by Katrina Brown | Feb 23, 2020 | Commercial Agreements, Commercial Law, Conveyancing, Leasing, Property Law
It comes as a surprise to clients when, on occasion, they find themselves either subject to, or trying to enforce, “informal agreements”. Informal agreements may come in the form of an exchange of discussions in respect to an arrangement, or a signed Lease Offer. It may be that the informal agreement is a sword for a client (for example, the client wants to push the arrangement in the absence of a written contract signed by the parties), or a shield for a client (for example, the client wants to avoid the arrangement because there was no written contract signed by the parties – or the terms were not finally agreed).
Whether the arrangement relates to a supply of goods, services or a commercial leasing arrangement – a legally binding arrangement may be determined by way the conduct of the parties (such as one of the parties completing a condition agreed to start the arrangement (for example, supplying a service), or an exchange of emails about an arrangement), even in the absence of a formal contract – whether or not the contract is ultimately signed.
When are negotiations binding?
Courts look at the objective intention of the parties when determining whether there is a legally binding agreement. That is, whether a reasonable person would consider the agreement to be legally binding, and not the parties’ subjective intention.
Courts have found a legally binding agreement in the following situations:-
- When a vendor and purchaser of commercial property agreed to the essential terms of the agreement over email, noting that the agreement was “subject to contract” and “subject to execution”. A court found that this was essentially an “agreement to contract” and made judgement against the vendor (who attempted to withdraw from the transaction due having found a more favourable third party purchaser);
- Negotiations between a tenant and landlord whereby the essential terms of the lease were agreed upon were found to constitute an agreement to lease. This was the case even though the negotiations began with “subject to formal lease documents being signed” and that not all (minor) terms were agreed. The landlord was ordered to pay damages to the tenant for failing to countersign the formal lease document; and
- A tenant who, after negotiating and signing a letter of offer with a landlord, proceeded to obtain council approvals (with the landlord’s assistance) and took steps to fit-out premises without a formal lease in place was found to be bound by an agreement to lease.
When determining the intention of the parties, regard will be to the surrounding circumstances of the negotiations, the relationship of the parties, subject matter of the agreement and other relevant factors.
What can you do to ensure no binding agreement is in place until documents are signed?
Parties who do not wish to be bound by negotiations or pre-contract documents (e.g. heads of agreement) must ensure that they clearly and consistently reiterate to the other party in all correspondence that no legally binding agreement will be formed until formal and final documentation has been signed. As the above cases reveal, merely stating “subject to contract” is not enough.
Further, prospective tenants should not enter into possession and pay rent until the lease is signed as this may constitute acceptance by conduct. Conversely, a landlord should not accept rent until they are in a position to be bound. More generally, parties should not begin performing their obligations under the agreement before the documents are signed.
However, the risks of making an agreement conditional is as a sword which can be used against you – as the other party to a transaction may similarly withdraw from the arrangement if there is no legally binding agreement. This may mean that you could lose a commercially advantageous deal if it is not locked in.
In any negotiation, you should always seek legal advice before accepting the terms of an agreement (whether by email, orally or otherwise) and before signing any preliminary document.
Nautilus Law Group has a team of professionals experienced in commercial and property agreements. It may be that our team can give you a “thumbs up” or recommendation for variations in a short meeting, or for more complex matters – the engagement may be extended.
Engaging a lawyer to advise on an agreement is an investment in certainty, as the costs of remedying a failed arrangement greatly outweigh the costs savings of avoiding advice.
We welcome you to contact our Property and Commercial Team to discuss your arrangements. Please free to contact Vicki by clicking her name, or by phoning to arrange an appointment with Vicki on (07) 5574 3560.
by Katrina Brown | Jun 11, 2019 | Commercial Law, Conveyancing, Credit Management, Credit Management Advice, Property Law, SMSF, Tax Advisory
The release of PCG 2016/5 comes as no surprise, which follows on the back of the Australian Taxation Office (ATO) publications ATO ID 2015/27 and ATO ID 2015/28, which set the tone for related party Limited Recourse Borrowing Arrangements (LRBAs). The ATO’s 2015 position clarified that nil interest rates and/or interest rate terms being other than “commercial” in nature, constituted “non-arms’ length income” within the meaning of subsection 295.550(1) of the Income Tax Assessment Act 1997 (ITAA97).
PCG 2016/5 sails past interest rates, and now gives the ATO’s position on the entirety of related party LRBAs, including requirements for principal and interest monthly payments, security, terms of lending and standards for setting fixed and variable interest rates.
IS ANYONE REALLY SURPRISED BY PCG 2016/5?
Given the overriding “sole purpose test” at section 62 of the Superannuation Industry (Supervision) Act 1993 (SISA) – what would lead anyone to think a related party LRBA could be made on other than an “arms’ length” basis, with a commercial standard of reference required? Let’s think this through – we are limited in acquiring assets from members and “related parties” of members by section 66 of the SISA, we are prohibited from providing financial assistance to members and relatives of members by section 65 of the SISA and we are required to deal with investments at an “arms’ length” in accordance with section 109 of the SISA. So, does it come as any real surprise that, if a member or a related party of the member is going to lend money to the self-managed superannuation fund (SMSF), it has to be on commercial terms?
