Home
Publications
Receivership Matters – September 2018

Receivership Matters – September 2018

Print newsletter

Leasehold issues for Lenders Mini-series 2: Ground rent[...]

Walker Morris’ Sandip Singh explains the ground rent issue that has resulted in many leasehold […]

Walker Morris’ Sandip Singh explains the ground rent issue that has resulted in many leasehold owners feeling trapped in a home where they are forced to pay higher ground rents than anticipated; cannot afford to buy-out the freehold owner; and cannot sell the property on. Sandip also explains related unfair practices within the leasehold market, reviews the UK Government’s response and comments on the potential for legal claims, and on the implications for mortgage lenders.

“the PPI of the housebuilding industry” and “legalised extortion”…

… is how Justin Madders MP and the chief executive of the Chartered Institute of Building respectively have referred to the issue of leasehold ground rent clauses in many new-build properties sold in recent years. The issue concerns leasehold houses and flats which have been sold by housebuilders to consumers where the lease includes clauses which provide for ground rent payable by the homeowner to increase at a significant and, crucially, an unexpected rate.

Diversity in Low Cost Home Ownership options, coupled with economic pressures facing borrowers of all ages and across all socio-economic groups today, has resulted in mortgages increasingly being offered on leasehold flats, retirement housing, shared ownership arrangements, and so on. While leasehold has traditionally been the appropriate form of land ownership for properties within communal buildings and estates, a trend has emerged for developers to sell new-build houses as leasehold properties.

There is nothing inherently wrong with leasehold houses, or flats for that matter. As far as lenders or purchasers are concerned, so long as the lease is properly drafted and attempts are not made to take advantage of the freeholder/leaseholder relationship.

Last year the BBC announced that: “Almost half of all newly built properties in the UK are sold as leasehold rather than freehold properties. Some homeowners have found they are then tied into paying a ground rent that increases every year.” In some of the cases we have seen, the ground rent doubles every 5 to 10 years so that by the end of the lease term it runs into the £millions.

The reason for this is commercially motivated and the problem is compounded where developers have then sold the freehold interest in the property to another party, who collects those rents and refuses to sell the freehold to the homeowner except in return for a large premium. In many cases, customers had been told outright, or had at least led to believe by sales staff, that they would be able to purchase the freehold themselves, shortly after their purchase, for a much lower sum only to find that such promises are not upheld by the new freeholder who has purchased from the developer.

This problem is further exacerbated because the Housing Act 1988 (the HA) deems leases of 21+ years with ground rents exceeding £1,000 per annum in London and £250 elsewhere (that is, a very large number of properties indeed) to be assured or assured shorthold tenancies; and provides that arrears of rent, including ground rent, are a mandatory ground for recovery of possession. This is an issue that affects not only new properties but also traditional, older leases where parties have failed to recognise the significance of the ground rent exceeding the maximum level set out in the HA.

An immediate problem for lenders of such assured or assured shorthold tenancies is that they are easily terminable under the HA and, unlike long leases, in the event of a default by the tenant the landlord/freeholder can bring statutory possession proceedings and obtain possession without the need to deal with a forfeiture process that would allow a lender to seek relief. With an assured or assured shorthold tenancy the landlord could obtain possession following a default before the lender was even aware that there was such an issue and without the lender being able to resolve the problem post-default.

Some retail lenders are also refusing to provide mortgages on properties containing onerous ground rent clauses. Such leases are at greater risk of forfeiture due to the high and unaffordable ground rents that will be payable year on year, as well as the risk that such leases are no longer long leases but assured tenancies with significantly less value.

So far as lease owners are concerned, many now feel trapped in a home where they are forced to pay higher ground rents than anticipated, cannot afford to buy-out the freehold owner and cannot sell the property on because the issue has come to light and is adversely affecting saleability

Housebuilders are facing a variety of complaints, including: the allegation that the leasehold structure is unnecessary and has been put in place merely to extract value via ground rent obligations and sale of the freehold to investors; the detail and significance of the ground rent clauses were not sufficiently brought to the attention of customers prior to and at the point of sale; customers were misled about the potential for them to purchase the freehold and/or the freehold was then sold out from under them to private investment companies; customers felt under pressure to appoint solicitors recommended by the developer (and those solicitors did not then properly advise their client); and that excessive administration fees are charged by developers each time a query or complaint is made by disgruntled homeowners. All of this has led to the issue being debated in Parliament and to housebuilders being denigrated by the all-party parliamentary group on leasehold reform and in the press.

Government response

In an attempt to address these, and related, issues, the Government consulted on various matters, including the following, in its consultation paper ‘Tackling unfair practices in the leasehold market’:

Whether and how the Government should limit the sale of new leasehold houses.
What reasons are there for houses to be sold with leasehold (as opposed to freehold) tenure.
Whether and how the Government should limit the reservation and increase of ground rent on new residential leases.
What effect the restriction of ground rents would have on the supply of new build homes.
Whether arrears of ground rent should be exempted from ‘Ground 8’ possession orders made pursuant to the Housing Act 1988.
Whether freeholders occupying shared private estates should be given rights to challenge the reasonableness of estate service charges similar to those enjoyed by leaseholders.

