Property Industry Update May 2010
Improving your chances of obtaining bank funding
Although we are seeing some recovery in property values, banks are continuing to restrict lending to a limited number of deals which have a clear likelihood of success and are virtually guaranteed to produce enough income to service interest and meet repayments throughout the loan term.
The market remains undeniably short of credit - but if you are looking to borrow, there are things you can do to improve your chances.
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Consider what you are actually trying to sell the bank and exactly what the basis of the proposal is. Present a credible strategy, know your deal and provide as much supporting information as you can, and you're on the right track.
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Looking at the basis of the deal, are you speaking to the right banks? Some industry sectors or asset classes are more or less off limits to certain lenders - so it's important that you know who's lending to whom.
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Take a long hard look at yourself - do you have a positive track record and can you offer what the bank is looking for in terms of expertise to lead the project through to a successful, and profitable, end? Should you be looking to introduce other parties for their expertise or to attract strategic investors?
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In these days of restricted loan to value, cash is king and so you need to demonstrate a healthy bank balance and equity interest. A detailed business plan setting out equity from principals and any outside investors will go a long way to demonstrating commitment to a project and allowing the bank to fund it.
Alex Innes, head of Semple Fraser's Banking & Finance Team, says:
"There are banks out there who are willing to commit to the right property deals. It's a frustrating market, and credit is hard to come by, but ultimately it's in your hands to find the opportunity and make it work."
If your lease is about to end...
If you occupy premises as a tenant, and your lease is due to end later this year, what should be thinking about?
The answer depends on whether you want to stay or leave.
If you want to stay:
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Consider opening negotiations with your landlord as soon as possible for a new lease or an extension to your existing lease - to avoid the risk of having to move out (or possibly being left in illegal occupation) after the end of your existing lease. It might also allow you to negotiate better terms for continuing occupation in a difficult market.
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Check whether your lease gives you an option to extend its length - if it does, check any notice provisions or other procedure you have to comply with to use the option.
Beyond that, the position is different north and south of the border.
In Scotland:
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If your lease is due to end very shortly, but your landlord hasn't yet sent you a notice to quit, contact your lawyer - if a notice to quit isn't served within the correct timescale, your lease may automatically continue (for a limited period) after the scheduled end date by what's called 'tacit relocation'.
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Depending on the nature of your business, you may be able to apply for a court order to let you stay in occupation for a limited period (this right is open to certain retail outlets but is not commonly authorised by the courts).
In England and Wales:
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As a business tenant you're likely to have security of tenure under the Landlord and Tenant Act 1954, unless your lease was excluded from the security of tenure provisions of the 1954 Act. If you are unsure whether or not your lease is excluded, ask your lawyer.
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If your lease is not excluded from the 1954 Act and is due to end within the next 12 months but your landlord hasn't yet served you with a 'Section 25 Notice' (a formal notice to terminate your tenancy) then you should consider serving a 'Section 26 Request' (a formal request for a new tenancy).
If the open market rent is less than the rent you are currently paying then it may be to your advantage to serve a Section 26 Request at least 6 months before your lease expires. However, if the open market rent is more than you are currently paying then it may be to your advantage simply to sit quiet and do nothing.
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If your landlord has served you with a Section 25 Notice, then seek immediate advice from your lawyer - because the notice will contain a deadline that must be observed, otherwise you will lose your security of tenure.
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If your landlord's Section 25 Notice states that the landlord opposes the grant of a new lease (e.g. because he wants to redevelop) then you may be entitled to compensation. You may also be able to challenge your landlord's intentions through the Courts if you do not believe they are genuine.
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However if your lease is excluded from the 1954 Act then you have no right to remain in the property after it ends. Therefore, you should ideally seek to agree terms for a new lease (or extension to your existing lease) with your landlord in good time before the lease ends.
If you want to leave:
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Check well in advance what you need to do at lease end - e.g. your lease will probably say what condition the premises should be left in (though you may be able to negotiate a lump sum with your landlord rather than doing repair/decoration works), and whether any physical alterations you've made should be removed. Your lease may also say whether you can take fixtures and fittings with you.
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Ensure that, when the lease ends, the landlord releases any rent deposit, guarantee or other security you provided.
Beyond that, again the position differs north and south of the border.
In Scotland:
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Speak with your lawyer to ensure you comply with the procedure and timescales for giving your landlord notice of your intention to end the lease (this will avoid the possibility of tacit relocation mentioned above).
In England and Wales:
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There's no need to serve any formal notice on your landlord if you intend to leave the property before your lease ends. However, it's strongly recommended that you return the keys to the landlord on or before lease end, in order to avoid any liability for rent after that date.