It scares me when Trustees lose sight of the overriding black cloud of Part IVA of the ITAA97, and forget that the ATO has the benefit of hindsight in assessing anti-avoidance schemes. Looking beyond Trustees, those of us advising Trustees must also be alert to our civil, and possible criminal, exposure under SISA, including but not limited to section 55 of the SISA, which puts us, as advisors, on the line to pay losses or damages suffered by any “person” (not limited to members) as a consequence of another “person” (not limited to trustees) involved in a contravention of a SISA covenant. Remembering the Courts and Financial Ombudsman Service quite often favour the consumer, we need only look to section 52 of the SISA to appreciate the broad liability stacked on our shoulders when giving advice to SMSF Trustees of any nature which is other than, on its face, based on all parties acting on commercial arms’ length terms.
Let’s look, therefore, at PCG 2016/5. Whilst the ATO provides us with peace of mind as to its interpretation of “arms’ length terms” for purposes of related party LRBAs in the Safe Harbour provisions, the ATO recognises at paragraph 4 of PCG 2016/5 that other arrangements may nonetheless be based on arms’ length terms.
Safe Harbour 1: The LRBA and real property (commercial or residential)
| Interest Rate |
Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors. Applicable rates:
– For the 2015-16 year, the rate is 5.75%[1]
– For the 2016 17 and later years, the rate published for May (the rate for the month of May immediately prior to the start of the relevant financial year) |
| Fixed / variable |
Interest rate may be variable or fixed
– Variable – uses the applicable rate (as set out above) for each year of the LBRA
– Fixed – trustees may choose to fix the rate at the commencement of the arrangement for a specified period, up to a maximum of 5 years.
The fixed rate is the rate published for May (the rate for the May before the relevant financial year).
The 2015-16 rate of 5.75% may be used for LRBAs in existence on publication of these guidelines, if the total period for which the interest rate is fixed does not exceed 5 years (see ‘Term of the loan’ below) |
| Term of the loan |
Variable interest rate loan (original) – 15 year maximum loan term (for both residential and commercial)
Variable interest rate loan (re-financing) – maximum loan term is 15 years less the duration(s) of any previous loan(s) relating to the asset (for both residential and commercial)
Fixed interest rate loan – a new LRBA commencing after publication of these guidelines may involve a loan with a fixed interest rate set at the beginning of the arrangement. The rate may be fixed for a maximum period of 5 years and must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed 15 years.
For an LRBA in existence on publication of these guidelines, the trustees may adopt the rate of 5.75% as their fixed rate, provided that the total fixed-rate period does not exceed 5 years. The interest rate must convert to a variable interest rate loan at the end of the nominated period. The total loan cannot exceed 15 years. |
| Loan to Market Value Ratio (LVR) |
Maximum 70% LVR for both commercial and residential property
If more than one loan is taken out to acquire (or refinance) the asset, the total amount of all those loans must not exceed 70% LVR.
The market value of the asset is to be established when the loan (original or re-financing) is entered into.
For an LRBA in existence on publication of these guidelines, the trustees may use the market value of the asset at 1 July 2015. |
| Security |
A registered mortgage over the property is required |
| Personal guarantee |
Not required |
| Nature and frequency of repayments |
Each repayment is of both principal and interest
Repayments are monthly |
| Loan agreement |
A written and executed loan agreement is required |
Safe Harbour 2: The LRBA and a collection of stock exchange listed shares or units
| Interest Rate |
Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors plus 2%. Applicable rates:
– For the 2015-16 year, the interest rate is 5.75% + 2% = 7.75%[2]
– For the 2016-17 and later years, the rate published for May plus 2% (the rate for the May before the relevant financial year) |
| Fixed / variable |
Interest rate may be variable or fixed – Variable – uses the applicable rate (as set out above) for each year of the LBRA
– Fixed – trustees may choose to fix the rate at the commencement of the arrangement for a specified period, up to a maximum of 3 years (see ‘Term of the loan’ below). The fixed rate is the rate for May plus 2% (the rate for the May before the relevant financial year)
The 2015-16 rate of 7.75% may be used for LRBAs in existence on publication of these guidelines, if the total period for which the interest rate is fixed does not exceed 3 years (see ‘Term of the loan’ below) |
| Term of the loan |
Variable interest rate loan (original) – 7 year maximum loan term
Variable interest rate loan (re-financing) – maximum loan term is 7 years less the duration(s) of any previous loan(s) relating to the collection of assets
Fixed interest rate loan – a new LRBA commencing after publication of these guidelines may involve a loan that has a fixed interest rate set at the beginning of the arrangement. The rate may be fixed up to for a maximum of 3 years, and must convert to a variable interest rate loan at the end of the nominated period. The total loan term cannot exceed 7 years.
