Another failed attempt to terminate a management rights agreement

The Reserve is one of three large buildings in the one management rights portfolio at Varsity Lakes on the Gold Coast. It has been a very large enterprise from the day it was built so it is safe to say the collective value of the management rights enterprise is in the millions.

Every management rights agreement is different. There are a few more standard ones you see around and about (one of which is ours), but you can never take for granted that the one you are looking at is the same as the next one (even if drafted by the same firm) because they all might have had slightly different ingredients when first drafted or later amended.

The agreement at The Reserve had a clause creating a ‘deemed’ assignment where control of the manager changed. We see these styles of clauses in probably about half of the management rights agreements we review.

A ‘true’ assignment of management rights is where ABC Pty Ltd sells to XYZ Pty Ltd. That assignment is documented in a deed of assignment where ABC Pty Ltd formally assigns its interest in the management rights agreements to XYZ Pty Ltd and the body corporate also consents to the assignment (usually in that same document).

Where a company owns a management rights business it is possible to transfer ownership of that business by transferring control of the company that owns it. You do this by selling the shares in the company itself.

So, what could also happen in the above example is that the shares in ABC Pty Ltd are sold by the owners of those shares to XYZ Pty Ltd. The interest in the management rights business is transferred to XYZ Pty Ltd through the transfer of the shares in ABC Pty Ltd as opposed to the assignment of ABC Pty Ltd’s interest in management rights agreements themselves.

The owner of the management rights is still ABC Pty Ltd, but it has new shareholders that own the business by virtue of the transfer of the shares.

A transfer of this nature is not caught by the assignment provisions under the Regulation Modules, so without a deemed assignment provision an interest in a management rights agreement can be transferred without the consent of the body corporate.

That is why deemed assignment provisions are sometimes included in management rights agreements. These ‘deem’ an assignment to take place in circumstances where the shares may be transferred or control of the manager changes – through directorship or shareholding. They can all differ a bit in wording but the intent is to allow the body corporate to be a participant in the decision to transfer the management rights business to a new manager.

There are pros and cons to transacting in this manner which are far beyond the scope of this article. If you are interested, we wrote an article for our aged care practice a while back that deals with share acquisitions in more detail.

In a management rights sense the big ticket issues are that you may be able to save significant stamp duty in exchange for assuming whatever risks exist in past for ABC Pty Ltd. The contract process is also far different and it does not work if there is a trust involved as the owner of the business.

Anyway, the management rights agreements at the Reserve had a clause which required the body corporate to consent to any change in directorship. The relevant timeline for what went on was:-

Date Event
5 December 2012
The body corporate consents to the assignment of the management rights agreements to a company (as agent for a partnership) with two directors.

12 February 2013
One of the directors resigns.

8 July 2014
The body corporate put the manager on notice that it believed there had been a change of control without its consent.

30 July 2014
The director who resigned is reappointed as director.

6 August 2014
The body corporate notifies the financier to the manager that it believes it has the right to terminate the management rights agreement for the failure of the manager to obtain body corporate consent to the change of control that happened with the director resignation.

30 September 2014 The body corporate passes a resolution to terminate the agreements based on the alleged breach relating to the change of control.

The manager filed proceedings to contest that termination and here we are.

The member of the QCAT held that the manager had changed control without the consent of the body corporate. Changing control in the management rights agreements without body corporate approval is a major thing, and that had clearly happened. The body corporate in general meeting quite clearly endorsed that the agreements should be terminated.

You could be excused for thinking that it was a clear cut case entitling termination.

It was not to be.

In what we think is a ground breaking decision relating to what it is for a body corporate to act reasonably, it was held that the body corporate acted unreasonably in seeking to terminate the management rights agreements.

The QCAT has added another layer to the onion of what “acting reasonably’ means for a all bodies corporate in Queensland.

The primary reasons were:-

The director who had resigned was still involved at the scheme doing what she had to do. In that sense there was no change in the operational control of the manager’s affairs.
If the body corporate had been requested to consent to the transfer of control then it more than likely would have been required to consent on the basis that it could not unreasonably refuse that consent. It had consented to the other director on the way in, and that person was still there.
The breach was remedied before the body corporate had taken any action. The director had been removed, and then reappointed before any steps to terminate were taken. The state of affairs had been restored. The question remains whether it would had been different if the body corporate had acted with more haste. We think probably not, but you never know.
There was no loss or damage occasioned by the breach in changing control without body corporate consent and the body corporate was not prejudiced by it.
What does it all mean?

For us it is pretty simple.

To terminate a management rights agreement the conduct complained of must be relatively serious. Bring termination proceedings for minor or technical matters at your own peril.

You also have to balance the equities (yes a nice legal phrase, and to put it in layperson’s terms – it’s about the vibe). This was a technical breach which had no operational effect that caused the body corporate no harm at all yet would have cost the manager (potentially) millions. Would it be fair if the decision went the other way?

We are seeing what is ‘acting reasonably’ coming across our desks more and more often. That is unlikely to change as word gets out that bodies corporate do not have an unfettered right to do as they choose (like any of us individually can).

You can read the case here.