Strata Reforms [NSW] Update 3: Part Strata Schemes
Preserving the uniqueness of part strata, whilst creating release valves for problems …
As one of the more complex, esoteric, and [arguably] important parts of strata title, part strata schemes need careful reforms that preserve their special character but provide solutions to the actual and likely challenges that arise.
Introduction about part strata schemes
Part strata schemes are one of the more complex parts of strata title operations. And, at the same time, it is one of the areas where the most innovative strata developments have occurred.
In the simplest terms, they are buildings [typically mixed use] where at least part of the building is subdivided into a strata title scheme, and the operation of the whole building is governed by an umbrella agreement underpinned by some strata title laws.
This isn’t the newsletter to explain part strata schemes since it’s about strata law reforms. But I will publish a newsletter overviewing part strata title schemes soon.
But, there are a few unusual features of part strata schemes that underpin my comments about desirable reforms as follows.
There’s no separate legal entity for the governing body [the Building Management Committee] in a part strata scheme.
There’s no common property in part strata schemes. Rather, private property is deemed shared according to the umbrella agreement [the Strata Management Statement].
The umbrella agreements that govern part strata schemes [the Strata Management Statement] is created by developer and unique to each building.
The use of private property in a part strata scheme can be shared with other owners in overlapping ways set out in the Strata Management Statement.
Operating and longer-term costs are allocated between owners in variable and often artificial ways in the Strata Management Statement.
Voting rights are split between owners in variable and often artificial ways in the Strata Management Statement.
Part strata schemes have their own dispute resolution regimes and operate outside most strata regulatory systems.
You can find the relevant strata laws for part strata schemes in Part 6 and Schedule 4 of the Strata Schemes Development Act 2015.
The 2020 NSW Statutory Review Paper discusses the reform issues at questions 20 to 35 which I’ve reproduced at the end of the newsletter.
Where reform is needed & my suggestions
Generally, the strata law provisions for part strata schemes work well as they have facilitated the creation and running of most part strata schemes quite effectively for more than 30 years.
So, I don’t think they need wholesale revision.
Rather, there are some things that are missing that should be covered in the new strata laws, some minimum protections that should be built into part strata scheme governance and operations, and mechanisms introduction to better cater for the problems that have and will inevitably arise in part strata schemes.
As you’ll see from my analyses and suggestions below, I generally think what’s needed is an improved ability for part strata stakeholders to access solutions outside the Strata Management Statement because Tribunal and Court decisions on those disputes will help everyone understand how the laws work better and what is [and is not] acceptable in part strata schemes. Plus, some more and better disclosure and operational rules need to be made.
There are 9 main areas for change as follows.
1. Unfair, unworkable, or problematic Strata Management Statement terms
Strata Management Statements are contracts between the owners forming each part strata scheme and, like all contracts, there can be problems with the words used.
Those words can be imprecise, meaningless, ambiguous, or contradict other parts of the document. Or, even if they make sense, they may not cover the future situations that could arise. In such cases, the part strata owners end up unsure about what do to do or, worse, in difficult disputes about the issue.
Additionally, the Strata Management Statement terms might be unfair or biased in favour of one or more part strata owner/s either from inception or because something changes afterward [like ownership changes, building changes, or external factors like economic downturns or law changes]. Like interpretation issues, these also lead to disputes between part strata owners about the Strata Management Statement terms.
In such cases, the disputes about the uncertainty or unfairness of the Strata Management Statement terms need a circuit breaker to resolve them. At, present that’s a very difficult and unanimous agreement process for amendment of the Strata Management Statement or typically long, slow and ineffective alternative dispute resolution processes set out in Strata Management Statements. [I make more comments and suggestions about these dispute resolution processes below].
I also don’t believe that a developer’s ability to create the Strata Management Statement needs more limitations than currently exist since there are controls arising from the developer’s fiduciary duties [after the Arrow Case] and under other laws such as the Australian Consumer Law.
So, the freedom to create innovative part strata schemes and Strata Management Statements is and should be preserved.
