

While this question is one which has exercised academics and practitioners alike, particularly in the context of the traditional “best interests” duty (before the recent introduction of the adjective “financial”), it remains of absolute and extreme practical significance for superannuation trustees.

This article will dig deeper into the duty with a view to provide yet more practical guidance to superannuation trustees in relation to their BFID decisions.

For those readers who cannot wait until the end of the movie, see our Distillation section at the end of this article.

Don’t be fooled by imitations

Imposing best interest duties (BIDs) on the providers of financial services has been a popular legislative response in recent decades. There is a strong temptation to assume that similar thinking can apply by analogy across the different statutory examples. We suggest that care should be taken in this regard.

Each of the statutory BIDs (section 601FC(1)(c) of the Corporations Act 2001 (Cth) for managed investment schemes, section 52(2)(c) of the Superannuation Industry (Supervision) Act 1993 (Cth) for superannuation, section 961B(1) of the Corporations Act 2001 (Cth) for FOFA, and most recently section 158LA of the National Consumer Credit Protection Act 2009 (Cth) in respect of consumer credit) sit within a bespoke regime reflecting the unique arrangements to which they apply, as well as the mechanisms by which they are to be enforced. They are, moreover, articulated differently. So statements by the court, such as Moshinsky J in ASIC v NSG Services Pty Ltd[1] (relating to FOFA) and Murphy J in ASIC v APCH Ltd[2] (relating to managed investment schemes) are likely to be less persuasive of the content of the superannuation BID as time passes and the various BIDs evolve on their divergent paths.

BFID is not outcomes or outputs-based

The first proposition we would like to propose is that the BFID is not an outputs-based test, at least in the manifestation of requiring members to be better off financially as a result of the relevant action or other conduct of the trustee. With respect, this rendition of the duty simply cannot be correct.

In the decision of Rein J in Manglicmot[3] in the Supreme Court of New South Wales, his Honour said (at [51]):

I do not accept that the trustee is made liable for any outcome which turns out to be unbeneficial to members, even if the original decision which led to that outcome was taken with the best interests of all members in mind. Another way of describing this approach is to say that s 52(2) is concerned with process, not outcome.

To apply an output-based slide rule to the conduct of the trustee would be impossible as a measure of compliance of a trustee with the BFID.

In ASIC v APCH Ltd[4] Murphy J said (at [488]):

I do not though wish to be seen as accepting the proposition that to act in the members’ best interests a trustee must actually achieve the best outcome. A trustee is not required to be prescient: (references omitted).

In a vast multitude of situations, a trustee might aspire in its conduct to put members in a better financial position but a small impediment presents itself at that stage – for present purposes, let us call it the universe. Many factors will determine whether in fact the well-motivated conduct of a trustee will result in a better financial position for members.

In Kelaher[5], Jagot J (at [57]) accepted APRA’s submission that:

A course of conduct that later turns out to have been unbeneficial to members’ interests is not a breach of s 52(2)(c) because of how events in fact play out.

So this cannot be the true nature of the BFID.

Is compliance with the BFID then solely about whether the trustee was properly focussed (motivated) on providing a better financial result for members? It is suggested that this motivation would dovetail into the BFID, but there may be situations where the trustee is simply taking action to preserve a particular financial result for members. This scenario, it is suggested, would be consistent with the trustee acting in accordance with the BFID.

So does it follow that the BFID is not outputs-focussed at all?

It is suggested no, for 4 simple reasons:

• first, that the BID (the former incarnation of the BFID) and the BFID should always be measured against one outputs-oriented criterion, namely that the decision/conduct of the trustee could be impunged if no reasonable trustee could have made that decision (or taken that course of action). This is the test expounded in the High Court Breckler[6] But this is not the typical type of outputs-test; it is an extremity, allowing a range of decisions and actions of a trustee if not manifestly unreasonable;
• second, and related to the first, it is clear that surrounding circumstances and objective outcomes may be relevant evidence which throws light on the question of the state of mind of the trustee (for corporate trustees, its directors) as well as an objective aspect of the duty so as to show whether they were acting in discharge of their powers in the best interests of the beneficiaries[7];
• third, in the real world, the question of trustee breach, and its consequences, will likely involve consideration of the consequences of the action in question. The question of causation will then consider the results had the trustee acted differently;
• fourth, whether the duty is primarily about process, this is not to say that the substance of the decision is irrelevant. As Moshinsky J observed in a presentation to the 2018 Law Council of Australia Superannuation Lawyers Conference:

While it may be accepted that liability is unlikely to turn on the outcome of a decision, it does not necessarily follow that best interests covenant is not concerned with the substance of the decision that is made, in the sense described in Cowan v Scargill.

At what point does something move from being part of the substance of the decision to being the outcome of that decision? One can identify examples which are easy to classify as either substance or as outcome. The percentage of the fund’s investment portfolio allocated to alternative investments is clearly part of the substance of the decision. The investment return earned by those alternative investments each year is clearly the outcome of the decision. A member might be able allege a breach of trust on the basis that the percentage allocation to alternative investments was not in the best financial interests of members (e.g. because the allocation was inconsistent with the risk profile of the members). However the member could not allege a breach of trust purely on the basis that the alternative investments lost money over some time period. However, between these examples, there are examples that are not so easy to classify as either substance or outcome.

