Why SMSFs need sound legal advice

SMSF technical expert and columnist for The Australian newspaper
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The 2005 NSW Supreme Court case Katz v Grossman is famous in super circles for all the wrong reasons. There are important lessons from this case that apply to every self-managed super fund, but regrettably, I think most people – including many in the super industry – misunderstand the case.

The case involved the payment of a super benefit following the death of Mr Ervin Katz in September 2003. As a result, many people assume it only shows how to stop your heirs and successors fighting over your super benefits by using binding death benefit nominations.

In reality, this case also demonstrates that you need, or at least need access to, people with an in-depth knowledge of superannuation law, general trust law and succession law to properly run your super fund when making complex decisions. Obviously, the various tax laws are also important in other aspects of your SMSF.

Let’s start at the beginning

In March 1965, Mr Katz’s employer started a small super fund to provide retirement benefits for its employees and Mr Katz immediately became a member of the fund. When Mr Katz died, he was the only member of the fund to have assets of more than $1 million. Sometime before his death he completed a non-binding death benefit nomination that said to pay his death benefit in equal shares to his children Linda Grossman and Daniel Katz.

These nominations indicate what a member would like to happen with their super death benefits. However, under most trust deeds, the trustee only needs to take the nomination into account – they don’t actually have to follow it.

Since the super fund’s establishment, its trust deed had been amended a number of times; the last being in 1995, before Mr Katz’s death. It’s reasonably safe to assume that this amendment was made to ensure the fund complied with super laws that were then coming into effect.

The judge in this case spent a considerable amount of time discussing the differences and impacts of the various deed amendments that have occurred over the years. This clearly shows that great care has to be taken when updating a super fund’s trust deed. Poor quality work (which in some cases will be done for the sake of administrative convenience or to save money) may ultimately turn expensive because aggrieved parties always find fault in prior documents and there is no such thing as a bulletproof legal document.

The seeds of the problem

Mr Katz’s wife, who had been a member of the super fund, died prior to Mr Katz in July 1998, with probate being granted in March 2000. Mr Katz was the executor and sole beneficiary of her estate. In May 1999, Mr Katz appointed his daughter Linda as an additional trustee of the fund, and not long after, Mr Katz received his wife’s death benefit of over $550,000.

Why did Mr Katz appoint his daughter as a trustee? The Katz super fund had an individual trustee structure and, as Mr Katz was the only member, he needed another person to act as trustee so that the fund remained an SMSF – SMSFs can’t have a single trustee!

The rules allowing a self-managed super fund to remain an SMSF when a member dies say that the deceased’s legal personal representative can act as the trustee for the deceased between the date the member passed away and the date when the death benefit is payable.

Mr Katz’s son believed that the appointment of his sister wasn’t allowed under these super laws, but the judge disagreed and used the NSW Trustee Act to justify his view. That legislation says that a new trustee can be appointed when one trustee passes away.

The problem deepens

One month before Mr Katz died, Linda applied to become a member of the fund. Acting alone in her role as trustee, she accepted herself as a fund member. No evidence was presented to show that her father had consented to this application and the judge decided that Linda’s fund membership application had been done incorrectly.

In December 2003, shortly after Mr Katz’s death, Linda appointed her husband as a trustee of the fund. The judge allowed this appointment because the fund’s trust deed said that a new trustee needed to be appointed within 90 days of a trustee vacancy arising. Further, the judge believed that the NSW Trustee Act allowed Linda to appoint her husband as trustee.

As a result of all these decisions, the fund effectively had three trustees: Mr and Mrs Grossman and Mr Katz’s executor. Clearly, a majority had been formed by Mr and Mrs Grossman. In any event, Mr Katz’s executor was not appointed until August 2004.

The judgment noted that Linda refused to confirm that she would pay out her father’s death benefit in accordance with his non-binding death benefit nomination – an equal share between the siblings. And it’s this refusal that may be the cause of the legal action.

The costly damage

Who paid for this court action? The judge said that the costs of both parties should be paid out of the super fund. In other words, the value of the death benefit was substantially reduced.

As you can see, a key matter in super fund death benefits is who controls the super fund – don’t make the mistake of assuming a non-binding death benefit nomination will be carried out as you wish. I’ll be looking at this issue of control in future articles.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Also in the Switzer Super Report

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