So, I suggest that the strata laws include an express right of part strata scheme owners to seek Court or Tribunal orders about the meaning of provisions of Strata Management Statements in place of or in addition to the internal Strata Management Statement dispute resolution mechanisms.
2. Amendment of SMS by order [NCAT &/or Superior Courts]
At present, a Strata Management Statement can only be amended by all owners’ agreement and signature [including an owners corporation members approval by special resolution] followed by a logistically complex registration process. So, it rarely happens.
And, although section 103(1)(b) of Strata Schemes Development Act 2015 refers to amendments ‘ordered under this Act or another Act by a court’ that’s problematic since there’s no provision in the Strata Schemes Development Act 2015 or Strata Schemes Management Act 2015 for orders about amending Strata Management Statements and there’s no clear legal authority about amending Strata Management Statements under other laws like the Australian Consumer Law. There’s also no Court ordered changes to Strata Management Statements either.
Plus, most of the Strata Management Statement internal dispute resolution processes do not expressly compel owners to act to implement any change to a Strata Management Statement that an arbitrator, adjudicator, or expert might order under that process. So, even after succeeding in an internal dispute, a Strata Management Statement may not get amended.
That means that in practice, Strata Management Statements are never likely to be amended if one owner doesn’t or won’t agree.
So, I suggest that the strata laws include an express right of part strata scheme owners to seek Court or Tribunal orders about proposed changes to Strata Management Statements that were unreasonably refused by the other owners in place of or in addition to any internal Strata Management Statement dispute resolution mechanisms.
3. Power to contract [collectively] & novation
Because the part strata scheme is not a separate legal entity, it and the decision-making committee [the Building Management Committee] cannot separately contract in their own right.
Rather, any contracts by a part strata scheme [for instance a management agreement] must be multi-party made by all the owners on one side and by the service provider on the other. This is cumbersome since getting multiple approvals and signatures is messy/slow and is impractical for the multitude of contracts any complex building will need to have in place and renew/replace.
Generally, this is dealt with by relying on the apparent or express agency of building or part strata managers which is fine until things go wrong and either the service provider, the manager, or an owner [or all of them] dispute its validity. In those situations, the legal relations and, consequent, obligations between the contract parties might need extensive investigation about the creation of the contract/s.
A separate but related issue with contracts also arises when there is an ownership change in the part strata scheme because the old owner doesn’t and shouldn’t continue to be a party to any existing contracts and the new owner needs to become a party to all the existing contracts. In most business and commercial situations this is handled by the novation [transfer] of the existing contracts from the old to the new party. But, in part strata schemes this mechanism operates outside the part strata scheme and is imperfect from the perspective of the other owners and the service providers.
So, I suggest that the strata laws include an option to multi-party contracts and formal nocation [as exists now] such that where part strata scheme contracts are made by an authorised agent [such as the part strata manager];
a. they must be recorded in a BMC contracts register with the obvious key information [date, party, expiry, etc],
b. a copy of the contract is kept in the BMC records and made available to owners on request, and
c. if a new owner is provided with a copy of the BMC contracts register and the copy contract/s, then the disclosed agreement is automatically novated to the new owner unless they object before becoming an owner.
4. Shared facility definitions, evolution & maintenance disputes
Shared facilities can be virtually anything that is described as such in a Strata Management Statement [from physical things like parking spaces to conceptual things like risk management or insurance] and usually defined by words in the Strata Management Statement.
So, like all other terms, their meaning is open to interpretation.
But in the case of shared facilities, that interpretation affects more consequential matters such as:
what the part strata scheme can control,
whether part of an owners lot is a shared facility,
owners obligations to use [or not use] the shared facility,
what maintenance, repair, or replacement should occur, and
liability for payment.
Plus, shared facilities can physically or contractually change over time as works change, technologies develop and/or legal controls evolve leading to less accurate descriptions in the Strata Management Statement.
Disputes about many aspects of the shared facilities are therefore even more critical in those situations but remain governed by the Strata Management Statement internal dispute resolution processes.
