Introduction
There are strata financiers marketing a product known as “hybrid” loan – structures in which an owners corporation (OC) borrows money from both a commercial lender and from individual lot owners within the scheme, variously called “Lending Owners”, “Participating Lot Owners” or “Self Funding Owners”. In this article I will use the generic term “Lending Owners”. On the surface, the concept has appeal: lot owners who prefer a special levy to fund their share of major capital works can do so directly without having to participate or contribute to the loan entered by the owners corporation.
However, in their current form, these arrangements are incompatible with the strata legislation in both New South Wales and Victoria. The legal problems are significant, and the consequences for owners corporations, lot owners and financiers alike could be severe.
How Lending Owners agreements are structured
To understand the legal difficulties, it helps to understand how the product attempts to work.
Consider a scheme with ten lots of equal unit entitlement that needs to fund $100,000 for capital works. Three lot owners volunteer to fund their proportionate share – $10,000 each – directly. Under a hybrid loan arrangement:
- The commercial lender advances $70,000 to the owners corporation;
- Each of the three participating Lending Owners lend $10,000 to the owners corporation under separate loan agreements; and
- All loan agreements – between the OC and the lender, and between the OC and each Lending Owner – carry the same interest rate and repayment terms.
Reviewing these agreements in light of the strata legislation with which they must comply reveals fundamental terms of the agreements a Court would hold to be void.
Under these agreements, the owners corporation raises levies on all lot owners to fund the repayment of both principal and interest on its loan obligations. However, the agreement creates a mechanism by which Lending Owners do not pay those levies using actual currency. Instead, the OC grants each Lending Owner a “credit” equal to the levy amount, which is then offset against what the OC owes the Lending Owner in principal and interest repayments. In effect, the two obligations – the Lending Owner’s levy liability and the OC’s loan repayment obligation – are netted off against each other, with no money actually changing hands.
It is this offset or “credit” mechanism that sits at the heart of one of the legal problems in both jurisdictions (I have referenced this other mechanism at the end of this article).
Why hybrid loans do not work with Strata Legislation?
The core legal problem is the ultra vires credits
Both the Strata Schemes Management Act 2015 (NSW) (see s.100) (SSMA) and the Owners Corporation Act 2006 (Vic) (OCA) (see s.25) grant owners corporations the power to borrow money. But neither Act grants any power to an owners corporation to credit a levy obligation against a debt owed by the OC in the manner these agreements require.
Strata legislation, for both New South Wales and Victoria, is quite prescriptive in how the finances of a strata scheme are managed, both in how funds are raised and how funds are expended. There is no power prescribed in either jurisdiction which authorises a strata scheme to grant a “credit” to a lot owner.
This is not a minor technical deficiency, neither is it something that can be resolved by contract or by a resolution at a general meeting. An act that is ultra vires (literally “beyond the powers” of the owners corporation) is unlawful, and the consequences flow through the entire structure of the loan agreements.
Consequences from the ultra vires “levy credit”
1. Lending Owners Become Unfinancial
In both New South Wales and Victoria, lot owners who fail to pay their levies become “unfinancial” – a status that, among other matters, strips them of the right to vote at general meetings. Because the levy credit is of no legal effect, the Lending Owner’s levy remains formally outstanding regardless of the offset arrangement in the loan documentation. The Lending Owner is therefore in default of their levy obligations.
The irony is stark: the lot owners who agreed to fund the scheme’s capital works – and who have in fact advanced their own money to the OC – find themselves classified as non-paying owners, unable to participate in the democratic governance of their own scheme.
2. Record Keeping and Audit Obligations Cannot Be Met
Strata legislation in both states imposes detailed obligations on owners corporations to keep accurate financial records and to reconcile their bank accounts. The New South Wales legislation specifically requires the OC to record every transaction of money received or disbursed, and each year to reconcile those transactions against the OC’s banking records.
