A [Not So] Long Time Ago in a [Strata] Galaxy Far Far Away
or, an old strata story that's deja vu …
A Quick Take
In another strata galaxy not so far far away, a strata insurance crisis engulfed NSW strata title that had very significant impacts at the time on how strata managers operated their businesses in relation to strata title insurance, commissions and disclosure. So, it’s timely to revisit the early nineties in Australian strata titles and what happened, what the Courts decided and what resulted from it all. It’s a very interesting, little known and important story that might give you déjà vu or contain a few lessons for all kinds of strata stakeholders.
[a 10:00 minute read with 1994 words]
The Full Article
INTRODUCTION
As we’re trying to deal with the dramas, impacts and challenges the 2024 Strata Insurance Commission Crisis has brought to the strata sector, I’d like to tell you a story from a long time ago in a galaxy far far away.
Imagine it’s 1992.
Strata titles are a booming new form of home ownership and investment, strata management is a relatively new part of the real estate services sector, there’s some strata laws and manager regulations but they are light, only a handful of people have much expertise and strata owners know very little about what’s going on.
One strata management business is dominant in New South Wales with over 2,000 strata building clients, 7 offices, over 75 strata managers, hundreds of other staff and bespoke management software [on funny looking computers] that was growing rapidly due to innovative services offerings and a shareholder manager structure that was profitable and incentivised everyone.
It was called Alliance Strata Management.
And, then suddenly, everything changed.
THE STORY, SO FAR & BEYOND
On 12 August 1992 Sydneysiders woke up to the banner headline on the front page of the Sydney Morning Herald.
EXPOSED: Strata Industry Kickbacks
That day’s newspaper included a multi page story by Ben Hills outlining allegations that Alliance Strata Management and its principal, John Scott, were deceiving strata buildings it managed by taking insurance commissions that were not disclosed, owning a related insurance broking business [progressive Property Insurance Agents] that was not disclosed, owning a related repair and maintenance business [Masterworks Repairs & Maintenance] that was not disclosed, and charging strata buildings for extra works and expenses that were not being performed and/or delivered.
The Daily Post, Old Strata News, Ain’t So Old Anymore, highlights that news story.
And, on the same day the NSW property services regulator, the Real Estate Services Council, started legal action against Alliance Strata Management and John Scott in the Licensing Court alleging that because of its shareholder manager structure, the non disclosure of insurance commissions, the non disclosure of related business entities and other matters they were not fit and proper [as the test was in those days] to hold strata manager licences and that the licences should be cancelled.
On top of that, John Scott was a board member of the Institute of Strata Title Management of NSW [the predecessor of Strata Community Association NSW].
And, the largest strata insurance underwriter at the time, who Alliance Strata Management dealt with, was CHU.
It was shocking news, it involved unprecedented legal action by the property regulator against a strata manager and it caused shock waves that travelled long and far in the strata sector.
Here are just a few examples of the events and impacts on strata stakeholders at the time.
First, the Real Estate Services Council created a hot line for strata owners and advertised its existence that provided information to strata owners about how to change strata managers from Alliance Strata Management to another business operator. Many strata buildings did so and over 2 years more than 800 strata buildings were no longer managed by Alliance Strata Management significantly reducing its revenues, profit and value.
Second, whilst the legal disputes between Alliance Strata Management and the Real Estate Services Council rolled on over 1992, 1993 and 1994, licence renewals for strata managers working at Alliance Strata Management were being refused unless they left its employ. That forced the strata managers to either appeal the refusal [at great legal and cost risk] or leave. So, many strata managers left and started their own businesses, many of which are the large successful strata management business that are operating today.
Third, John Scott stepped down from the board of the Institute of Strata Title Management of NSW pending the outcome of the legal dispute with the Real Estate Services Council and the Institute of Strata Titles Management took a silent approach to the issues, the litigation and Alliance Strata Management, waiting for the outcome of property services regulator actions.
THE COURT CASES
From August 1992 to June 1994 the litigation between Real Estate Services Council and Alliance Strata Management rolled on over a range of issues and in a number of different Courts as follows.
The primary legal disputes centered on two main issues.
Alliance Strata Management’s business structure
Alliance Strata Management held a corporate strata manager licence and contracted with strata buildings.
It also created a capital structure with blocks of non-voting and non-capital shares that gave the shareholders rights to:
participate in managing portfolios of strata buildings under Alliance’s licence, from its offices, and using its business systems, and
receive part of the management fees paid by those strata buildings to Alliance Strata Management.
In some instances, the shareholders did not hold a strata manager licence.
So, the Real Estate Services Council said that these arrangements breached section 42AA of the Property Stock and Business Agents Act 1941 [which applied at the time] and that prohibited strata managers from delegating strata building functions to and sharing management fees with unlicensed people.
Alliance Strata Management's right to keep insurance commissions
Alliance Strata Management had arrangements with insurers, underwriters and brokers form which it earned commissions on the premiums paid by strata buildings it managed that placed insurance with those insurers, underwriters and brokers.
Alliance Strata Management kept those insurance commissions.
Alliance Strata Management only partially disclosed the arrangements and the insurance commissions to the strata buildings under different contracts they signed or otherwise in invoices, meeting notices and financial reports.
