Due diligence searches are an important factor when purchasing a commercial or residential property, and ensuring you are considering all important information is key to determining that the investment is sound and whether to proceed with the transaction.
As body corporate solicitors, we strongly urge all potential buyers of strata property to consider a thorough search of the historical minutes, financials and general communications available in the strata records to ascertain how the body corporate is functioning and to appreciate what expenses are anticipated. A search of the strata agenda, minutes, resolutions and other records available on a Body Corporate Records Inspection can demonstrate how well the property functions generally (for example, is the property governed by a dysfunctional committee and/or are there owners who make resolving Strata matters difficulty and/or are there expenses unmet (such as a roof repair that has been considered, but not addressed requiring a special levy). In addition to the “standard searches,” we strongly urge clients to conduct a Body Corporate Records Inspection to find the “skeleton in the closet.”
What is a Body Corporate Records Inspection?
A Body Corporate Records Inspection is a physical inspection of all records held by the relevant body corporate. Depending on the size and age of the body corporate, the records are anywhere from the size of a binder folder, to the size of several archive boxes. While the amount of information to be reviewed can be slightly overwhelming, it is important to examine all relevant records.
What do you look at in a Body Corporate Records Inspection?
As a general rule of thumb, we suggest reviewing all body corporate records from the previous 3 years.
There are, however, key documents that we would suggest reviewing:-
- Account records
Recent accounts statements for the administrative and sinking funds will indicate the current balance of each fund. Bear in mind that the administrative fund pays for ongoing, day-to-day expenses (this can include gardening, general maintenance, insurance, body corporate manger’s fees), whereas the sinking fund pays for capital expenses (such as painting).
It is important to ensure there are sufficient funds coming into and maintained in the administrative account to fund ongoing expenses (there should be numerous transactions on this account), and to check the balance of the sinking fund (which, in most cases, rises steadily – if the account is decreasing, there may be large capital improvements that have been made for you to investigate).
- Balance sheet and budget
Review and compare the balance sheet and budget for the current and prior financial years – look at whether there are any significant changes to the budget or balance sheet that are unexplained, and to ensure that levies charged throughout the financial year are sufficient to cover the budget for that year.
The body corporate may have commissioned reports for specific inspections of the complex – such as fire inspections, general building and pest inspections, or structural reports. Review these reports in detail to check for any concerns raised or recommendations made by the report writer, and check the body corporate records as to whether these have been addressed.
Make a copy of the body corporate insurance (if you are obtaining finance, you will generally need to provide this to your lender). Review the insurance to ensure it covers all crucial elements, and check whether the building is insured for the recommended amount.
Review the By-Laws for any changes and to ensure you have received the most current copy. Remember that the owner and tenant of the complex must ensure that these By-Laws are complied with at all times.
Although this covers a broad range of information to review, it is crucial that the correspondence is thoroughly reviewed – it might only be one line in an email that is enough to raise a “red flag” of a potential issue.
Unfortunately, there is no cheap or easy way to do the records inspection – however, while combing through several years of information about the body corporate can be time consuming, it is certainly a worthwhile exercise.
Residential Case Study: Jane’s purchase of Unit 3 University Drive
Jane signed a Contract for the purchase of Unit 3 University Drive – a unit on the second floor of a two story building (which is around 15 years old), in which there are eight units. The Contract contained a specific provision that she was permitted 14 days to conduct a body corporate records inspection, and had the right to terminate if the results were not satisfactory. When Jane initially provided her instructions, she advised she didn’t think the records inspection was necessary – the building looked stable, the unit was just intended to be an investment property, and the cost of the inspection was too high (at a few hundred dollars). Despite her solicitor warning of the potential issues that could be uncovered in a body corporate records inspection, Jane confirmed she didn’t want to pay for the inspection and to only conduct standard searches.
Her lawyer telephoned Jane on the date the condition was due to confirm she was prepared to let the date pass with no action, and did not require the search to be conducted – during the telephone call, Jane had a change of heart and requested that the inspection be conducted and results advised immediately (please try to avoid doing this to your solicitor – while we appreciate that you may change your mind, short notice of a change of your instructions may result in insufficient time to conduct the search – it is best to give your solicitor as much notice as possible). The lawyer was able to arrange an inspection of the records, and attended at the body corporate’s office to inspect same that afternoon. The person inspecting the records initially went through 3 years’ worth of records (as we suggest above) but, due to the size of the body corporate and age of the building, decided to inspect records back to 4 years instead.
A one line email 2 days before the 4 year mark was to the effect of one owner of a unit complaining that the structural issues with the building of their earlier email (dating back approximately one year prior) had not been resolved. This caused concern with the inspector, who then reviewed older reports and correspondence, which indicated that there was structural cracking in the building at two places, that could only be fixed by costly repairs (in the sum of approximately $40,000).
This outcome was reported to Jane, who, on the basis that the issue was unresolved (and assumed to have worsened due to inaction over the prior 4 years), elected to terminate the contract.
Commercial Case Study: John’s purchase of Unit 1 Industrial Estate
John signed a Contract for the purchase of a commercial unit from which he was going to run a manufacturing workshop. His contract contained a 14 day due diligence clause and he gave his solicitor immediate instructions to conduct a records inspection.
Upon inspection of the records, correspondence indicated complaints from unit owners of cracking in the foundation of the central carpark of the complex. Further investigation into the reports obtained by the body corporate revealed that the cracking was caused by the foundation of the building “slipping”, and indicated that action would eventually need to be taken, but was not yet critical. The body corporate had resolved that no action was to be taken at present, but was aware that the cost to repair the damage caused and to prevent further “slipping” was in the vicinity of $100,000.
Further investigation into the balance of the sinking fund indicated that the body corporate held approximately $300,000.
On the basis that the body corporate held a sufficient sum in the sinking fund so as to fund the repairs in the future, John did not object to the outcome of the records inspection and satisfied the condition.
What happens if I find a problem when I conduct an inspection?
If your lawyer reviews the contract for the purchase of a unit or apartment before you have sign it, they will most likely recommend that either a “due diligence” or “body corporate records inspection” clause be inserted. These types of clauses allow the buyer to inspect the records and, if an issue is revealed through the course of such investigations, will give rise to rights under the contract (such as to terminate). If you are alerted to an issue with a records inspection, we recommend you contact your lawyer as soon as possible to discuss appropriate action and to obtain advice as to your options. Once you have been fully informed of these matters, you can provided instructions on how you wish to proceed.
If you are considering purchasing a property that is part of a body corporate or have any questions about body corporate records inspections, please contact our Property Team on 07 5574 3560. Thank you, Katrina Brown, Senior Lawyer.