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Delayed Completion Contracts

Solicitor Mike Alexander of Alexander Lawyers LLP gives some invaluable analysis and insight into acquiring property via Delayed Completions and Options.

The purpose of this article is to explain the advantages, and disadvantages, of using a contract route (with delayed completion) as a methodology of acquiring buy to let properties or indeed selling properties, as opposed to using the more well known 'option' route.

It is first of all important to understand the difference between an option agreement and a contract for the sale and purchase of a property. Both documents are effectively contracts but an option is a contract with initially a one way commitment only. Under an option the seller is obliged to sell if the buyer wishes to purchase. However the buyer is not contractually obliged to purchase until he serves an option notice and it is only at that stage that he commits himself. Normally under the terms of the option agreement completion will then take place within approximately 4 weeks, so on the part of the buyer there is no long term commitment whatsoever and the buyer can walk away from the transaction at any time if he so wishes, and his only loss will be the option fee that he paid at the outset. In many cases this is relatively low, although the popular £1.00 option fee can cause a number of problems and have a number of disadvantages.

On the other hand a contract for the sale and purchase of land is a two way commitment. Under the contract the seller is obliged to sell and the buyer is obliged to purchase upon the terms of the contract itself which will provide for completion at a set date. In most normal property transactions that completion date is usually between 2 and 4 weeks after the date of exchange of contracts, but in a delayed completion contract that completion date can be 5 years or any other period of time in the future.

It must be borne in mind here that there is no legal reason whatsoever why two consenting adults cannot enter into a contract to provide for a completion date in 20 years time. There is nothing at all wrong with that and with the abolition now of the rule against perpetuities (a lovely mystical expression which has confused in its time many lawyers let alone their clients!), there is really no limit on the length of time that completion can be delayed for. The only real limits are therefore practical considerations, such as the health and the life expectancy of the seller, because obviously if the seller dies between exchange and completion this will cause some complications as happens in any normal regular conveyancing deal.

It is therefore very important to take a view at the outset of any negotiations as to whether an option route or a contract route is more suitable, bearing in mind the advantages and disadvantages of both. The purpose of this article however, is merely to explore some of the advantages and disadvantages of the contract route.

There are a number of different types of contract the most popular of which are:-

• A normal contract for a sale and purchase which is unconditional
• A conditional contract which is the same as the contract above except that it is initially conditional upon the occurrence of a certain event as set out in the contract itself, and if that event does not occur within a set timetable then either or both parties can walk away from the contract. In the meantime both parties are bound by the contract and are automatically obliged to start moving towards completion once the conditional event has occurred. This conditional event is traditionally obtaining planning permission, for example, for an extension or conversion of the property into a house in multiple occupation (HMO) or even obtaining a mortgage offer in acceptable form.
• An instalment contract. This type of contract should not be confused with a delayed completion contract and it is the writers experience that very often, indeed, frequently, when people are talking about an instalment contract they often mean a delayed completion contract. An instalment contract is exactly what the label says it is, a contract where the purchase price is payable by instalments. Again there is nothing wrong with this (although many may find this type of contract a little unusual), provided that the title (to the property) is not actually transferred to the buyer until all instalments have been paid. There can be problems with this type of contract if some of the instalments are payable after completion which is the point in time when title is transferred. Care should therefore be taken when structuring any deal on the basis of instalments being paid after completion.

An important consideration when considering which type of document to use is stamp duty land tax (SDLT). SDLT must not be compared with the old form of stamp duty which was a tax on a legal document. SDLT is a tax on the transaction. It also, as with all other taxes now, relies upon the tax payer to disclose all appropriate information to the Revenue (ie self assessment), and if there is failure to do so, it has a system of penalties and fines which can be imposed.

On this basis, therefore, SDLT differs significantly from the old form of stamp duty and basically is payable if there is substantial performance of the transaction. This means that if the keys to the front door are handed over and therefore possession of the property obtained, even though there is no transfer of title and hence no completion, there is 'substantial performance' in the eyes of the Revenue and SDLT is payable at the time when the keys are handed over, which in the case of many delayed completion contracts will be therefore the point of contract exchange.

This therefore has a significant cash flow implication depending upon the value of the property. It should be borne in mind here that on current rates any property valued at £125,000.00 or less will not attract SDLT, and those between £125,000.00 and £250,000.00 will attract tax at the rate of 1% (subject to the first time buyer exemption). Obviously higher rates will apply for property values above £250,000.00.