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If your lease is not excluded from the 1954 Act then it will continue (potentially indefinitely) if you fail to leave the property before the lease ends. In these circumstances, you will need to serve a formal notice on your landlord (called a Section 27 Notice) if you wish to bring your lease to an end.
A firm foundation for collateral warranties
In the recent cases of Scottish Widows Services Limited v Harmon/CRM Facades Limited & Ors, and Scottish Widows Services Limited v Kershaw Mechanical Services Limited & Ors, the Court of Session issued an opinion relating to two separate actions arising out of the construction of the Scottish Widows HQ at Port Hamilton, on Morrison Street, Edinburgh, during the late 1990s.
Scottish Widows wanted to enforce certain collateral warranties granted by various contractors which had been assigned in its favour in 2003.
Collateral warranties are of course a common requirement in development funding, purchases and lettings of recently developed properties.
They seek to give the funder, purchaser or tenant a right of recourse should any issues arise in the course of, or following, construction. They're designed to ensure that the party who actually suffers the loss is the one who has a right of action against the party who caused the loss - whether or not they otherwise have a direct contractual relationship.
Lord Drummond Young considered various arguments before allowing the case to move to proof before answer, the main emphasis of which was the Court's opinion that collateral warranties are an 'important feature of modern practice in the construction industry,' and ought to be 'construed in such a way as to further their essential purpose, namely to ensure that the party who suffers loss has a right of action against any contractor or member of the professional team who has provided defective work.'
So it's important to look at the parties' commercial intentions behind the grant of the warranty.
It was suggested that a net contribution clause (which tries to restrict joint and several liability to the actual loss caused by each member of the construction and professional team) may be enforced in line with market expectations, albeit it was not for the Court to consider this at this stage in the case.
The Court observed that the physical defect in the building is itself the primary loss, though it may have economic consequences for many parties (i.e. the cost of repairs). That liability for repairs is also a loss, and the party incurring that loss should be able to sue to recover it. It also doesn't matter whether the party has to carry out any necessary repairs under the terms of a lease or otherwise - it's the fact that they have been carried out at the beneficiary's expense that gives rise to a claim.
And what about the potential situation where many beneficiaries may have a claim for the same defect? The Court agreed that this may be a problem requiring a solution, but in practice it may be easily dealt with so as to avoid 'double recovery'.
It was also considered whether an architect might have a liability to a beneficiary (or to its original client), for failing to appoint a specialist sub-consultant, if the architect didn't have the in-house expertise to fulfil a function required of it under its professional appointment. The Court agreed this was possible but whether the architect was in fact in breach was a matter for proof.
Stuart Macfarlane, head of Semple Fraser's Construction Team, says that:
"It's heartening to see that the Court of Session has taken a pragmatic view of the arguments presented in this case - with an overall nod to the commercial intentions and current market practice used within the construction industry. From the point of view of funders, purchasers and tenants, they give judicial support to their rights to rely on the terms of collateral warranties which they hold - particularly in relation to loss suffered."
Guarantees no longer guaranteed?
The Landlord and Tenant (Covenants) Act 1995 applies to all leases granted in England and Wales since 1996.
The Act strictly limits the scope and extent of guarantees that can be taken from an outgoing tenant who assigns a lease granted in England and Wales since 1996 (a 1995 Act Lease).
Any guarantee from an outgoing tenant under a 1995 Act Lease which doesn't comply with the Act is unenforceable.
The outgoing tenant under a 1995 Act Lease can only guarantee the incoming tenant's obligations, not those of any subsequent assignee. Therefore, the next time that the lease is assigned, the original tenant is released from his guarantee.
What about the position where a tenant has one or more guarantors?
Typically, 1995 Act Leases state that when the lease is assigned, the tenant's guarantors must join in the guarantee of the incoming tenant's obligations.
However in February this year, the High Court in England ruled (in Good Harvest Partnership LLP v Centaur Services Ltd) that such guarantees are void.
So for a 1995 Act Lease, the only valid guarantee is one taken from outgoing tenant himself; a guarantee taken from the outgoing tenant's guarantors is void and unenforceable.
Ewan Thomson, a partner in Semple Fraser's Manchester office, comments that:
"In light of the Court's decision, landlords should be more careful when considering applications to assign 1995 Act Leases - because any existing guarantees will be lost as soon as the lease is assigned."
The landlord in the Good Harvest Partnership case has however been given permission to appeal to the Court of Appeal - so it's possible that the decision may be reversed. One to watch...
