Paper 8 - Sinking Funds

This document is not to be construed as providing legal advice, or as prescribing how any particular owners corporation should manage its affairs. It is a summary, in layman's language wherever possible, of how some important concepts are provided for in the legislation, and how owners corporations might take account of those provisions when formulating their management philosophies and procedures.

1 The Act

a. Every owners corporation must maintain its common property, and those with 4 or more units must have a sinking fund plan for doing so. Plans complying with the provisions of the Unit Titles Act or earlier versions of the Unit Titles (Management) Act (the Act) that were adopted before 4 April 2013 are deemed to comply with this Act, but should be brought into line at their first review. In all other cases, owners corporations must adopt a sinking fund plan compliant with this Act by 30 March 2013 or 12 months after the corporation's first AGM, which ever is the later. (Ss 81, 84 & 157). A Sinking fund plan must be approved for the 10 year period beginning on the first day of the financial year after it is approved.

b. A sinking fund plan must be based on estimated expenditures of the kinds identified in section 83 of the Act, and it must state:

the expected sinking fund expenditure for at least the 10 year period of the plan;

the total contribution needed in each year of the plan to meet expenditure in that year; and

an amount necessary to accumulate funds to meet expected expenditure over at least the remaining years of the plan

c. Each owners corporation must review (and if necessary update) its sinking fund plan at the end of the plan's first four years, and at the end of each five year period thereafter. (S 85)

d. Expenditures from the sinking fund must be consistent with the sinking fund plan, but the plan may be amended at any time to ensure its ongoing adequacy. (Ss 86 & 88)

e. Each year, an owners corporation may determine a sinking fund contribution required from its members, which amount is the “total sinking fund expenditure” identified in the sinking fund plan for the financial year, divided and levied in accordance with each member's unit entitlement. (Ss 72 & 89).

f. Owners corporations may, by special resolution, establish funds for particular purposes, (special purpose funds) and the purposes for which special purpose funds may be spent can only be altered by special resolution of the owners corporation. (S74)

g. Owners corporations must pay into their sinking funds:

i. sinking fund contributions received from members;
ii. any amount received that is not required or allowed to be paid into a general fund;
iii. amounts authorized by ordinary resolution to be transferred from the general account; and
iv.  amounts transferred from a special purpose fund to the sinking fund in accordance with the purpose for which the special purpose fund was established. (S87 (d))

2. Planning

a. A Sinking Fund is a way of ˜saving up” for known large costs, and often with a bit extra for insurance against unforeseen contingencies. Some costs will be incurred in the shorter term and others some years in the future. Sinking funds need to cater for both the short and long term and the plan should be designed and managed so as to have on hand the appropriate funds to meet scheduled or predictable maintenance and repair obligations as and whenever they may arise. Owners corporations may also deem it appropriate to make special arrangements to cater for unpredictable contingencies, such as the unpredictable failure of a major item of property or other asset that will require urgent expenditure.

b. Sub-section 82 (2) of the Act requires an owners corporation to have a plan that covers a ten year period. Section 82 continues, at sub-section (3), to provide that the plan must state the expected expenditure for at least the 10-year period of the plan and the contributions required to meet expenditure in each year of the plan plus an amount necessary to accumulate funds to meet expected expenditure over at least the remaining years of the plan.

c. To a lay person there is some uncertainty as to the total amount of expected expenditure that could be included in a sinking fund plan as being for expenditure during “at least” the period of the plan, which is stated to be 10 years and approved as such by the owners corporation. At first glance, it would seem that the corporation’s power to accumulate sinking funds is limited to the amount of expected expenditure during the 10 years of the approved plan.

d. Many owners corporations are, however, responsible for the maintenance and repair of assets that require major expenditure at intervals considerably greater than the 10 year slice of time that seems to be prescribed by section 82 of the Act. But the revised wording of section 82 seems still to restrict the contributions that can be required of owners under section 89 to those amounts that are planned for expenditure during the 10 years of the current plan. The reasoning given for a recent ACAT decision suggests that in the event of an appeal against a levy aimed at accumulating funds for expenditures beyond that 10 year horizon, the tribunal might base its ruling on the literal meaning of the Act’s wording, and find the levy to be invalid. Pending resolution of this apparent oversight, owners corporations that have assets with refurbishment or repair periods longer than 10 years would be wise to consider how funds for those responsibilities might best be accumulated.

This aspect is discussed further under “Funding a Plan”, below.

3 Formulating a Plan

a. Sinking funds must to the extent possible cater for three classes of repairs and maintenance:

(i) those that are carried out in most or all years and which are readily costed;

(ii) those which are predictable, but are required only at longer intervals; and

(iii) those that cannot be forecast but which nevertheless could require significant outlays.

b. The plan should identify each item of common property or other asset for which the owners corporation is responsible, and quantify the funds required from time to time to maintain the property or asset in good condition.

c. As a first step, the executive committee should prepare an inventory of the common property and other assets, and obtain annual and long term cost estimates for necessary maintenance, repair, and reconstitution for each asset. Each item should also be classified as being once off or recurrent, and the time(s) at which each category of expenditure should be estimated. If possible, the cost and likelihood of contingencies should also be estimated.

Note that some major assets not only have long lead times, but the costs may vary widely between premises. Lifts that, depending on age and type fitted, might require replacement of the cars at 15 to 20 year intervals and major refurbishment of machine rooms at 20 to 25 year intervals, with significant unit cost variation depending on type, are challenges which few owners corporations will have the ability to estimate without professional advice. Similar considerations apply to various other facilities.

d. The plan must cover not less than the 10 year period with 5 yearly reviews prescribed by the Act. The plan should encompass shorter lead time items as they occur, but the minimum period that must be covered by the plan is at least that required to arrive at the longest lead time item.

