Autumn 2018 ISSUE
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FIRST COMMENT IN THIS ISSUE: • PROTECTING DEPOSITS ON NEW-BUILDS • BUILDING SCHEMES - A TIMELY REMINDER? • TENANT ENDORSEMENTS • UNDERWRITING PRODUCT FOCUS: UNKNOWN RESTRICTIVE COVENANTS
Leading Title Insurance
Welcome to the Autumn edition of our newsletter for 2018. In this issue we have a contribution from Paul Butt, of Rowlinsons Solicitors, who gives his thoughts on the subject of protecting deposits, especially around new-builds. We have contributions from two of our London-based Team Managers and Commercial Underwriters: William Goodwin and Ben Baker. Will has written us a piece around the enforceability of restrictive covenants, particularly the complicated method of building schemes. And Ben looks at how we can protect tenants as well as property owners.
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FIRST COMMENT
Protecting deposits on new-builds by Paul Butt Consultant Solicitor Rowlinsons Solicitors
Introduction A recent query by a colleague reminded me of the risks of paying large deposits to developers of new-build properties, should the developer become insolvent. The ‘normal’ deposit is, of course, 10% of the purchase price, a large enough sum to lose, but in some new-builds of investment properties, a larger deposit is often required – sometimes as much as 50%. So what is the risk in such cases? Normally, on an ‘ordinary’ purchase, the Standard Conditions require the deposit to be held as stakeholder. So the deposit does not belong to the seller and will often remain in the seller’s solicitors’ client bank account until completion. Alternatively, the Standard Conditions allow the seller to use the deposit as a deposit on his / her own purchase, as long as it is then held on the same stakeholder terms. In either case the deposit does not belong to the seller and will be unaffected by the seller’s insolvency.
But on any type of new-build, the developer will usually require the use of the deposit to help fund the building work and thus reduce its borrowing costs. To facilitate this, it is standard for new-build contracts to require the deposit to be held as agent for the seller. It thus belongs to the seller and, indeed, will usually be handed over to the seller by the solicitors so it can be used to help fund the building work. On insolvency, the buyer would then be left with a claim as a creditor in that insolvency for the amount of the deposit and would likely receive only a very small percentage of the amount paid – if anything at all! In most cases, of course, the developer will be offering a new-build guarantee (e.g. NHBC) that will also offer deposit protection in the case of the developer’s insolvency. Note, however, that this usually only covers the normal 10% deposit; there are still risks if a higher deposit is paid. So in most new-build purchases it is a non-issue which we can safely ignore.
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FIRST COMMENT However, the query I received involved a new-build purchase from a small developer who was not offering an NHBC or similar style warranty. On offer was a professional consultant’s certificate in the UK Finance (previously CML) approved form – in this case by an architect who was to supervise the building work and would make various promises as to the quality of the construction work. As usual in a new-build the deposit was to be held as agent for the seller. To digress slightly it is rather surprising that most lenders will accept these professional consultant’s certificates. I say ‘surprising’ as they really are the poor relations to the other kinds of warranty available. For a start they only offer six years’ cover, rather than the 10 years of other warranties. They also depend upon the particular consultant continuing to be insured throughout that period. All the buyer has is a right to sue the consultant if defects in the property occur, without the added benefits of the other schemes. But if the consultant ceases to be insured during the six year period you will be left with a claim against the consultant personally – who could, of course, have no assets to meet such a claim. And let’s not forget the Court of Appeal decision in Hunt & Others v Optima (Cambridge) Ltd [2014] EWCA Civ 714 where it was held that buyers could not rely on such a certificate at all unless they had received it prior to exchange of contracts or the consultant had entered into a collateral warranty – i.e. a direct contract between the consultant and the buyer. Without one or the other the buyer obtains no protection at all – and the conveyancer will face a claim for negligence if there are unresolved structural problems. But what about the risk of losing the deposit? Such a certificate does not, of course, offer any protection for the deposit in the case of the developer’s insolvency. So how can a buyer be protected against such a loss where the new home warranty offered does not cover it? The answer is that there is no absolute guarantee that the money can be recovered in the case of insolvency and so clients should be warned at an early stage of the risk involved and that we cannot be expected to guarantee the builder’s continuing solvency.
