Australia: Does the care, skill and diligence covenant in Stronger Super heighten existing requirements?

The Superannuation Legislation Amendment (Trustee Obligations and Prudential Standards) Bill 2012 will repeal section 52 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) and insert four sections that set out new statutory covenants. The explanatory memorandum to the Bill (EM) refers to new section 52(2)(b) as heightening existing requirements in relation to the degree of care, skill and diligence required of trustees.¹ In this article, I test that claim by looking at the current care, skill and diligence covenant, its general law origin and requirements under State and Territory trustee legislation.

Understanding the required degree of care, skill and diligence is important because, in Apostolovski v Total Risk Management, Gzell J held that the defence regarding investments, under section 55(5) of the SIS Act, does not apply if the covenant in paragraph 52(2)(b) is breached.² Further, the Bill will amend section 55(5) to clarify that trustees must comply with all applicable covenants in order to access the defence.

Care, skill and diligence covenant

As most readers will be aware, section 52(2)(b) currently sets out a covenant:

"to exercise, in relation to all matters affecting the entity, the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide".

I note that the statutory covenant refers to an "ordinary prudent person" and "the property of another for whom the person felt morally bound to provide".

General law origin

In Manglicmot v Commonwealth Bank, Giles JA observed, in relation to section 52(2)(b) that "[t]he terms of the covenant appear to have been taken from Re Whiteley ".³ I agree with that observation. However, as explained below, in my view, matching the language of the covenant to the decision in Re Whiteley does not mean that the covenant applies the same standard as the general law.

In my view, the best summary of the position at general law can be found in Finn J's decision in ASC v AS Nominees Ltd⁴. He observed:

"It is old and accepted law that in managing a trust business the trustee should exercise the same care as an ordinary, prudent business person would exercise in conducting that business as if it were his or her own: Speight v Gaunt (1883) 9 App Cas 1; Learoyd v Whiteley (1887) 12 App Cas 727; Knox v Mackinnon (1888) 13 App Cas 753. There is an equally well-accepted gloss on (or adjunct to) this in relation to trustee investments which is aptly described in Scott on Trusts, par 227.3 as the "requirement of caution", That requirement is well expressed in King v Talbot (1869) 40 NY 76 to which Scott refers:

'It... does not follow, that, because prudent men may, and often do, conduct their own affairs with the hope of growing rich, and therein take the hazard of adventures which they deem hopeful, trustees may do the same; the preservation of the fund, and the procurement of a just income therefrom, are primary objects of the creation of the trust itself, and are to be primarily regarded.'

To like effect are the observations of Lindley LJ in Re Whiteley; Whiteley v Learoyd (1886) 33 Ch D 347 at 355."⁵

There are three points to note. First, at general law, the standard of care required is the standard of care that an ordinary, prudent businessperson would take in managing his or her own affairs. Second, that general rule is qualified by a "requirement of caution" to avoid hazardous or speculative investments. Third, Lindley LJ's comments in Re Whiteley have the same or a similar effect to the requirement of caution.

In Re Whiteley, Lindley LJ held:

"The principle applicable to cases of this description was stated by the late Master of the Rolls in Speight v Gaunt (1) to be that a trustee ought to conduct the business of the trust in the same manner that an ordinary prudent man of business would conduct his own, and that beyond that there is no liability or obligation on the trustee. I accept this principle; but in applying it care must be taken not to lose sight of the fact that the business of the trustee, and the business which the ordinary prudent man is supposed to be conducting for himself, is the business of investing money for the benefit of persons who are to enjoy it at some future time, and not for the sole benefit of the person entitled to the present income. The duty of a trustee is not to take such care only as a prudent man would take if he had only himself to consider; the duty rather is to take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide."⁶

The portion of Lindley LJ's judgment quoted above makes it clear that he accepted the prudent business person principle. In that context, I do not consider that his references to an ordinary prudent man and the property of another for whom the trustee felt morally bound to provide create a separate duty at general law.

In my view, Lindley LJ's remarks should be seen as qualification to the prudent business person principle.⁷ Because I view the covenant set out in section 52(2)(b) as having been based on a decision that establishes a qualification to the general rule, I consider that the statutory covenant is different to the general law. In my view, the references in the covenant to "an ordinary prudent person" and "the property of another for whom the person felt morally bound to provide" are points of distinction from the general law. As Lindley LJ's formulation in Re Whiteley has a similar effect to the requirement of caution,⁸ and the terminology for the covenant set out in section 52(2)(b) is taken from Re Whiteley,⁹ in my view, a trustee that invests in hazardous or speculative investments in breach of the requirement of caution also contravenes the statutory covenant.

Higher standard for professional trustees

In ASC v AS Nominees, Finn J indicated that he did not regard the observations of the High Court in Fouche v The Superannuation Fund Board¹⁰ regarding the standard of care expected of the statutory corporation in that case as precluding the adoption of a different and higher standard where a trustee company is (a) carrying on business in the field of superannuation; (b) soliciting members of the public to utilise its services as funds manager; and (c) charging significant fees.¹¹ However, it was not necessary for his Honour to apply that standard in those proceedings.¹²

In my view, where a company carries on business as a superannuation trustee, a court might be prepared to apply a higher standard of care under the general law than the prudent businessperson standard, but I do not consider that we are yet at a point where the general law should be described as imposing a standard of care, skill and diligence for superannuation trustees that is higher than the ordinary prudent businessperson standard.

