Winter 2010

This issue:

• Leaky homes: issues for owners and legal advisors
  Two recent decisions of the Court of Appeal relating to leaky apartments provide some reassurance for purchasers and owners, but also reinforce the need to be vigilant in pre-purchase investigations.  more
• Price reduction for breach of warranty
  A recent Supreme Court decision on a case of an alleged breach of warranty by a vendor hampering settlement, has resulted in the purchaser being entitled to apply a 'reasonable' discount to the purchase price.  more
• If it seems to good to be true, it probably is
  A recent Court of Appeal decision has found in favour of pensioner investors where processes appear not to have been correctly followed by lenders, and the intent of the law seems to have been ignored.  more
• Trustee obligations - the extent of trustee liability
  A trusteeship is a personal obligation. Trustees have this personal obligation in relation to the trust fund, the assets held by the trust and to the beneficiaries of the trust.  more
• Property Ownership, More on Tax and Removal of Trustees
  The reasons why properties are often owned by more than one person; the need for trustees to be aware of what their co-trustees are up to; and the power to remove a trustee must be validly exercised.  more
• NEC3 (a family of standard contracts) an alternative for procurement
  NEC3 contracts are increasingly promoted in New Zealand as a modern and more progressive alternative to NZS 3910, particularly for more complex or long term projects.  more
• Government Reform of Marine Aquaculture
  In a recently released Cabinet Paper the Government has signalled significant reform to the management of marine based aquaculture under the Resource Management Act 1991.  more

Leaky Homes:  Issues For Owners And Legal Advisors

Leaky homes continue to be in the media limelight and are likely to do so for many years to come.  There have been two recent decisions of the Court of Appeal concerning claims by owners of leaky apartments.  While these cases provide some reassurance for purchasers and owners, they also demonstrate the need to be vigilant in pre-purchase investigations.

Both cases (referred to below as Sunset Terraces and Byron Avenue) alleged that the Council was negligent when approving building consents, undertaking inspection of building work and subsequently issuing code compliance certificates on the completion.   Both cases concern the duty of care owed by the Council to owners of leaky buildings.  They clarify who is entitled to bring a claim against the Council, and in what circumstances. 

The decision in Invercargill City Council v Hamlin was affirmed in both cases.  That case found that a Council owes a duty of care to the original home owner and to subsequent home owners when inspecting and certifying building work, even though a subsequent owner suffers economic loss rather than physical loss.  In addition, the cause of action against the Council for breach of its duty of care arises when the defect is discovered, or reasonably discoverable, rather than at the time that the house was constructed and inspected by the Council. 

Of note, a later decision of the Court of Appeal in Te Mata Properties Limited v Hastings District Council held that the duty of care owed by a Council is limited to owners of 'residential' properties, and does not extend to the owners of 'commercial' property who should able to inform themselves of the risks involved – more on that in our Sunset Terraces summary below.

Sunset Terraces Case

In this case, the Court of Appeal held that the Council owed a duty of care to owners of leaky buildings, intended to be used for residential purposes, even though there had been experts such as engineers and architects engaged by the developer.  Although those experts were engaged by the developer, the Council must satisfy itself that it has exercised a reasonable duty of care in inspecting and certifying the building work.

Subsequent purchasers can also sue the Council, even though it is the previous owner who has suffered, typically through a lower market value.  Any purchaser can sue within the relevant statutory limitation period which commences from the date the defect is discovered or was reasonably discoverable, unless they have purchased the property with knowledge or the means of acquiring knowledge of the leaky issues.  The subsequent purchasers will need to demonstrate that they did not know and could not have known about the leaky issues.  They must be able to demonstrate that they took some minimum steps to investigate the property.

The Court also found that purchasers of apartments as an investment can sue the Council in negligence, provided that the plans and specifications for the apartment complex or the building submitted as part of the original building consent application make it clear that the property was intended for a residential purpose.  An argument that investment properties should be treated as commercial properties, and the Council's duty of care reduced as in the Te Mata Properties case, was rejected.

This case has now gone to the Supreme Court – we will let you know the outcome when it comes to hand.

Byron Avenue

This case addressed additional issues, particularly in relation to a Council's duty of care prior to issuing a Code Compliance Certificate, and 'unit title' properties.

The Court found that even though a Council has not issued a Code Compliance Certificate, and thereby is not certifying that all of the work required under a Building Consent has been done, it still has a duty of care in respect of the inspections, and the performance of its statutory duties undertaken to date.  Purchasers are entitled to rely on the Council performing its duties under the Building Act in relation to its inspections at various stages of construction.  Those inspections occur notwithstanding that the Council may not have issued a Code Compliance Certificate. 

In respect of property held on a unit title under the Unit Titles Act 1972, the Court found that a body corporate has standing to sue the Council as the agent for the individual owners of units.  If an individual unit owner has contributed to the negligence of the Council, that contributory negligence will reduce the body corporate's claim in respect of common property.  The Court also found that a body corporate cannot sue in general damages for stress and inconvenience.  Those are matters personal to individual owners. 

