The Deposit Builder Strategy (“the Strategy”)
This article explores the merits of the Strategy and examines whether it is likely to be effective in avoiding the requirement of the National Consumer Credit Code (“the Code) that vendors in the business of selling residential real estate to consumers under vendor terms contracts (aka instalment sales agreements) obtain an Australian Credit Licence. Whilst some of the legal concepts are complicated, I have tried to explain them as simply as possible.
I should make the point at the outset that lease option agreements (or rent to buy arrangements) do not typically involve interest being charged and therefore do not generally attract the operation of the Code or the need for an Australian Credit Licence.
The Deposit Builder Strategy was launched in 2013 as a solution for those investors who wished to sell residential property on vendor terms (aka instalment sales agreements) but did not have an Australian Credit Licence.
The Strategy involves a property being sold under a standard contract of sale. Whilst the contract provides for a 10% deposit, this is paid in instalments over an extended period – say two years – after which time the purchaser is supposed to pay the remaining 90% with the assistance of a bank loan. The purchaser takes possession of the property shortly after the contract is signed under a Licence to Occupy. The purchaser pays a separate amount as rent under the Licence to Occupy.
The promoters of the Strategy argue that no interest is being charged and the instalments due under the contract total a deposit of no more than 10% the Code cannot apply. Specific mention is made of Section 10 of the Code which provides that the Code will apply to contracts for the sale of land where the purchaser moves in before they get title and makes payments (other than a deposit of no more than 10%) without getting the title to the property. As no payments, other than the deposit, are made they argue the Code cannot apply.
The problems begin with section 10(3) of the Code which says that if the contract is subject to the Code section 10 doesn’t mean that it is outside the Code.
Hence, we need to go back to basics. Under the Code, the test of whether interest is being charged is whether there is a charge for deferring payment of a debt. That is, if I allow you to repay the $100.00 you owe me in a month’s time there is no charge and hence no interest. On the other hand if I let you hang on to the $100 if you agree to give me $105 in a month’s time, then there is a charge for deferring payment and hence interest.
In the context of the Strategy, it makes no sense to sell a house at today’s price on the basis that I get paid in two years time. It is implicit that I will set a higher price for the house, knowing that I won’t get my money for two years and / or that house prices may increase over two years. Hence there is a charge for deferring the payment of the 90% – being the amount by which the contract price exceeds the market value of the property. This means the purchaser is paying interest. For what it is worth, the fact that the 90% is payable in two years means that payment is deferred.
Put another way, selling a property using the Strategy will usually involve charging a premium for allowing the purchaser to pay in two years – and hence the vendor is charging the equivalent of interest. If the vendor does this a number of times then the vendor is in the business of charging interest to consumers, is subject to the Code and needs an Australian Credit Licence.
In words extracted from the Explanatory Memorandum accompanying the legislation when it was introduced to Parliament:
“Section 10 applies the Code to sale of land by instalments contracts by treating them as credit contracts.”
The Explanatory Memorandum makes it clear that the intent of section 10 was not to provide exceptions to the Code, but to expand the operation of the Code to ensure that terms contracts were subject to the Code. I note that the Victorian Supreme Court had already decided that the Code applied to terms contracts anyway.
There are other reasons to think that the Strategy would not be effective in avoiding the need for an Australian Credit Licence.
It is implicit in the Strategy that the vendor may need to bridge the gap when the contract is refinanced. That is, in two years when the purchaser needs to refinance the purchaser may not be able to obtain sufficient finance to pay out the 90% (plus stamp duty) the vendor will provide some sort of bridging loan. This loan might attract the operation of the Code (to the extent that interest is charged).
A court may decide that the payments over two years fall outside the meaning of “deposit”. There is some statutory basis for the argument that a deposit is an amount paid prior to the purchaser taking possession of the property. That is payments made after the purchaser moves in may be found not to be part of the deposit.
The Strategy suggests that if the purchase cannot refinance after two years the term of the deferral can be extended for a further period without reduction of the purchaser’s payments. However, if the purchaser has reached the 10% deposit ceiling, the purchaser is effectively paying higher than market rent for no direct benefit. A court may find this to be unconscionable and set the arrangement aside.
In Victoria, the Sale of Land Act provides that any contract where the purchaser takes possession prior to getting a transfer of title is a terms contract. A terms contract which runs for more than 90 days must require that the purchaser takes responsibility for the vendor’s mortgage. The Victorian Supreme Court has suggested that the mere act of taking responsibility for the vendor’s mortgage may be sufficient to attract the operation of the Code.
You cannot contract out of the relevant Victorian provisions so this is another reasons why the Strategy cannot be effective in Victoria (to the extent the aim is to avoid the Code).
Given that the Code is what is known as consumer protection legislation the courts will favour approaches and interpretations that seek to expand the ambit of the Code (and the protection for consumers) rather than uphold technical arguments that seek to limit the scope of the Code.
I do not believe that the Strategy is an effective way to avoid the need to obtain an Australian Credit Licence or to avoid the operation of the Code.
I believe that the Strategy offers no real advantage over a conventional terms contract. On the other hand, I am concerned that being new, untried and untested it raises new and unforseen risks.
The above represents a summary of my views – albeit after having taken advice from a barrister experienced in the area. This summary does not take into account the personal circumstances of any reader or their specific needs and objectives. It is general advice only and has been simplified to aid understanding and is therefore not intended to take the place of specific legal advice.
Thanks Lewis Obrien