Chapter 5: Contract and Exchange Flashcards

Question

2.8 Summary

Answer 1

* A property contract must be in writing, signed by or on behalf of the parties and incorporate all the agreed terms * A contract may not be needed for certain transactions, such as a gift of property between family members or land of low value. * The contract allows the parties to fix a completion date and set out their respective obligations.

Answer 2

* There are standard forms of contract, which are always used in residential transactions, and used for some commercial transactions. * More complex commercial transactions are likely to have a tailor made contract. * Standard conditions of sale are usually adopted by the contract, and amended as necessary. * Special conditions may be used to exclude, add to, or amend standard conditions

Answer 3

* Specified incumbrances * Title guarantee * Completion date (and time) * Contract rate * Deposit * Value Added Tax (VAT) * Risk and insurance * Indemnity covenant

Answer 4

You will recall that although the general principle is caveat emptor, the seller must disclose latent incumbrances and defects in title: * Latent incumbrances are rights burdening the property that are not apparent on inspection. Examples would be covenants and easements. * Defects in title are issues that cast doubt on the seller’s ownership of the property or the rights that affect it; for example, if a deed containing covenants has been lost. Both sets of standard conditions amend this duty and list incumbrances which the seller need not disclose.

Answer 5

SCS 3.1.2 The incumbrances subject to which the property is sold are: (a) those specified in the contract (b) those discoverable by inspection of the property before the date of this contract (c) those the seller does not and could not reasonably know about (d) those, other than mortgages, which the buyer knows about (e) entries made before the date of the contract in any public register except those maintained by the Land Registry or the Land Charges Department or by Companies House (f) public requirements

Answer 6

The incumbrances subject to which the property is sold are: (a) those specified in the contract (b) those discoverable by inspection of the property before the date of this contract (c) those the seller does not and could not reasonably know about (d) matters, other than mortgages, disclosed or which would have been disclosed by searches and enquiries which a prudent buyer would have made before entering into the contract (e) public requirements

Answer 7

The seller needs to disclose any incumbrances registered at the Land Registry, the Land Charges Registry (for unregistered land) and at Companies House. If they do not, then the seller is in breach of SCS 3.1.2 (d) and (e).

Answer 8

The buyer is deemed to buy the property subject to any incumbrances which would be revealed by a prudent buyer’s searches and enquiries. This places the onus on the buyer to carry out all relevant searches and enquiries.

Answer 9

An exception to caveat emptor is the title guarantee. The seller can offer one of two types of guarantee or none as to the quality of title of the property. Both types of title guarantee confirm that the seller has the right to sell the property. Full title guarantee – this is the default (SCS and SCPC), and should be offered unless there is a good reason not to. This means that the property is free of all incumbrances other than those disclosed in the contract, and those which the seller didn’t and couldn’t reasonably have known about

Answer 10

Limited title guarantee is given by sellers with little knowledge of the property, such as executors of a deceased estate. This means that no incumbrances have been created over the property during the seller’s period of ownership. No title guarantee means that the seller does not guarantee the seller’s right to sell the property, nor that the property is free of incumbrances. The buyer has no remedy against the seller if a title issue arises after completion. An administrator or liquidator selling property may offer no title guarantee.

Answer 11

The completion date is usually fixed by the parties. If the parties do not fix a completion date, then the SCS and SCPC default to ‘the date that is 20 working days after the date of the contract’. This is rare in practice

Answer 12

The time for completion under both SCS and SCPC is 2 pm. For the buyer’s solicitor, this means that the money must be received by the seller’s solicitor before 2 pm. If the buyer will use money from a related sale to buy the property, then the buyer’s solicitor should ensure that there is sufficient time to receive and forward the funds.

Answer 13

Both SCS and SCPC state that ‘time is not of the essence until a notice to complete is served’. This means that if a party fails to complete (the ‘defaulting party’) by the specified completion date and time, the other (the ‘non-defaulting party’) can claim damages for the breach, but cannot yet walk away from the transaction.

