THE IMPLICATIONS OF THE ARROW ASSET MANAGEMENT CASE. Presented by: Francesco Andreone

Transcription

1 Strata and Community Title in Australia for the 21 st Century III Conference THE IMPLICATIONS OF THE ARROW ASSET MANAGEMENT CASE Presented by: Francesco Andreone The Implications of the Arrow Asset Management Case Page 1 of 15

2 THE IMPLICATIONS OF THE ARROW ASSET MANAGEMENT CASE By Francesco Andreone INTRODUCTION This paper supports a presentation by Francesco Andreone for Griffith University at its biannual conference Strata & Community Title in the 21 st Century III about The Implications of the Arrow Asset Management Case following the decision of the New South Wales Supreme Court decision in Community Association DP No v Arrow Asset Management Pty Ltd & Ors [2007] NSWSC 527 which was delivered by McDougall J. on 30 May THE DECISION The case involved an attempt by the plaintiff, Community Association DP No , (Association) to avoid a Site Management Agreement (Agreement) entered into by it on 2 December 1998 when the Association was under the control of the third defendant, Australand Consolidated Investments Pty Ltd (known at the time as Walker Consolidated Investments Pty Ltd) (Australand). Under the Agreement o the manager, Arrow Asset Management Pty Ltd ( Arrow ), was the first defendant; o Arrow was required to perform certain specified duties in exchange for an annual fee; o the annual fee escalated each year by the higher of CPI or 5%; o the term was 10 years with 2 options of up to 5 years each; and o Arrow had the sole right to enter into an agreement with the Association to conduct a letting service and tenancy management service, as well as to provide ancillary services. The Association was constituted on 27 November The Implications of the Arrow Asset Management Case Page 2 of 15

3 On 2 December 1998 when Australand owned all the lots in the community scheme, an inaugural general meeting of the Association was held at which Australand and its solicitors were the only persons present. At that meeting the Association resolved, inter alia, to enter into the Agreement with Arrow. The Agreement was made on the same day. On or about 30 June 2000 the Agreement was, by Deed of Assignment, assigned to the second defendant, Bondlake Pty Ltd (Bondlake). The Association was a consenting party to that deed. The Association alleged many issues for determination by the Court (there were 32 separate questions in total). The first issue which was decided in the Association s favour was whether the Agreement came to an end at the end of the first annual general meeting as a consequence of the operation of section 24 of the Community Land Management Act 1989 (NSW) because it was an agreement made in the initial period that was not adequately disclosed in the community management statement and was not ratified at the first annual general meeting. This issue became non contentious because of the earlier decision of the NSW Court of Appeal in Hudson Property Group Pty Ltd v. Community Association DP [2005] NSWCA 374. The second issue was whether the entry into the agreement during the initial period for the Association was in breach of the restrictions under section 23(1)(a) of the Community Land Management Act 1989 (NSW) because a debt was incurred for the Association when it did not have sufficient money in its administrative or sinking funds to meet the debt. Whilst the breach was found based on analogous reasoning for a strata title scheme in the earlier decision of the NSW Court of Appeal in Bondlake Pty Ltd v. The Owners Strata Plan No [2005] NSWCA 35 no damage was found to have been suffered because Australand paid the amounts due under the Agreement during the initial period. The third issue was whether or not the assignment of the Agreement to Bondlake created an estoppel that overrode the effect of section 24 of the Community Land Management Act 1989 (NSW) to end the Agreement at the end of the first annual general meeting; thereby preserving the operation of the Agreement. Whilst an important matter for associations this is not the key issue for this paper. In simple terms the court found that estoppel by convention existed as a result of the terms of the Assignment (which included estoppel by deed) and that since the effect The Implications of the Arrow Asset Management Case Page 3 of 15