The Court considered that purchasers should obtain a LIM report from the Council, to ascertain whether a code compliance certificate had been issued for building work.  This might also indicate whether the Council, a previous owner, or possibly others, such as the developer had been negligent.  In some circumstances the purchaser might be entitled to withhold settlement until such time as a code compliance certificate had issued, and if none was likely to issue, potentially cancel the agreement for breach of an essential term.  All of these matters and the potential options of the purchaser, depend on the particular facts.

In the case of a unit title, the Court considered that a prudent purchaser should obtain copies of previous minutes of body corporate meetings.  The question then becomes what period of time should a prospective purchaser go back and look at the matters considered by the body corporate, and their resultant decisions.  A reasonable period might be between say three and five years depending on the particular circumstances.

Practical Matters for Purchasers and their Legal Advisors

As a bare minimum:

• always obtain a LIM report (regardless of whether or not the sale and purchase agreement is conditional on a satisfactory LIM report – ideally it should be a condition of your agreement);

• in the case of a unit title, obtain copies of previous minutes of the body corporate.  We suggest that it would not be too much of an extension of the Court's reasoning to say that where the opportunity arises, the sale and purchase agreement should be made conditional on the purchaser being satisfied with the contents of those minutes going back for a minimum of three years.  Even where the contract is not conditional, still make efforts to obtain those minutes.

For more information please contact: Deborah Miller, Ian McCombe, Chris Paterson or Howard Johnston (Partners, Commercial Property)

Price Reduction For Breach Of Warranty

Property Venture Investments Ltd v Regalwood Holdings Ltd (Supreme Court)

When a purchaser refuses to settle at the full price because of an alleged breach of warranty, what recourse is open to the vendor?  A recent Supreme Court decision gives some clear guidelines in the case of an alleged breach of warranty by the vendor hampering settlement, with the result that the purchaser was ultimately entitled to apply a 'reasonable' discount to the purchase price.

Regalwood Holdings Limited (Regalwood) owned a commercial building in Lichfield Street, Christchurch.  In 2004 the parties entered into an agreement whereby Property Venture Investments Limited (PVIL) would purchase the building for $1.5m.  The agreement contained a standard warranty that on possession, which was to occur on settlement, all obligations imposed on Regalwood as vendor under the Building Act 1991 would be fully complied with.  The date for settlement was 25 January 2005.

PVIL refused to settle the contract because it said that the building did not comply as it did not have a building warrant of fitness.  PVIL alleged that the costs of remedying the problem and obtaining compliance with the Building Act was in excess of $500,000.  Regalwood disputed that there was any breach of the Building Act and demanded that PVIL settle the contract by paying the purchase price in full.  Regalwood issued a settlement notice requiring settlement in full.  PVIL did not settle and Regalwood cancelled the contract.

Regalwood then issued proceedings in the High Court and obtained a judgment declaring that its cancellation was valid, even though there was an alleged breach of the warranty by Regalwood.  PVIL then appealed to the Court of Appeal which also found that Regalwood was entitled to demand settlement in full and was entitled to cancel the agreement once PVIL failed to settle.  PVIL appealed the decision to the Supreme Court.

The Supreme Court allowed PVIL's appeal and overturned the decisions of the High Court and the Court of Appeal.  It found that, if the breach of warranty alleged by PVIL (being Regalwood's failure to obtain a building warrant of fitness and therefore to comply with the Building Act) is proved at a final trial, then Regalwood was in "material breach" of the contract.  As a result, Regalwood was not in a position where it was ready, able and willing to settle the transaction in accordance with the contract and so could not demand that PVIL settle in full nor cancel the contract following PVIL's failure to settle in full. 

PVIL also argued that Regalwood's failure to obtain a building warrant of fitness and to comply with the Building Act represented misdescription of the property and that, as a result, PVIL was entitled to compensation which entitled it to an abatement (or reduction) of the purchase price, so that it was not obliged to pay the full purchase price on settlement.  The majority of the Supreme Court found that this did not amount to a misdescription, with the Chief Justice preferring the view that it did.

Regalwood argued that clause 6.5 of the agreement provided a barrier to PVIL asserting that it had a right to an abatement in the purchase price.  Clause 6.5 states:

"Breach of any warranty or undertaking contained in this clause does not defer the obligation to settle.  Settlement shall be without prejudice to any rights or remedies available to the parties at law or in equity, including but not limited to the rights to cancel this agreement under the Contractual Remedies Act". (emphasis added) 

Regalwood argued that, as a result of clause 6.5, its alleged breach of the warranty did not, in accordance with the terms of the agreement, act to defer PVIL's obligation to settle.  It argued that the obligation to settle was an obligation to settle by payment of the purchase price in full.  The majority of the Supreme Court found that while there was an obligation on the part of PVIL as purchaser to settle, it was not obliged to settle by payment of the full purchase price as it was entitled to seek a reduction in the purchase price on account of Regalwood's breach.

