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Did you hear the rumours about bank lending on management rights?

25 Jun 2015

Death, taxes and change. The only constants in life.

The management rights industry does not get affected all that often by Court decisions (the Body Corporate and Community Management Act 1997 (BCCM Act) and its interpretation being relatively stable), but a recent decision from the Queensland Civil and Administrative Tribunal (QCAT) has caused a bit of discussion in the industry, particularly amongst management rights financiers.

As with all investments, availability of debt funding assists with asset price maintenance and growth.  We only need to look back to the global financial crisis (GFC) (now roughly seven years ago) to see what happens to asset prices when banks impose tighter credit guidelines or withdraw from any particular market.

To understand what happened to a bank when it appointed receivers to a management rights business we will look at a recent scenario. 

The facts

For the less insolvency minded readers, it is worth understanding some basic concepts before we get into the detail of what has happened here.

Receivers or receivers and managers are people appointed by a secured creditor (i.e. a bank) to recover the amount due to the secured creditor from the sale of a secured asset. That security arises under loan or mortgage documents signed by the borrower.   Receivers are not appointed for the benefit of the company or its other creditors – their job is to get the money back for the bank but they have a statutory duty to get market value for any assets they sell.

An administrator is a person appointed by either the directors of a company, a secured creditor or a liquidator (if a better return can be realised than liquidating the company) to assist an insolvent company in satisfying its debts by coming to a formal arrangement with its creditors.

A liquidator is appointed by a court after application from any creditor of a company (secured or unsecured) to wind the assets of a company up and then return any balance remaining after that to creditors. A liquidator is appointed for the benefit of creditors.

In essence, you can have all three operating at once.  As an example, a company that operates a business might be getting close to insolvency, so the directors appoint an administrator to step in and run it for the time being. 

The bank that has loaned the company money does not like that and appoints a receiver to the company to watch the performance of the administrator.  A third party creditor decides they do not like either of those and applies for, and obtains, an order that the company be placed in liquidation and a liquidator appointed. 

The liquidator must sit in the wings until the receiver has worked through its issues (i.e. recovery of the secured amount owed) and then what remains of the carcass of the company would then be handed over to the liquidator to deal with.

This is a very simplified version of what can be an incredibly complicated (and expensive) process, but should be sufficient background for all for the purposes of this article.

Now to the story.

Gallery Vie is a permanent management rights at Varsity Lakes on the Gold Coast.

The management rights at Gallery Vie were owned by Vie Management Pty Ltd. That entity had a mortgage to a management rights financier. The financier had given the usual  notice to the body corporate of its rights with respect to the management rights agreements under s. 126 of the BCCM Act meaning that the body corporate could not terminate the management rights agreements just because the financier appointed receivers.

The prevailing belief amongst management rights financiers was that bodies corporate could only terminate management rights agreements after the appointment of receivers for something done (or not done) by the receivers themselves. A body corporate is quite reasonably entitled to expect a receiver to perform the obligations contained in any management rights agreements as much as it does from a resident manager.

That belief has turned out to be not quite correct.

A body corporate has a statutory (i.e. legislative right) to terminate a management rights agreement for certain things under the BCCM Act.

Those things are where a person who is the manager, or is a director of the manager:

  • is convicted of an indictable offence involving fraud or dishonesty; or
  • is convicted on indictment of an assault or an offence involving an assault; or
  • carries on a business involving the supply of services to the body corporate, or to owners or occupiers of lots, and the carrying on of the business is contrary to law (i.e. operating a letting business without a licence); or
  • transfers an interest in the management rights business without the body corporate's approval.

In addition to those rights, the BCCM Act allows further grounds for termination to be included in any management rights agreement. Those grounds vary from agreement to agreement, but a standard one is to allow termination where the manager is a company and it is placed into liquidation.

The financier at Gallery Vie appointed receivers on 16 December 2014.  A liquidator was appointed on 19 December 2014.  Allegedly that liquidator was appointed by a third party creditor who was the entity that sold the management rights business to Vie Management Pty Ltd and left some vendor finance in the deal.

Vendor finance is not common in management rights matters, but we wrote about it in March 2009 here.  The context for that article at the time was a slowing management rights market as the GFC started to hit home.  We think it is very safe to say that after this decision there is very little prospect of attempting to do a management rights deal involving vendor finance. Bank credit departments are very unlikely to accept it. 

Anyway, the body corporate then asserted that the appointment of a liquidator (which was an event of default under the management rights agreements) was a breach that occurred after the appointment of the receiver – and therefore occurred on the receiver’s watch.   The receiver, as you would expect, contested that.

The receiver lost.

Even though the appointment of the liquidator had nothing to do with the receivers themselves, they were (in effect) held accountable for it as if it was their breach of the management rights agreements.  The breach happened after they took over.  The fact they had nothing to do with it was academic for the purposes of QCAT.

What does this all mean?

From our end it is a once in decade event at a minimum as it is a very rare set of circumstances.  The genesis of the whole issue was a dispute between the body corporate and the resident manager over charging uplifts on electricity.  The convergence of the appointments of both a receiver and a liquidator in circumstances where the body corporate was actively seeking to terminate the management rights agreements is pretty much a one off. 

Not quite a black swan event, but as close to it as we are going to get in management rights land.

Banks being banks, they will all be wary. 

The ultimate way to address the issue is a small legislative change. This would be to be to the effect that management rights agreements could only be terminated once receivers were appointed for events that happen as a result of the receiver’s conduct (i.e. poor performance). 

Unfortunately legislative change seems a long way away.

So in the meantime, what do you do?

Buyers of management rights businesses

Talk to your bank. They will have a Gallery Vie policy. Most banks are requiring changes to agreements, but some may not depending on how much you are borrowing and what your relevant experience is. Initially, the banks were proposing that Gallery Vie changes be approved at committee level when the assignment was approved but that has largely been killed off by the body corporate lawyers. The better argument is that a committee cannot agree to these style of changes. 

It is absolutely something we look at in due diligence every time now.

Sellers of management rights businesses

Be ready to have the conversation about committee support at general meeting level as part of the sale process for the required changes.

Potential sellers of management rights businesses

Find out whether you are caught and when your AGM will be. If you are not sure, we can help you find the date. Then, get what is needed approved. We can guarantee you this will make your sale (when it happens) far smoother.   

What could the financier have done?

Hindsight is always 20/20 but it could have:

  • paid out the vendor finance.  That way there would be no liquidator. Banks sometimes regard this as negotiating with terrorists, hence why it probably didn’t happen. 
  • allowed the liquidator to be appointed first, then appointed receivers after that.

We are working with ARAMA and some of the other panel lawyers on the legislative front and will keep you all advised on progress.

For the time being (as John Howard once famously said), be alert, but not alarmed.  For banks, the risk has always been there - it has just never been as clearly understood as it is now.  Over the last decade there would have been thousands of management rights transactions financed and dozens of receiver appointments made and this is the first one to have gone this way.   

For those that want the detail, you can read the decision here.