Answer 14

However, the party who is ready to complete can serve a notice to complete and make time of the essence. The contract rate sets the interest that is payable by the defaulting party for the delayed completion

Answer 15

This wording means that the contract must be performed by the specified time, and if not, the non-defaulting party can walk away from the contract and claim damages for the breach

Answer 16

* Both SCS and SCPS require the buyer to pay a 10% deposit on exchange of contracts, but this can be varied by special condition (say 5%). * If the parties agree a lower deposit, but the buyer doesn’t complete on time and the seller serves notice to complete, the buyer must immediately pay the balance of the 10% deposit (unless this provision is also amended by special condition). * When acting for a seller, always advise the client and check with them before agreeing to a reduced deposit

Answer 17

* The balance of the purchase price payable on completion is the purchase price less the deposit. * Under SCS, the deposit can be paid by a cheque from the buyer’s solicitor’s client account (not a cheque from the buyer) or electronically. * Under SCPS, the deposit must be paid electronically. * The deposit may be held by the seller’s solicitor as stakeholder or agent.

Answer 18

When the seller’s solicitor holds the deposit as stakeholder, it means that the seller’s solicitor must keep the deposit safe and not pay it to the seller until completion. Think of putting a stake in the ground – it stays where it is!

Answer 19

If the seller’s solicitor holds the deposit as agent for the seller, the seller may demand the deposit immediately after exchange. Mostly buyers will not accept this, as there is a risk of loss to the deposit if the seller is unable to complete (particularly if insolvent)

Answer 20

Both SCS and SCPC therefore provide for the deposit to be held as stakeholder. As a residential seller may need the deposit for a related transaction, however, SCS provides that part or all of the deposit may be used for the deposit on that transaction. Any remaining deposit is still held as stakeholder.

Answer 21

Residential property is usually an exempt supply or a zero rated supply, meaning that no VAT is payable by the buyer. Under SCS, the purchase price is inclusive of VAT. The buyer does not need to worry about the possibility of VAT on top of the purchase price.

Answer 22

VAT always needs to be considered with commercial property. The default position under SCPC is that the property is a standard rated supply, meaning that VAT is payable at the normal rate (currently 20%) on top of the purchase price. There are exceptions. For example, if the property is over three years old, and the seller has not made an option to tax, then there will be no VAT to pay. The parties should amend SCPC with a special condition.

Answer 23

Perhaps surprisingly, once contracts are exchanged, risk passes to the buyer under both SCS and SCPC.This means that if the property is damaged or destroyed between exchange and completion, the buyer must still complete.

Answer 24

The buyer’s solicitor should therefore advise the buyer to obtain insurance quotes before exchange, ready to insure the property from the date of exchange.The lender may also want confirmation that insurance is in place before advancing the completion funds.

Answer 25

In some cases, it may be better for the seller to keep their insurance policy going (eg, if the building is still under construction), in which case a special condition is needed. If this is the case, then SCS and SCPC contain standard obligations on the seller regarding insurance.

Answer 26

In the title investigation topic we saw how the burden of positive covenants can be passed by a chain of indemnity covenants. If the chain is unbroken, then the seller can require the buyer to give an indemnity covenant and continue the chain. Both SCS and SCPC make this an obligation of the contract.

Answer 27

However, if the seller did not give an indemnity covenant, then this obligation does not apply. The parties may want to agree the wording and set this out in a special condition. The transfer to the Buyer will contain a provision similar to this: ‘The Transferee covenants with the Transferor to observe and perform the covenants contained or referred to in entry no 3 of the charges registered of title number XXXXX and to indemnify the Transferor against any liability for any future breach or non-observance of those covenants.’ Note that the seller is described in the transfer as the transferor, and the buyer as the transferee.

Answer 28

* When drafting a contract, it is important to know what conditions need to be included. * Important conditions to consider include specified incumbrances, title guarantee, completion date (and time), contract rate, deposit, VAT, risk and insurance and indemnity covenants * SCS and SCPC evolved to make contract drafting and negotiation simpler and more transparent. * SCS and SCPC can be amended by special condition.