For an LRBA in existence on publication of these guidelines, the trustees may adopt the rate of 7.75% as their fixed rate, provided that the total period of the fixed rate does not exceed 3 years. The interest rate must convert to a variable interest rate loan at the end of the nominated period. The total loan cannot exceed 7 years. |
| LVR |
Maximum 50% LVR
If more than one loan is taken out to acquire (or refinance) the collection of assets, the total amount of all those loans must not exceed 50% LVR.
The market value of the collection of assets is to be established when the loan (original or re-financing) is entered into.
For an LRBA in existence on publication of these guidelines, the trustees may use the market value of the asset at 1 July 2015. |
| Security |
A registered charge/mortgage or similar security (that provides security for loans for such assets) |
| Personal guarantee |
Not required |
| Nature and frequency of repayments |
Each repayment is of both principal and interest
Repayments are monthly |
| Loan agreement |
A written and executed loan agreement is required |
So, what happens if you can’t fit your arrangements into the Safe Harbours? You aren’t sunk just yet.
LET’S CONSIDER THE LOAN TERMS…
If your client borrowed from a commercial lender to on-lend to the SMSF, what does the commercial lender’s terms to the client look like?
To keep this simple, let’s create a reference:
Client Pty Ltd, as Trustee for Client Superfund, borrows from John Smith, the sole director of Client Pty Ltd and sole member of Client Superfund, to acquire Greenacre for $500,000. John borrowed $530,000 from Awesome Bank, secured against his home, on a 30 year interest free term, with the first 5 years being interest free only, with principal and interest from year 6. John gave a personal guarantee, and also offered up security against his personal share portfolio. The LVR was 80% of the combined value of John’s home and his share portfolio. The interest on the loan is variable, based on Awesome Bank’s published rates. Awesome Bank has their own internal assessment processes for determining variable rates. John’s advisor told him that he could on-lend at the Awesome Bank’s rate for the full acquisition value, on matching loan terms. John’s advisor also made sure John registered a mortgage over the property. What happens now?
Can John rely on Awesome Bank’s terms to escape the Safe Harbours? Not entirely.
Awesome Bank has recourse against John’s income as well, as the security and later acquired assets of John (through the personal guarantee). John only has recourse against the real property owned by the SMSF, and nothing else. Accordingly, given the additional risk, one would expect a commercial lender in John’s position would have either required higher interest rates, shorter terms or a varied LVR. However, the terms of Awesome Bank’s lending to John are nonetheless material; the first approach for John is to seek out Awesome Bank’s LRBA terms. If Awesome Bank’s LRBA terms at the time of acquisition were more lenient than the Safe Harbour provisions, John has a commercial “arms’ length” reference to hold to support a variation from the Safe Harbour. However, to the extent his LRBA terms are more favourable than the Awesome Bank’s LRBA terms, John would need to vary his own LRBA to match (even if the variation was less than the Safe Harbour provisions).
What if Awesome Bank did not offer LRBA lending at the time of acquisition? Perhaps John could then look to Community Bank instead. If Community Bank has lending terms which were more lenient than the Safe Harbour provisions, then John would have a commercial “arms’ length” reference to support a variation.
To the extent John tries to find “arms’ length” terms different to the Safe Harbour provisions, he is best to ensure the comparative is truly “commercial”. John should not look to his best mate Bob, who is a third party lender, to provide the “commercial” comparative – unless Bob is a recognised credit provider who has engaged in LRBA arrangements as a regular component of his business (which business commenced well before the publication of ATO ID 2015/27 and ATO ID 2015/28).
LET’S CONSIDER SOME STRATEGIES…
Let’s say that John has to figure out how to raise the shortfall in the LVR. What are some options?
- John could make additional concessional and non-concessional contributions (subject to the contribution caps and restrictions) by allowing part of the loan to be paid down (do not forget the paperwork and required transactions!);
- John could invite new members to the fund and their rollovers and/or contributions could be used to reduce the loan (make sure the investment strategy is considered for each);
- John could sell the asset (which could be difficult by 30 June – but it is an option); and/or
- John could re-finance through Awesome Bank, and give Awesome Bank a personal guarantee (hopefully Awesome Bank values his business).
What if John is in pension phase, and he has to fund increased repayments on the LRBA from the SMSF? John could look to any of the above options, and he could also:
- Commute his pension and roll back to growth phase;
- Commute his pension, and commence a part pension with the balance of his member interest in growth phase; and/or
- Vary the terms of his pension to reduce his payments to the statutory minimums.
PCG 2016/5 is not the end of the world, but it is a wake-up call to all advisors in the SMSF space to favour conservatism in strategies. There may be litigation which flows out of PCG 2016/5, given some advisors made exceedingly ambitious strategic recommendations to clients who will not be able to float adequate remedial action by 30 June 2016. The ATO has given advisors a bit of leeway and, with a bit of creative manoeuvring, many SMSFs can sail to the Safe Harbours with minimal frustration (consider the above options, if the client could fund to lend – the client may likely remediate by treating funds as contributions).
If you would like to discuss PCG 2016/5 or what the ATO Safe Harbours mean for you or your clients, please contact Katrina Brown on 07 5574 3560 or via email.
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