This factor is therefore an important consideration when structuring a deal, because the amount of SDLT payable will not be insignificant and may well be payable even if you are looking at a conditional contract (the Revenue's guidance here is that each case must be considered on its merits) or in the case of an instalment contract, again, even if some of those instalments may themselves be conditional in one way or another. The Revenue's view is that the tax is payable, but if in the case of a conditional contract or an instalment contract where some of the payments are conditional then if there is an overpayment because the condition is not satisfied, then the amount must be reclaimed by the tax payer.

Please remember however, that in the current UK economic climate, taxes are more likely to rise than to go down, and one of the advantages of paying tax today is that it is then paid and is out of the way. If there is a tax rise in the future; if for example SDLT rates double, then you will have paid your tax and you will therefore not suffer the increase. It is therefore not always bad news to pay today rather than tomorrow.

Having said the above if you are completely adverse to paying any tax whatsoever until the last possible date, then the answer must be to favour an option agreement rather than a contract. However always bear in mind that whilst many commercial property people are used to the mythology of an option, it is still very unfamiliar territory for estate agents and many residential letting agents etc. In many cases it is therefore very difficult to structure a deal or even get a deal off the ground by suggesting an option arrangement.

Even if you are successful in moving forward with an option arrangement you still then have the hurdle to overcome of convincing the solicitors involved that this is an arrangement that their clients should accept. Many residential conveyancing solicitors have no experience whatsoever with option agreements and find the whole philosophy of these type of arrangements completely alien and as a result their gut reaction is to advise clients against them on the simple basis that if it is not something that is dealt with regularly, then there has to be something wrong with it and it is therefore better not to get involved.

This viewpoint is exaggerated with many solicitors because of the recent high incidence of mortgage fraud particularly within the buy to let market place, which makes many people very wary and indeed in some cases even frightened to deal with anything that is even marginally unusual. Indeed it is probably true to say that more potential option arrangements fall apart for this reason than any other.

Having said the above there are some very significant advantages using a contract mythology as opposed to an option agreement. The most important of these is that if the seller of the property challenges the validity of an option agreement and succeeds for any reason at all (and the purpose of this article is not to explore the possible grounds of challenge but there are quite a few) or if other problems arise such as the death of the seller or indeed the insolvency of the seller within a short period of time, then the option premium can be lost and indeed extremely difficult to recover in any circumstances.

On the other hand when considering a contract, generally speaking if the contract is set aside it is likely to be set aside on terms on that the deposit is returned. Hence financially there is likely to be less risk using a contract mythology. It should also be borne in mind here that even if a deposit is expressed to be non-returnable that does not mean it cannot be reclaimed and indeed there are specific statutory provisions in the Law of Property Act 1925 which deal with this situation. Indeed, it should be noted very simply that there is no such thing from a legal point of view as a non-returnable deposit insofar as property is concerned.

It follows therefore that if the transaction ultimately fails there is a better chance therefore of recovering the deposit you paid up front to the seller than if you had used an option and paid an option fee.

Equally the approach of the courts in the UK to contracts is going to be somewhat more clinical because they are more likely to look at the contract on a technical basis, if there is challenge against the transaction as a whole, whereas if they are looking at an option agreement there will be less consideration taken of the actual terms of the option. It follows from this that in reality it is likely to be easier to defend a contract than an option agreement, particularly in a county court environment where many county court judges do take into account what they consider to be fair and reasonable and may well give more emphasis to that consideration than to pure technical considerations.

Finally the other main attraction of a contract is its flexibility. With a contract it is possible, particularly if you are looking to sell a property to a tenant buyer to build into the contract a licence to occupy. That licence can be on terms, for example, that the occupier pays the outgoings and the outgoings can be defined to include mortgage repayments. Very often in structuring a deal in this way the actual buyer is more comfortable with it because they understand exactly what payments they are making, when and for what.

On the other hand if you are considering the option route then to avoid an occupier (tenant buyer) obtaining statutory security, the only document you can in reality use to cover the occupation is an Assured Shorthold Tenancy Agreement (AST). This has various disadvantages because there are rights in existence for the tenant, (the occupier) to apply for registration of a fair rent and the amount of rent you can therefore charge can therefore be reduced after you have actually entered into the transaction. This can blow a complete hole through the deal that has been structured, and unless the deal has been thought through very, very carefully you can suddenly find that you are losing some of the money you thought you were gaining!

Perhaps more importantly however is that you do not need to worry too much about rental deposits and putting them on statutory schemes; you do not have to keep complicated accounting systems to show money coming in and money going out for different reasons; you do not have to employ accountants to do your tax returns because the revenue are digging into your affairs deeply because they believe you are hiding some income somewhere because the arrangements are quite complicated and anything that looks complicated is therefore suspicious to them!

