Commonhold without sovereignty – a failed state?

As leasehold reform is being debated furiously, now is the time for considering second generation commonhold reforms for flats that might become a viable alternative to leasehold. This post considers the proposed corporate structure of a commonhold association and its shortcomings in challenging times for owners of apartments worldwide.

In the leasehold and commonhold reform debate that has escalated in England concomitant with the high-rise safety crisis, Australian strata systems are sometimes held up as the pinnacle of well-functioning alternatives to the vagaries of the English system of split ownership of buildings held by freeholders, and flats held by leaseholders. In Australian strata systems apartment owners hold individual titles to the inside of their apartment and an owners corporation compulsorily made up of each of the owners holds and controls the outside of the buildings and other common property and facilities and makes decisions about these things collectively. 

A freehold system for flats that works

It is true that strata systems work well in Australia. Although by no means perfect, strata systems are the dominant and preferred form of apartment ownership for Australian developers, financiers, legislators, investors, and owners alike. It has been this way since inception of strata in 1961. There are more than 3 million strata apartments in Australia with a replacement building value over $1 Trillion. For context, this represents about 20 % of Australia’s residential housing stock. This is so even though leasehold remains an option for developers in Australia. Very few apartments in Australia are leasehold. Leasehold is used mainly for retirement villages and foreshore land of state significance. Even then, laws facilitate leasehold strata to provide a strata system of self-governance for owners of apartments built on leasehold land.

It is no wonder then that this trusted and popular form of apartment ownership is an attractive argument for leasehold and commonhold reform campaigners in England and Wales. Unfortunately, the argument is flawed. It overlooks no fewer than five fundamental principles of Australian strata systems that differentiates them from both the present split system of flat ownership system in England and Wales, and its alternative, commonhold.

 In the Australian strata systems-

1. An owners corporation is a bespoke creature of strata laws and is excluded from company law so that it exists statutorily until the strata scheme itself is terminated.
2. An owners corporation cannot be wound up for insolvency.
3. Strata owners have personal liability for the liabilities of the owners corporation.
4. Owners corporations have strict liability for maintenance and repairs, even when these have been caused by others including the original developer or builder (fix it first – sue later).
5. Strata owners are responsible for the liabilities of the owners corporation jointly and severally. 

The benefits and burdens of a sovereign system

The principles outlined above underpin the sovereignty of strata. They entrench the right to self-determination in an entity that exists until the strata scheme itself is terminated which can only happen by unanimous agreement and the consent of the registrar of titles or by a super majority of owners with court orders to protect the dissenting minority. Termination must not occur until all the liabilities of the owners corporation are discharged.

Absolute sovereignty protects all who deal with an owners’ corporation: owners purchasing on the owners’ corporation representations about governance, owners and tenants given special approvals and common property rights, contractors and traders providing services and supplies, banks providing mortgage finance for purchasers and specialist strata lenders lending to the owners’ corporation on the security of a future income from compulsory levies on owners.

Strata sovereignty is consistent with owning property ‘free-of-hold’ but with freedom comes responsibilities. The recent Australian case of Mascot Towers highlights the high price of self-determination. The towers were evacuated more than 4 years ago due to building defects of the original developer and subsidence caused by excavation of the neighbouring development site. They remain unoccupied and unremedied. These unfortunate events for the owners have however been compounded by their own poor decisions and dysfunctionality. You can read about that here.

For present purposes, the Mascot Towers owners corporations application to wind up the owners corporation to end their woes has been denied. The five principles set out earlier were upheld. The state government has provided $21 M of aid to the owners so far but has signalled that this can’t continue. In the result, the owners and their financiers will bear the financial losses for an unfortunate purchasing decision and poor-quality decisions in the wake of the evacuation. This is sad, but as it should be. Owners must be ultimately responsible for their decisions. 

Commonhold – the opposite of a sovereign system

Exactly the opposite of strata sovereignty is proposed by the Law Commission for commonhold in England and Wales. Commonhold Associations will be companies limited by guarantee and subject to company law. Commonhold Associations, which more accurately should be called commonhold companies, will be able to be wound up for insolvency thereby relieving flat owners of personal liability for the commonhold debts, and the duty to maintain and repair commonhold property. This approach is a fundamental departure from the eight comparison countries studied by the Law Commission where insolvency by creditors is not permitted: Australia, Canada, New Zealand, USA, Scotland, Germany, Italy, and France. Tellingly, all these countries have well established and functioning apartment management systems controlled and funded collectively by apartment owners.

Why would the Law Commission recommend this structure be maintained? The answer probably lies in the Parliament’s terms of reference, and a bad first draft in the failed Commonhold and Leasehold Reform Act 2002. The terms of reference charged the Law Commission with invigorating commonhold rather than perfecting it. Therefore, the Law Commission has focused on making commonhold at least as attractive as leasehold where both freeholder and leaseholders have protection from insolvency by winding up freehold and right to manage companies. Instead, of pinning strict liability on freehold owners without the protection of insolvency, the Law Commission recommendations tinker around the edges of solvency by bolstering provisions about insurance, reserve funds, and levy collection powers, to make insolvency of commonhold associations ‘rare’ and to support successor associations that ‘might’ be appointed to provide ongoing governance arrangements for the commonholders but which will not be bound by its predecessors decisions or liabilities.  

Experienced lawyers and practitioners of the eight comparison countries will know that apartment owners in self-determining ownership structures will flaunt their obligations for insurance, reserve funds and levies to suit their own purposes no matter how tight the legislative provisions are drafted. Attempts to make insolvency of commonhold associations ‘rare’ and provide for successor entities that ‘might’ be appointed by administrators is not going to form the basis of a robust system of apartment ownership and management that operates almost everywhere else in the developed world. In these systems elsewhere there might not be effective consequences for owners breaching procedural laws, but ultimate personal responsibility for the liabilities of the commonhold entity brings a certain clarity to the collective decision-making process on the big issues.

Failing once is a mistake, twice is a problem!

There are a myriad of big issues presently testing the capacity of owners to collectively make quality decisions about apartment buildings no matter where they are located. Building defects, building product safety and information transparency, ageing buildings, neglected repairs and maintenance, inadequate reserve funds, urban development sustainability, and net zero policies are the issues of this strata age. England and Wales have an opportunity to invigorate commonhold by removing insolvency protection for all freeholders but this would have to happen under both under both leasehold and commonhold if the latter is to become viable.

This is not an attack on commonhold but rather an attempt to prevent a second failure.