Agreement can minimise property co-ownership risks
Trustees wanting to invest in property with co-owners through their SMSF should engage in a special agreement to increase the funds available to invest and to minimise a range of risks, according to a law firm.
In a blog, DBA Lawyers director Daniel Butler and lawyer Shaun Backhaus said the tenants in common (TIC) agreement is a prudent way to ensure that each owner’s rights and obligations in respect of various events are considered and clearly set out from the commencement of the investment.
They said a TIC agreement can also assist the trustee in maintaining compliance with superannuation legislation and formulating an appropriate exit strategy for a co-owner.
Potential pitfalls for trustees without a TIC agreement
Mr Butler and Mr Backhaus warned that many things can happen to a person, company or trustee of a trust (or the persons controlling such an entity) that could cause problems for other co-owners.
As examples, that could include the co-owner or their controllers:
- in the case of an individual, this includes getting divorced, experiencing other familial or personal issues, dying or losing capacity;
- becoming bankrupt, insolvent or being placed under administration;
- defaulting under an agreement that secures their interest in the real estate (noting that an SMSF cannot secure or charge its assets);
- being sued or otherwise caught up in litigation; or
- simply wanting to sell their interest in the real estate.
“Investments with other co-owners often commence with parties communicating and agreeing on the above issues. However, the sort of events outlined above may arise when different persons or entities hold an interest in the property compared to the original investment,” Mr Butler and Mr Backhaus said.
“Accordingly, a dispute may arise between the parties, and without a TIC agreement, there would be no agreed way to resolve disputes.”
Issues that can be addressed in a TIC agreement
According to Mr Butler and Mr Backhaus, a TIC agreement could address some of the following issues or provide the following mechanisms:
- the day-to-day management of the real estate;
- what insurance is required;
- how the real estate will be used;
- the division of income and expenditure derived from the real estate between the owners;
- a power of sale and right of first refusal;
- the procedure for valuing the real estate;
- dealing with encumbrances and restrictions on charging an interest in the real estate (e.g. while an SMSF is a co-owner, no security or charge can be imposed on the title);
- defining what constitutes a “default event” and the consequences of such an event (e.g. do the other co-owner(s) obtain the right to purchase the defaulting party’s interest if the defaulting party has not rectified their default within 30 days?);
- restrictions on an owner dealing with their interest without providing the other co-owner(s) the first right of refusal;
- providing for co-owners’ meetings and procedures (e.g. regular meetings and decision-making rules); and
- alternative dispute resolution and mediation procedures to seek to minimise court and dispute costs.
Adrian Flores is the deputy editor of SMSF Adviser. Before that, he was the features editor for ifa (Independent Financial Adviser), InvestorDaily, Risk Adviser, Fintech Business and Adviser Innovation.