So, I suggest that the strata laws include an express right of part strata scheme owners to seek Court or Tribunal orders about shared facilities [scope; repair maintenance & replacement; rights; obligations, etc] as an automatic alternative to the internal Strata Management Statement dispute resolution mechanisms.
5. Shared facility cost allocations & re-allocations
Shared facility costs in part strata schemes are usually allocated amongst members by fixed arbitrary percentages in the Strata Management Statement based on apparently objective criteria [such gross floor area, percentage of use, location, etc], and since 2016 that allocation needs to be ‘fair’. Plus, an owner can be excluded from the payment of one or more shared facility costs.
But, there’s plenty of examples of problems with shared facility cost allocations, including:
using allocation criteria that is inappropriate or partly inappropriate for the shared facility,
the allocation criteria not matching the allocation percentage after investigation of the actual measurements,
changes in circumstances over time that make the allocation percentages wrong,
apparently unfair exclusions from shared facility costs, and
allocation measurement criteria that are impossible to ascertain practically or at all.
But, again, like all other Strata Management Statement changes, the shared facility cost allocations need unanimity or practically unobtainable orders.
So, I suggest that the strata laws include an express right of part strata scheme owners to seek Court or Tribunal orders about shared facilities cost allocations as an automatic alternative to the internal Strata Management Statement dispute resolution mechanisms.
I also suggest that the review rights should cover pre-2016 Strata Management Statements despite the changes made at that time.
6. Voting rights, entrenched majorities/minorities, voting channels, deadlocks, etc
Voting rights in part strata schemes are also fixed between owners in the Strata Management Statement so stay that way forever.
And, they can establish permanent majority voting control or, more commonly, entrenched minority positions for one or more owners [often the strata scheme member].
There’s usually no veto power for owners at meetings and owners can also lose voting power due to non-payment of their shared facility cost contributions.
But, despite those things, I do not believe it is appropriate to change the disclosed voting rights in Strata Management Statements. It’s far better to ensure that decisions are reviewable on process and merit grounds when the voting structures in a part strata scheme improperly disenfranchise owners.
I also don’t agree with the recent fashion in Strata Management Statements that voting rights are aligned with contributions to shared facility costs so only the owners that pay for a shared facility get to make decisions about that shared facility. After all, all owners in a part strata scheme may have an interest in the operation of a shared facility and/or are affected by the operation of a shared facility; so they should have a say in decisions about it.
So, my more general position on strata decision making should apply. Namely, that:
Proposals for making decisions need to be appropriately notified to owners so that they know about them and have access to related material and information.
Owners need adequate time to consider the proposed decisions and obtain whatever advice they want.
Owners can participate in the decision as far as they are entitled, including the right to make comments in all cases.
Decisions can be independently reviewed for process validity and merits at any owners’ initiative.
So, I suggest that the strata laws do not permit the splitting of voting rights on different issues based on shared facility contributions.
I also suggest that all part strata decisions require at least 72 hours notice before being made unless there is express agreement to reduce that in specific instances by all part strata owners.
I also suggest that any part strata owner who consider a decision is wrong, have an express right to review the decision [see my suggestions about dispute resolution].
7. Accounting matters
To say that part strata scheme finances are awkward is an understatement.
Put simply, multiple part-owners split building expenses between them in variable ratios depending on the type, pool that money based on estimates, and then have to work out the actual split in annual cycles.
Some of the ingredients to this complexity include the following quirks of part strata schemes.
A. Pooled money
Whilst part strata scheme owners have independent obligations to pay their share of the operating and other costs, most Strata Management Statements create a system that requires them to pay their estimated shares of those costs in advance into a pool from which the costs are paid.
But, that money pooling is problematic.
That’s because whenever a shared facility cost exceeds the budget estimate, and consequently, the owner’s in advance payment for that cost, the part strata scheme is actually using another owner’s money that was paid into the pool for something else when that other owner has no obligation to contribute that amount. In other words, one owner’s money is being used to pay another owner’s liability; effectively subsidising that other owner.