Budget 2010: the implications for property
This year's first Budget was a quiet affair for the property industry, particularly when compared to the more recent noise of the general election campaign. The main changes of note are as follows. The Finance Act 2010 was rushed through Parliament before it was dissolved for the election, and almost all of the changes noted here are now law.
A new Government would no doubt produce a new Budget within a few weeks, but so far it does not appear that any of the recent changes are likely to be reversed.
STAMP DUTY LAND TAX
Residential property
Hard on the heels of the temporary increase in the threshold for SDLT on residential property to £175,000 (which expired on 31 December), there is now a temporary exemption for residential property purchases up to £250,000 but this time it only applies to first-time buyers. HMRC has published detailed rules on what previous transactions would disbar a buyer from counting as a first-time buyer, and they are in places surprisingly strict. A property vendor, whether the developer or not, need not be concerned about this though - it is purely a matter for the buyer's SDLT return. The exemption runs for two years from 25 March 2010 until 24 March 2012.
There is to be a new top rate of SDLT of 5% on purchases of residential property for over £1 million. This has been widely publicised, but note that it is not due to begin until 6 April 2011.
Neither of these changes affect commercial property transactions.
The rates and thresholds for SDLT are otherwise unchanged.
SDLT avoidance schemes
New anti-avoidance rules are intended to close down some SDLT planning which used partnerships, from 24 March 2010. Normally there is full or partial relief on purchases by a partnership from a partner (or a person connected with a partner), and many schemes took advantage of that. Now a loophole in existing anti-avoidance rules has been plugged so that those rules apply to contrived schemes, such that the full purchase price is subject to SDLT.
As previously proposed, the SDLT avoidance disclosure regime applies to residential property worth £1 million or more, with effect from 1 April 2010.
Also with effect from 1 April 2010, users of disclosed avoidance schemes have to notify HMRC that they have used a scheme. Previously only the promoter of a scheme had to notify HMRC that it had been used, without identifying the client. In addition the promoter now has to identify each client which uses a scheme. We can expect HMRC to use this information to attack more schemes
CAPITAL ALLOWANCES
The limit on the amount of expenditure which qualifies for the 100% first-year allowance (known as the Annual Investment Allowance) is doubled to £100,000 with effect from 1 April 2010. Expenditure on fixtures in a building can qualify for this allowance.
Losses created by tax avoidance schemes which exploit the 100% capital allowances will not be eligible for offset against other income.
There are some changes to the lists of assets which qualify for enhanced (100%) capital allowances on energy-saving or water-saving technologies. Two categories of equipment are added and one is removed. Other minor changes are made as well. All effective from a date to be announced, expected to be before the summer. It is unclear what effect, if any, the general election will have on these changes.
CAPITAL GAINS TAX
Entrepreneurs' Relief
The lifetime limit on the amount of capital gains which can qualify for Entrepreneurs' Relief is to be doubled to £2 million with effect from 6 April 2010. The relief reduces the effective rate of CGT from 18% to 10% so its maximum value will become £160,000. Note that property investment does not qualify for this relief, but dealing and development do. If a taxpayer has already used his old £1 million entitlement, he will be able to qualify for another £1 million, but no extra relief will be given on past gains.
LANDFILL TAX
The rate of Landfill Tax will rise to £48 per tonne on 1 April 2010 and to £56 per tonne on 1 April 2011. The outgoing Government intended to increase it by a further £8 per tonne each year until 2013. The lower rate remains at £2.50 per tonne.
The criteria by which the Treasury determines what material is lower-rated will be published, and this may lead to slight changes from 1 October 2010.
INCREASED LENDING BY GOVERNMENT CONTROLLED BANKS
The Government has reached agreement with Royal Bank of Scotland and Lloyds Bank that they will in aggregate lend £105 billion to homebuyers and businesses over the next twelve months. Just how much of an increase this is, is not stated.
Competition in the Real Estate Sector
Until recently, the property industry has not needed to concern itself too much with competition law. That has now changed as the Government has recently announced it's intention to apply the full provisions of competition law to land agreements, with effect from 6 April 2011.
Semple Fraser will be issuing a full briefing on this shortly.
The matters covered in this ebulletin are intended as a general overview and discussion of the subjects dealt with. They are not intended, and should not be used, as a substitute for taking legal advice in any specific situation. Semple Fraser LLP will accept no responsibility for any actions taken or not taken on the basis of this publication.
FOR FURTHER INFORMATION PLEASE CONTACT: ROLAND SMYTH