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FIRST COMMENT What we can do – indeed must do - is to register a Unilateral Notice against the developer’s title at Land Registry to protect the contract as far as we are able. This must be done immediately on exchange and does not need the developer’s consent to effect the registration. This will then make the contract binding on a sale by the developer. It will also protect against a sale by a subsequent lender – but not against a sale by an existing lender. But more importantly, recent cases also show that there will be some protection in the case of the developer’s insolvency. In Eason v Wong [2017] EWHC 209 (Ch) the developer planned to redevelop a site in Nottingham with 131 flats above a ground floor commercial unit. Contracts were exchanged for the sale of most of the flats, the buyers paying a deposit of 50% of the purchase price. Unfortunately, the developer became insolvent. Although the existing building on the site had been demolished, no work had been carried out on the construction of the new building. The buyers had registered their contracts at Land Registry. However, when the liquidator found a buyer for the site, the liquidator then contested the validity of the registrations effected by the buyers on the basis that the flats they had agreed to purchase did not exist. The point was, of course, that if the buyers’ registrations were valid, then they would in effect be secured creditors and would be reimbursed from the sale of the development site. This was because the payment of the deposit gave them an equitable lien or charge over the property agreed to be purchased for the amount of the lost deposit. If the registrations were not valid, then they would just be unsecured creditors in the liquidation, and bearing in mind that the site was the company’s sole asset, would end up with nothing. The liquidator argued that as the flats did not exist, the buyers could not have a charge over them. The court disagreed. It confirmed that, provided the contract referred to a specific identifiable property,
where a buyer has paid all or part of its purchase money, this entitled the buyer to a lien over the property in respect of the monies paid. The lien would not attach to the whole of the seller’s land but to that specifically identified property being sold. In this case the lien attached to the air-space, which the property referred to would be occupying, had it been built. It did not matter that the building had not been fully or even partially completed. In the more recent case of Williams v Broadoak Private Finance Ltd [2018] EWHC 1107 (Ch) the developer, Birchen House Ltd, planned to convert the former Pier Hotel in Birkenhead into 62 flats with commercial units on the ground floor. Unfortunately, it went into administration during the course of the project but only after a large number of the flats had been sold off-plan. Each buyer had paid a deposit of 25% of the purchase price of the flat they had agreed to buy. Despite the payments of these deposits, the developer obtained further funding by way of a secured loan from Broadoak Private Finance Ltd. The administrator applied to the court for directions as to which of the buyers, if any, had priority to the proceeds from the sale of the development. The company was a special purpose vehicle set up just to carry out this development, so its only asset was the property. And the sale of the property was likely to fetch approximately the amount that was owed to Broadoak which had a registered charge over the property. If Broadoak had priority over the claims of the buyers to recover their deposits, they would get nothing back of the 25% they had paid. For the purpose of the exercise of considering priorities, the court divided the contracting buyers into three categories. First, category A, were three buyers who had registered their contracts against the seller’s title before the charge in favour of Broadoak was registered. Second, category B, were 46 buyers who had registered their contract only after the charge in favour of Broadoak had been registered. Finally, there were five buyers in category C, who had taken no steps at all to register their contracts against the seller’s title.
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FIRST COMMENT Citing paragraph 25.203 of Volume 2 of Emmet and Farrand on Title, the court (HHJ Hodge QC) followed the general rules of priority relating to registered land as laid down by the Land Registration Act 2002. So, as between registered and unregistered charges, a registered chargee takes subject to any prior mortgages and charges which are protected by notice on the register or are overriding, but free from all others. Prior mortgages and charges can be overriding interests only if they are local land charges or if the prior chargee is in actual occupation of the mortgaged property. Neither was the case here as none of the buyers were in actual occupation of the property. Thus the category A buyers, who had registered their contracts before the creation of the legal charge to Broadoak, had priority to any proceeds from the sale of the development to a third party. However, having registered its legal charge, Broadoak had priority over the category B buyers as their equitable interests arose after the creation of the legal charge. The category C buyers, of course, had no protection at all. Thus, the category A buyers could expect the return of their deposits in full (together with interest) before any proceeds were due to Broadoak. The remaining buyers would be likely to lose their deposits and be left with nothing.
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Conclusion These cases should act as a warning to conveyancers. Buyers must be advised of the risk of a developer becoming insolvent. The conveyancer should protect the deposit as far as it can be by registering the contract by means of a Unilateral Notice on the seller’s title. This will then provide protection for a buyer where there are no prior interests, such as a legal charge, that take priority to the buyer’s claim under its sale and purchase contract. But very often, of course, there will be a prior charge in favour of a lender which will have priority over the buyers. In such cases, buyers must be warned of the risk of the deposit being lost completely should the seller become insolvent. Buyer – and conveyancer - beware still remains very true in this area.
