Mascot Towers - Termination of a strata scheme and priority in strata lending

In brief: In a recent landmark decision the NSW Supreme Court refused an application to terminate the strata scheme of the beleaguered Mascot Towers complex. 

Background 

Mascot Towers has been in the news since 2019 when structural issues in the building were first discovered and engineers declared it unfit for habitation. The residents were moved out of the building and have not been able to return since. Only a few businesses trading from shops on the ground floor have been able to operate in the meantime while the owners corporation discussed what to do.

After 3 years, the owners corporation elected to proceed with an application to terminate the strata scheme itself under Part 9 of the Strata Schemes Development Act 2015 (NSW) (SSDA) and then sell the building as a single lot to a developer rather than proceeding with a collective sale. An application was filed in the Supreme Court in May 2022 for the necessary orders. The principal defendant to the application was Lannock Capital 2 Pty Ltd, a strata financier, who sought to protect its position as a significant creditor of the owners corporation. Other defendants included all four major banks, other financiers, an individual lot owner and one of the remaining commercial tenants.

Termination of a strata scheme 

Termination of a strata scheme is a step which has only been taken a handful of times since strata schemes first came into existence in NSW. In each case there has been some supervening factor which rendered the strata scheme no longer necessary. In Pritpro Pty Ltd v Willoughby Municipal Council (1986) 3 BPR 97224 a single owner owned all four lots in the strata scheme and was therefore the only member of the owners corporation. He successfully applied to the Court for orders terminating that strata scheme. In Owners of Argosy Court Strata Plan 21513 v Wise (2016) 90 SR (WA) 148 a tropical cyclone damaged all 12 dwellings which were part of a strata plan, which were then removed, leaving the site vacant. The Court deemed the strata plan to no longer be necessary in that case. 

The process for conducting termination is set out in Part 9 of the SSDA and involves the dissolution of all lots in the strata scheme back into a single title which vests in the owners corporation. The proposed orders in the case of Mascot Towers were that this process should be conducted under the auspices of a liquidator who would sell the building, pay off the debts of the strata and distribute any leftover funds amongst the owners in proportion to their unit entitlement in the former strata.

The contentious issue was in how that distribution was to be carried out and in what order. The majority of the defendants, with the exception of Lannock, did not oppose the making of the termination order itself, only seeking to ensure that their interests were preserved through the process. Lannock argued that a collective sale under Part 10 was the more appropriate course and that in any event the repair of the building remained a viable prospect. Alternatively, Lannock argued, if the strata was to be terminated then it, as a direct creditor of the owners corporation itself, should have priority in payment of the debt to it from the sale proceeds of the building before any distribution to individual owners. 

This position caused friction with the banks and other lenders who were also defendants and had security in the form of mortgages over individual lots in the building. These lots would be dissolved as part of the termination order and their owners rights and obligations, including the mortgages, would transfer onto the single lot after termination. The proper order for payment of debts, they argued, was for secured creditors like them to rank in priority to an unsecured creditor such as Lannock, which was unsecured owing to the operation of section 100 of the Strata Schemes Management Act 2015 (NSW) (SSMA) which allows an owners corporation to borrow, but not to secure any debt over the common property. Lannock's argument was that payment of mortgages first from the proceeds of sale would result in those owners without mortgages subsidising those with mortgages while the banks argued that paying Lannock first would mean that it had on termination a greater level of security and priority than it held prior to termination.

Cause for concern

The principal cause for concern amongst all parties was that it was anticipated that the proceeds of sale of the building would not be sufficient to discharge all of the debts. The owners were likely to end up with nothing and even amongst the lenders, whoever ranked lower in priority was likely to be left tens of millions of dollars out of pocket.

This was also the concern of the owners and the owners corporation and their reason for seeking the termination order. However, it became apparent during the hearing that at least some of the owners did not understand the effect of the termination order and expected it would  relieve the owners of their burden of debt and allow them to move on with their lives. The termination process was likened to the winding up of a company in which a liquidator was appointed, the assets were sold and such of the liabilities were paid as could be with the remaining funds with the lowest ranking creditor having to accept cents on the dollar in payment of their debts.

That is the process for winding up a limited liability company. Unfortunately, as her Honour pointed out, a strata owners corporation is not a limited liability company. The operation of section 81(4) of the SSMA is such that an owners corporation is required to continue to issue levies upon the owners until such time as it has sufficient funds to meet its expenses. An owners corporation is therefore an unlimited liability entity to the extent that its owners are liable for the full extent of its obligations and their liability is not limited to the value of their lots.

Outcome

In circumstances where not all owners had voted for termination in the first place and where the evidence before the Court indicated that the building could be repaired more cheaply than initially estimated, her Honour took the view that a termination order was not the most appropriate course. Declining to make the termination order rendered the payment priority dispute between Lannock and the banks no longer relevant but, given that the outcome of that dispute would have a significant impact on the mortgage and strata lending industries, Justice Peden elected to determine that dispute as well. 

Her Honour found that the proper order of priority was for the proceeds of sale to be called in and to then be divided amongst the owners in accordance with their unit entitlements. From those allocated funds any secured creditors of each owner, such as banks, should be paid first. In this way individual owners without mortgages were not made to effectively subsidise those with mortgages as the division of funds took place first. The owners were then still collectively liable for any debts of the owners corporation, such as the one to Lannock, which could be the subject of levies to be paid equally by all owners.

Key takeaways

With the termination application dismissed, the fate of Mascot Towers remains uncertain but the owners corporation is now armed with a better understanding of its position and with new information about the cost of repair and should be better placed to resolve the situation going forward. The strata lending and mortgage industries have also had their relationship clarified in the event that a similar situation should arise in the future.

This case illustrates the need for experienced legal advice at an early stage of any discussion on complex strata issues. Should you find yourself in such a situation please contact our team at the earliest opportunity.