BFID has both subjective and objective elements

Is compliance by the trustee with the BFID to be measured wholly by whether the trustee held a belief that its conduct was in the best financial interests of members or, while not outputs-based in the full sense described above (i.e. compliance is not determined by assessing the result of the trustee’s conduct i.e. financial impact on members), is the BFID objectively based such that the trustee must both hold a bona fide belief that its conduct would be in the best financial interests of members and the belief must be objectively sustainable?

This is in itself a crucial practical issue for trustees in terms of the BFID as the answer will go directly to compliance or non-compliance.

Best interests in the eye of the beholder?

It is likely that the BID started off as one where compliance would be subjectively measured. In other words adherence would depend on the trustee giving genuine and honest consideration to the best interests of beneficiaries when carrying out the relevant conduct.

This position accords with cognate duties such as the equitable duty of a company director to act in the best interests of the company.

At the same time it was always open to detect an objective element of the BID. For instance it is noteworthy that Lehane J favoured an objective test of the BID more than 25 years ago when he observed that the BID is not “an obligation to act in a way which the trustee honestly considers to be in their interests (and is not demonstrably not in their interests)” but “a positive obligation to act in what are, objectively, their interests…”[8].

Most recently and relevantly, Jagot J held a similar view of the BID when her Honour observed in the Kelaher decision at [53]:

A decision which is taken to ensure and is objectively in the best interests of beneficiaries at the time it is made does not lose that character because, at that time, more information could have been obtained.

and at [55]:

It will frequently be the case that there is more than one course of action which may be regarded as being in the best interests of the beneficiaries. The test is objective and is to be applied prospectively, that is, from the position of the trustee at the time of the decision, without impermissible hindsight.

The reality is that the BFID has both a subjective and an objective aspect to it. This is relatively clear from Jagot J’s judgment in Kelaher where her Honour traversed both subjective and objective elements, in accepting the following wording from APRA’s submissions at [49]:

By parity of reasoning, the trustee’s best interests obligation when applied to the duty to get in the trust property and to protect and vindicate the rights attaching to it (CGU Insurance Limited v One.Tel Ltd (in liq) (2010) 242 CLR 174 at [36]; Fischer v Nemeske Pty Ltd (2016) 257 CLR 615 at [11]) requires, in the superannuation context, that the trustee seek to achieve the best outcome for the capital of the fund, judged in relation to the risks of particular action and the prospects that it might provide a partial or complete recovery of funds for the trust.

and subsequently observing at [64]:

Another aspect of its submission put orally, however, is inconsistent with Cowan v Scargill. APRA proposed that the only relevant matter was the respondent’s state of mind at the time of the decision. I disagree. In my view, a decision which is not reasonably justifiable as in the best interests of the beneficiaries, assessed objectively by reference to the circumstances as they in fact existed at the time, will be in breach of the covenant.

This is not to say that even with an objective component, there can only be one right decision of a trustee. Jagot J made this clear in Kelaher (at [308]):

Further, the mere fact that APRA thinks another plan would have been in the best interests of members does not mean Mr Rossitto’s plan was not in the best interests of members.

Elsewhere Jagot J indicated support for the following defendant submissions (at [62]):

As the fourth to seventh respondents put it (my emphasis):

Once it is appreciated that the power or duty in relation to which the “best interests” obligation arises is the obligation to vindicate the rights attaching to trust property, it is clear that the relevant question can only be whether the trustees’ decisions to pursue alternative sources of compensation are objectively capable of being supported. APRA’s attempts to convert the inquiry mandated by the “best interests” obligation into one concerned with “process”, rather than “action”, should be rejected.

The observations in the cases to which APRA refers in its submissions at [51]-[52] reinforce, rather than undermine this point. Indeed, the point being made in Mercer Superannuation (Australia) Ltd v Billinghurst (2007) 255 FCR 144 at [38] was that flaws in the decision-making process were only relevant to the extent that they produced a flawed decision.

It is submitted that if the BFID is not already properly characterised as having an objective element to it, in our view it is likely to take that trajectory in future judicial analysis. That trajectory is consistent with the approach taken to the duty of corporate directors to exercise their powers and discharge their duties “in good faith in the best interests of the corporation”. The question for trustees, as it is for directors, is what deference will courts give to a trustees real time assessment of the best (financial) interests.

Reversal of burden of proof

By its nature, the presumption that an action of a trustee is not in the best financial interests of beneficiaries is revolutionary.

It is not only a radical departure from the traditional common law position but in our opinion, this presumption is entirely capable of contributing to more of an objective-based test.

This is because rebuttal of a presumption is more likely to require something more in the way of objective evidence as opposed to evidence of a subjective belief.

