NRMA case raises some issues

Background In the New South Wales Supreme Court decision of Re NRMA Ltd and NRMA Insurance Ltd (2000) 33 ACSR 595, Santow J had cause to consider the effect of the principles of mutuality on a demutualisation of a mutual insurance company by way of a scheme of arrangement under s.411 of the Corporations Law (now s.411 of the Corporations Act 2001 (Cth)).

The case arose during the application for orders to convene meetings of the members of NRMA Ltd (NRMA) and NRMA Insurance Ltd (Insurance Ltd) to vote on a proposal to demutualise Insurance Ltd. During the course of the application, an objection was raised against the proposal on the basis that there had been a breach of the mutuality principles. This breach is alleged to have occured through the Board's failure to distribute accumulated assets to members in the form of either rebates or lower premiums. It was submitted to the court that this breach created a legal impediment to the demutualisation of the Insurance Ltd which would preclude the court approving of the scheme. Accordingly, if the court could not approve of the implementation of the scheme, there was little point in refering the proposal to members for approval.

At the time of the proposed scheme, Insurance Ltd was a mutual insurance company registered under the Corporations Law as a company limited by guarantee. It was the insurance arm to the National Road and Motorists Association (the NRMA), which was also registered under the Corporations Law as company limited by guarantee.

The NRMA was a mutual company providing road and related motoring services to its members within New South Wales and the Australian Capital Territory. NRMA also controlled Insurance Ltd in that it had the power to appoint and remove directors from the board of the company. However, both companies enjoyed a common membership by virtue of the fact that a person could not be a member of Insurance with out being a member of NRMA.

The effect of the scheme was to extinguish members rights in Insurance Ltd in exchange for the issue of shares in a new holding company called NRMA Insurance Group Ltd (NIGL), which would control Insurance Ltd.

However, after implementation of the scheme, former members of Insurance Ltd would continue in their capacity as policy holders of the company to receive entitlements according to the terms of their policies. Coinciding with the scheme to demutualise Insurance Ltd were a number of associated schemes of arrangement covering NRMA and its members.

These schemes involved NRMA relinquishing membership of Insurance Ltd, and the right of control over the board of the company, in return for the issue of shares to NRMA and its members in NIGL.

The combined effect of the schemes was to implement a series of interlocking steps to demutualise Insurance Ltd. None of the schemes affected the mutual nature of the NRMA which would continue to provide road services to its members who would be independent of the shareholders in the new holding company.

Function of the Court Under a Scheme of Arrangement

Before considering the legal status of the principles of mutuality, it is proposed to review the operation of s.411 and the functions of the court under the section.

Section 411 of the Corporations Law provides a mechanism enabling rights and liabilities of members and creditors (if applicable) of a company to be re-organised by way of a "scheme of arrangement". Once approved by the court, the scheme becomes binding on the members and creditors who are subject to the terms of the scheme. A scheme may involve either members or creditors depending on the nature of the terms of the proposal.

Under s.411 the Court has jurisdiction to order separate meetings of members and creditors to vote upon the terms of a scheme of arrangement. In granting leave to order the meetings the court must approve of an explanatory memorandum to accompany the notices of the meetings. The explanatory memorandum contains all of the relevant information relating to the scheme of arrangement to enable members and creditors to exercise their judgement on the scheme. The standard of disclosure required is the same as that expected for a conventional takeover.

For a scheme to be approved by the court, there must be

  1. agreement of 75% of the members AND
  2. agreement of creditors, whose debts or claims against the company amount to 75% of the comapny's debts and claims.

There is no obligation on the directors of a mutual company to satisfy the court that the scheme is the best that could be devised. Nor is the court required to consider other alternatives that could be pursued by the company. At this stage the function of the court is supervisory. If the court is satisfied that the provisions of s.411 are complied with, that the scheme is fair and reasonable and is not oppressive, it may approve of the scheme which then becomes binding on members and creditors. Issues involved in determining the Legal status of the Principles of Mutuality In determining whether there was any legal impediment to demutualisation by way of a scheme of arrangement the court had to consider three issues: one the nature of the mutuality principles within the context of the Corporations Law; two, whether the mutuality principles created a legal obligation or duty on the directors to distribute surpluses in the form of rebates, by way of mutual pricing or through the provision of other member services; and three, whether a breach of the mutuality principles by the Board precluded the demutualisation.