Answer 29

We have looked at the Standard Conditions of Sale (SCS) and Standard Commercial Property Conditions (SCPC). Both sets of conditions can be amended, excluded or supplemented with special conditions. The standard form of residential draft contract provides a set of seven pre-written special conditions that can be used for the most common amendments. The commercial standard contract is similar, but has nine special conditions.

Answer 30

These clauses tie the contract to SCS.

Answer 31

These clauses tie the contract to SCS.

Answer 32

Allows the parties to amend the title guarantee from full (default) to limited by changing the front page

Answer 33

Allows the parties to specify included and excluded contents on an attached list

Answer 34

There are two special conditions 4, of which one is deleted as appropriate. The first option is most common, as vacant possession means that the property is sold without any occupiers. If the property is sold subject to leases and tenancies, these are detailed

Answer 35

This allows the parties to agree a different time by which completion must have taken place without having to draft a special condition from scratch.

Answer 36

This gives the seller some protection against misrepresentation by limiting liability to written statements. However, if the seller is fraudulent or reckless even if it is something they say, then the buyer may still have a cause of action.

Answer 37

This special condition is concerned with adults (ie, over 18) who live in the property other than the seller. Replies to enquiries (the property information form) should reveal any such occupiers. The concern is that they may have an overriding right to occupation, and may refuse to leave. By signing the contract, the occupiers give the buyer comfort of getting vacant possession. It is for the seller’s solicitor to obtain this signature, and the occupier should be advised to seek independent legal advice. (The seller’s solicitor cannot advise, as this would be a conflict of interest.)

Answer 38

There is no limit to what might be covered by special conditions, but here are two more examples: (a) The Seller agrees to pay the Buyer £80 for a chancel repair indemnity policy, a draft of which is attached. (simple contribution to title insurance policy) (b) The Seller and the Buyer agree that neither of them shall disclose to any third person any details of this agreement, any documents supplied to the Buyer or the Buyer’s advisors in connection with this agreement or the transfer made under this agreement. (agreement to be kept confidential, adapted from Encyclopaedia of Forms and Precedents)

Answer 39

Special condition 6 allows the parties to specify that the deposit and balance of purchase price will come from an account other than the buyer’s solicitor’s client account. This might be appropriate, for example, if the buyer is a financial institution whom can be trusted absolutely by the buyer

Answer 40

Special condition 8 provides a space for specific terms of the transfer, or for the draft transfer to be annexed. This is particularly for a sale of part where the seller wishes to reserve rights (covenants and easements) Special condition 9 contains options to tick for the VAT treatment, capital allowances (a tax applicable to plant and machinery) and rights of residential tenants in a property, such as a block of flats, with long leases

Answer 41

* Special conditions may be pre-written on the standard residential or commercial form of contract, or may be tailor made by the parties’ solicitors. * The pre-written standard conditions deal with some of the more common amendments that the parties may want to make to the Standard Conditions of Sale and the Standard Commercial Property Conditions. * Tailor-made special conditions can cover a wide variety of matters

Answer 42

‘I hate paying taxes. But I love the civilisation they give me.’ Oliver Wendell Holmes

Answer 43

VAT is charged on any taxable supply, namely the supply of certain goods or services by a taxable person in the course of business. * A taxable person is a VAT registered business. When it supplies certain goods or services, it must charge VAT on the sale price. * Every three months, the VAT registered business pays the VAT collected to HM Revenue & Customs. * The business therefore functions as a tax collector on behalf of HM Revenue & Customs.

Answer 44

A company manufactures cars, which they sell for £10,000 each plus VAT @20% = £2,000. Over three months they sell 100 cars. They therefore have to account for the £200,000 they have collected to HM Revenue & Customs.

Answer 45

In the previous example, the VAT that the car manufacturer has charged its buyers is output tax. It may be helpful to think of the cars as the output of the factory! The car manufacturer will likely, however, also buy goods and services in the manufacture of the car, such as materials and components, paint, etc. The VAT that the car manufacturer pays for these goods/services is input tax. The car manufacturer can offset the input tax it has paid against the output tax it has collected.

