Six Questions Every Strata Committee Should Ask Before Signing a Loan Agreement

Strata finance has been and should be a very straightforward process, with well-trodden decision criteria and clear loan documentation and processes.

Now committees are faced with complexity in dealing with a subset of owners who want to pursue a different loan structure – usually called a hybrid strata loan.

Hybrid strata loans were the subject of a recent in-depth legal analysis by leading strata lawyers Bugden Allen Group Legal, who found these products to be incompatible with strata legislation in New South Wales and Victoria.

This article takes that analysis and considers its implications for strata committees, particularly regarding the questions they should be asking before putting a hybrid strata loan agreement for decision by the corporation, and the duty of committee members to act in the interests of the owners corporation – which extends to understanding what they are approving.

Six questions committees need to answer.

Question 1: Is this loan structure compliant with strata legislation in your state?

This is the foundational question. It is the one most committees do not ask explicitly, but they must do so.

Owners corporations in Australia are “creatures of statute” – they are created and governed by specific state legislation: the Strata Schemes Management Act 2015 in NSW, the Owners Corporations Act 2006 in Victoria, the Body Corporate and Community Management Act 1997 in Queensland and their equivalents in other states. These Acts prescribe the powers that an owners corporation has, powers that are limited to those expressly set out. You can’t just ‘make up’ things you want an owners corporation to do – if the legislation doesn't say the corporation can do something, then it can’t.

A recent legal analysis by leading strata lawyers Bugden Allen Group Legal found that the levy credit mechanism used in hybrid strata loan products is ultra vires, that is, “beyond the powers” that legislation grants to owners corporations. A general meeting resolution cannot authorise something the legislation does not permit or is silent on.

Ask your legal adviser directly:

• Is this loan structure compliant with strata legislation in your state?

• Are all elements of the structure “within the powers” of an owners corporation?

• Can my owners corporation authorise something that the legislation does not explicitly permit?

  Make sure it addresses the issues raised by Bugden Allen Group Legal. If it does not, that is an answer in itself.

Question 2: Will all lot owners retain their full voting rights throughout the loan term?

In both NSW and Victoria, lot owners who fail to pay their levies become “unfinancial”, a status that removes their right to vote at general meetings for the duration of the arrears.

Under a hybrid strata loan, Lending Owners do not pay their levies directly. Rather than pay a special levy, they lend their share of the corporation’s requirements to the owners corporation before works commence. These hybrid loan contracts purport to allow a mechanism whereby Lending Owners receive a "credit" from the owners corporation that offsets their levy obligation against what the owners corporation owes them in repayments. The Bugden Allen analysis concludes that this credit mechanism is ultra vires and therefore legally void. The levy credit being legally void means that the levy remains unpaid. Which means the Lending Owner is in arrears. 

The consequence is significant: Lot owners who have made this unsecured project finance loan to the owners corporation at law lose their right to participate in the governance of that scheme for the life of the loan.

Consider that for a moment. The lot owners who choose to lend their own hard-earned money to fund their building's capital works may be classified as non-paying owners. They attend their AGM, take a seat, and are told they have lost their right to vote on the future of their asset.

Any loan product that affects the voting rights of lot owners creates a governance problem that the committee will be responsible for managing. It’s important to understand this before these loan structures are proposed.

But there is more. Because the credit mechanism is a fundamental term of these contracts, for them to be void would lead to what is called ‘frustration of the contract’ – leaving the whole arrangement without any contractual foundation. What happens then to money already lent? To repayments? To the money already used by the owners corporation?

Your legal advice should cover these issues.

Question 3: Can your treasurer/auditor actually sign off the accounts?

Strata legislation in both NSW and Victoria requires owners corporations to keep accurate financial records, reconcile them against bank statements each year and produce accounts that give a ‘true and fair view’ of the owners corporation's financial position. This is not optional. It is a legal obligation of the owners corporation. 

Under a hybrid strata loan, when a levy credit is applied, no money changes hands so nothing appears on the owners corporation's bank statement. There is no transaction to record. An auditor presented with accounts containing notional credits that cannot be verified against bank records faces an impossible task. In Victoria, the legislation requires that the bank accounts show a 'true and fair view' of the owners corporation's financial position, something that cannot be achieved when the offset arrangements are absent from the banking records.

Ask your auditor:

• How does your product allow our treasurer to complete the accounts?