The majority decision on this aspect was that clause 6.5 obliges a purchaser, faced with a breach of warranty, to either cancel or perform the contract. If a purchaser decides to perform in such circumstances, it is entitled to claim a deduction in the purchase price.   It was suggested that a vendor faced with a claim for deduction should issue urgent court proceedings seeking performance of the contract.  The Court also suggested that standard form real estate contracts should be revised to include a procedure for the prompt resolution of such disputes. (This is a matter presently being reviewed by the Auckland District Law Society). 

The summary judgment order confirming that the cancellation by Regalwood was valid was set aside and the case has been sent back to the High Court for a full trial.

When negotiating the terms of a sale and purchase agreement, be sure to check standard clauses reflect the true nature of the understandings between the parties or are adjusted to do so.  In this case, three trials were required to get to a stage of some certainty of the implications of a warranty clause, with another pending to determine the final outcome – a costly and lengthy exercise for all involved.

For more information please contact: Deborah Miller, Ian McCombe, Chris Paterson or Howard Johnston (Partners, Commercial Property)

If It Seems To Good To Be True, It Probably Is!

Bartles v GE Custodians Limited (CA)

From the moral high ground of hindsight, there are many who believe that those who have in recent times come to grief through risky 'investment' practices must share some of the blame for their naiveté.  But there are instances where processes have not been followed correctly by lenders, and indeed, the intent of the law seems to have been ignored.

One such case has gone through intense judicial scrutiny in the High Court and Court of Appeal.  By way of background, the Bartles (both pensioners) invested in a Blue Chip scheme, said to be attractive to people who were "asset rich but cash poor".  The Bartles used equity in their unencumbered home to assist with the purchase of a residential apartment.  This was not a long term scheme – after four years the apartment would be sold and the Bartles would receive a small share of the capital gain as well as the rental during the ownership period.

The Bartles entered into an unconditional agreement to purchase the apartment for $552,000.  Finance was confirmed at that stage but was not formally arranged until later.  They believed they would only be borrowing the initial advance of $137,000 (and possibly a further $50,000).  They did not understand until much later (and too late) that they would be responsible for the total borrowings.  It was their understanding that Blue Chip would provide any additional funding and take care of all payments and expenses.

The Bartles were actually borrowing nearly $630,000 to purchase the unit for $552,000, secured over their family home which was worth $400,000 and the unit itself.  The difference in the amount borrowed and the purchase price was to be used to pay substantial Blue Chip fees.  In the meantime, the Bartles' income would increase by $451 per fortnight (before tax), being rental on the apartment.  In reality of course, the Bartles were actually borrowing the money to pay that sum to themselves.  So the Bartles were unwittingly borrowing very heavily in order to facilitate a relatively small income stream for four years paid from borrowed moneys and with only the possibility of a small capital gain, and with a good chunk of what they had borrowed going to Blue Chip's various pockets.

Although GE advanced the loan, GE outsourced the 'origination and management' aspects of the loan to TML.  The loan was set up through a "fast document scheme" under which self employed investors were not required to produce proof of income.  Advances would be approved if borrowers had sufficient loan to equity value ratio in their home and signed a declaration as to ability to pay.

The Bartles received poor advice from their lawyer which did not enlighten them of the true situation until much too late.  When the mortgage inevitably went into default, the unit fetched only $250,000 on resale. 

The Bartles sought to have this credit transaction ruled invalid on the basis that it was unconscionable at common law or oppressive and should be reopened under the Credit Contracts and Consumer Finance Act 2003 (CCCF Act). The High Court declined to reopen the mortgage transaction and the Bartles then went to the Court of Appeal to decide whether the credit transaction was susceptible to being reopened under the CCCF Act. 

The three Court of Appeal judges each found that the case did involve oppression within the meaning of the CCCF Act, albeit that their reasons differed somewhat.  The case was remitted back to the High Court for relief to be determined. 

In essence, and probably most significantly from the three separate judgments, the Court of Appeal held that GE remained responsible for the 'oppressive' transaction.  Even though GE had outsourced the origination and management of the loan to TML, and relied on TML to ensure the transaction was processed correctly, GE could not avoid its statutory responsibilities as the lender.  Justice Hammond found that GE failed to look into transactions which were vital for loans to be serviced.  A significant fact is that if GE had known the real facts as to Bartles' financial position, it would not have lent on these terms.  As Justice Arnold stated in his judgment, the CCCF Act is intended to protect the interests of borrowers under credit contracts and it is not possible to contract out of it.  To do so would mean that lenders could conduct their business outside the intent of the law.

While the CCF Act seeks to provide protection to borrowers, that in itself may not have been sufficient in this case without other contributing factors.  The Bartles had poor legal advice from their lawyer.  The overall scheme was 'fractured' and unnecessarily complex.  'Reasonable' standards of commercial practice were not observed by the lender.  The Bartles became party to an asset lending scheme where Blue Chip reaped the most rewards.  It was clearly evident that the Bartles would struggle to meet their repayment obligations.

For more information please contact: Deborah Miller, Ian McCombe, Chris Paterson or Howard Johnston (Partners, Commercial Property)

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Last updated: 22 June 2010

The contents of this publication are general in nature and are not intended to serve as a substitute for legal advice on a specific matter. In the absence of such advice no responsibility is accepted by Brookfields for reliance on any of the information provided in this publication.