After receiving some 6,000 responses, the majority of which were from private individuals, the Government published its consultation response on 21 December 2017. The key points to note are:

New legislation will prohibit new long leases being granted on residential houses (whether new-build or existing houses).
The Government will work with UK Finance to address any misunderstanding of lending criteria in relation to leasehold property.
The legislation will ensure that ground rents on new leases of houses and flats are set at a peppercorn rate only.
The Government has written to developers to discourage the use of ‘Help to Buy’ equity loans for the purchase of leasehold houses.
A number of developers have already introduced schemes to compensate existing leaseholders with onerous ground rents. The Government wants to see such support accelerated and extended to all affected leaseholders (including second-hand buyers) and for all developers to proactively contact customers.
The Government will work with redress schemes and Trading Standards to provide leaseholders with comprehensive information on the available routes to redress, including where their conveyancer has acted negligently, and the Law Commission will consider whether unfair terms apply when a lease is sold on to a new leaseholder.
The Law Commission will also consult on introducing a prescribed formula that makes it easier for leaseholders to buy the freehold of their home, while providing fair compensation to the landlord.
The Government will consider what it can do to get commonhold [1] off the ground across the property sector, including working with mortgage lenders. (Commonhold was not successful when first introduced because of the financial incentives for developers in building leasehold.)
The Government has committed to action to ensure that leaseholders are not subject to unfair possession orders as an unintended consequence of the HA’s deemed assured tenancy and mandatory possession for arrears provisions.
The Government will also ensure that, where a freeholder pays a rentcharge, the rentcharge owner is not able to take possession or grant a lease on the property where the rentcharge remains unpaid for a short period of time.

The response also states that the Government is committed to improving the situation of leaseholders more generally, and the proposals outlined so far are a starting point only.

Practical implications for lenders

If the Government enacts proposals in line with its consultation response, the situation should be significantly improved for homeowners and for mortgage lenders in the future.

Issues are likely to remain, however, for existing leaseholders already affected by escalating ground rents.

Some housebuilders have so far announced voluntary schemes enabling affected leaseholders to receive financial assistance with onerous ground rents, or whereby developers will buy back freehold reversions from third party investors so that ground rent obligations can be rectified. If such schemes work, then lenders will obtain the security that they expected and thus will not be any worse off than they should have been. The same will naturally apply for lease owners too. However, such schemes are currently by no means common across the industry, and even where they do exist they are generally limited, whether in terms of customer-eligibility or because only a finite financial provision has been made available. Such schemes will also not resolve issues relating to historic leases that have static or increasing ground rents that have gone unnoticed.

Lease owners and, if the lender’s mortgage terms allow, lenders may be able to either negotiate for a variation to the ground rent clause with the freeholder or may be eligible to seek a statutory lease extension which would then not only increase the term length but also mean the ground rent becomes a peppercorn. However a word of warning: a statutory lease extension requires a premium to be paid to the freeholder which is calculated with reference to, amongst other things the rent he will lose if the new lease is at a peppercorn. As a result, the premium itself may be prohibitive given the ground rent on an onerous lease will likely be high.

All of this means that affected parties may look elsewhere to try to recoup their losses. Property professionals and indemnity insurers are already receiving large numbers of claim notifications. Conveyancing solicitors who failed to advise upon escalating ground rent clauses or high static ground rents and/or mortgage valuation/Homebuyer surveyors who failed to raise such provisions as a risk in their reports could find themselves facing claims.

In addition, Walker Morris has written previously about consumer protection risks facing the property industry. It is possible that a failure, on the part of estate agents or developer’s sales staff, to flag onerous ground rent clauses to potential customers could amount to an unlawful material omission, giving rise to liability for prosecution under the Consumer Protection from Unfair Trading Regulations 2008.

This leasehold market review and response is likely to result in some significant market and practice changes for housebuilders/developers, mortgage lenders and homeowners alike when it comes to how leases are dealt with in the future, but there is no intention to revise or disapply onerous clauses in leases that already exist. As a result, lenders will need to be alive to the terms of the leases that they lend on. Where appropriate, lenders should also ensure that they act quickly to safeguard as many options as possible, whether by seeking to vary the terms of the lease, agree a statutory lease extension or bring third party claims against solicitors or valuers.

__________________

[1] Commonhold is a type of freehold ownership which is created by a further registration at the Land Registry. Commonhold combines freehold ownership of a single property within a larger development, with membership of a company limited by guarantee that owns and manages the common parts of the development. It allows the owners of each unit within a development to be in control of the development, without a landlord or other party able to make decisions about how the development is run.

Reform of the possession claims process announced

HM Courts & Tribunal Service has announced that the shorthold tenancy possession claim process is […]

HM Courts & Tribunal Service has announced that the shorthold tenancy possession claim process is to be simplified and made digital.