State and Territory trustee legislation

State and Territory trustee legislation¹³ currently impose a different standard of care on professional trustees, in relation to their investment powers, than a covenant to the effect of the covenant set out in section 52(2)(b) of the SIS Act. For example, section 14A(2) of the Trustee Act 1925 (NSW) provides:

"A trustee shall, in exercising a power of investment—

1. if the trustee's profession, business or employment is or includes acting as a trustee or investing money on behalf of other persons—exercise the care, diligence and skill that a prudent person engaged in that profession, business or employment would exercise in managing the affairs of other persons; or
2. if the trustee is not engaged in such a profession, business or employment—exercise the care, diligence and skill that a prudent person would exercise in managing the affairs of other persons."

For superannuation funds other than self managed superannuation funds, the trustee's profession or business typically is, or includes, acting as a trustee and therefore the relevant standard is the care, skill and diligence that a prudent person engaged in that profession, business or employment would exercise in managing the affairs of other persons.

The State and Territory trustee legislation provides that duties in respect of powers of investment have effect subject to the trust instrument.¹⁴ Currently, when setting up a superannuation fund, the trust deed could be drafted to exclude or modify the standard of care required under the trustee legislation in exercising a power of investment. However, I do not consider that an express covenant in a trust deed to the effect of a covenant set out in section 52(2)(b) of the SIS Act, or a covenant that is taken to be contained by virtue of section 52(1), has the effect of changing the standard under the trustee legislation.

Changes to the care, skill and diligence covenant

Under the changes in the Bill to section 52(2)(b), the governing rules of an RSE will include a covenant by each trustee:

"to exercise, in relation to all matters affecting the entity, the same degree of care, skill and diligence as a prudent superannuation trustee would exercise in relation to an entity of which it is trustee and on behalf of the beneficiaries of which it makes investments".

Subsection 52(3) will define "superannuation trustee" for this purpose as "a person whose profession, business or employment is or includes acting as a trustee of a superannuation entity and investing money on behalf of beneficiaries of the superannuation entity".

As mentioned above, the EM refers to section 52(2) as heightening existing requirements in relation to the degree of care, skill and diligence required of trustees.¹⁵ However, the EM also describes the changes to the care, skill and diligence covenant as "bringing this requirement into line with State and Territory trustee legislation applying to professional trustees".¹⁶

Conclusion

I view Lindley LJ's remarks, about taking such care as an ordinary prudent man would take in making an investment for someone for whom he felt morally bound to provide, as a qualification to the general rule that a trustee has a duty, in managing trust affairs, to take all those precautions which an ordinary, prudent businessperson would take in managing similar affairs of his or her own. As section 52(2)(b) is expressed in terms of that qualification, rather than the general rule, I consider that the current standard in the statutory covenant is different to the standard at general law. If a trustee's profession, business or employment includes acting as a trustee, State and Territory trustee legislation requires the trustee to exercise the care, skill and diligence that a prudent person engaged in that profession, business or employment would exercise in managing the affairs of other persons.

In my view, the Bill will align the care, skill and diligence covenant for each trustee of an RSE with the standard required under the State and Territory trustee legislation in exercising an investment power. The Bill will also extend that professional trustee standard beyond the exercise of investment powers. Accordingly, I consider that the Bill heightens the standard that is required of a trustee of an RSE, other than in exercising investment powers. In relation to investment powers, the new section 52(2)(b) will operates to prevent the governing rules of an RSE being used to change the standard that would otherwise apply and therefore strengthens, but does not heighten, the existing requirements in exercising investment powers.

This article was first published in the Australian Superannuation Law Bulletin, March 2012

Footnotes

¹ at [1.46]
² [2010] NSWSC 1451 at [45] The action in Apostolovski was for loss or damage as a result of delay in processing a claim for a total and permanent disablement benefit and it is questionable whether the section 55(5) defence would have been available in those circumstances. As a result, the decision might be distinguished in an investment context.
³ Manglicmot v Commonwealth Bank [2011] NSWCA 204 at [120]
⁴ (1995) 62 FCR 504 [back]
⁵ (1995) 62 FCR 504 at 516
⁶ (1886) 33 Ch D 347 at 355
⁷ That is the approach taken in J D Heydon & M J Leeming, Jacobs' Law of Trusts in Australia, (7th ed, 2006) at 1718
⁸ ASC v AS Nominees Ltd (1995) 62 FCR 504 at 516, per Finn J
⁹ Manglicmot v Commonwealth Bank [2011] NSWCA 204 at [120], per Giles JA
¹⁰ (1952) 88 CLR 609 at 641
¹¹ (1995) 62 FCR 504 at 518
¹² (1995) 62 FCR 504 at 518
¹³ Trustee Act 1925 (ACT); Trustee Act 1925 (NSW); Trustee Act 1893 (NT); Trusts Act 1973 (Qld); Trustee Act 1936 (SA); Trustee Act 1898 (Tas); Trustee Act 1958 (Vic); Trustees Act 1962 (WA)
¹⁴ section 14A(1) Trustee Act 1925 (ACT); section 14A(1) Trustee Act 1925 (NSW); section 6(1) Trustee Act 1893 (NT); section 22(2) Trusts Act 1973 (Qld); section 7(1) Trustee Act 1936 (SA); section 7(1) Trustee Act 1898 (Tas); section 6(1) Trustee Act 1958 (Vic); section 18(1) Trustees Act 1962 (WA)
¹⁵ at [1.46]
¹⁶ at [1.57]

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.