Compliance risk from LRBA default

LRBA loan guarantor

The instance of a lender to an SMSF exercising an LRBA loan guarantor clause could lead to a compliance breach of superannuation (SIS) law.

A specialist lawyer has warned SMSFs with a limited recourse borrowing arrangement (LRBA) in place that includes a loan guarantor may result in a compliance breach of the Superannuation Industry (Supervision) (SIS) Act in the event of the fund no longer being able to service the original liability.

Under these circumstances if the repayments for the LRBA cannot be met, the lending institution will approach the guarantor for the amount outstanding on the loan. This effectively means that the debt obligations will be between the SMSF and the guarantor from that point onwards. This situation can lead to compliance breach of superannuation laws from LRBA default, DBA Lawyers director Daniel Butler noted.

“[In this situation] the lender is stepping out and the guarantor is stepping in as the [new] lender. So there is still a loan and the super fund still has a liability for the loan under the right of subrogation,” Butler said during an SMSF Online Update last Friday.

“The ATO then says, in (Interpretive Decision) ID 2010/170, unless the rights of the guarantor against the trustee are limited to the rights relating to that asset, then that would breach [the] SIS [Act]. Security against the trustee [by law] has to be limited to the asset.

“You’ve got to watch out for guarantee [conditions.] Some guarantees not only allow [for a claim] against the asset, but [also] legal fees, accrued interest and costs of recovery.”

He also cautioned that in some situations the guarantor’s actions, or inaction, can lead to non-payment of the liability being treated as a contribution by the guarantor.

“This will arise where, for instance, the right of indemnity expired. As we know with a personal right, you can generally only recover [it] within six years,” he told practitioners in attendance.

“So if for instance the guarantor has a right against the super fund, [it must be determined whether] the guarantor insisted the right be [honoured].

“[So] if the super fund has been paying the guarantor, [then] fine, that right of expiry has not ceased. But if there hasn’t been any action by the guarantor to get the super fund to [make repayments], then there is an issue with a deemed contribution [from the guarantor].”

According to Butler, the current economic environment featuring rising interest rates should prompt a review of LRBA guarantor conditions as the probability of loan defaults will have increased.

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