4 Funding a Plan

a. Having documented the maintenance program (the plan) the owners corporation must determine the funding strategy that will best suit its needs, having regard to how much money it presently has in its sinking fund or other funds that might be available for transfer to the sinking fund. Figure1 is intended to illustrate how part of one possible plan might look. The example is of a unit plan, two years old, with one major asset requiring refurbishment every 14 years, and another every 23 years. Also included, as Asset 1, are those minor maintenance activities (cleaning, lawn mowing, etc) that occur every year and can be accurately costed. Other assets, with shorter maintenance periods, (5 or 8 years for example) could be included, but this example should serve to illustrate an approach consistent with the section 82 example but covering some other possible requirements as well. In this hypothetical scenario, in year 9, the owners corporation amends its plan to include the acquisition of some new property, which will require major maintenance every 8 years. No provision has been made in the sinking fund prior to that time. The new property will benefit owners from that time on, but owners have derived no benefit prior to the acquisition.

b. The strategy adopted in Figure 1 is that as each major asset is refurbished or replaced, the accumulation of funds towards its next refurbishment or replacement begins, with (in this case) in addition, the amounts required to service a loan taken out to finance the purchase of the new asset as well as the contribution for its maintenance which from then on will be catered for in the same way as the other assets. Figure 1 shows 4 separate elements:

(i) Asset 1, in which it is assumed that the levy is collected and spent each year with no contribution to the accumulation in the sinking fund;

(ii) Asset 2, which starts with an opening balance of $6,500 and an estimated requirement to increase that balance to $50,000 by year 12; and then to start raising funds toward its next overhaul in year 26 and then towards its year 40 overhaul and so on;

(iii) Asset 3, which starts with an opening balance of $6,000 and an estimated requirement to increase that balance to $75,000 by year 21, and then commence raising funds towards its next overhaul, which will be due in year 44; and.

(iv) Asset 4, requiring expenditure of $25,000 in year 9, to be repaid over 15 years at 6% and with an expected maintenance expenditure of 5,000 at the end of 8 years, and each 8 years thereafter.

c. The chart also shows the effects of amendments to the plan to accommodate successive reviews and updating of cost estimates, and the benefits of interest earned on the accumulated fund. The total levy column shows how the major expenditures have been “averaged out” over the thirty years covered in the chart to arrive at the amount which each year should be divided among and levied on unit owners in accordance with their unit entitlements.

The OCN will continue its attempts to resolve the apparent anomalies in the way the sinking fund provisions focus on a fixed calendar period instead of the lifetime of the assets that have to be maintained.

BUT pending progress on that front, and noting the considerations mentioned in 2.d above, owners corporations may deem it prudent establish special purpose funds for the purpose of augmenting the sinking fund as and when necessary, and holding the funds identified in the long term columns of their sinking fund plans in those special purpose funds (which are not subject to the restrictions of sections 82 and 89).

5 Contingencies

a. The best laid plans of mice and men gang aft agley. Disasters happen. In the context of a unit plan, the cost of refurbishing an asset might turn out to be much more than expected, such as might happen if what started out to be a routine overhaul of some equipment turned out to be total replacement and associated building works because parts for the original equipment were no longer available. Even in a small class B plan a variety of possibilities, however improbable, might appropriately be provided for. The question is how best to do so.

b. Funds, once placed in a sinking fund can only be spent for the specified purposes, and providing for something which it is estimated will never occur seems at odds with that sort of planning. An owners corporation might, where it deems it appropriate, establish a special purpose fund for the purpose of augmenting the sinking fund in the event of an unforeseen or unpredictable event. Keeping reserve moneys in a reserve special purpose fund not only avoids that conundrum, but allows, in the event of some or all of such funds not being required for the original purpose, they can, by special resolution, be directed to other expenses of the corporation.

6 Supplementing the Sinking Fund

a. Some parts of an owners corporation property are protected by the insurance policy that it is required to have (with some exclusions - see S 99 ), but the corporation must maintain a sinking fund plan and fund to maintain the common property. Funds once placed in a sinking fund may be expended only on the purposes listed in S 83.

b. When owners corporations compile their list of assets to be protected by their sinking fund plan, they may sometimes identify possible events of which the likely repair cost and/or probability of occurrence are difficult to estimate. Providing sinking fund cover for the minimum likely cost risks possible major shortfall and need for special levies at an unpredictable time. Providing sinking fund cover for the maximum possible cost may result in funds being collected but never spent.

c. Funds can be transferred from the administrative fund to the sinking fund by ordinary resolution, but owners corporations would need to consider the desirability of accruing sufficient surpluses in that fund to provide the required protection.

d. One, and possibly a better, solution is to establish a special purpose fund for the purpose of augmenting the sinking fund when and if any event mentioned in the establishing resolution occurs. Thus the sinking fund would identify every known possible outlay requirement, but except where the outlay on a given item can confidently be predicted, would be funded only to the minimum estimated expenditure on each. The amount to be put in the special purpose fund is the difference between what is put in the sinking fund and the maximum amount(s) required for the difficult to estimate items.

e. Such a special purpose fund might be entitled “Sinking Fund Augmentation Fund”, and the resolution by which it is established might read: “That a fund be established pursuant to section 74 of the Unit Titles (Management) Act for the particular purpose of augmenting the Sinking fund in the event that the provision made in that fund (for named events if desired) proves not to be sufficient to allow the owners corporation to discharge its responsibilities under section 24 of the said Act.”

Revised:  30 June 2013.

The Administrator,
5 Jun 2015, 20:29