Introduction

Unit trusts are a common investment structure and can provide a simple way for parties to co-invest in property or business together. In particular, investing via a unit trust is a popular way for SMSFs to invest in real estate including to develop property.

While the terms of a unit trust deed typically cover a number of important points, there are many other critical points that can be covered in a variation to the deed or in a unitholders agreement. These provide greater certainty, minimise risks, and can assist avoiding costly disputes.

This article outlines what a unitholders agreement should typically contain and why they should be considered where there is more than one unitholder; including a related party.

What should be included in a typical unitholders agreement?

A unitholders agreement is dependent on the quality of the drafting in the unit trust deed and on how well the unitholders agreement is drafted and integrates with the deed. Such an agreement should cover the key points in the relationship between the unitholders that are not covered by the unit trust deed and also cover the key risks and rights that each unitholder may have in certain scenarios.

We now examine various types of provisions and issues that should be considered in preparing a unitholders agreement.

How units can be offered by sale and to whom?

Some unit trust deeds and unitholder agreements will include provisions requiring a unitholder intending to dispose of their units (ie, a vendor) to offer their units in the first instance to other unitholders in proportion to the other (purchasing) unitholders’ unitholdings. 

Initially, the vendor might offer their units at the value notified by them based on their market value; which may be at an inflated or deflated price. There may be provisions allowing the purchasing unitholders to dispute the vendor’s market value and request an independent valuation of the units.

Provisions can be inserted in a unitholders agreement to include a more detailed process agreed between the unitholders. For example, where there is an individual unitholder who dies, rather than their units transferring to their executors upon their death to form part of their deceased estate (which the other unitholders do not get along with, etc), the other unitholders could be provided with the right to purchase those units subject to the specified valuation process set out in the unitholders agreement.

Similarly, where the unitholder is a company or trustee of a trust and the key person(s) in respect of that company or trust dies or loses capacity, a trigger event may arise allowing the other unitholders to undertake a compulsory purchase of the units held by that company or trust. 

Where an SMSF is a unitholder, care is needed so that a contravention of the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA) does not occur. For example, where there is a 50/50 arrangement between two unrelated SMSF unitholders and the key person of one of the SMSF unitholders dies and the other 50 per cent SMSF unitholder obtains the right to purchase the deceased’s SMSF’s units, then the in-house asset rule in part 8 of the SISA could be contravened.

In this situation, for the purchase to proceed, the SMSF related to the key person who is still alive, would first need their SMSF to dispose of its entire unitholding in that unit trust. Note that if that SMSF did not dispose of its 50% before a related party (related to that SMSF) acquires a greater unitholding interest giving rise to control of more than 50% of the unit trust, then a related trust relationship arises, and an immediate contravention of the in-house asset rules is likely to occur. 

When should a unitholder be forced to sell their units?

The unitholders agreement can specify a range of limitations or prohibitions which, if contravened, give rise to a compulsory sale of the defaulting unitholder’s units. For example, unitholders, especially when one or more SMSFs are involved, should prohibit unitholders placing any security or charge in respect of their units (eg, some lenders may want to register a charge under the Personal Property Securities Act 2009 (Cth) (PPSA) in respect of a unitholder’s unit certificates). Thus, if a unitholder did pledge their units for security in respect of a mortgage or charge, this event could give rise to a compulsory purchase trigger under a unitholders agreement. 

Note that a unitholder that places their units to some form of security or charge increases the risk of other unitholders and the trustee of the unit trust may also become embroiled in a legal dispute seeking to resolve any issues that arise from the enforcement of the charge in respect of a unitholder.

The agreement may also list other criteria for when a compulsorily buy out would be invoked such as, change of control of a unitholder, where the unitholder becomes insolvent or rendered bankrupt, or where the unitholder breaches any of its obligations under the trust deed or unitholders agreement and fails to rectify within a specified time frame.

What decisions require a greater than majority vote?