Defining Mutuality

In considering the nature and characteristics of a mutual organisation, Santow J referred to the definition contained in the New Shorter Oxford Dictionary, which defined a mutual as " ... a building society, insurance company, etc. owned by its members and dividing some or all of its profits between them ". In determining the characteristics of a mutual insurance company, his Honour then refered to the decision of Upjohn J in Falconbridge - v - National Employers Mutual General Assurance [1952] 1 Lloyds's List Law Reports 17, in which it was held that there were two essential characteristics of a mutual insurance association. These were:

An interesting point in the consideration of the Insurance Ltd structure is that members of the company did not have direct control over the appointment of the board. This occurred through their membership in NRMA which enabled them to elect the directors of that company who had the power to appoint the directors of Insurance Ltd. In addition, the constitution of Insurance Ltd provided for surpluses on liquidation to be transferred to the NRMA. Therefore, based on the criteria of Upjohn J, Insurance Ltd would not have qualified as a mutual insurance company. Nevertheless, Santow J was prepared to proceed with the hearing of the case on the basis that Insurance Ltd was a mutual organisation.

Santow J referred to a number of US decisions in which it was held that a mutual insurance company is one which furnished insurance at cost. However, his Honour noted that there was no legal authority precluding a mutual insurance company setting premiums with a view to the probable accumulation of surpluses. Nor was there any authority requiring a mutual insurance company to operate along the lines of a not-for-profit organisation.

On the issue of the distribution of surpluses, Santow J accepted that a mutual concern was one which trades with its members and that it did not change its status by choosing to retain profits to expand the business activities of the company. Directors could have a discretion under the constitution as to the distribution of a company's surpluses. Where a distribution was authorised by the board, the distribution could be in the form of dividends (if the company was limited by shares) or by way of premium rebates, mutual pricing or other membership benefits. However, until a distribution was made no person in the capacity of a member or policyholder of the company had any title to surpluses owned by the company.

Application of Mutual Principles Under the Corporations Law

Insurance Ltd was incorporated under the Corporations Law as a company limited by guarantee with all of the associated privileges and obligations that go with that class of company. However, Santow J noted that there was no reference in the Corporations Law to a mutual company. Nor was there any articulation of the mutuality principles for management of the affairs of a mutual company. Therefore, unless specifically provided for under the Corporations Law, or under the constitution of Insurance Ltd, there is no legal obligation or duty on the directors of Insurance Ltd to follow the mutuality principles. As a result, the directors of Insurance Ltd would be subject only to the legal and statutory duties that apply to the directors of a public company limited by guarantee.

This meant that the issue of distributing surpluses in the form of rebates, mutuality pricing of polices, or any other member benefits, remained a matter within the province of the board's discretion. Failure to distribute surpluses did not amount to a breach of duty on the part of each member of the board; although his Honour did not address the issue of whether a board policy to retain surpluses might, in certain circumstances, amount to oppression on the part of the board, within the terms of Part 2F1 of the Corporations Law.

Santow J did however refer to the US decision of Huber v Martin 105 NW 1031 (1906 Wisc) to support the proposition that the Court may intervene in a case where accumulated surpluses are unreasonably large. Also, his Honour noted that there was an US authority enabling the Court to intervene where there was bad faith, wilful neglect or abuse of discretion by directors regarding the distribution of surpluses. In the absence of these factors, there was no obligation on a board to distribute surpluses.

Accordingly, his Honour held that there was no legal impediment based on mutuality principles, in particular the non-distribution of surpluses, that prevented a company demutualising by way of a members scheme of arrangement. The issue of whether the scheme was commercially desirable was a matter for the current members to decide based on the scheme documentation.