4 of section 24 of the Community Land Management Act 1989 (NSW) did not make an agreement illegal, void or offensive to public policy then no complication about estoppel in the face of a statue arose. So, the Agreement continued as assigned in favour of Bondlake despite section 24 of the Community Land Management Act 1989 (NSW) because the Association was estopped from denying its efficacy and continuing operation. But, the most significant issue and the main focus of this paper was whether Australand, when it caused the Association to enter into the Agreement with Arrow, owed the Association a fiduciary duty to not place itself in a position of conflict or to profit from contracts entered into between the Association and Arrow, without proper disclosure. This was put more succinctly by McDougall J. (at paragraph 208 of his reasons) as follows: In essence, the Association s case was that Australand, as developer of the community scheme, stood in a position vis- à - vis the Association analogist to that of a promoter vis-à-vis the company promoted. It relied on the judgment of Else-Mitchell J. in Re Steel & Ors and the Conveyancing (Strata Titles) Act 1961 (1968) 88 WN(PT1) (NSW) 467, and on an article by David Bugden, Management Rights Are Developers Promoters? (1996) QLSJ 281. After analysing the various cases on fiduciary duties, the Court held 1. It is appropriate to regard the developer of a community title scheme as being, vis-à-vis, the community association, in a position analogous to that of a promoter of a company. 2. The relationship between the developer and the community association is a fiduciary relationship. 3. Australand owed the Association a duty not to place itself in a position of conflict or to profit from contracts entered into between the Association and Arrow, without proper disclosure. 4. There was a clear conflict between Australand s interest and its duty. On this point His Honour said (at paragraph 231) There was a clear conflict between Australand s interest and its duty. Australand s interest was to extract the maximum price from Arrow. That conflicted, or might conflict, The Implications of the Arrow Asset Management Case Page 4 of 15

5 with its duty to the Association: to get the benefit of management services at the most reasonable terms commercially available. Further, to the extent that the management agreement provided for an excessive remuneration (see para [105(4)] above), Australand acted to the detriment of the Association in causing it to enter into the management agreement on the terms contained in that agreement. 5. If a premium was to be paid for the making of the Agreement, it should have been paid to the Association and not to Australand. 6. Australand made a profit for itself, in the form of the premium of $190,000, through its exploitation of its control of the Association. 7. Prima facie, the breach of duty was not cured by adequate disclosure because, although the Agreement was disclosed, the separate agreement between Australand and Arrow under which the $190,000 was paid, was not disclosed. 8. Australand is liable to account to the Association for the profit of $190,000 it made by causing the Association to enter into the Agreement. The Court also decided a number of other important issues. One was to deny the Association equitable compensation, being the difference between the amount payable under the Agreement and an amount payable under an agreement entered into at arms length as at the date of the Agreement. This was based on two things (a) (b) failure of the Association to prove its losses (because of evidentiary shortcomings); and the fact that the Agreement terminated at the end of the First Annual General Meeting pursuant to a trigger in the Strata Schemes Management Act 1996 (NSW); (this being one of the other points decided by the Court). OTHER EXISTING CONTROLS ON DEVELOPERS The decision highlights the application of common law principles to developers in the creation of strata and community title schemes. The Implications of the Arrow Asset Management Case Page 5 of 15

6 But there are already statutory controls and restrictions on developers in many states that impose obligations on what developers can do. Some relevant examples include the following things. In NSW there are restrictions on the following things. o Incurring debts that exceed the moneys then available from the administrative or sinking funds ie, can t be used to improve common property (which might increase the value of lots remaining to be sold) at the cost of the owners corporation (which will now be referred to as the body corporate) (s.113(1)(b) Strata Schemes Management Act For example, it would not be permissible for a developer to spend money improving the common property (which might increase the value of the lots remaining to be sold) at the expense of the body corporate. o Appointing a strata managing agent or caretaker for a period extending beyond the first annual general meeting (s.113(1)(c) Strata Schemes Management Act 1996). o Reduced voting power at general meetings upon a poll (cl.18(3), Sch 2 Strata Schemes Management Act If owners corporation has suffered a loss, then it will be entitled to sue for damages for breach of the relevant statutory duty. In Queensland there are restrictions on the following things. o The engagement of a person as the body corporate manager or as a service contractor. o The authorisation of a person to conduct a letting agent business. o Original owners must exercise reasonable skill, care and diligence and act in the best interests of the body corporate in ensuring that: o the terms of the engagement achieve a fair and reasonable balance between the contracted party and the body corporate (post original owner control period); o the terms and powers able to be exercised etc are appropriate for the scheme; and o the powers able to be exercised etc do not adversely affect the body corporate s ability to carry out its functions (s.112 Body Corporate and Community Management Act 1997). The Implications of the Arrow Asset Management Case Page 6 of 15