In short using a contract mythology may well make your life easier and less expensive. This is especially so where you already own a property that you are seeking to sell to a tenant - because clearly in these circumstances it is the buyers risk to worry about SDLT not yours and therefore you can make your life a lot easier and the flexibility that can be built into the contract particularly with regard to instalments of the purchase price can be used to maximum advantage therefore.

It is however, notwithstanding everything said above, important to consider the position of the mortgage lender on the property. The key attraction of using an option type of arrangement or a contractual arrangement is very simply that it enables the transaction to be wrapped around the existing mortgage loan on the property hence taking the advantage of, very often, low mortgage repayments (at least until interest rates rise!)

Mortgage lenders however in the buy to let market place are now very wary because of the high incidence of mortgage fraud, and therefore you must be very cautious as to how you deal with them. If the property has the benefit of a buy to let mortgage, then that mortgage will contain various conditions and those conditions very often will provide that the property can only be occupied by a tenant who signs up to an AST.

It may therefore well be a mortgage condition that obliges you to use an AST and the licence arrangement mythology referred to above may not be possible for this reason. Care should always be taken to check for this. Equally if the property was previously occupied by an owner occupier who is trying to use one of these arrangements to dispose of the property and resolve financial difficulties, then most mortgage lenders will be quite amenable to an application to let the property but again will insist that it is only let on an AST. Care must always be taken to get the mortgage lenders consent to let and to comply with any conditions that are attached to it.

Most lenders it must be noted are very much against their borrowers entering into contracts for the sale of a property and allowing the buyer into occupation before completion. Most will simply say no without question whether you are looking at the buyer being in one week before completion or three years before completion!

Clearly it is important to avoid any problems with the mortgage lender and to make full disclosure to the mortgage lender and to comply with all of their requirements. It is important to check on this before finalising a deal because this may therefore have a bearing on how you structure the deal and certainly may well have an impact on points made above.

Obviously if you are acquiring a property using one of these methods then it is often advisable to tie your acquisition into a Management Agreement so that as the purchaser taking control of the property ahead of completion it is in the capacity of a manager of the property and there is a clear agreement that you are managing the property on behalf of the actual seller.

What this means is, that if the mortgage lender looks at the transaction they will still see their borrower as being in control of the property and will look upon the manager in a similar way as to a letting agent or similar. Nevertheless it is still very important to comply with all of their requirements and in a number of cases this will inevitably mean that you will need to let the property on an AST for this reason and this reason alone.

Whatever method you use it is also very important to obtain Powers of Attorney by way of security. Generally speaking a Power of Attorney can be revoked by a number of events which includes revocation by notice, death, mental incapacity etc. A Power of Attorney taken by way of security cannot be revoked and therefore will survive but it must be correctly drawn up. This is essential if you are purchasing a property in this way, and you must also remember that if there are two owners (for example, a husband and wife) then they both need to appoint a separate attorney. It is a common mistake for both parties to appoint the same person.

The other reason for taking the Power of Attorney is that if you are looking at a delayed completion contract or even an option arrangement with a five year plus time frame, then you have no guarantee at all that the sellers will remain in touch with you during the whole period. They may move to a different part of the country or they may even emigrate abroad.

One thing is however certain, and that is with the passage of time they will lose interest in the property, especially if their life improves from a financial standing point of view. Powers of Attorney are therefore essential to enable you to transfer title to the property when the relevant documentation comes to complete. In the meantime if the Powers of Attorney are correctly drawn, they will also allow you to implement court proceedings to evict tenants, to deal with the mortgage lender (and some mortgage lenders will require a formal Power of Attorney) etc. They will, in short, make your life a lot easier.

In summary, therefore, a delayed completion contract is therefore simply another way of structuring a transaction, particularly if you are selling a property to a tenant buyer or you are looking to acquire a property and need to wrap the deal around an existing mortgage. It is in short, another tool for you to use in building up a portfolio of properties. It should therefore be treated as such and you should always ensure that you take full advice, preferably from an experienced solicitor, on the nature of your transaction and whether or not what you are seeking to achieve is achievable in practice by using the delayed completion method.

Please note that this article is only intended to provide a general overview of the questions dealt by it, and it not intended to constitute detailed legal advice in any way whatsoever. It is therefore critical that on all matters arising in your dealings with properties or otherwise you should seek detailed legal advice at all times and you must not rely upon anything said or referred to in this article.

For further information you can contact Mike Alexander or Dean by clicking here.