Developers owe Fiduciary Duties to Strata Buildings

or, have we already forgotten about the Arrow Asset Management case …

We’re hearing a lot more about developers stitching up new strata buildings by locking them into long-term, expensive and unfair contracts without proper disclosure.  It’s wrong and shouldn’t happen. And, there’s a 15 year old Supreme Court decision that says so and helps strata buildings tear up those contracts.

[7:30 minutes estimated reading time, 1492 words]

Introduction

Developers set up all of the key features of strata buildings as they have to and need to so that the new strata owners can take over a finished, organised and operating building complex. 

Developers also have many incentives to set up new strata buildings properly since they want buyers to settle promptly and a smooth transition for control, management and costs.  Plus, there’s a range of strata laws that force developers to do that properly and to protect strata owners.

But, those incentives and controls don’t always work well. Especially, when there’s a commercial advantage to the developer to things differently.

More recently there’s been increasing complaints about developer practices about long-term maintenance contracts for essential building services and utilities being forced onto strata buildings.  Those complaints are coupled with a sense of helplessness by strata stakeholders who feel forced to accept and live with the consequences.

I’m not sure why.  Because there’s a NSW Supreme Court decision that makes developer’s duties in relation to long-term strata building contacts very clear and can help many of those affected strata buildings as I explain in this article.

What’s the problem with long-term contracts?

There’s nothing unusual with long-term contracts in strata buildings, and, in many instances they are necessary and appropriate to get operational certainty, quality services, and good pricing.  Things like lift maintenance, fire services, building management, and, even strata management are typically arranged on a multi-year basis.

So, it’s entirely appropriate for developers to arrange those kinds of services when they set up new strata buildings.

The problem occurs when the long-term contracts that are arranged by developers are associated with benefits to the developer rather than the strata building and/or at the extra cost of the strata building. 

Here are a few examples.

• An onsite building manager contract is set up for 10 years for an annual fee which is above competitive market rates and with annual fixed % increases.  In exchange for their appointment, the nominated building manager pays the developer a one-off fee which it retains.

• Instead of the developer installing a sewage or sewerage detention, management and pump-out system at its cost in the new strata building, a specialist supplier and maintenance business does so at its cost [thereby saving the developer money] in exchange for 20-plus year contract with the strata building to maintain, service and/or operate the system at an annual fee which is above competitive market rates and with annual fixed % increases.

• The developer authorises a telecommunications business to install internal telecommunications cabling and network infrastructure and equipment for data and other communications at the telco’s cost in the new strata building [thereby saving the developer money] and to set up the first telecommunications connections for each strata apartment owner or resident.  So that the telco becomes the only practically available supplier in the building, effectively embedding themselves into the strata building.

There are lots of other examples like these.

In each instance, the developer is saving money or making money, and thereby profiting, whilst the strata building is paying more than it could for the services that it has to accept.

In some instances, there are controls in strata laws about those kinds of arrangements that restrict what developers can do and/or limit the potential cost exposure to strata buildings and strata owners.  But they don’t cover all situations that might and are increasingly occurring.

Otherwise, strata buildings need to rely on other legal remedies to address the unfair and uncommercial consequences of these arrangements. 

Fortunately, remedies exist because strata developers owe fiduciary duties to strata buildings and strata owners as the Arrow Asset Management case confirms.

The Arrow Asset Management case

The NSW Supreme Court's decision in the case of Arrow Asset Management case in 2007 has major implications for medium and high-density development industry in Australia. 

It was a very big deal when it was decided.

The case revolved around an attempt by a strata community to nullify a long-term and uncommercial site management agreement they entered into with Arrow Asset Management when the strata community was under the control of the developer, Australand.

The key points from the decision are as follows.

1.  Australand was accused of profiting from its position by causing the strata community to enter into an agreement with Arrow and receiving $190,000 from Arrow for doing so.

2.  The central issue was whether Australand had a fiduciary duty to the strata community to avoid conflicts of interest and whether this duty was violated by not fully disclosing the $190,000 deal with Arrow.

3.  The Court found Australand to be in a fiduciary position, similar to a company promoter, towards the strata community.

4.  Australand was deemed to have a conflict of interest as it received a benefit from Arrow while also being responsible for ensuring the strata community secured site management arrangements on the best [or at least market] terms.

5.  The Court decided that the $190,000 should have been paid to the strata community and not Australand for entering the site agreement.

6.  If the strata community could have shown that the charges under the Agreement were uncommercial, which it alleged but did not prove adequately, Australand may also have been liable for the difference in charges.

6.  Despite disclosing the Agreement in the sale contracts of lots, Australand did not disclose the separate $190,000 deal, which was crucial.

7.  Australand had to pay $190,000 to the Association.

The implications of this decision are significant including, at least, the following. 

• Developers need to fully disclose any profits they are making when selling or setting up management rights [and other contracts or ongoing arrangements] with future strata communities.

• Developers must inform and get consent from strata buyers about all aspects of the sale or set up management rights [and other contracts or ongoing arrangements].

• Developers might face legal action from strata communities for previously undisclosed profits from the sale of management rights [and other contracts or ongoing arrangements].

• Developers might face legal action from strata communities for the consequences of uncommercial terms under contracts or ongoing arrangements they establish for future strata communities.

• The ruling may also impact other arrangements [not just management rights] between developers and future strata communities.

In essence, this decision demonstrates that Courts will seriously scrutinise developers' actions that unfairly prejudice the future strata corporations and strata owners.

If you want more detail about the Arrow Asset Management case you can read my 2009 presentation and paper on it for the TEN Annual Property Law Conference here.

How does this help strata buildings?

The principles confirmed in the Arrow Asset Management case help strata buildings with developer arranged unfair contracts in several ways.

Firstly, if a long-term contract was arranged by the developer for the strata building where the developer obtained a financial advantage without proper disclosure, the strata corporation can [by legal action] recover the financial advantage from the developer as damages.

Secondly, if a long-term contract was arranged by the developer for the strata building where the terms [including how much is paid] are uncommercial without proper disclosure, the strata corporation can [by legal action] have the contract cancelled, and/or recover the financial disadvantage it suffers under the contract from the developer as damages.

Thirdly, strata owners going to the first annual or other meetings where these kinds of contracts are being considered can rely on the principles in the Arrow Asset Management case to affect, change, or stop decisions and approvals.

Fourthly, strata buildings or committees with developer arranged long-term and unfair or uncommercial contracts can rely on the principles in the Arrow Asset Management case and threats of legal action to renegotiate or prematurely end those contracts with the suppliers.

But, like all legal rights, using them effectively requires knowledge and awareness of those rights and how they work, some homework to establish the background facts properly, a logical strategy, clear objectives, and decisive action to enforce them with skilled and experienced advisors.

Conclusions

It’s not right that unfair contracts are foisted on strata buildings by developers to the developer’s commercial advantage or benefit, especially where the strata building suffers or pays for them in the longer term.

And, it’s happening more and more these days because it’s tempting, it makes developers and businesses money, strata owners aren’t aware of the potential problems, and, strata buildings aren’t aware of their rights.  Plus, strata stakeholders seem to have forgotten about the Arrow Asset Management case and how it can help them.

Hopefully, I’ve reminded everyone of those things now.

November 07, 2023

Francesco ...