That situation is exacerbated when a part strata owner doesn’t pay their share of the costs into the pool at all [they’re in arrears] as the subsidising is for the whole shared facility cost and not just part of it.
We’ve all experienced the situation where one part strata owner [often the strata scheme that has trust reserves] effectively cashflows the part strata scheme.
Ideally, part strata owners’ money is not pooled. But, rather, each owner’s money is paid proportionately up to the limit of their liability towards the relevant expenditure.
B. Budgeted vs actual costs
For practical reasons, part strata owners need to pay their share of the operating and other costs for a cycle in advance based on estimates which cannot be accurate.
So, at the end of the cycle, the part strata owners’ payments for estimated expenses need to be reconciled against the actual costs, and owners either need to pay any shortfall or get refunded and overpayment.
I have serious doubts, based on my experiences, of the accuracy and timeliness of these reconciliations. Plus, typically Strata Management Statements do not expressly require them, detail any processes for them, and/or place any time limits on them. And, should the difference be a credit/debit on the next cycle or an actual refund or additional payment to or by the part strata owner?
Additionally, I’ve never seen any mechanisms allowing for interest in favour of an overpaying part strata owner or imposed on an underpaying owner. After all, if I paid more money than I should have for a year, why shouldn’t I get the cost of that overpayment back as well?
C. Loss of voting rights
Most Strata Management Statements provide that a part strata owner loses their rights to vote [and sometimes to requisition meetings or decisions] if they have not paid their in advance estimated contributions to the shared facility costs.
This is problematic for 2 reasons.
1. In some cases I’ve been involved in, the non-payment is due to a reasonable dispute about the budget, the shared facility cost, the cost allocation, or the in advance estimated contributions. So, a dilemma is created for that part strata owner. They either pay money they dispute is liable to pay it and then try to dispute it and get it back, or, they don’t pay and lose their voting and other rights whilst they dispute the payment.
2. Since the obligation is to pay an in advance estimate and not the actual liability, the voting rights may be lost for non-payment of an amount that the part strata owner may not have actually been liable for. Whilst a more esoteric objection, it reveals what I consider to be a serious disenfranchisement problem in part strata schemes.
D. Long term funding
Even though part strata scheme financials for annual cycles have difficult problems, long-term capital works funding is even more difficult.
Despite this, we see more and more Strata Management Statements include mechanisms for long-term funding. But, in my view, most of those are not well structured or properly thought through.
That’s because just like all other shared facility costs, the longer-term funding of capital works for building replacements or upgrades are:
shared between owners according to their allocation share, and
is based on the actual costs of the building replacements or upgrades,
but just over a longer and indeterminate cycle.
This exacerbates the problem by pooling even more part strata owner money over a longer time, delaying the ultimate reconciliation of the money and exposing the pooled money, obligation to pay, and the reconciliation to the risk of owner changes before the money is spent.
For example, if part strata owner A pays money towards lift replacement for 5 years based on a longer-term budget estimate, but then sells their property before the lifts are replaced should they get their money back since in a reconciliation made at the time of sale there was no lift replacement cost they were liable to pay?
In reality, emulating strata capital works funds in part strata schemes is an unnecessary and faulty technique to give part strata owners and managers comfort about future expenditures.
So, I suggest that the strata laws include the following changes.
I suggest that part strata owner money is not pooled, but rather that it is separately held, applied, and accounted for.
I suggest that there is an express obligation to reconcile estimated costs against actual costs each financial cycle within 3 months.
I suggest that any debit or credit due to a part strata owner after reconciliation is actually paid to or by them.
I suggest that interest at the prevailing rate for the part strata scheme is paid to or by an owner on any debit or credit due after reconciliation.
I suggest the following financial changes in that part strata schemes not be permitted to require payment for long term costs that are held over multiple financial cycles.
I also suggest that if long-term funding is permitted that contributions for the long-term must specify the funding cycle of the contribution needs to be set so as to trigger reconciliation provisions and specify which owner [the paying owner or actual owner] benefits or is liable for any adjustment.