• How does our auditor sign off?

  If the answer is unclear, that is a significant red flag for the corporation's legal obligations.

Question 4: What happens if a Lending Owner wants to sell during the loan term?

Property sales occur frequently. People's circumstances change. An owner who entered a hybrid strata loan arrangement in good faith may need to sell their property before the loan term ends.

Under a hybrid strata loan, the Lending Owner's agreement is a contract between that individual, the owners corporation and the commercial lender. An incoming purchaser is not automatically a party to this contract and so cannot automatically step into the Lending Owner’s position. To transfer the arrangement on sale requires a deed of assignment executed by four parties: the Lending Owner (seller), the purchaser, the owners corporation and the commercial strata lender. The owners corporation might also need to convene a general meeting to approve the assignment.

The coordination of four parties and a general meeting inside a standard property settlement window is a significant practical burden. It may affect the sale timeline, the sale price, or whether a buyer proceeds at all. A purchaser's bank or conveyancer may treat the internal loan as a complication that affects their assessment of the property.

Ask your lender and legal adviser:

• What is the documented process for assignment on sale?

• Has it been done?

  And most importantly, get your own personal independent advice! Have your own conveyancer review the assignment requirements before the committee votes.

Question 5: What are the tax implications for owners in the scheme?

ATO product ruling PR 2024/2 determines that interest received by a Lending Owner (even when received as a levy credit rather than the transfer of funds) is assessable income in the year the credit is applied. This means Lending Owners must declare the interest component of every levy credit as income in their annual tax returns, even though no money has entered their bank account.

For investors who entered the arrangement expecting higher returns, the after-tax position may be materially less attractive and more complicated.

The tax impact extends beyond the Lending Owners. The additional administration, multiple lenders, multiple accounts and the ATO Annual Investment Income Return that must be rendered by the owners corporations drive up strata management fees for every owner in the scheme. Ordinary owners who did not lend personal funds to the owners corporation may still face higher levies and administration costs as a result of the structure.

Ask your lender to provide a worked example of the after-tax position for a Lending Owner at your strata scheme's levy level. Then have an independent accountant review it. 

Question 6: As a Lending Owner, have you actually reduced your financial exposure?

In a hybrid strata loan, Lending Owners believe, or are led to believe, that making a loan directly to the owners corporation removes them from the external borrowing arrangement. It does not.

The hybrid strata loan structure creates two tiers of owners but it does not create two tiers of liability. Arrears, defaults, budget blowouts, cost overruns, shortfalls, fees and penalties – a Lending Owner’s liability for the full obligations of the owners corporation remains intact.

What has changed is your exposure. Your loan to the owners corporation is unsecured project finance. You now carry a lender's risk. If the owners corporation cannot repay you, you are an unsecured creditor of a corporation of which you are also a member and for whose debts you remain personally liable [on a joint and several basis].

As a Lending Owner, you have not reduced your exposure. You have added to it.

Ask your legal adviser to provide a written summary of your joint and several liability as a Lending Owner under this structure.

A note on due diligence

Every one of these questions has two simple tests: if the lender cannot answer it clearly, in writing, with supporting documentation to a standard that results in no confusion on the part of any owner, the committee should seriously question if it is in a position to table this loan structure for a vote.  And if your legal adviser cannot address these questions to the level of detail and certainty required, the committee should also question whether it is wise to put this loan structure to a general meeting.

The Bugden Allen Group Legal analysis does not just conclude that hybrid strata loan products are complex. It concludes that in their current form, hybrid strata loans are incompatible with the legislation that governs every owners corporation in NSW and Victoria. This is the first legal review we have seen which analyses these agreements in depth and considers the critical mechanism that purports to make them work – the levy credit. It is not acceptable to state that an owners corporation can borrow from an owner (of course it can) and therefore state that these loans are OK – the devil is in the detail, and here that detail is a cane toad.

At Lannock, we made a deliberate decision not to offer hybrid strata loan products. Not because flexibility is a bad idea, but because structures that cannot meet the legal tests that apply to every owners corporation are not loan structures we are willing to put our name to.  

Lannock continues to lead the way in strata for more than 20 years, helping strata communities find finance that works simply, transparently and fairly for everyone in the scheme. If your committee is evaluating loan options or trying to make sense of an arrangement it is already in, we are happy to walk you through the corporation’s options.