21 August 2010

Clarification of Matters Contained in the Notice of Meeting & Explanatory Memorandum

Proposed Litigation and Treatment of Proceeds/Costs from Proposed Litigation
The Notice of Meeting and Explanatory Memorandum set out that, in the event that Resolution 1 is passed by unitholders to approve the proposed New Strategy, there will be a separate entitlement created for the benefit of all unitholders in respect of the proceeds from successful litigation. This entitlement cannot be redeemed by the Fund but remains an "asset" of each unitholder until such time as the litigation is completed and the proceeds (if any) are distributed.

The carriage of these proceedings will be directly handled by Trilogy and Balmain Trilogy in their respective capacity as responsible entity and investment manager of the Fund. The management of this process is a significant undertaking which may well extend over several years. Maurice Blackburn Solicitors has been retained by Trilogy to act as the Funds legal representatives.

At this stage Maurice Blackburn Pty Limited are seeking leave from ASIC to conduct examinations (in much the same way as would be conducted by a liquidator) of the examinable affairs of City Pacific Limited in its capacity as the previous responsible entity of the Fund. Leave was sought from ASIC on 27 May 2010 and Maurice Blackburn have been addressing ASIC's queries since that date. We have not received any advice from ASIC as to when our application will be determined.

The reason for the decision to use a litigation funder (IMF) to fund 100% of the cost of the proposed litigation (and to be liable for any adverse costs orders from failed litigation) was two-fold. Firstly to protect the Fund from significant losses in the event that the litigation is not successful (which, as advised by our independent advisors, we estimate could be in the order of $20-30m) and secondly to improve the liquidity of the Fund (from not having to set $20-30m aside as a contingency for the litigation not being successful) which would enable redemptions to unitholders to be increased significantly (i.e. by $20-30m).

The "price" that the Fund is paying for IMF to fund 100% of ALL of the Fund's expenses in bringing the proceedings and being liable for 100% of any adverse costs orders made against the Fund is 26% of the proceeds from any litigation (i.e. $0 if net proceeds are nil and $2.6m if proceeds are $10m). IMF receives no fee or other recompense unless the proceedings are successful.

On page 20 of the Explanatory Memorandum, it states that "In the event that the collective proceeds from legal actions are insufficient to meet the costs incurred in conducting those legal actions, then these costs will be recoverable from the remaining Assets of the Fund (and which, if this were to occur, would have an adverse impact on the value of the Ordinary Units)". This will only be applicable if the arrangement with IMF were to come to an end and BT continued with any action that had already commenced or if BT commences any litigation outside the scope of the IMF agreement.

In consideration for Balmain Trilogy undertaking the significant process of managing these proceedings over the coming years Balmain Trilogy's "fee" is incorporated in to the Performance Fee (i.e. 20% of the net proceeds after deduction of IMF's fee). In a similar manner to IMF, if the proceedings are NOT successful Balmain Trilogy will receive NO fee.

We believe that this is appropriate remuneration given that the fee is conditional on success, is in no way guaranteed, and will involve considerable exertion and expertise from Balmain Trilogy over the coming years.

The Redemption Process and Liquidity of the Fund
It is Trilogy's expectation that at all times the Fund will remain liquid for the purposes of the Corporations Act. As such Trilogy does not anticipate a situation where the redemption facility would not be carried out in accordance with its terms.

However, even if the Fund were illiquid (which is not anticipated will occur) then during that period, Trilogy (in accordance with the constitution and Notice of Meeting) could suspend the redemption arrangement. Alternatively Trilogy could return capital on a pro rata basis (without redemptions) under the existing provisions of the constitution.

Nevertheless, to address any residual concerns, we propose to put in the constitution a further provision to the effect that the responsible entity will be appointed as each unitholder's agent and attorney to complete any documents as is necessary to give effect to the relevant redemption facility. This would allow the redemption facility to be effected when the Fund is illiquid. Such a provision is quite common (e.g. in redemption based schemes of arrangement).

How Does the Indexation Work?
The Performance Fee is calculated on the extent to which the net value of the assets can be improved above $415m plus indexation in accordance with the RBA cash rate. This was done to clearly indicate to all unitholders that if Trilogy simply 'did nothing for a few years and hoped for a general growth in property values from inflation' that Trilogy would not benefit from any Performance Fee related to asset growth by inflation as opposed to Trilogy's exertion and expertise.

There is no index for properties of the types that the Fund has as its assets (large land-banks, distressed sites and half-completed developments, etc). Indices exist for shopping centres, residential property, and other classes of real estate but these classes bear no relation to the assets of the Fund. Other mortgage funds are currently yielding in the order of 5%* although these funds generally benefit from significantly better assets which are producing income. To use an index of other mortgage funds' returns would be too volatile. We believe that the RBA cash rate is a fair approximation for returns from performing mortgage funds and, given that the Fund has effectively no performing loans, is a fair, if not generous, assumption of expected returns.

Consequently we believe that the RBA cash rate is a fair "proxy" for a return on a non-performing mortgage fund.