Should an SMSF have a tenants in common agreement?

Introduction

Real estate is a common and popular investment for SMSFs. Indeed, the ATO’s SMSF statistical report for the quarter ended 30 September 2019 shows that SMSFs held around $35 billion in residential real property and around $64.6 billion in non-residential property, ie, around $99.6 billion worth of real property.

It is also reasonably popular for SMSF trustees to hold property with others to increase the funds available to invest and to minimise risk. However, it is important that each SMSF trustee is aware of the pros and cons of co-investment and the consequences that may arise when things don’t go as planned or if a disposal or exit from a jointly held investment is needed.

An SMSF trustee will usually hold a part interest in real estate as tenants in common with the other co‑owners and as such a tenants in common agreement (‘TIC Agreement’) is recommended to place the relationship at arm’s length. A TIC Agreement also provides greater certainty and can minimise the risk of costly and protracted disputes.

This article explains some key considerations that should be reflected in a TIC Agreement.

What can go wrong?

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. This can 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. Accordingly, a dispute may arise between the parties, and without a TIC Agreement, there would be no agreed way to resolve disputes.

Types of provisions to consider in a TIC Agreement

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 ( eg, 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 (eg, 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 (eg, regular meetings and decision making rules); and
• alternative dispute resolution and mediation procedures to seek to minimise court and dispute costs.

Conclusion

A TIC Agreement is a prudent way to ensure that each owners’ rights and obligations in respect of various events are considered and clearly set out from the commencement of the investment.

Indeed, before an SMSF trustee invests in real estate with another person or entity, whether that be a related or unrelated party, a TIC Agreement should be considered. Advisers should notify their SMSF clients of the pros and cons of having a TIC Agreement without holding themslevs out as providing legal advice.

A TIC Agreement can also assist the SMSF trustee in maintaining compliance with superannuation legislation and formulating an appropriate exit strategy for a co-owner.

DBA Lawyers are regularly engaged to prepare or review TIC Agreements where SMSFs are involved. Please contact us if you would like to discuss these agreements and how we might assist you.

Related articles

Related articles and links below:

• Should an SMSF have a unitholders agreement?
• SMSFs and contractual tips and traps
• Many building and similar contracts place SMSFs at risk
• Trustee and unitholder liability in unit trusts
• SMSFs investing via unit trusts
• Advantages of ordering unit trusts from DBA Lawyers
• The new ‘ipso facto’ regime and SMSFs

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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

Note: DBA Lawyers hold SMSF CPD training at venues all around Australia and online. For more details or to register, visit www.dbanetwork.com.au or call DBA Lawyers on 03 9092 9400.

By Shaun Backhaus ([email protected]), Lawyer and Daniel Butler ([email protected]), Director, DBA Lawyers.