Rights and Obligations of Members in a Mutual Insurance Company

Santow J held that the rights and obligations of members in a mutual concern arose from the constitution of the company, from the terms of the policies issued by the company, and from the applicable legislation, rather than by reference to any general principles. His Honour relied on number of English and American decisions in support of this finding. In particular, the Californian Appeal Court decision of Pierce Insurance Co- v - Maloney 269 P2d 57 (Cal. App., 1954), which was also cited to support his Honour's finding that member policy holders had no legal entitlement to the assets of a mutual insurance company unless otherwise stated in the policies issued by the company. His Honour did not, however, make any finding as to whether ah insurance policy represents a variation to the statutory contract as to distributions of the company's general surpluses. Nor did His Honour determine whether an insurance policy was an independent contract conferring rights to distributions from a specific fund operated by a mutual insurance company. In the latter case the fund would represent assets of the company with the policy holder having no interest apart from that which is recognised under the policy.

There were no provisions contained in the constitution of Insurance Ltd, or in the insurance policies issued by the company, creating a trust over the residual assets in favour of the current or former policyholders of the company. The assets belonged to the company to be distributed by the board in accordance with the terms of the constitution. However, it is interesting to note that there was no discussion by the Court as to the nature of a member's interest in assets belonging to particular benefit funds managed or operated by Insurance Ltd, in accordance with the insurance policies issued by the company.

Owners of a Mutual Insurance Company

In ascertaining the owners of Insurance Ltd, Santow J cited the US decision in Huber v Martin 105 NW 1031 (1906, Wisc) in which the Supreme Court of Wisconsin held that, at any given time, the owners of a mutual company were its current policy holding members. His Honour also agreed with the finding of the Supreme Court that the interests which a person has in a mutual insurance company lapses on the person ceasing to be a policy holder and member without further recall to the assets of the company. This would be subject to the terms of the policy and to the provisions of the company's constitution. However, the Court held that there was no requirement at law for a mutual insurance company to give former members entitlements on demutualisation. The Court also found that there was no trust created over the surplus assets which would give former members an equitable interest in those assets.

Preservation of the Rights of Former Members

There were no provisions in the constitution of Insurance Ltd that preserved the rights of former members to the accumulated value of the company. Nor were there any provisions under the Corporations Law, or the applicable insurance legislation, that preserved those rights. Accordingly, as the rights of the former members ceased on them being policy holders or members of Insurance Ltd, there was nothing intrinsically unfair in leaving former members out of the scheme. Under the scheme provisions of the Corporations Law, the demutualisation proposal was primarily an issue for the current members of NRMA and Insurance Ltd to consider based on the contents of the scheme documentation. The business or commercial efficacy of the proposal was a matter for determination by those members. The court would not substitute its own commercial judgement for that of the members of both companies.


The case raises the following important issues:


It is suggested that the case provides a good example in support of the adoption of legislation dealing with the incorporation and regulation of mutual entities in Australia. But what objectives would the legislation have and to what extent would it modify the current law?

Clearly the courts in common law countries rely heavily on corporate law principles when making decisions affecting mutual organisations. An example of this is the concept of the company as a separate legal entity. Anglo Australian courts have always adopted the principles enunciated in Salomon - v -Salomon & Co [1897] AC 22, that a company is a legal entity separate and distinct from its members. The concept is a necessary incident of incorporation as it limits member liability for debts of the company. However, as result of incorporation members have no legal or equitable interest in particular assets of a company, unless an interest is specifically created under the constitution or by other contractual means. As such, a company does not hold its assets on trust for its current or future members; although directors will have fiduciary and statutory duties to the company as to the use of the company's assets. Therefore, without modification of the law, members of a mutual company stand in the same position as shareholders in an ordinary public company in regards to the distribution of company assets. Legal title of assets in a mutual insurance company vests in the company. In the absence of any restrictions under the constitution of the company or under any insurance policies issued by the company, the directors will have a discretion as to the use or distribution of those assets.

Creation of Interests in the Surplus Assets of a Mutual Organisation

There is scope for legislative intervention to give members in a mutual company an equitable interest in the assets of the company, subject to those interests being subordinated to the rights of creditors. Also for the legislation to impose statutory duties on directors as to the use of the assets of the company for the mutual benefit of the members along similar lines to the obligations which trustees have in the use of trust assets. Directors could be required to obtain the consent of members before incurring costs in exploring a proposal to demutualise. Complementing this requirement would be an obligation for directors to justify to members that they have explored all reasonable alternatives and that there is no other viable option than demutualisation. That is, to show that there were no other viable options which could be explored by the board, given the particular circumstances of the organisation.