I also suggest that any long term funds held by a part strata scheme are kept separately from operating money and not used for operating expenses.
8. Legal Actions
Because there is no separate legal entity in a part strata scheme, legal actions by or against a part strata scheme must be taken by the part strata owners.
This is less of a problem by actions against the part strata scheme since a litigant will sue all the owners. But, where the part strata scheme wants to take legal action it may need all the part strata owners to be the litigants and there may be no way to compel them to do so.
It’s also not likely that the part strata manager will have the authority [or willingness] to act as an agent for that litigation.
A solution for that kind of impasse is required.
So, I suggest that the strata laws authorise any part strata owner or group of part strata owners to take and defend legal actions in relation to the part strata scheme and deem that action to be taken by all part strata owners with protective requirements covering: notification of the legal action to non-participating owners; the ability for owners to opt-in or out; indemnity for costs between owners; and; entitlement to litigation proceeds between owners.
9. Cross enforcement by members
The Strata Management Statement applies to all part strata owners and, in the case of strata corporation owners, to the strata lot owners, and sometimes to the sub-occupiers of non-strata parts of the building.
But, Strata Management Statement conduct rules [for things like parking, noise, etc] are usually not enforceable across members so that a part strata owner cannot make the sub-occupiers or another part of the building comply directly.
For example, a part strata owners corporation must enforce parking controls in its common property against strata owners and occupiers but cannot do so against the tenants of another part of the same building, even if it’s in exactly the same carpark.
This can lead to inconsistent behaviours in the building and erratic rule enforcement and outcomes for part strata owners.
So, I suggest that the strata laws authorise all part strata owners to be able to cross enforce conduct related Strata Management Statement provisions against each other plus the non-owner occupiers of any part of the building.
Francesco ...
Feb 01, 2021
STRATA LAW REFORM DISCUSSION PAPER QUESTIONS ABOUT PART STRATA SCHEMES
20. Are management statements effective in regulating mixed-use developments and setting out interested parties’ rights and obligations? If not, why not, and how could the legislation be improved?
21. Are there circumstances where a strata management statement should not be required (for example, where the commercial lot area is relatively small, compared to the residential strata scheme)? If so, how could the various interests in the building be effectively managed without a management statement?
22. Are the matters set out in Schedule 4 for inclusion in the strata management statement sufficient? If not, what other matters should be prescribed and why?
23. Should the legislation require the management statement to balance the rights of various lot owners? How could this be achieved?
24. What improvements could be made to the governance of building management committees and their meeting processes?
25. What measures could be implemented to reduce conflicts of interest and unfair contracting in mixed-use schemes?
26. Should existing contracts negotiated by the building management committee automatically apply to new lot owners as they join the committee? How can the legislation be improved to deal with this issue?
27. Should there be limits on how long managing agents are appointed for by the building management committee? Should this apply to other types of contract? What would be a reasonable restriction?
28. Should a duty of good faith be imposed on strata managers and building management committees?
29. Should the requirement for management statements to provide for the fair allocation of shared expenses and the obligation to review that allocation, apply retrospectively to schemes registered prior to the commencement of the reforms (November 2016)? If not, why not?
30. What other improvements, if any, could be made in relation to responsibility for shared facilities and why?
31. Should voting rights be aligned to the relative contribution of building management committee members to the cost of the shared facilities, instead of being determined by the management statement? Are there any other alternative methods of allocating voting rights that could be implemented?
32. What improvements can be made to the legislation that balance the interests of commercial and residential lot owners in a mixed-use development, while ensuring fair decision-making?
33. What changes would provide fairer outcomes where strata management statements are in place? Should owners corporations be provided with rights and protections like those in the Management Act – for example, by placing limits on service contract terms?
34. How can dispute resolution be better managed in mixed-use developments, balancing the needs of commercial and residential property owners?
35. What, if any, legislative protection is needed for residential owners in the rectification of complaints?