The credit mechanism creates an insurmountable problem: because no money actually moves when the offset is applied, nothing appears on the OC’s bank statement. The owners corporation, treasurer or auditor cannot verify a bank reconciliation that does not reflect the notional credits, and an auditor cannot sign off on accounts that cannot be reconciled. In Victoria, the legislation requires the accounts to provide a true and fair view of the OC’s financial position – something that cannot be achieved if the offset arrangements are not properly reflected in the records.
3. Void or Unenforceable Loan Agreements
The OCA 2006, section 202 states that any contractual term that purports to “exclude, modify or restrict the operation” of the Act is void. If the Lending Owners’ loan agreements are found to have this effect – by, for example, purporting to relieve a Lending Owner of a levy obligation the Act requires to be paid – those terms may be struck out entirely.
There is a similar provision in the New South Wales legislation, see s.270 of the SSMA.
The consequences of this would be dramatic. If key provisions of the contract (i.e. the loan agreement) are void, the agreement becomes unworkable. Monies advanced to the OC by both the commercial lender and the Lending Owner may no longer be subject to any enforceable repayment obligation, potentially causing the lenders to commence urgent legal proceedings to protect funds advanced.
Additional issues
Taxation: An Additional Concern
Even setting aside these structural legal problems, Lending Owners face a tax complication that many may not anticipate. In ATO Product Ruling PR2024/2, the Australian Taxation Office confirmed that interest received by a participating lot owner – even when received by way of a credit rather than as an actual cash payment – constitutes assessable income in the hands of the Lending Owner in the year the credit is applied.
This means lot owners who have lent funds to their owners corporation must declare the interest component of any levy credit as income in their annual tax returns. For a lot owner who entered the arrangement expecting a straightforward way to fund their share of works without ongoing tax complications, this may come as an unwelcome surprise.
What Happens When a Lending Owner Who Has Lent funds to their Owners Corporation Wants to Sell?
A further practical difficulty emerges if a lot owner who has lent to their owners corporation wishes to sell their lot during the term of the loan. The Lending Owner loan agreement is a contract between that individual and the owners corporation (and the strata lender). An incoming purchaser is not a party to that agreement and cannot automatically step into the Lending Owner’s position.
Arranging an assignment of the loan will require a deed of assignment executed by the Lending Owner, the incoming purchaser, the owners corporation and the strata lender. The OC would need to convene a general meeting to pass the necessary resolution. Coordinating four parties – including a strata lender and a body corporate manager – in the course of a property sale is, to say the least, a significant practical burden that the current products do not adequately address.
What Should Happen Next?
The “hybrid” loan product, in its current form, is not compatible with the strata legislation of New South Wales or Victoria. Owners corporations that have already entered into these arrangements face considerable uncertainty, and those considering doing so should seek independent legal advice before proceeding.
For the product to have a viable future, it would need to be fundamentally redesigned to eliminate the levy credit mechanism and replace it with an arrangement that operates within the strict framework that strata legislation prescribes for the collection, management and recording of levy funds. That is no small task – but it is the necessary starting point for any structure that seeks to involve lot owners in the funding of their scheme’s capital works and ensures compliance by the owners corporation, the strata manager, the treasurer and the auditor.
There are further problems not covered here including:
- These products bear all the hallmarks of Managed Investment Schemes (MIS). If the regulator holds them to be MIS – the question becomes whether the finance companies promoting them will be able to deal with the very onerous added costs of compliance – and any penalties that might be applied under the MIS regime?
- Commercial lenders promoting these loans will need to be very clear that such a complicated offering is clearly described in their Target Market Determination under Part 7.8A of the Corporations Act 2001 (Cth).
- These loan products raise the problem of split interests (those owners who are Lending Owners and those owners that are borrowing the funds) which need consideration in light of legislative requirements to manage conflicts of interest.
Owners corporations and their committees, strata managers, auditors and financiers alike should approach existing hybrid loan arrangements with caution and ensure that appropriate legal and financial advice is obtained to protect all parties involved.
This article is written by Gerard Doyle, Partner at Bugden Allen and was first published on 19th May 2026.
© Bugden Allen Group Legal Pty Ltd. This is general information only and not legal advice. You should not rely on this information without seeking legal advice tailored to your specific circumstances.