7 o Sections of the Body Corporate and Community Management Act 1997prohibit the body corporate from requiring a payment or any other benefit for entry into a service contract or letting agreement. If an owners corporation has suffered a loss then it has a claim for damages. In Victoria there are restrictions on the following things. o The initial owner must act honestly and in good faith and with due care and diligence in the interests of the owners corporation in exercising any rights under the Owners Corporations Act 2006 (s.68(1)). o The initial owner must take all reasonable steps to enforce any domestic building contract (within the meaning of the Domestic Building Contracts Act 1995) entered into by the initial owner (s.68(2) Owners Corporations Act 2006). o These obligations last for 5 years from registration of the subdivision plan. If an owners corporation has suffered a loss then it has a claim for damages. THE IMPLICATIONS OF THE DECISION The decision about the fiduciary position of a developer has a range of implications for all developers as follows. 1. Developers are common law promoters for all purposes. 2. Developers have a new status as fiduciaries in relation to schemes and their members. 3. Equitable property of the Association. 4. No profit is allowed to be made from those positions without disclosure. 5. More extensive disclosures are required. 6. There are Australia wide effects. 7. There are retrospective effects. The Implications of the Arrow Asset Management Case Page 7 of 15

8 8. Uncertain impacts of other laws and regulations. 9. Impacts on other initial arrangements. 1. DEVELOPERS ARE COMMON LAW PROMOTERS A person who is involved, as a principal, in the birth, formation and floating of the company is a promoter of that company and remains a promoter until the board of directors of the company is in place and takes control of the company. During the period that a person is a promoter of a company, that person is in a fiduciary relationship with the company and under an obligation to act in good faith towards the company. A promoter must make real and meaningful disclosure to company in respect of related party transactions. This requires disclosure to an independent board of the company, or if such a board is not in place, to the shareholders or prospective shareholders of the company. The onus lies on the promoter to show that full disclosure has been made. Where the company is party to a contract the promoter may not retain any profit out of the transaction unless full disclosure is made. The disclosure must be made before the transaction is completed and must include the fact that there is an interest in the transaction, the nature of the interest and all other material facts. Available remedies include affirmation of the contract and an account for secret profits, including interest, and rescission of the contract. 2. DEVELOPERS HAVE A NEW STATUS AS FIDUCIARIES Developers must now accept that vis-à-vis the associations that they create in medium and high density developments they are promoters and owe fiduciary duties. Whilst the original authority for that proposition is not new (Re Steel and Others and The Conveyancing Act (Strata Titles) Act 1961 (1968) 88 WN (Pt 1) (NSW) 467) the expression of that status and duty in a context where damages were ordered is a pivotal change in the law in Australia. So, that from now on all developers must consider their actions, insofar as they are a The Implications of the Arrow Asset Management Case Page 8 of 15

9 consequence of their ability to influence and control the association s decisions and result in adverse effects on the association and/or advantages to the developer. In all such cases, there are duties to do the following. o A duty to act with absolute candour and honesty to the Association. o A duty not to place itself in a position of conflict or to profit from contracts entered into between the Association and Arrow, without proper disclosure. o A duty to act in the best interest of the Association in the exercise of a power or discretion affecting the Association s interests. o A duty not to act to the detriment of the Association. o A duty of disclosure to enable the Association to make an informed and impartial decision about whether to enter into the site management agreement. 3. EQUITABLE PROPERTY OF THE ASSOCIATION Since the non unit components of management rights (i.e. the management and letting agreements) belong to associations and not to developers, developers must consider them as alienated rights and non accessible benefits which developers cannot sell and profit personally from the sale. Developers must make full disclosure and obtain informed consent from persons purchasing units and proposing to become members of the association. Where a developer breaches fiduciary duties the association: O will be entitled to receive the profit (the consideration for the sale); and O may be entitled to equitable compensation or an account for profits if the relevant agreement is continuing and the fee under that agreement is excessive for the services provided or is likely in the future to become excessive. 4. NO PROFIT IS PERMITTED FROM THOSE POSITIONS Once a fiduciary relationship exists the obligations on the fiduciary arise from the facts and circumstances of the relationship. The Implications of the Arrow Asset Management Case Page 9 of 15

