The exchange of contracts is a very significant stage in a conveyancing transaction. It introduces a legal obligation on both parties to complete and consequences can follow if completion does not follow exchange of contracts. At the moment of the exchange the parties should accordingly be ready to commit to the purchase and sale respectively. By exchanging contracts the buyer should know exactly what they are getting and the parties are bound to complete the transaction once the contracts are exchanged.
The legal title in a property does not change hands with the exchange of contract. That will follow on in completion. The contract is merely an agreement to transfer the land at a later stage. The contract provides both parties with certainty as to the nature and the extent of property that is being purchased, the financial terms, the timetable for completion and prevents either party from withdrawing from the transaction without being liable to the other for breach of contract.
There are currently two standard sets of standard conditions commonly in use. Firstly, the Standard Conditions of Sale Fifth Edition 2018 revision and secondly the Standard Commercial Property Conditions Third Edition 2018 revision.
The Standard Conditions of Sale are used for all residential transactions and some simple commercial transactions for example those involving properties which are empty with a straightforward title and relatively low price. The Standard Commercial Property Conditions are more suitable for use with high value commercial properties and contain more detailed provisions for the management of occupational leases with which the property is being sold.
It is necessary to specify on the contract all burdens on the property against the heading ‘specified encumbrances’. These are third party rights which will survive the transfer of the property to the buyer such as restrictive covenants, easements and obligations to contribute to shared facilities.
For a registered property these encumbrances normally appear on the charges register of the official copies but the property register should also be checked as burdens are often hidden away there perhaps where a right benefitting the property has been given subject to an obligation to pay for it.
A seller can sell with either full or limited title guarantee. A seller should sell with full title guarantee if they own the entire legal and equitable title in the property. Limited title guarantee is given where the seller has limited knowledge of the property for example where the seller is an executor or trustee.
A full title guarantee implies more comprehensive implied covenants for title than would be the case with a limited title guarantee. With both full and limited title guarantee the seller will be impliedly covenanting the transfer of the property that they have the right to dispose of the land, that they will do all they reasonably can to transfer the title and that in the case of leasehold land the lease is subsisting at the time of the disposal and there is no breach of covenant making the lease liable to forfeiture. With full title guarantee the seller will also impliedly covenant that the land is disposed free from encumbrances other than those the seller does not know about and could not reasonably know about.
The front page will also detail the contract rate which is the interest rate that will be charged if the parties are late in completing. The interest is charged on the purchase price. The rate must be high enough to incentivise potentially defaulting party to complete on time.
The front page will also detail the deposit. A deposit is a prepayment of part of the purchase price made from the buyer to the seller. A deposit is evidence of the buyer’s commitment to the transaction and if the buyer fails to complete the seller may forfeit and keep the deposit. The deposit is normally paid on exchange of contracts.
Special conditions appear on the back page of a pre-printed contract. Some special conditions might stipulate whether a sale includes any contents or excludes any fixtures and whether the property is to be sold in vacant possession or subject to leasing tendencies. There is also space to incorporate new special conditions because every property transaction is unique.
It is impossible to describe everything that might require a special condition however as a starting point the parties may require conditions dealing with disclosing a defect in title the seller selling with limited or no guarantee or the payment of VAT.
An indemnity covenant might be necessary where when the title is burdened with covenants and the seller is the original covenanter or has given an indemnity covenant to their seller when they acquired the property. This means they will have an ongoing liability even after they part with the property and are no longer in a position to ensure compliance with the covenants.
On the both sets of Standard Conditions the risk of damage to the property passes to the buyer on exchange of contracts. This means that the buyer must complete the purchase even if the property is damaged or destroyed between exchange and completion. The buyer may not be expecting this so will need prior warning so that insurance arrangements can be put into place at the moment of the exchange.
As explained above, VAT is not normally chargeable in residential transactions. The seller’s solicitor will usually choose to incorporate the SE which provides that the purchase price and the contents price are inclusive of any VAT. Contracts for the sale and purchase of commercial property should deal with whether the buyer will have to pay VAT and addition to the purchase price. VAT is payable when the property is less than three years old or because the seller has exercised the option to tax.
The requirements of a lender
One of the most important parts of any property transaction is the funding. Even cash rich buyers of commercial property may choose to the borrow the money to purchase because of the interest payable on the loan is a deductible expense for tax purposes and for a large company it could be far less than the return they are making by investing the cash.
Mortgage lenders seek to limit their exposure to risks by setting out their own specific instructions and requirements for a conveyancer. For a potential buyer the important considerations in choosing a lender will be the amount they can borrow, the interest rates available and the particular product. They may not have considered whether their chosen lender has any specific requirements as to the nature of the property to be purchased or the amount of control a lender has over decisions that need to be made in the conveyancing process.