This observation is not unassailable. One could simply be required to adduce evidence of a subjective belief that the trustee considered the relevant action or decision to be in the best interests of the membership but the point is that this construction does not seem consistent with the intent of the new regime. The Revised Explanatory Memorandum[9] provides in relation to the reversal of the evidential burden of proof at [3.60] that:

Trustees should assess the costs and benefits of actions, which will commonly include quantifiable metrics to demonstrate what the anticipated financial outcome is and the reasonable basis for that expectation.

and at [3.67] that:

Reversing the evidential burden will mean that if the trustee is able to adduce evidence or point to evidence that suggests a reasonable possibility that there was a proper discharge of its duties, the evidential burden is discharged and the Regulator will then be required to prove on the balance of probabilities that the trustee did not perform their duties and exercise their powers in the best financial interests of the beneficiaries.

The Revised Explanatory Memorandum[10] at [3.33] also provides that:

Provided any expenditure is essential to the prudent operation of a superannuation entity and reporting and monitoring frameworks for such expenditure are put in place by trustees to ensure that the expenditure is necessary and provided on competitive terms (and any ongoing expenditure continues to achieve its intended outcomes), then the expenditure decision would likely be regarded to be in the best financial interests of the beneficiaries.

The legislative intent seems much more consistent with an objective test, rather than a solely subjective test. But the High Court has described an honest/genuine belief and a reasonable belief as being two radically different and distinct ideas.[11]

Significance of an objective test

The main prong of an objective test is that the trustee must be able to demonstrate not just that it genuinely believed its conduct to harmonise with the best financial interests of beneficiaries but also that a reasonable and prudent trustee, in the position of that trustee, would or could have also held that view.

This test appears at least less forgiving than the Breckler[12] type test of whether any reasonable trustee could have held that view.

This objective test is likely to mean that courts will place emphasis on not so much the outcome of the conduct, but more precisely on the criteria, evidence and thought processes involved in the trustee’s decision-making as to whether that conduct was reasonably capable/designed and likely to lead to a favourable outcome for members. Importantly, this is a different test to an outcomes-based test which measures the result of the trustee’s conduct against the best financial interests of members. Evidence of a belief on the part of a trustee that it is acting in the best financial interests of members would be less conclusive.

Practically this difference means that trustees will discharge the BFID if there is sufficient evidence to justify the particular conduct was reasonably capable/designed and likely to lead to a favourable outcome for members, where it gave genuine and reasonable consideration to the decision. That focus on contemporaneous evidence will then cause attention to documentation, including investment analysis, consideration of options, together with board papers and minutes.

Despite the foregoing comments, some focus on outcomes may be relevant to assessing whether the action/decision of the trustee was objectively capable of being made.

The Distillation – BFID Key Principles

In our submission, based on the analysis expounded in this article, the BFID has the following attributes:

1. It is not an outcomes-based test. In other words satisfaction of the duty is not dependent on any particular outcome and in particular, not an outcome of achieving the best financial outcome. An outer extremity outcome element is that the action/decision can be impugned if no reasonable trustee could have taken that action/decision.
2. While not outcomes-based in the sense of being measured by and dependent on the best financial outcome being achieved, focus on outcome might flow from the objective element of the duty (i.e. was the decision a reasonable one?). In other words, an outcomes prism may flow from an objective element of the duty.
3. The duty has both subjective and objective elements (on the basis of the Kelaher decision). In other words, it requires:
   • the trustee to give genuine consideration to, and hold a genuine belief that, the action or decision will have a favourable financial outcome, and that the purpose was to achieve that outcome and not some other, extraneous, outcome; and
   • an objective element of being reasonably regarded as being in the best financial interests of members.
4. If the trustee satisfies these thresholds, the duty allows for different decisions to be capable of being made by a trustee, all of which would satisfy the BFID.
5. The reversal of burden of proof is likely to now require evidence of not just the subjective element but also the objective element. That will require attention to contemporaneous documentation.

 

 

[1]                 [2017] FCA 345.

[2]                 ASIC v Australian Property Custodian Holdings Limited (Receivers and Managers appointed) (in liquidation) (Controllers appointed) (No 3) [2013] FCA 1342.

[3]                 Manglicmot v Commonwealth Bank Officers Superannuation Corporation Pty Ltd [2010] NSWSC 363.

[4]                 ASIC v Australian Property Custodian Holdings Limited (Receivers and Managers appointed) (in liquidation) (Controllers appointed) (No 3) [2013] FCA 1342.

[5]                 Australian Prudential Regulation Authority v Kelaher [2019] FCA 1521.

[6]                 Attorney-General (Cth) v Breckler (1999) 197 CLR 87.

[7]                 See Hindle v John Cotton Ltd (1919) 56 Sc LR 625, 630 – 631.

[8]                    Lehane JRF, “Delegation of Trustees’ Powers and Current Developments in Investment Funds Management” (1995) Bond Law Review: Vol. 7: Iss. 1, Article 4.

[9]                 Revised Explanatory Memorandum, Treasury Laws Amendment (Your Future, Your Super) Bill 2021.

[10]               Revised Explanatory Memorandum, Treasury Laws Amendment (Your Future, Your Super) Bill 2021.

[11]               Forrest v Australian Securities and Investments Commission [2012] HCA 39 at [22].

[12]               Attorney-General (Cth) v Breckler (1999) 197 CLR 87.