10 But it is clear that the obligations of the fiduciary are proscriptive: not to obtain any unauthorised benefit from the relationship and not be in a position of conflict and not positive (or prescriptive): positive legal duties on the fiduciary to act in the interests of the person to whom the duty is owed. It appears that the duty is also absolute in that the fiduciary must not place themselves in a position where their duty to the principal and the fiduciary s interest conflict such that when controlling an association the developer must not benefit from that control. In those circumstances the benefit is the benefit of the association and not the developer and the developer must account to the association for the benefit. In this case it was clear that because the payment of $190,000 was made to Australand and not the Association it was in Australand s interest (but not the Association s) to ensure the terms of the Agreement were generous enough to justify the consideration. And, this was an immediate and inherent conflict of interest. 5. MORE DISCLOSURE IS REQUIRED A breach of duty by a fiduciary can be cured by disclosure if it is adequate. But, what is proper disclosure can only be determined by reference to the particular circumstances of the duty and potential breach. On the question of disclosure, the evidence in the Arrow Asset Management case was that o Clause 42 of the Association s community management statement noted that the Association had power to enter into agreements such as the Agreement; and o Clause 43 of the community management statement went into considerable detail about the Association s intention to enter the Agreement and the actual terms of the Agreement. And, where a relevant statutory scheme exists, the nature and sufficiency of disclosure under that scheme will be relevant. The Court was mindful of the statutory disclosure requirements that applied to the Agreement. McDougall J. said at paragraph 218 Clearly, any application in this case of the principles relating to fiduciaries must take account of the way in which the legislature has sought to impose duties of disclosure in certain cases, The Implications of the Arrow Asset Management Case Page 10 of 15

11 and to provide for the consequences of non-disclosure. But it does not follow from the legislative scheme that all principles relating to the obligations of fiduciaries have been excluded. In particular, I think, nothing in that scheme excludes the basic principle that a fiduciary should not benefit from its position. It is clear, at least, that disclosure to the Association committee when it comprised Australand representatives is not adequate since they are not the same as a completely independent board. Instead disclosure must be made to a truly independent board or all the potential members as a whole. Australand also relied upon the doctrine of unanimous consent. It submitted that there had been full disclosure to the Association s sole member, Australand, at the time of the impugned conduct. That proposition was rejected by the Court given the intent of the law on these matters to protect future members. So that, in a normal transaction for the sale of management rights by a developer, the required disclosure and informed consent must be made to and obtained from the purchasers of all of the units or land in the association being promoted. Additionally, the disclosure must be of the arrangements for and/or the profit that Australand made from procuring the Agreement rather than just disclosure of the Agreement. The disclosure must also cover all relevant information, at a minimum. The community management statement was disclosed in the Contracts for Sale of the lots in the community scheme. However, Australand did not disclose in those contracts for sale, or otherwise to purchasers, an agreement Australand had with Arrow providing for payment of $190,000 in exchange for Australand procuring the Association to enter into the Agreement with Arrow. 6. RETROSPECTIVE EFFECT Another serious indirect implication is the real possibility of existing associations suing developers of their schemes to recover amounts received by the developers on the sale of the non unit components of management rights. The Implications of the Arrow Asset Management Case Page 11 of 15