Once the lender is satisfied that the property is good security for the loan and that the buyer is creditworthy the lender will issue a document to the buyer setting out the terms on which the lender is prepared to make the loan. This is called a mortgage offer. These documents normally give the loan amount, the interest rate, the term, the initial repayments and any other conditions that the buyer must carry out for example repair works.
In terms of further documents required by the lender most lenders will want a first legal mortgage over the property owned by a borrower. Mortgages are legal if they are deemed completed by registration. This is important to a lender as a mortgage may be made by deed has implied into it the power of sale under Section 101 of the Law of Property Act 1925 although a mortgage deed will usually have an express power.
Once the mortgage offer has been sent to the borrower the lender will instruct solicitors to act on its behalf on the mortgage of the property. In residential conveyancing the mortgage is likely to be on standard terms and it is common for a solicitor to act for both the borrower and the lender. However a commercial mortgage is less likely to be offered on standard terms and the terms of the mortgage documentation often have to be negotiated and agreed. Even where the lender is separately represented it is common for the buyer’s solicitor to report to the lender on the results of title investigation and the pre-contract searches and enquiries. The lender needs to know the borrower will have good title to the property just as much as the buyer because it wants to know it can sell the property in the future if it needs to enforce the security.
The lender will want to know that the property is adequate security for the loan. In particular the lender will require a certificate from the solicitor acting for them that the property has good and marketable title. In residential transactions the lender will usually require a certificate of title in the form approved by the Law Society and UK Finance which aims to reduce the conflict of interest when solicitors act for both the lender and the borrower.
The parties have now reached a critical stage in the transaction. Both sets of solicitors have taken their client’s instructions. The seller’s solicitors have investigated the client’s title, prepared a draft contract and produced evidence of title to the buyer’s solicitor. The buyer’s solicitor has raised pre-contract searches and enquiries and the results have been received and analysed. The buyer’s solicitor has also investigated the seller’s title and approved the draft contract. At this point the buyer’s solicitor will send to the buyer a pre-contract report summing up the results of the pre-contract searches and investigation of title. The report usually also explains the terms of the contract and the mortgage offer.
After this the following steps should be taken in preparation for exchange of contracts:-
- Report to the buyer – The buyer’s solicitor should report to the client in writing explaining the results of the title investigation, searches and enquiries and the terms of the contract and the mortgage offer.
- Report to the lender – The buyer’s solicitor should report to the lender who will need to know that the property is good security for the loan and has good and marketable title.
- Ensure deposit funds are available – The deposit funds should be available to the buyer’s solicitors and cleared funds ready to send to the seller’s solicitor at exchange of contracts.
- Check the mortgage offer is in place and the client has sufficient funds to complete – The buyer needs to have the mortgage offer in place and accepted and to have complied with any conditions attached to the mortgage offer the buyer’s solicitor should also check that the buyer has the funds to proceed at the stage of completion.
- Ensure arrangements are in place through insurance indemnity immediately following exchange in most cases the contractual position is that risk passes to the buyer on exchange and therefore the buyer needs to have insurance in place from exchange.
- Contracts signed – Both solicitors need to ensure that their client has signed their copy of the contract. In most cases the client will sign in wet ink although a 2019 Law Commission report concludes that an electronic signature can be lawfully used to execute a document provided the person signing the document intends to authenticate it and any execution formalities are satisfied.
- Completion date – Both solicitors will need to address this with their client and other side in advance of exchanging contracts.
- Before exchanging both solicitors must obtain their client’s authority to exchange. The client should be made aware of the consequences of exchange ie that they can no longer withdraw from the contract. The main requirements for creating a binding contract are set out in Section 1 of the Law of Property Miscellaneous Provisions Act 1989. Exchange of contracts can be done in one of three ways:
- In person, by one solicitor attending the other’s office and handing the contract over;
- By post with each solicitor sending their client’s part of the contract by post to the other side; or
- Over the telephone.
Exchanging contracts in person obviously has a greater advantage of certainty as the solicitor can physically receive the contract. They could instruct an agent to exchange contracts on their behalf but the quickest and most cost effective and reliable way to exchange contracts is to telephone the other solicitor and agree over the phone that contracts are exchanged. This only works if there are arrangements in place to ensure that each solicitor forwards their client’s part of the contract to the other and the sellers receive the buyer’s deposit.
Following exchange, a binding contract exists from which neither party can withdraw without incurring liability of breach. The seller retains the legal title in the property until completion but holds the beneficial interest on behalf of the buyer. During this period the seller is entitled to remain in physical possession of the property. The seller must pay the outgoings such as the community charge or the business rates until conclusion.