To avoid a defacto demutualisation of a company's activities, the legislation should preclude the issue of policies to non-members without the board first obtaining the consent of the members. In recommending the issue of non-member policies the board should indicate the effect that this will have on mutual pricing of policies and the provision of services to members. The legislation could exclude non-member policy holders from having an interest in the assets of the company and provide for them to rank after member policy holders for entitlements on liquidation.

The application of the current scheme of arrangement provisions facilitates the demutualisation of a company without any requirement for the board to investigate other options. This could be rectified by requiring a court to be satisfied that all viable options have been explored by the company and that the scheme to demutualise is the most viable option for consideration by members and creditors.

Application of Mutual Principles

If specific legislation were enacted to regulate mutual organisations, it would be necessary to define the mutuality principles and to enshrine those principles within the legislation. The interpretation of the legislation could then be made subject to the application of the mutuality principles. It is suggested that the mutuality principles be defined as follows:

The return of surpluses would be subject to other commercial imperatives that were focused upon enhancing the value of membership in a mutual organisation. For example, the extension of the organisation's business activities to encompass new opportunities within a particular industry which add value to membership in the organisation, or which would complement existing services provided to members. Also, an exemption would need to apply where there were statutory or prudential obligations requiring an organisation to hold a specified amount in reserves or other liquid assets.

Directors duties could also be tailored to take account of the mutuality principles and to encourage policies that would increase the value membership and facilitate member involvement in the organisation. This could be supplemented by a requirement for the board to report annually to members on the policies or activities pursued by the company which have added value to membership and encouraged member involvement.

Incorporation of Mutual Companies

The enactment of separate legislation provides an ideal opportunity to create new class of company called a "mutual company". If enacted, the registration of a mutual company should be subject to the company's constitution imposing duties upon directors to follow the principles of mutuality and to manage the entity as a mutual organisation. It is expected that the legislation would cover the incorporation and regulation of friendly societies, mutual insurance and benefit companies, and any association representing the interests of those bodies

Conferral of Notional Rights on Former Members

Given that demutualisation under the Corporations Law appears to give the current members an ability to unlock, or gain access to, the accumulated wealth of entity, it would seem that there is a case for the adoption of provisions that would give notional rights to former members for a limited time. A precedent which could be considered is the provisions of section 139 Co-operatives Act 1992, Section 139 gives former members notional shareholding entitlements for a period of 5 years from the date that their membership is cancelled under a co-operatives active membership rules. These entitlements crystallise on the takeover of a co-operative, on the conversion of a co-operative to a company, or on the liquidation of a co-operative. The entitlements will not arise where there is a takeover of a by another co-operative.

If similar legislation were adopted, former members of mutual companies would be given notional entitlements to surplus assets of the company. These entitlements would crystallise within a 5 year period:

Where any of the above events occur, former members would be deemed to be members of the company and to have a an entitlement:

A former member's entitlements could be based on the years of membership or on the number of policies the person had at the time the person ceased membership in the mutual. The legislation would recognise the commitment and support of past members in the building of wealth in a mutual organisation, as well as addressing the perception of the new members gaining an undeserved windfall.

Quantification of Financial Interests and Membership Rights

One of the problems facing independent experts when considering whether a demutualisation proposal is fair and reasonable, is the quantification of the financial interest of a member, and the value of membership rights, in the mutual organisation. Legislation could prescribe standards for assisting independent experts in quantifying the value of membership rights, including loss of democratic control in the organisation. The standard could also provide for the valuation of the current services provided to members in their capacity as members and the value of services which are to be provide to members as customers of the demutualised organisation. This information would be provided to members as part of the demutualisation documentation.

In addition, the standard could require the independent expert to review similar demutualisations and report on the effects which those demutualisations have had on the provision and cost of services to members. As part of this review, a valuation of shares received by each member should be undertaken to determine whether the shares reflect adequate compensation to the member, for any variation in the provision and cost of post-demutualisation services received by a member.

This article appears on the website of The Australian Centre for Co-Operative Research and Development (ACCORD)