Sale and purchase of multi-tenanted commercial properties

This is a brief overview of some of the issues which arise during the negotiation of contracts for the sale and purchase of multi-tenanted commercial properties. Some of the generally accepted methods of dealing with such issues are somewhat esoteric, and are often unfamiliar to overseas investors new to commercial property in England and Wales.

To keep this overview as succinct as possible it has been necessary to deal briefly with some points that are in reality quite complex, and specific legal advice should always be obtained on the negotiation of legal documents.

In English law, the process of purchasing a property involves two distinct stages:

1. The ‘exchange’ of contracts by the parties to sell and purchase. At this point the parties become legally bound to comply with the terms of the contract (heads of terms generally have no legal status in English law and are not binding upon the parties). A deposit of 10 per cent of the agreed price is often paid by the buyer to the seller at exchange of contracts. From exchange, the seller continues to hold the legal title to the property but holds it on trust for the buyer;
2. The completion of the sale and purchase by transfer. This is the point at which the buyer pays the balance of the purchase price to the seller. For properties which are registered at the Land Registry (which is now most properties), the legal title does not pass on completion but only once the transfer is registered at the Land Registry.

When the property to be sold is multi-tenanted, additional considerations arise which, if not addressed in the contract, can cause significant problems on completion of the sale and purchase. These include the following:

The parties need to agree the method by which the rent received from tenants is apportioned between them. It will either be calculated on the basis of a daily rate (annual rent / 365) or a proportion of the quarter’s rent received and held by the seller for the quarter in which completion takes place. The parties also need to agree who receives rent for the day of completion itself as a single day’s rent on a large property can amount to tens of thousands of pounds. Only rent received is apportioned.

Any rent which has fallen due but has not been received by the seller from tenants is dealt with separately under a sale and purchase contract as arrears. A buyer will often be reluctant to take on any liability in respect of arrears which relate to the seller’s period of ownership but in contrast, a seller wants a ‘clean break’ upon sale, with no ongoing obligation to pursue arrears.

There are three ways of dealing with arrears in the contract:

1. The buyer pays the arrears to the seller on completion and then pursues tenants for arrears and retains any received. This is usually the seller’s preferred method as it gives the seller a ‘clean break’ at completion and the seller avoids the risk of non-recovery. However, most buyers will not agree to this, particularly on higher value transactions, as it transfers all the risk of non-recovery to the buyer;
2. Neither party makes any payment to the other at completion in respect of arrears; the seller retains the right to collect all arrears and, once recovered, passes any arrears relating to the period after completion to the buyer. This is particularly useful where a buyer does not wish to begin its landlord/tenant relationship chasing old arrears;
3. Neither party makes any payment to the other at completion in respect of arrears; the buyer collects them in the ordinary course of management, and, once recovered, passes any arrears relating to the period before completion to the seller. If the buyer has not collected them within a specified period following completion, the contract can provide for the seller to take back the right to collect arrears. This is a common compromise, particularly if the arrears are not large or a rent payment date (usually a quarter day: March 25, June 24, September 29 or December 25) has only just passed and so the arrears are recent.

The widely-used Standard Commercial Property Conditions of Sale use the third method, but without the ability for the seller to demand the right to collect arrears to be assigned back to it after an agreed period. However, it is possible to amend the Standard Commercial Property Conditions in the sale and purchase contract.

Where a lease is a ‘new tenancy’ under the Landlord and Tenant (Covenants) Act 1995 (in general terms these are tenancies granted after January 1, 1996) a seller landlord automatically retains the right to sue for arrears. For an ‘old tenancy’, a seller landlord does not retain the right. Depending on which of the above options is agreed, it may therefore be necessary for the parties to enter into a deed of assignment of the right to collect arrears.

This can often present a major sticking point between a buyer and seller, particularly if the service charge has been poorly managed.

The Standard Commercial Property Conditions require the buyer to pay to the seller any service charge sums already incurred by the seller but not yet recovered from the tenants. These sums may not yet be arrears as they may not yet be due from tenants under the leases. Buyers are often unwilling to agree this position, as it effectively means the buyer is funding the service charge when the seller may have budgeted inappropriately.

It is usually too complicated to apportion service charge at completion as the seller (or its managing agent) may not yet have fully ascertained all sums incurred. There is therefore often a fixed period (between two and four months after completion) in which a balancing statement is prepared by the seller.

Once it is known whether the service charge is in surplus or deficit, any surplus will be transferred by the seller to the buyer. Deficits present a bigger issue; for the reasons given above, buyers will not want to fund a deficit. A compromise position is that the buyer will seek to recover funds due from tenants and pass relevant sums back to the seller to cover the deficit.

The delay between completion and availability of a balancing statement can present a further issue for a buyer in that it will need to operate the service charge from completion but will have no service charge fund with which to do so. A compromise position where there is a surplus of funds in the service charge account, is for a provisional payment to be made from the account by the seller to the buyer at completion, with such payment to be factored into the balancing statement.

The general rule is that risk in the property passes to the buyer at exchange of contracts. However, where a property is let to tenants, the seller will be required to insure until completion as there will be lease covenants requiring it to do so. The parties often agree that the seller will continue to insure between exchange and completion, but that the buyer will be responsible for the premiums for that period (save where they are recovered from tenants).

It will be for the buyer to satisfy itself that the sums insured by the seller are sufficient.

The sale contract will commonly provide that if the property is damaged or destroyed between exchange and completion, the seller must pay any insurance proceeds received and assign any rights to claim under the insurance policy to the buyer. The buyer will still be required to complete the purchase pursuant to the sale contract and will then be required to comply with any reinstatement provisions in the leases.

The insurance generally also covers loss of rent and any insurance monies received in respect of this would be apportioned between the parties in the same way as the rent.

Rent deposits taken as security for tenant obligations can be structured in a multitude of ways but are frequently held by the landlord in a designated account. Rent deposit deeds generally require a seller landlord to transfer the deposit funds to a buyer and that the buyer covenants with the tenant to comply with the landlord obligations in the rent deposit deed. Accordingly on the sale of a property where rent deposits are held by the seller, provision will need to be made in the sale and purchase contract either for the transfer of the relevant deposit funds held to the buyer (including interest accrued) at completion or, alternatively, for the deduction of the equivalent sum from the completion monies. If the second alternative is used, the buyer must place equivalent funds into a designated account following completion in order to comply with the rent deposit deed.

On the sale and purchase of a multi-let property where the buyer intends to continue the letting business after completion, the sale will frequently be structured as a ‘transfer of a going concern’. Provided that (i) the seller has notified an option to tax to HM Revenue & Customs and (ii) the buyer does the same prior to the relevant date (usually completion), the buyer will not be required to pay value added tax on the purchase price. Specialist tax advice is recommended in this situation.