12 Of course, such action would need to be taken within the relevant limitation period but that period may be longer than 6 years. 7. AUSTRALIA WIDE EFFECT The direct implications of this decision potentially extend to all Australian jurisdictions and are not confined just to New South Wales although so far the decision has been referred to in one Western Australian case only. This is because of the general principles on which the decision is based rather than the impact of the state specific legislation. 8. UNCERTAIN IMPACT OF OTHER LAWS & REGULATIONS Since the impact of other relevant legislative schemes affects fiduciary duties and the required disclosure, it is likely that where other laws cover the subject matter of the potential breach of fiduciary duties by a developer, the decision will not affect the developer or not affect the developer in the same ways. Many people argue that where the creation of management agreements for schemes is regulated (such as in Queensland) that the legislative scheme overrides the common law principles. I do not agree. In New South Wales section 24 of the Community Land Management Act 1989 provides that an agreement made during the initial period will terminate at the first annual general meeting unless the effect of the agreement was disclosed in the community management statement (which regulates the on-going management of the scheme) before the transfer of any lots in the scheme it is ratified at the meeting. But this legislative scheme (which applied in the Arrow Asset Management case) did not displace fiduciary obligations. And, it is worth noting that McDougall J said that it is disclosure of not only the management agreement that is required, but the precursor to it - the agreement for the sale of the management rights as between the developer and the service provider. In Queensland the sale of management rights in accordance with the legislation is clearly permissible, but this does not mean that developers in Queensland are not in fiduciary relationships with the bodies corporate they create. The scope of their fiduciary duty will, as The Implications of the Arrow Asset Management Case Page 12 of 15

13 always, need to be defined in the context of the particular relationship and need to take into account the legislative regime, but it does not mean that the fiduciary duty and its inherent obligations do not apply at all. In fact, the stringent equitable duties imposed on fiduciaries would apply in all respects other than those exempted by the legislation. 9. IMPACTS ON OTHER ARRANGEMENTS The implications of the decision may not be confined to management rights agreements. Any other agreements that a developer procures for the association will be subject to the same principles. Some obvious examples include the following. o Long term lift maintenance contracts. o Strata manager appointment and contracts. o Facility management contracts. o Energy (or other utility) supply contracts. Some less obvious examples are. o Utility service arrangements where the utility supplier offered to pay the cost of installing the system in consideration of the scheme being bound to a long term contract. o Developers obtaining proxies (where legislation does not already prevent it) from lot owners and voting in favour of decisions which are to the benefit of the developer at the detriment of the scheme (for example, a decision not to pursue a building defects claim or other litigation against itself). o A strata manager providing a developer with advice and assistance on structuring and establishment issues and/or the set up of scheme records for nominal or no fees on the basis that the developer will procure the appointment of the strata manager to the scheme. STRATEGIES FOR DEVELOPERS TO PROTECT THEMSELVES The Implications of the Arrow Asset Management Case Page 13 of 15

14 Developers play an important role in the housing and construction industry, an industry which can be crucial to the stimulation of economic activity. They expect, and are entitled, to earn a profit out of their business activities. But, it is important for a developer to: o recognise that, following Arrow, they stand in a fiduciary relationship with each body corporate that they create, o understand the nature of fiduciary obligations, in particular the conflict and profit rules: fiduciaries must not place themselves in a position of conflict between their duty and their interest and fiduciaries must not profit from their position of trust, and o determine the scope of their fiduciary obligations. In Noranda Australia Ltd v Lachlan Resources NL 1 Bryson J stated that: A person under a fiduciary obligation to another should be under that obligation in relation to a defined area of conduct, and exempt from the obligation in all other respects. Except in the defined area, a person under a fiduciary duty retains his own economic liberty. Developers will need to be very clear about exactly when they are acting or controlling the body corporate, and in those instances they must put the interests of that body corporate first, take care to ensure that they do not place themselves in a position which conflicts with their fiduciary duties and must ensure that they do not profit from their position. Any benefit received, in value or kind, must be for the relevant body corporate and not the developer in its own right. CONCLUSIONS Developers and their advisors cannot ignore the principles in this case when establishing associations and must be careful to either avoid conflicts and/or to make full disclosure of the benefits they receive and obtain informed consent to retention. 1 (1988) 14 NSWLR 1 at 15 The Implications of the Arrow Asset Management Case Page 14 of 15

15 Exactly where the lines will be drawn is impossible to predict but it is clear many previous practices cannot continue in the same ways (if at all). Francesco Andreone 12 August Copyright in this paper is retained by the author. The author would like to acknowledge the assistance of Gary Bugden s OAM paper Implications of the Arrow Asset Management decision presented at the second annual conference of the Australian College of Community Association Lawyers on 21 August 2007 The Implications of the Arrow Asset Management Case Page 15 of 15