There are typically a range of decisions that unitholders want to specify a vote that is higher than the usual 50% threshold to pass a unitholders’ resolution. For many decisions at least a 75% (ie, a special resolution) threshold is required, and certain decisions may be set to a 100% (ie, a unanimous resolution) threshold. Broadly, the unitholders need to consider what key decisions should be subject to a higher threshold and set them out in the unitholders agreement. For example:

• A special resolution may be required to invest more than $100,000 on improvements to a property; or
• A unanimous resolution may be required to decide to purchase or decide to dispose of a property.

In recent times where there are numerous unrelated unitholders involved, there is a trend to include a provision that requires the property to be sold in say 5 to 7 years’ time unless a special resolution is passed to retain the property. Tax advice should be obtained before inserting such a provision as this may suggest that the investment is not for long-term capital appreciation but rather an asset held on revenue account where any capital appreciation might be assessed as normal income. 

Other restrictions in respect of superannuation law issues

There are a range of safeguarding provisions that we like to insert into a unitholders agreement to minimise the risk of there being a contravention of the SISA and Superannuation Industry (Supervision) Regulations 1994 (Cth) (SISR).

These provisions require input from the client and the lawyer preparing the agreement to ensure the provisions are suitable for the parties. Such provisions usually include:

• That suitable wording is included to limit an SMSF and its related parties from acquiring more than a 50% stake in the unit trust nor a controlling interest unless approved by a special process. This is designed to minimise the risk of an in-house asset contravention as a ‘related trust’ relationship can easily arise under s 70E(2) of the SISA.
• Appropriate provisions to confirm each SMSF trustee has undertaken appropriate due diligence, investigations, and checks and has had ample opportunity to obtain professional advice before investing in the unit trust and entering into the agreement. These provisions would also confirm that the investor will not contravene the SISA and SISR and has responsibility for their ongoing compliance with the super rules. Moreover, if any provision in the unitholders agreement was ever considered to breach or constitute a SISA or SISR contravention, then the relevant provision in the unitholders agreement is to be read down to the extent of inconsistency with the SISA and SISR.

What can go wrong?

There are many things that can happen to a unitholder (or the person controlling a unitholder entity) that can cause complications for other unitholders. These include things such as a unitholder or their controllers or associates:

• dying or losing capacity;
• becoming bankrupt, insolvent or being placed into liquidation or under administration;
• being sued or otherwise caught up in litigation;
• getting divorced or experiencing other familial or personal issues; or
• simply wanting to divest their unitholding.

While an investor may initially know and get along with all of their fellow unitholders, these events can result in another unknown person or entity becoming a unitholder (or controlling a unitholder entity) which may be  undesirable for the remaining unitholders. Having appropriate compulsory purchase triggers in the unitholders agreement to cover the key risks for those involved is highly recommended.

Further, the unitholders may be involved in a time consuming dispute and require some mechanism for one or more unitholders to resolve the issue. To minimise any dispute, appropriate alternative dispute resolution (ADR) provisions should be included to minimise the involvement of the courts until the ADR provisions have been exhausted, eg, the parties seek to resolve first and if after 5 business days, there is still a dispute, the parties involve a mediator before commencing legal action. Appropriate ADR provisions may result in hundreds of thousands of dollars not being charged in a drawn-out legal battle and having a unitholders agreement to just include these provisions can justify the investment in obtaining one.

The process of discussing and agreeing on what should be included and what not to include in a unitholders agreement is usually a great way to understanding what is in the minds of the prospective investors and what goals and risks they consider important in respect of the relationship. It is much easier to discuss these upfront compared to after a falling out when the parties are only corresponding between their lawyers.

Conclusion 

Ideally, the parties’ rights and obligations in respect of various matters included in a unitholders agreement should be clear from the commencement of the relationship. Such an agreement can ensure any default events or disputes are dealt with more effectively. The unitholders agreement needs to integrate with the provisions in the unit trust deed.

Prudent advisers should discuss the option of having their client’s unit trust deeds reviewed and updated if needed and advising clients on the appropriateness of implementing a unitholders agreement tailored to their client’s particular circumstances.

By Shaun Backhaus, lawyer, and Daniel Butler, director, DBA Lawyer