Body corporate management rights

The law relating to body corporate management contracts remains in a state of flux. Two recent cases provide some clarity, but also invite further questions – and some criticism. This article outlines these cases, and points to the importance of form over substance where management rights are concerned.

ABCDE – the background

ABCDE Investments Ltd & Ors v Van Gog & Ors [2012] NZHC 1131 (24 May 2012) involved a 23-unit complex in Mt Maunganui called “The Terraces”. Units 1-22 were for holiday accommodation, with unit 23 the manager’s unit. Each holiday unit was subject to an encumbrance. The decision concerned a range of instruments: body corporate rules; a management agreement entered into by the body corporate; the encumbrance; and letting agreements.

The Court held that the body corporate rules had purported to be amended before the unit plan was deposited and the body corporate created. Therefore, following Fifer Residential Ltd v Gieseg (2005) 6 NZCPR 306 (HC), the amended rules had never been properly adopted and were invalid. The Court did not proceed to consider the validity of specific rules.

The management agreement entered into by the body corporate primarily granted the manager exclusive letting service rights. The Court determined that entering into the management agreement was beyond the powers of the body corporate (ultra vires), as the amended rules which might have authorised the agreement were invalid, and the agreement was not authorised by the default body corporate rules. Again, the Court did not consider whether specific clauses were unenforceable and should be struck out, as occurred in Russell Management Ltd v Body Corporate 341073 (2008) 10 NZCPR 136 (HC).

The Court did not explore the letting agreement very far, but noted it was an annexure to the management agreement, and was to link individual owners into the exclusive letting service arrangements. More attention was instead given to the encumbrance. This instrument was registered over units 1-22, and provided for a letting service in favour of the manager as encumbrancee.

ABCDE – the encumbrance

The encumbrance was treated as a mortgage, and interpreted following the general contractual principles set out in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 (HL) and Vector Gas Ltd v Bay of Plenty Energy Ltd [2010] 2 NZLR 444 (SC), including attention to context. In this respect, the Court held that the amended rules, though invalid, were an important part of the context, and could be used as a guide to interpretation of the encumbrance. The Court also looked to Gibbons Holdings Ltd v Wholesale Distributors Ltd [2008] 1 NZLR 277 (SC), and held that subsequent conduct was a useful guide to interpretation. I have criticised this approach in a forthcoming article in the Conveyancing Bulletin.

However, the Court’s finding was that the encumbrance was to be read in light of the other documents, and bound the 22 holiday-unit owners to exclusive letting rights through the manager. So while a contract for the sale of exclusive letting rights may not be enforceable (see Atrium Management Ltd v Quayside Trustee Ltd [2012] NZCA 26, discussed in “What’s Wrong with Management Rights”, NZLawyer, issue 182, 20 April 2012), following ABCDE, an encumbrance providing for exclusive letting rights will be.

And this finding seems correct. A unit owner can encumber a unit title as he or she wishes, and the encumbrance will bind future owners. A body corporate, on the other hand, has quite limited powers, and cannot enter into arrangements that encumber or restrict unit owners’ rights in the same way. In this sense, form is clearly more important than substance. So exclusive letting rights set out in an encumbrance will be enforceable, while those set out in a body corporate management agreement will not be. But while I can agree with the finding, I do not agree with all the reasoning, as the Conveyancing Bulletin article sets out in more detail.

Sentinel Management – the background

Body Corporate 396711 & Anor v Sentinel Management Ltd [2012] NZHC 1957 (8 August 2012) goes a step further, considering broader issues relating to management agreements, their enforceability, and section 140 of the Unit Titles Act 2010. In Sentinel Management, a 30-storey complex in Takapuna comprised 117 apartments and a number of retail shops. The body corporate and Ansley – one of the unit owners – claimed that a management agreement between the body corporate and Sentinel (as manager) was unenforceable. Ansley had signed an agreement to purchase his unit in December 2003, though titles did not issue until February 2008. Shortly after the titles issued, amended body corporate rules were registered, and later that year, the shares in Sentinel were sold to Freestone, which had been involved in arranging management services for Sentinel.

The claim against the enforceability of the management agreement was brought on a number of grounds, each of which will be discussed in turn. By way of background, the agreement was for a 10-year term, with two rights of renewal of 10 years each, and the management fee itself was not under challenge.

Sentinel Management – the usual claims

The body corporate rules were challenged, but held to be enforceable on the basis of the “unanimous assent” rule set out in Bobbie Pins Ltd v Robertson [1950] NZLR 301 (SC), with the Court noting that no particular formalities were required for unanimity.