Answer 46

Continuing the previous example, the car manufacturer has output tax of £200,000 for the three months’ sales. In the same period, it has spent £150,000 of VAT on goods and services for the manufacture of the cars. It will only need to pay £200,000 - £150,000 = £50,000 VAT to HM Revenue & Customs.

Answer 47

Any business with a VAT taxable turnover of more than £85,000 each year must register for VAT with HM Revenue & Customs. Businesses with a turnover of less than £85,000 each year may voluntarily register for VAT with HM Revenue & Customs.

Answer 48

The advantage of registration is that the business will be able to offset the input tax it has paid to suppliers against the output tax it charges its customers. Some business are only make exempt supplies (not taxable for VAT) and are therefore unable to recover input tax

Answer 49

A bank provides banking services, which are VAT exempt supplies. If the bank pays input tax on stationery, office furniture, etc, it has no output tax to offset, and the input tax is an additional cost to the bank.

Answer 50

In a similar way, if a VAT registered business sells property that is a standard rated supply, it must charge VAT on the purchase price. The VAT on the land it sells is output tax. If the business has had to pay VAT in connection with the property, then it can offset that input tax against the output tax.

Answer 51

A development company pays a construction company £1 million plus £200,000 VAT to build a warehouse. It sells the warehouse to an investor for £1.5 million plus £300,000 VAT. The development company pay HM Revenue & Customs £300,000 output tax less £200,000 input tax = £100,000.

Answer 52

Newly constructed commercial property (less than 3 years old) is standard rated. Older commercial property is standard rated if the seller has opted to tax. Exempt supplies. Residential property, except for newly developed property. Commercial property over 3 years old, and the owner has not opted to tax

Answer 53

Newly constructed property is a zero-rated supply. The buyer doesn’t pay VAT, but because the output is taxable, the seller can recover its input tax from HM Revenue & Customs.

Answer 54

This is a notice to HM Revenue & Customs that has the effect of making commercial property over three years old standard-rated instead of exempt

Answer 55

With many types of property, their tax treatment will not be in doubt. However, with older commercial buildings (+3 years), whether the property is exempt or standard rated depends upon the option to tax. Enquiry 28.3 of Commercial Property Standard Enquiries (CPSE) 1 asks the seller whether an option to tax has been made, and if so, to provide a copy of the option and any related correspondence with HM Revenue & Customs.

Answer 56

Whether VAT is payable on the property could be a particular concern if the buyer is not able to recover the VAT (for example, a bank or building society which provides exempt supplies). For such a buyer, the VAT is a 20% increase in the price. The option to tax is personal, so that the buyer cannot rely on the seller’s option.

Answer 57

An investor buys a 10 year old office block with the floors let out to different companies. If the investor wants to continue to charge the tenants VAT on the rent, then the investor will need to make its own option to tax.

Answer 58

* For commercial transactions, the seller’s solicitor needs to consider the VAT treatment when drafting the contract, which is made easier by the SCPC. For this section, you may wish to have the standard commercial contract to hand (available at https://www.lawsociety.org.uk/en/topics/property/freehold-forms). * Condition 2 provides by default that the property is standard-rated.

Answer 59

* Special condition 9 provides tick boxes that bring in sets of conditions in Part 2 of the contract * Tickbox A1 brings in conditions that override condition 2, and are relevant for properties that are exempt from VAT * Tickbox A2 brings in conditions that override condition 2, and are relevant for transactions that are treated as a Transfer Of a Going Concern (TOGC).

Answer 60

This is a transaction where the seller uses the property for the business of letting to produce rental income, the buyer will do the same, and meets certain other requirements. A transaction that qualifies as a TOGC is not a taxable supply for VAT.

