IOOF legal loss exposes it to tens of millions in compo

A week is a long time in business. And so it was for financial services giant IOOF which last week celebrated a high profile win in the Federal Court only to find itself on the wrong end of a case days later that exposes it to millions of dollars in compensation for breaching its duties as a trustee.

In a judgment in the Supreme Court of NSW, IOOF subsidiary, Australian Executor Trustees (AET), was found to be liable to pay up to $82 million in compensation to thousands of scheme investors after it was found to have breached its duties as trustee of the SEAS Sapfor forestry scheme.

The investors put money into forestry schemes. Credit: Andrew Quilty

Last November IOOF sold the AET Corporate Trust to Sargon Capital for $51 million but it indemnified Sargon for any liability relating to the legal action.

The judgment was handed down on Thursday but it took IOOF until Friday at 3.58pm to inform the market of the loss.  The statement followed inquiries from The Sydney Morning Herald and The Age hours earlier as to why the company hadn't issued a statement.

In its statement to the ASX, IOOF said it was currently discussing the compensation with its insurers but that the maximum exposure to IOOF, net of insurance proceeds, was $16. 5 million.

It said it expected to appeal the judgment. The case puts IOOF and its role as a trustee back in the spotlight along with the need for more transparency in the trustee sector which is opaque, complex and rarely finds itself on the hook.

The legal action was bankrolled by litigation funder IMF Bentham and run by Piper Alderman on behalf of 4500 scheme investors – known as covenant holders - who lost tens of millions of dollars when the forestry scheme collapsed.

When the covenant holders invested their money in the scheme they were told it was a low risk, "set and forget" tax effective investment product with a long-term income stream. “The trees just keep on growing,” marketing brochures said.

In his judgment summary, Justice James Stevenson said AET had admitted to breaching its duties. He said there were two main issues: first, whether the plaintiff David Kerr had proven that breach caused damage; and second, whether AET was able to avoid liability because it relied upon the advice of its lawyers Sparke Helmore.

The problems date back to 2008 when SEAS Sapfor - and its parent Auspine - was bought by Tasmanian timber group Gunns. Gunns collapsed a few years later owing hundreds of millions of dollars to creditors.

Gunns Limited executive chairman John Gay. Credit: Peter Mathew

Before it went under it was granted $340 million in credit from ANZ and put a fixed and floating charge over the Sapfor scheme assets as collateral. It then sold the Sapfor trees and land in a deal where AET would receive $1 for covenant holders and the remaining $33.9 million for the trees and $4.8 million for the land was paid to a Gunns entity.

The transaction was a breach of AET’s duties on the basis it agreed to the sale of the land and discharged the covenant holders’ security without receiving the sale proceeds or organising alternative security.

Indeed covenant holders had previously been told AET held security instruments called encumbrances over the land which thereby secured Sapfor’s obligation to pay proceeds of timber sales to covenant holders.

"AET was obliged to withhold its consent to any sale of the land if that sale would cause the interests of Covenant holders to be materially prejudiced or cause any reduction in the protection afforded to the Covenant holders," Justice Stevenson said.

When Gunns collapsed the funds were seized by the receivers. It wiped out the 4500 covenant holders' entire investment.

AET argued in court that the decision to sell the assets was based on a misapprehension of an encumbrance. It was an argument that was not entertained by the judge.

"If Mr [Stewart] Howard had the misapprehension he asserted, that was an astounding state of affairs," Justice Stevenson said in his judgment. "Mr Howard was the senior relationship manager corporate trust at AET. He had the day to day management and oversight of this transaction and made the decisions on behalf of AET in relation to it."

Whatever the case, the fight for compensation has been a long and tortuous haul. It began in 2012 when AET pursued the receivers of Gunns to retrieve the money, but failed.

Four years later, in 2016 a new trustee was appointed after Piper Alderman applied to the NSW Supreme Court. The new trustee, David Kerr of RSM Australia, conducted his own investigations.

Then in 2017 Kerr decided to take legal action against the trustee for breach of trust and negligence. AET denied liability and cross-claimed against the law firm it appointed for advice on the sale of the assets.

IOOF has been in the headlines in recent years for all the wrong reasons.

It is now waiting to see whether APRA appeals a case it lost a week ago in the federal court where IOOF and five senior executives and directors, including former CEO Chris Kelaher, were accused of failing to act in the best interests of super fund members in a series of incidents.

But in the case relating to its duties as a trustee it says it is likely to appeal. For long-suffering covenant holders it means the light at the end of the tunnel just got a bit further away.