Understanding Body Corporate Borrowings and Levy Insurance

By Prof. Graham Paddock

A sectional title body corporate might sometimes need to borrow funds to fulfil its statutory functions or exercise its powers. This article explores situations where borrowing may be necessary, the legal framework governing borrowings, available types of security, the practical pros and cons, and the emerging practice of levy insurance.

When is Borrowing Necessary?

Typical scenarios where a body corporate may consider borrowing include:

• Members’ inability or refusal to pay levies, causing critical cash flow shortages.
• Urgent repairs required after damage from natural disasters that insurance does not fully cover.
• Necessary and immediate structural repairs to ensure building safety and habitability.
• Investments in enhancements such as security systems or power generation/storage.
• Cost-effective large-scale projects better executed as one phase with repayments spread over time.

Administrative funds, reserve funds, and special levies often cannot sufficiently address these scenarios, making borrowing a viable alternative.

Legal Framework and Conditions for Borrowing

Section 4(e) of the Sectional Titles Schemes Management Act (STSMA) permits borrowing under two conditions:

• The borrowing must be necessary for the body corporate’s functions or powers.
• The borrowing must be authorised by members via a special resolution.

Each borrowing initiative must meet these criteria individually. Trustees must provide clear documentation (including copies or detailed summaries of loan agreements) when calling meetings to approve borrowings, as required by Prescribed Management Rule (PMR) 15(3)(b).

Members disputing the necessity or validity of a borrowing resolution can seek relief from the Community Schemes Ombud Service (CSOS) under Section 39(4)(c) of the Community Schemes Ombud Service Act (CSOSA) or the High Court.

Providing Security for Borrowings

Section 4(f) of the STSMA allows two forms of security:

• Notarial bonds over unpaid contributions (levied or unlevied).
• Mortgages of property vested in the body corporate.

Notarial bonds require specific terms and amounts to be publicly registered, offering greater transparency and security compared to an unregistered cession over unpaid contributions. Notably, the academic interpretation by R. Brits and C.G. van der Merwe has suggested broader interpretations of “mortgage” under section 4(f). While this interpretation is practically supported, it diverges from the literal statutory wording and punctuation, highlighting the need for legislative clarification or judicial determination.

Types of Borrowings

Bodies corporate typically access loan finance through:

• Bank Loans: Rarely offered, banks typically require mortgage security or personal suretyships from members, unlike jurisdictions such as Australia, where unsecured loans are common.
• Member Loans: Members might offer loans under favourable terms in exchange for specific privileges. Legal advice is essential to formalise these arrangements.
• Levy Finance Contracts: Specialised levy financiers provide tailored loans, often secured through notarial cession of unpaid levies. This approach may involve financiers directly managing or overseeing levy collections.

Pros and Cons of Borrowing

Advantages:

• Spreads large costs over time.
• Allows immediate project completion.
• May enhance common property value and utility.

Challenges:

• Potentially high interest and fees.
• Risk of dependency on loan finance and increased levy defaults.
• Solvent members bearing higher costs due to defaulting members.

Levy Insurance: A Complex Solution

Levy insurance addresses risks associated with levy payment defaults. Under this arrangement:

• The body corporate pays an insurance premium covering levy defaults.
• The insurer pays the body corporate when owners default, maintaining essential cash flow.
• Security is robust, involving cession of claims against owners and potential recourse against solvent members.

Concerns with Levy Finance and Insurance Practices

Despite their benefits, levy finance and levy insurance arrangements introduce significant concerns:

1. Lack of Transparency: Levy financiers and insurers often maintain separate accounting records not accessible to body corporate members, obscuring details of charges for interest, fines, and legal fees.
2. Erosion of Consumer Protections: STSMA consumer protections can be circumvented, including the right to require court or CSOS verification before the debiting of  legal costs and contributions or charges that are not levies or other charges raised under the Act or rules, and the taxation and certification of any body corporate legal costs before they are debited. Debits applied by levy financiers or insurers may bypass procedural safeguards, leaving levy defaulters without visibility or effective recourse.

Recommended Actions

To address transparency and uphold statutory protections, bodies corporate should:

• Negotiate clear contractual terms when entering into borrowing or levy insurance agreements so as to ensure transparent financial management.
• Implement oversight mechanisms and periodic audits of financier or insurer records.
• Amend management rules to explicitly define the scope and conditions under which security is provided, ensuring compliance with the STSMA.

Conclusion

Borrowing and levy insurance can significantly aid a body corporate in managing unforeseen financial challenges and major projects. However, trustees and members must carefully navigate these arrangements, prioritising transparency, compliance with statutory requirements, and safeguarding consumer protections.

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Article reference: Paddocks Press: Volume 20, Issue 04

This article is published under the Creative Commons Attribution license.

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