Can developers still rely on a sunset clause to terminate a contract for sale?
The media often portrays sunset clauses as nothing more than a method for unscrupulous developers to profit from a rising real estate market. Little wonder then, that the State government recently moved to curb their use by introducing s 66ZL into the Conveyancing Act.
But sunset clauses have a real and practical commercial effect that can benefit both sides, particularly when a developer simply can’t complete a development within the timeframe they’d hoped.
So has the sun really set on sunset clauses or should you rely on those that you’ve included in your contracts for sale?
What’s the purpose of sunset clauses?
A sunset clause lets a developer rescind an off-the-plan contract if the preconditions for settlement haven’t been met by a certain time. On a practical level, that usually means that the development hasn’t been completed, which in turn means that the strata plan hasn’t been registered and the subject lots haven’t been created.
For many years, the sunset clause has been a standard and unremarkable feature in contracts for off the plan properties. But, since 2012, the significant rise in Sydney residential property prices has meant some developers have been using the sunset clause as a means for terminating the contract with the original purchaser and reselling the same property at today’s prices.
This has led the NSW government to introduce s 66ZL.
What section 66ZL says
Section 66ZL of the Conveyancing Act now lets a developer use a sunset clause to rescind an off-the-plan purchase only:
- If each purchaser under the contract consents in writing to the rescission, or
- Where a Supreme Court order permits it to do so.
To rescind the contract through either method, the developer must first serve a written notice on each purchaser of their intention, at least 28 days before they propose to rescind the contract. This notice must specify why they propose to invoke the sunset clause and why there has been a delay in creating the subject lot.
The Supreme Court will only make an order that the contract can be rescinded where it is satisfied that it’s just and equitable in all the circumstances. To determine this it will examine:
- The terms of the off the plan contract
- Whether the vendor has acted unreasonably or in bad faith
- The reason for the delay in creating the subject lot
- The likely date on which the subject lot will be created
- Whether the subject lot has increased in value
- The effect of the rescission on each purchaser, and
- Any other matter it considers relevant.
One developer’s post-section 66ZL application to rescind
Since s 66ZL was introduced in late 2015, there has only been one reported case in which a developer has applied for permission to exercise its rights under a sunset clause.
In Jobema Developments Pty Limited v Zhu, a sunset clause in the contract for sale allowed two years for a strata plan to be registered, after which the developer could rescind unilaterally. This two-year period expired on 31 December 2015.
The developer, Jobema, had taken over the project at the centre of the case from another developer, who had fallen well behind in its construction schedule. Jobema formed the view that the strata plan wouldn’t be registered until 2017.
On 1 December 2015 Jobema, issued a notice of proposed rescission to some, but not all, purchasers, stating that:
- Construction costs had increased significantly
- The original developer didn’t advance the project as it should have, and
- The contracts it signed didn’t meet the financial requirements for funding the build
Jobema offered the purchasers the chance to re-buy the same lot at 2015 prices but the purchasers refused this and did not give permission to rescind the contract. So the developer then applied to the Supreme Court.
What the court said
Justice Black of the Supreme Court denied the developer the chance to rescind and said that it had to honour the original contracts. In doing so, he ruled that:
- The original developer had breached a term of the contract requiring it to use reasonable endeavours to have the strata plan registered on or before the sunset date.
- There was no evidence for the delay in creating the subject lot, just speculation that the original vendor may have had difficulty in obtaining construction finance.
- There was no evidence that the lot had increased in value. However, if there was, he may have been less likely to grant permission because it would have allowed Jobema to profit from the original developer’s breach of contract while depriving the purchasers of their bargain.
- Jobema hadn’t established several matters its application relied on, including increases in construction costs and purchase prices.
- Jobema knew about the original developer’s delay and would have taken this into account when assuming responsibility for its obligations under the contract.
- Any assumption on Jobema’s part that it could enforce the sunset clause was a business risk, and the legislative change was also a risk which it assumed.
- He was concerned by the selective and unexplained process by which some purchasers received notices of proposed rescission and others did not.
Despite this, Justice Black found that Jobema had not acted unreasonably or in bad faith. He noted that the fact that construction wasn’t likely until 2017 didn’t count for or against allowing it to rescind. He also noted that there was no evidence of the effect of rescission on the purchasers, simply that they hadn’t consented to it.
6 lessons developers can learn from Jobema
Developers who are running behind schedule should take six main things from the Jobema decision before they attempt to enforce a sunset clause.
- They must be able to show they’ve complied with any obligation to make reasonable efforts to create the subject lots before the sunset date.
- They must be able to clearly state any reasons for the delay in creating the subject lots and also be able to support this with admissible evidence. Appropriate reasons may include difficulty in obtaining construction finance and other matters beyond their control.
- They should be aware that evidence of an increase in the value of the subject lots may be adverse to the application, but this may be countered by offering to share the increase in value with the purchaser.
- A projected time for completion of the development of 12 to 18 months after the rescission does not favour the developer or the purchaser. There is no guidance as to which party a shorter or longer period will favour.
- If they argue that there will be adverse financial consequences if it is unable to rescind the contracts, they must tender admissible evidence about:
- The likely profit or cash flow effects
- The attitude of their funders, and
- Their overall financial position.
- They should treat all purchasers equally, unless there is a reasonable explanation (supported by admissible evidence) for not doing so.
There’s no doubt that s 66ZL has curtailed developers’ ability to use a sunset clause to rescind a contract for sale. However, that does not mean that they can’t continue to be used as a proper and reasonable measure to manage the commercial risks of long-term projects.