FIRST COMMENT
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Building schemes - a timely reminder? by William Goodwin Commercial Underwriter / Team Manager
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FIRST COMMENT
When a landowner is contemplating whether to develop their land, restrictive covenants are one of the first potential legal title obstacles that they need to consider in order to decide whether the proposed scheme is viable. Restrictive covenants present a significant risk on development schemes, as depending on the nature
of the restriction, its enforceability and potential numerous beneficiaries, it could render the entire scheme at risk. Once the landowner identifies a potential onerous restrictive covenant issue the next question to ask is whether they are enforceable and by whom.
It is well established that there are three basic methods by which successors in title can seek to enforce restrictive covenants.
on the framework which the court uses to interpret whether such scheme is in existence. The key characteristics are:
i) assignment (i) it applies to a clearly defined area; ii) annexation iii) building scheme Annexation and to a lesser degree assignment are arguably the most common methods in the conscience of a landowner by which restrictive covenants may be deemed enforceable. The third and the subject matter of this article, is one of the lesser known methods. This method has recently been brought to the attention of landowners and their advisors by a flurry of cases where the claimant seeks to demonstrate that the restrictive covenants formed part of a building scheme.
Birdlip Ltd v Hunter and another [2016] EWCA Civ 603 is the first significant case dealing with building schemes to reach the Court of Appeal for over 25 years. It serves as a timely reminder
(ii) it relies on a common vendor who creates the scheme; (iii) each property must be burdened by restrictions intended to be mutually enforceable; (iv) the limits of the defined area and intended mutual enforceability must be known to each of the purchasers; (v) the common vendor is himself bound by the scheme so they cannot dispose of plots within the defined area, other than on the terms of the scheme; and (vi) the effect of the scheme is that it will bind future purchasers within the area.
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FIRST COMMENT In this case, the Court of Appeal overturned the lower court’s interpretation that a building scheme existed and cited the limitations of permissible inference, in particular when considering points i), iii) and iv). Judge Lewison LJ stated the following:
’25. One would have thought, a priori, that in the case of a scheme of mutual covenants designed to last potentially for ever, that that intention would be readily ascertainable without having to undertake laborious research in dusty archives searching for ephemera more than a century old. In almost all cases to which we were referred where a scheme of mutual covenants was found to exist, the area of land to which the scheme applied was ascertainable from the terms of the conveyance or other transactional documents in question. Conversely where the conveyance or other transactional documents gave no indication of the land to which the scheme applied, no scheme was found.’
Khoury v Kensell is another recent example. Unfortunately for the claimants, they failed to convince the court that a scheme existed. In the County Court the judge cited there was no sufficiently defined area where the scheme operated nor was there a clear intention that the purchasers of the plots were intended to be subject to mutually enforceable covenants. On appeal, the High Court accepted a defined area existed, but reaffirmed the lower court’s interpretation that there was no express intention for the restrictions to be mutually enforceable and that there was no evidence provided to infer such an intention. They draw particular attention to an express reservation within the underlying deed of a right to use the retained land as the seller wished, and the inclusion of an obligation on the purchaser to ensure that any successor in title enters into a direct covenant with other plot owners to comply with the covenants.
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The court held that such a scheme of covenants should be inferred as pointing in the opposite direction from creating a building scheme. Both these cases are timely reminders of the characteristics required to demonstrate the existence of a building scheme and the difficulties in evidencing them. Particular attention is drawn in both these cases to a potential stumbling block relating to the lack of clearly ascertainable express intention within the terms of the imposing conveyance or the transactional documents.
FIRST COMMENT
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Tenant endorsements by Ben Baker
Commercial Underwriter / Team Manager
The majority of our title insurance policies are geared towards protecting property owners. However, did you know that we also offer cover that is aimed at protecting the interests of tenants? The automatic inclusion of tenant endorsements in defective title insurance policies is not normal practice. A standard title insurance policy insures against the loss in value of a site. It will also cover the costs that an insured is legally liable to pay pursuant to an order or settlement.
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Why are tenant endorsements necessary? Standard title insurance products are ideal for property owners and the losses they are likely to suffer if a title defect adversely affects their use of a site. However, tenants typically have different interests in a site and could therefore benefit from additional, bespoke cover under a policy to protect their interests.
When might tenant endorsements be appropriate?
These policies are ideal for a developer or property owner trying to protect an asset they own. However, in the event of a claim where there is a lease, and a known risk prevents the use of the site, specific tenant losses could be incurred that are not included in a standard title insurance policy.
