SMSF trustees undertake a wide range of investments and activities across many different sectors in many different countries around the world. In so doing, SMSF trustees enter into various contracts, some standard form contracts and others with negotiated or tailor-made provisions.
SMSF trustees must act prudently and in beneficiaries’ best financial interests. To this end, SMSF trustees should be careful when entering into contracts and ensure the terms and conditions (T&Cs) are appropriate and, most importantly, do not result in any contravention of the Superannuation Industry (Supervision) (SIS) Act 1993 or the SIS Regulations 1994.
This article examines some contractual factors SMSF trustees should be aware of before entering into a contract and outlines a number of practical tips and traps. First, let’s start with some basics.
When is a contract formed?
A contract is an agreement between parties intended to be legally enforceable. The following elements are required to form a contract:
- consideration, and
- intention to create legal relations.
In certain cases, a contract may not come into existence until certain conditions are satisfied. In this regard, SMSF trustees should be aware of the differences between the following:
- Condition precedent: the contract does not come into existence until the event specified in the term occurs, for example, a contract for the sale of land may be subject to finance. It is not until finance is approved that a contract is formed. The courts construe conditions strictly and it is important that a condition precedent is a condition to the formation of a contract, in contrast to a condition precedent to a subsidiary part of a contract.
- Condition subsequent: a contract is entered into but comes to an end if the event specified in the term does not occur within a stipulated timeframe. For example, a purchaser may want to insert a term in the purchase of a new property that it ceases unless they can sell their existing property by a specified time.
SMSFs and builders’ contracts
Generally, building and similar contracts authorise the supplier to place a mortgage, charge or lien (builder’s charge) over property in order to secure payment. These provisions are designed to ensure the builder gets paid and recover any outstanding fees, costs and interest on overdue payments, usually at penalty interest rates.
Invariably, a number of clauses may need to be deleted from most standard or pro-forma building contracts. Requests to delete such terms may prompt resistance and, accordingly, this may require ‘delicate’ negotiations with the builder to exclude such terms from the contract.
It is important to note it is not necessary for a builder’s charge to be registered on title (to property) for a contravention to arise. Thus, any charging provision should be reviewed and revised so a charge does not arise under regulation 13.14 of the SIS Regulations. This regulation states: “For the purposes of subsections 31(1) and 32(1) of the act, it is a standard applicable to the operation of regulated superannuation funds … subject to regulations 13.15 and 13.15A, the trustee of a fund must not give a charge over, or in relation to, an asset of the fund.”
The term ‘charge’ is defined in regulation 13.11 as follows: “’Charge’ includes a mortgage, lien or other encumbrance.”
The Personal Property Securities Act 2009 also allows builders to register a security interest in respect of personal property, such as building materials and equipment. Builders are encouraged to register their security interests so in the event the client, that is, the grantor of the interest, becomes insolvent, their registered security interests can be enforced under the Corporations Act 2001 and take priority over any unregistered security interest.
Many contracts seek to exclude or limit liability and in some cases the supplier attempts to exclude their fundamental duty to perform anything under the contract whatsoever. While the courts seek to read down the effectiveness of exclusion clauses, a careful review and negotiation of what is being provided and what warranties should be provided needs to be undertaken. Moreover, there are various protections that may apply under the Australian consumer law and other state and territory legislation to protect consumers and small businesses from unfair bargaining positions and unfair contractual T&Cs in some contracts, especially in certain standard form contracts.
Heads of agreements versus contracts
Some prefer to prepare a written heads of agreement (HOA) rather than thinking through and documenting an agreement setting out the T&Cs in detail. However, we generally recommend against relying on an HOA as, while if expressly stated, they can be non-binding, there are invariably key T&Cs overlooked or omitted that may become sticking points when it comes to documenting the agreement. Moreover, there have been disputes where one party has claimed the HoA was binding. In one recent matter, the client had signed an HOA that expressly stated it was binding, but the vendor orally said it was not. The purchaser then wanted to terminate, but due to the legal costs and uncertainty of a dispute, instead negotiated changes to the agreement.
Potential adverse consequences
There can be severe adverse consequences for both the SMSF and its trustees/directors for contravening the SIS Act and SIS Regulations. These can potentially include:
- the imposition of administrative and civil penalties,
- the fund being stripped of its complying fund status and losing its concessional tax status, and having to pay considerable tax, penalties and interest thereon, or
- the SMSF trustees/directors being disqualified from holding these positions in the future.
Further, if the SMSF trustees/directors enter into a building and similar contract with a related party, this may potentially give rise to additional issues, including:
- engaging in non-arm’s-length dealings with potential consequences under section 109 of the SIS Act or non-arm’s-length income risks under section 295-550 of the Income Tax Assessment Act 1997, or
- providing financial assistance to a fund member or relative by entering into a building contract with potential consequences under section 65 of the SIS Act.
SMSF trustees and advisers should review all building and similar contracts to ensure there are no charges or other issues.
SMSF trustees must act prudently and should obtain advice before entering into any contracts unless they are comfortable with the T&Cs in the contract in question. Obtaining advice upfront may save on costs and potential penalties later on, especially if any T&Cs in the contract give rise to a contravention.
Daniel Butler is director, Bruce Figot special counsel and Alex Aktepe a lawyer at DBA Lawyers.