Answer 61

Standard condition 2: * The seller warrants that the property is a standard-rated supply * The buyer agrees to pay the VAT over the purchase price in exchange for a VAT invoice from the seller

Answer 62

Under the Part 2, A1 conditions: * The seller warrants that the property is not subject to VAT * The seller agrees not to exercise the option to tax

Answer 63

Under the Part 2, A2 conditions: * The seller warrants that it is using the property for the business of letting to produce rental income * The parties agree various other matters necessary to the transaction being treated as a TOGC The first provision of both the A1 conditions and the A2 conditions is that standard condition 2 does not apply. The A1 and A2 conditions only apply if the relevant tick box is ticked.

Answer 64

* A taxable person collects tax on certain goods and services it supplies (output tax) * A person pays tax on certain goods and services it obtains (input tax) * A taxable person can offset output tax against input tax * Property transactions may be exempt from VAT, zero-rated or standard-rated

Answer 65

* Commercial property over 3 years old is exempt, unless the owner exercise the option to tax, in which case it is standard-rated * New commercial property is standard rated * Investment property used for collecting rents from occupational tenants may qualify as a Transfer Of a Going Concern which is exempt from VAT * The Standard Commercial Property Conditions provide a framework for the contract to accommodate the different types of VAT treatment

Answer 66

* The seller’s solicitor drafts the contract * In doing so, the seller’s solicitor will refer to the heads of terms to the seller for instructions on any point on which there is doubt, and to the title * If the Law Society Conveyancing Protocol is adopted, then the contract should be in standard form, and official copies and protocol forms will be sent to the buyer’s solicitor at the same time * These papers are collectively known as the contract bundle.

Answer 67

* The buyer’s solicitor checks the contract against the heads of terms, and the buyer’s instructions. * The buyer’s solicitor may want to amend the contract if it is weighted towards the seller, or to take account of matters that arise from the buyer’s solicitors’ investigations. * In a commercial transaction, the contract may go back and forth between the seller’s solicitor and the buyer’s solicitor until the contract terms are agreed.

Answer 68

Until exchange, the parties’ losses are limited to whatever expenses they have incurred in expectation of selling/buying the property. After exchange, the parties are committed, and there is the potential for significant financial loss if all is not in order. Before exchange, then, both seller and buyer need to ensure that they are ready. Some solicitors use checklists to ensure that nothing is missed.

Answer 69

* check have received all search results and replies to enquiries, and followed up any issues arising from them as needed * check that buyer has received survey and is satisfied with it * advise buyer that insurance must be in place from exchange of contracts * check that have cleared funds from the buyer for the deposit (usually 10%) * for a commercial transaction, ensure that the lender’s solicitor has approved the draft certificate of title

Answer 70

* ensure that have reported fully to the buyer on title and advised on any issues of concern * send contract to the buyer for signature * obtain instructions on proposed completion date * obtain authority of the buyer to exchange contracts (do not rely on merely having a signed contract as authority to exchange!), and if necessary check again just before exchange

Answer 71

* obtain a redemption figure (ie, the amount needed to pay off the loan in full) from the lender to check that the proceeds of sale will cover it * reply to any outstanding additional enquiries (the buyer’s solicitor will likely refuse to exchange without this in any case)

Answer 72

* prepare engrossments (final versions) of the contract and send one copy to the seller for signature, and the other to the buyer’s solicitor * obtain seller’s authority to exchange contracts (again, do not rely on the signed contract as authority), and if necessary check again immediately before exchange

Answer 73

You receive a signed contract and authority to exchange from your client (the seller). The buyer is not ready to exchange until two weeks later. You check with the seller, who tells you not to exchange, because it has that morning come to light that the buyer intends to let the property to a direct competitor of the seller.

Answer 74

Exchange of contracts is the point at which the parties enter into a binding contract. Whilst traditionally, this involved the parties meeting and exchanging paper copies of the contract, contracts are now almost always exchanged by telephone. The solicitors carry out the exchange according to Law Society Formula B, a prescribed set of steps and obligations.