So, the Real Estate Services Council said that Alliance Strata Management was not entitled to keep the insurance commissions because doing so breached its fiduciary duties to the strata buildings, because the disclosures that had been made [if any] were inadequate, and, because receiving the insurance commissions without contract provisions covering them also breached section 42AA of the Property Stock and Business Agents Act 1941.
The Licensing Court hearing
The hearing in the Licensing Court before Magistrate Harvey involved 25 hearing days between March 1993 to and February 1994.
On 10 February 1994, Magistrate Harvey issued preliminary findings and invited both the Real Estate Services Council and Alliance Strata Management to make further submissions before he made decisions about the licences.
The preliminary findings were damning: concluding that Alliance Strata Management’s business structure was illegal, that Alliance Strata Management had not and could not properly disclose the insurance commissions in ways that entitled it to keep them, and that it was very likely that both Alliance Strata Management and John Scott were not fit and proper persons.
The Supreme Court hearings
The litigation quickly moved to the NSW Supreme Court.
Firstly, Alliance Strata Management applied to the NSW Supreme Court for declarations that Magistrate Harvey’s preliminary findings about the application of the laws were wrong and to make declarations about the correct interpretation and application of laws about its business structure and keeping insurance commissions.
That case was heard by Justice Allen who decided that Magistrate Harvey had wrongly interpreted the law relating to fiduciaries, agreements and disclosure and issued a declaration that permitted Alliance Strata Management to keep insurance commissions on some conditions.
Justice Allen didn’t have to decide about the business structure issue, because of the second case.
Secondly, Alliance Strata Management applied to the NSW Supreme Court to accept a formal undertaking by it and John Scott to dismantle the existing business structure and replace it with new arrangements for strata manager portfolios that complied with section 42AA of the Property Stock and Business Agents Act 1941.
Although the Real Estate Services Council refused to accept that undertaking, the NSW Supreme Court agreed that it was validly made, accepted it and made it binding on both parties.
Third, the Real Estate Services Council appealed Justice Allen’s decision to the NSW Court Appeal which heard the appeal in March 1994 and delivered judgment in June 1994.
In that decision, the NSW Court of Appeal, outlined how the law applies to strata managers and insurance commissions, overturned Justice Allen’s decision and returned the case to the Licensing Court to make its final decisions about licences taking into account the NSW Court of Appeal’s findings about fiduciary duties, management contracts and insurance commissions.
Allliance Strata Management is sold, a licence is surrendered & a licence is saved
During April and May 1994, Alliance Strata Management was sold to new and independent owners, who took over the business, the litigation and the undertakings to restructure the business arrangements.
John Scott surrendered his strata manager licence.
The Licensing Court did not cancel Alliance Strata Management’s strata manager licence based on the NSW Court of Appeal’s decision, the undertaking by Alliance Strata Management to restructure the business, and the new ownership of the business.
Eventually, Alliance Strata Management became Body Corporate Services and further down the track, along with a few other strata management businesses, became the core of the PICA Group.
STRATA MANAGER & INSURANCE COMMISSIONS LAW
This long, old and dramatic story resulted in a very clear statement by one of the more senior Australian Courts about strata managers and insurance commissions that has been the applicable law ever since 1994.
You can find a more detailed review of the NSW Court of Appeal decision and it implications at the GoStrata Casewatch, An Older Strata Manager Insurance Commission Story.
But, here’s a short summary of what it said in 1994.
A strata managing agent is a fiduciary in its role as an agent for strata buildings.
The law affecting fiduciaries and their duties is very clear and well known.
A strata manager fiduciary cannot keep an insurance commission unless an exception applies to the commission.
One exemption is full disclosure by the strata manager about the insurance commission and informed consent from the strata building to keep it, which both have very high requirements.
Another exception involves an agreement between the strata manager and strata building about keeping the insurance commission made before a fiduciary relationship exists, which also has pre qualifications and strict requirements.
Even though a strata manager fiduciary’s management contract can say that it can retain specified insurance commissions, the contract must not be affected [when made] by fraud, undue influence or misrepresentation otherwise it will not cover retained commissions.
Even if a strata manager can keep insurance commissions, it must still select or recommend insurance arrangements that are in the best interests of strata buildings regardless of insurance commission entitlements.
Neither full disclosure of insurance commissions with fully informed consent nor a management contract that specifies retained insurance commissions changes the other fiduciary duties of a strata manager to strata buildings.
Only one of the 7 management contracts used by Alliance Strata Management [the last one] effectively entitled it to keep insurance commissions in some circumstances.
S.42AA of the Property Stock and Business Agents Act 1941 didn’t apply to insurance commissions.
A strata manager fiduciary’s entitlement to keep insurance commissions depends on the exact details around the creation of the fiduciary relationship with a strata building, the wording of the management contract, the type, amount and circumstance of the insurance commission when received and other factors, so it can vary between strata buildings and from time to time.
CONCLUSIONS
Why have I told you this old story now?
It’s an interesting, little known and important part of Australian strata history.
I know it well as I was very heavily involved in it from before it happened to long after it ended as I acted for Alliance Strata Management in relation to most of the disputes, litigation, business ownership changes and restructuring.
The NSW Court of Appeal decision still helps strata stakeholders understand strata manager insurance commission issues.
I see many parallels between this story and what’s happening now.
So, I hope you enjoyed this old story from a strata galaxy that’s far far away. Or, maybe it’s neither that old nor that far away?
September 18, 2024
Francesco ...