Tenant endorsements should be included in a title indemnity policy when there is a risk of loss to the tenant. If, for example, a site is developed subject to a covenant not to sell alcohol, and a retail tenant takes a 15-year lease of the ground floor, they would expect to be able to sell alcohol as part of their usual retail offering.
Specific tenant losses include: a tenant’s ongoing obligation to pay rent; tenant fit out costs that become abortive; and loss of profits if the tenant cannot trade from the site while a title insurance issue is being dealt with.
If such a covenant is successfully enforced, the freehold owner of the site would be compensated for the loss in value suffered as a result of the ground floor retail unit being unusable for the sale of alcohol.
This means that tenant endorsements on the policy may be appropriate to protect the tenant’s interests.
The tenant will then be covered as a successor in title, and eligible for cover in relation to the
standard policy losses. However, as a relatively short lease, the tenant’s leasehold interest will not have significant value. Furthermore, the tenant will probably have an obligation to continue paying rent under the lease until such point as they can exercise a tenant break clause. This is where a Rental Liability endorsement from First Title could be invaluable. Under this endorsement, the named tenant would be able to call upon First Title to pay their rent in circumstances where they are unable to use the site for the insured purpose. In addition, a First Title Tenant Relocation endorsement could be included to cover the cost of finding and relocating to an alternative location for an equivalent term, allowing the tenant’s business to continue to trade. As mentioned earlier, loss of profits may be a concern and a Loss of Profit endorsement could be included to cover the lost profit to a tenant for the period in which they are unable to trade, while a claim is being dealt with.
What is required to provide tenant endorsements? Tenant endorsements are typically provided for the benefit of a named tenant, in relation to a specific lease or agreement for lease. Tenant endorsements have their own apportioned limit of indemnity, so that the tenant is reassured that they will have sufficient cover in the event of a claim.
First Title will therefore require details of the proposed tenant; the value and type of losses the tenant intends to insure; and details of the proposed use of the site.
What issues should landlords and tenants consider? Landlords might want to consider offering an incoming tenant the benefit of a tenant endorsement to make the site more attractive; or to ensure that any potential claim would not have a significant impact on the viability of the tenant’s business. Landlords must be aware that there will be an additional premium payable for tenant endorsements. They should also understand that a tenant endorsement needs to be provided in relation to a specific lease or agreement for lease. This means that it may not be something the landlord can include at the outset of a project when acquiring their own title insurance. However, tenant endorsements can be added to a policy that has already been issued, once the proposed tenant and their intended use of the site is known. Tenants should consider what losses they may suffer in the event of a claim against the freehold. They may, for instance, require tenant fit out costs to be specifically ring fenced within a policy. They may also need to consider their options in the event that a title defect prevents them from trading.
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Unlike some other providers, we: • can help with over 45 known
risks as well as providing bespoke cover • have one of the largest single underwriting capacities in the market • are directly responsible for handling and paying claims
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Call: +44(0)207 160 8100 Email: info@firsttitle.co.uk Visit: www.firsttitle.co.uk First Title Insurance plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. First Title Insurance plc is registered in England under company number 01112603. Registered office: ECA Court, 24-26 South Park, Sevenoaks, Kent, TN13 1DU.
Leading Title Insurance
FIRST COMMENT
Product Focus:
Unknown restrictive covenants Background The insured was the purchaser of the land, which included a church hall with parking and associated children’s play areas. This was being demolished and the site redeveloped, with residential dwellings. Cover was required on a post-planning basis, in accordance with the planning permission obtained, to cover a possible breach of unknown restrictive covenants affecting the site as a result of the redevelopment. Restrictive covenants are a burden on land. They restrict what a land owner may or may not do with the land.
• Action by a third party resulting in payment for a release of the restrictive covenants. • Action by a third party resulting in the insured expending monies in order to discharge or modify the restrictive covenants at the Lands Tribunal.
Challenge As the restrictive covenants are unknown, it was impossible to assess whether or not these restrictive covenants would be breached by the redevelopment.
The possible risks to the insured:
Solution
• Action by a third party resulting in a possible injunction preventing or restricting the development and / or an award of damages. In a worst case scenario, demolition.
First Title was able to underwrite the risk and provide a policy to the insured, ensuring they would be indemnified in the event of a claim by a third party seeking to enforce any unknown restrictive covenants.
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To find out more about our products and services email info@firsttitle.co.uk or call +44 (0)20 7160 8100
www.firsttitle.co.uk
First Title Insurance plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. First Title Insurance plc is registered in England under company number 01112603. Registered office: First Title Insurance plc, ECA Court, 24-26 South Park, Sevenoaks, Kent TN13 1DU.