The Court held that some provisions of the management agreement were ultra vires, and should be severed from the remainder of the agreement, essentially on the basis set out in Russell Management. In this sense, it is important to note that ‘building management services’ (an acceptable arrangement for a body corporate) were treated differently from ‘letting services’ (not an acceptable arrangement for a body corporate).

Sentinel Management – the novel claims

The Court then considered several more complex – and previously largely unconsidered – issues.

The first of these was that a constructive trust arrangement was created by the agreements for sale and purchase, and that Sentinel had dishonestly assisted a breach of that trust. While the Court accepted that an equitable interest passed from a vendor to a purchaser when an agreement was entered into (see Bevin v Smith [1994] 3 NZLR 648), this was not the same as a trustee-beneficiary relationship, nor did it impose full trustee-type duties. There was no breach of duty, and there was also no dishonest assistance.

The second was for breach of a duty by a promoter, drawing on the analogy of the equitable duties owed by a promoter of a company to that company. The Court agreed that a promoter had fiduciary duties. Further, the New South Wales Supreme Court in Community Association DP No 270180 v Arrow Asset Management Pty Ltd & Ors [2007] NSWSC 527 had held a developer owed fiduciary duties to a body corporate; the Court noted that this decision had not been applied in New Zealand, and found the comparison of a developer to a promoter “novel”. Because of its other findings, the Court held it did not need to consider this issue, but it commented that it believed a developer was in a fiduciary position in relation to the body corporate.

The third issue was that the management agreement was an unconscionable bargain. On this issue, the Court held that the body corporate did not suffer any disability or disadvantage. Rather, the Court determined that there was an equality of bargaining power that meant this cause of action must fail.

Sentinel Management – section 140

We then turn to the nuclear option – a claim under section 140(5) of the Unit Titles Act 2010, which allows a “service contract” between a body corporate and another party for a term of more than one year to be terminated if it is “harsh or unconscionable”. This was the first case to consider this provision.

First, the Court held that the provision applied to all relevant management agreements, whether entered into before or after the commencement of the Unit Titles Act 2010 on 20 June 2011. Looking to the words “harsh or unconscionable”, the Court noted that neither Select Committee comments nor the use of the phrase in other statutes provided much guidance.

The Court considered “oppression”, “unconscionability”, and “unfairness”, and held that something more than unfairness was involved for section 140 to apply: rather, there must be something close to “outrageousness”, involving an intrusion upon unit owners’ rights or the functioning of the development. The words “harsh or unconscionable” could also be read separately.

The Court then drew on three points to find that the management agreement in this case was “harsh or unconscionable”: the combination of ultra vires clauses; the potential length of its term; and the different termination rights applying to the body corporate and manager. Having been found to be harsh or unconscionable, the agreement was terminated. While this caused disadvantage to Freestone, the Court noted that Freestone was involved in setting up the management agreements, and was an author of the management-rights scheme.

Lessons

Sentinel Management provides useful guidance on section 140(5), and on challenges to management agreements generally. However, the Court came close to inviting an appeal (at [271]), and I understand ABCDE is to be appealed as well.

Looking to the two cases, the reasoning in Sentinel Management appears sounder. However, it is significant that the Court drew on a combination of points, rather than any single point, in finding the contract harsh or unconscionable. The term of the agreement, the ultra vires provisions, and the difference in termination rights were all relevant, as was the knowledge of the manager’s shareholder. Things might be different in other cases involving (say) an innocent purchaser of the management rights, congruent termination rights, and a shorter term. In this sense, while Sentinel Management provides some general guidance, it could also be seen as quite fact specific. But for now, it is the best statement of law we have, and these cases reinforce some simple lessons:

• ‘Building management services’ are different from ‘exclusive letting services’.
• Exclusive letting rights set out in a body corporate management agreement will be unenforceable.
• Exclusive letting rights secured against individual titles by an encumbrance will be enforceable.
• A management agreement with a long term, ultra vires provisions, and incongruent termination rights will be harsh and unconscionable, and subject to a termination order under section 140 of the Unit Titles Act 2010.
• But these same provisions in an encumbrance will not be subject to section 140, and will stand.

A simple conclusion can be stated: “don’t mess with unit owners’ rights through the body corporate”. Rather, “mess with their titles instead”. Because, where the enforceability of management rights is at issue, form matters more than substance.

If you would like further information please contact Dale Thomas on 07 958 7428.