Answer 75

The buyer’s solicitor and seller’s solicitor will let each other know when they are ready to exchange. Before doing so, they need to have received their respective client’s signed contract. The exchange conversation will involve the solicitors: * identifying any blanks left in the contract and agreeing what wording/figures need to be inserted * agreeing any handwritten amendments or special conditions * agreeing and writing in the completion date in the appropriate space

Answer 76

Once both solicitors are happy that the contracts are complete and identical, they agree that they will exchange the contracts under Law Society Formula B, agree the date and time of exchange, and give each other their names to write on the contract. The contract is then exchanged, and from that time onwards, the parties are legally obliged to complete

Answer 77

After exchange, Law Society Formula B imposes the following undertakings on the solicitors: * to hold the signed contract to the other solicitor’s order – this means that the buyer’s signed part belongs to the seller and vice versa

Answer 78

* to post the signed contract to the other solicitor that day by first class post or DX (the document exchange used by solicitors and certain other professionals) or by hand delivery * in the case of the buyer’s solicitor, to send the deposit in the form of payment specified by the contract (eg, solicitors’ client account cheque in the first class post, or same day electronic transfer)

Answer 79

This is a formal promise in the course of acting as a solicitor to take some action. A solicitor can be disciplined for breaching an undertaking, so a solicitor should only give an undertaking that they know they can perform

Answer 80

Law Society Formula B is used for the vast majority of transactions, but Law Society Formula A is used sometimes, and Formula C rarely. Formula A Law Society Formula A is used when the same solicitor holds contracts signed by both seller and buyer. It might be appropriate, for example, where a solicitor knows that they will be abroad at the time of exchange

Answer 81

The solicitors have a similar telephone conversation as with Formula B, but the solicitor who holds both parts undertakes just to send their client’s signed contract to the other solicitor. Formula C Law Society Formula C is for chain transactions, meaning that the money from one property is used to buy the next. A chain may involve two or more properties. Although chain transactions are common, Law Society Formula C is not, as it is complex. Instead, the parties use Formula B, but care must be taken to tie the transactions together.

Answer 82

* Related sales and purchases must be tied together. Never exchange on one, hoping that you can exchange on the other, as there is a risk that the second exchange will fall through.

Answer 83

* A solicitor will ‘release’ the contract to the solicitor who is dealing with a related transaction. This means that if the solicitor manages to exchange on the related transaction by an agreed time, the first contract is treated as exchanged, but if not, the exchange is cancelled. * This method comes from Formula C, but as Formula C is complex, the solicitors usually just adopt the release method and apply it to Formula B.

Answer 84

Your client is selling a flat to buy a house. You telephone the buyer’s solicitor on the flat, and agree to exchange with a release until 3 pm. At 2 pm, you telephone the seller’s solicitor on the house and exchange. You can then go back to the buyer’s solicitor on the flat and confirm the exchange – as long as this happens before 3 pm, the buyer’s solicitor cannot refuse to exchange

Answer 85

Each of the parties’ solicitors should prepare a memorandum of exchange with the key contract terms for the file. It is also wise to keep a copy of the signed contract in case the original is lost in the post to the other solicitor. Risk passes to the buyer on exchange, so the buyer should have in place insurance in case the property is damaged or destroyed.

Answer 86

The parties will start to make arrangements for completion, such as submitting the certificate of title to the lender, and requesting the mortgage funds in time for the completion date. In residential transactions, the seller and buyer may also book removal vans to physically move house on the completion date.

Answer 87

The buyer also holds an equitable interest in the property which may be protected by a notice on the register or, for unregistered land, a class c(iv) land charge. This is only necessary if there is going to be a long time until completion (eg, a contract where completion is dependent upon the property being built).

Answer 88

* As exchange is the point at which the parties are bound to complete, it is essential that both parties ensure they are ready. * Solicitors may want to use checklists to ensure that nothing has been missed. * Law Society Formula B is most frequently used to allow for exchange of contracts to take place by telephone.

Answer 89

* Law Society Formula B imposes undertakings on the solicitors with which they need to ensure they can comply. * Law Society Formula A is used where one solicitor is holding both signed contracts, and Formula C for a chain transaction (but is rarely used). * It is important to tie related transactions together, and this can be achieved with Law Society Formula B and the ‘release’ of contracts method.

Chapter 5: Contract and Exchange Flashcards

(114 cards)