Beware of occupational hazards

This article was first published in Estates Gazette on July 1, 2017

Louisa Roe and Charlotte Tullis share tips on avoiding the common pitfalls in the sale and purchase of multi-tenanted commercial properties

When selling a multi-tenanted property, certain additional considerations need to be addressed in the contract. This article provides an overview of the issues a buyer and seller may need to tackle.

Rent

Apportionments

The parties need to agree how rent received from tenants is apportioned (as different methods can produce very different results): either calculated on a daily rate or a proportion of the quarter’s rent received for the quarter in which completion takes place. The parties also need to establish who receives rent for the day of completion itself – a single day’s rent on a large property can be significant. 

Arrears

Any rent which has fallen due but has not been paid (“arrears”) is dealt with separately under the contract. There are three ways of dealing with arrears:

1. the buyer pays a sum equivalent to the arrears to the seller on completion and seeks to recover from the tenants. This tends to be the seller’s preference as it achieves a “clean break”. However, this is unpopular with buyers, as they take on all risk of non-recovery;
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 passes any recovered arrears relating to the period after completion to the buyer.  This is useful where a buyer does not wish to begin its relationship with the tenants chasing arrears;
3. neither party makes any payment to the other at completion in respect of arrears; the buyer pursues them, and passes any recovered 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 the arrears are recent.

Deeds of assignment of the right to collect arrears may be required depending on the date of the relevant lease.

Service charge

The Standard Commercial Property Conditions (3^rd Edition) (Standard Conditions) require a buyer to pay to a 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 the 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 period following completion in which a reconciliation 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, as buyers will not want to fund a deficit.  A buyer may  instead agree to pursue the tenants and pass relevant sums back to the seller to cover the deficit.

The delay between completion and availability of a reconciliation statement can present a further issue for a buyer in that it will require funds in order to operate the service charge from completion.  Where there is a surplus of funds in the service charge account, a seller may agree to make a provisional payment to the buyer at completion, with such payment to be factored into the reconciliation statement.

Insurance

Under the Standard Conditions, risk in the property passes to the buyer at exchange of contracts. However, where a property is let, the seller will insure until completion as there will be lease covenants requiring it to do so, but the buyer will be responsible for the premiums for that period (save where they are recovered from tenants).  A buyer should take care to ensure that their interest is protected by the seller’s policy and that the level of cover is adequate.

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 and will then be required to comply with any reinstatement provisions in the leases.

Any insurance paid out in respect of loss of rent would be apportioned between the parties in the same way as rent received.

Rent Deposits

Rent deposit deeds generally require a seller landlord to transfer the deposit to the buyer and the buyer to covenant with the tenant to comply with the landlord obligations in the deed. Accordingly,  where there are deposits, the contract needs to cater for either the deposit (including accrued interest) to be transferred at completion or for 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.

Transfers of a going concern (TOGCs)

Where the buyer intends to continue the letting business after completion, the sale will frequently be structured as a TOGC. 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 VAT on the purchase price.