Earlier this year HM Courts & Tribunal Service (HMCTS) embarked upon an ambitious programme of court reform, aiming to bring new technology and modern ways of working to the UK’s justice system.

One area targeted for reform is the shorthold tenancy possession claim process. Early opportunities have been identified by HMCTS to simplify the process for possession cases, improve engagement between the parties and HMCTS and to digitise the end-to-end service for all claims. As a first step, administrative processes will be improved, automated and streamlined to make them more efficient and reliable. Considerations are being given to ways of standardising the administration of possession claims.

WM comment

The project will formally start in October 2018 and HMCTS states that it “welcomes input, suggestions and involvement from interested parties in helping to design a better possession process”.

Receivers and the truth about VAT

Fixed-charge receivers will be all too familiar with that uncomfortable feeling of needing to complete […]

Fixed-charge receivers will be all too familiar with that uncomfortable feeling of needing to complete on a sale, but having no clarity on the VAT position of the property. Many will have experienced the frustration of trying to extract information from HM Revenue & Customs (HMRC) as to whether or not a commercial property has been opted to tax.

Regardless of whatever contractual protection is in place, a receiver cannot help but feel nervous that they should be collecting VAT and, if they don’t, that they may get HMRC knocking on their door if it is not collected.

But are these concerns valid? The truth is that a fixed-charge receiver is unlikely to be liable for VAT even if VAT was chargeable on a property provided that the receiver did adequate due diligence.

A fixed-charge receiver is primarily concerned with the collection of rents and sale proceeds from the property over which they are appointed, and the application of that money to the secured lender. A receiver has control over the property, but not of the wider business and affairs of the mortgagor (even though the income from the property may comprise the fundamental element of that business), and therefore, unlike an administrator or liquidator, not the tax liability of that mortgagor.

Legislation and case law

The starting position is that a fixed-charge receiver acts as an agent of the mortgagor, with any supply of goods or services being made by the mortgagor. If that supply of goods or services is VATable, any VAT should be charged using the mortgagor’s VAT registration number.

HMRC does not treat fixed-charge receivership as a form of insolvency[1] and acknowledges that a receiver is unable to be separately VAT-registered as they are merely acting as agent for the mortgagor: “[The mortgagor’s] business retains responsibility for its own VAT registration and all taxable supplies made and expenditure incurred by either it or the receiver must be accounted for on the VAT Return for the business’ registration”[2].

It follows therefore that, in the event of any liability arising in respect of VAT for a taxable supply, liability remains with the mortgagor rather than the fixed-charge receiver.

This does not mean to say that a fixed-charge receiver can give total disregard to the collection of VAT. There is a duty to account to HMRC for VAT but only where the receiver has in fact charged and collected VAT from the recipient of the supply in question.

The main case is Sargent v Customs and Excise Commissioners[3] in which the Court of Appeal confirmed that a receiver could not be treated as a taxable person and therefore was not personally liable for VAT. However, the Court of Appeal also confirmed that a receiver must be accountable to HMRC for any VAT charged and received during the course of their appointment on the following grounds:

firstly, where a receiver has collected VAT from tenants or a buyer, that VAT has been paid to the receiver on the expectation that it would be paid over by them to HMRC, therefore it would be “dishonourable and unjust” (and therefore against public policy) for the receiver not to account for this money to HMRC. The VAT collected by a receiver should not form part of the income which is applied to the secured creditor
secondly, the receiver owes duties to the mortgagor as well as to the mortgagee. The Court of Appeal commented that “Faced with a choice between protecting the company against the potential serious consequences to it of a failure to account to the commissioners and paying an uncovenanted bonus to the bank, the receiver could not properly exercise his discretion by taking the latter course”.

So, if a receiver has not collected any VAT then there is no obligation to account to HMRC. Panic over? Not quite. Provided that the decision not to collect any VAT is based on sound and reasonable judgement at the time, the receiver would not be expected to account to HMRC even if it transpired that VAT was chargeable and should have been collected. Making enquiries of the mortgagor, and HMRC directly[4], in good time ahead of a sale, are therefore important steps to avoid liability. Current guidance from the Association of Property and Fixed Charge Receivers (NARA) recommends that receivers should make all possible enquiries to establish the VAT status of the borrower and the property, including seeking copy rental invoices from any tenants.

If a receiver is aware that VAT is payable or flagrantly or carelessly fails to address the issue and therefore fails to collect VAT, this is the only time the receiver can foreseeably be expected to account to VAT from the proceeds of sale which would otherwise have been due to the secured creditor. Mr Creditor is unlikely to be happy.

Transfer of business as a going concern

It is possible for a sale by a receiver to qualify as a transfer of a business as a going concern (TOGC) under section 49 of the Value Added Tax Act 1994. This will usually be the situation where a let property is being disposed of, including partially let properties and properties where a lease has been agreed, but the tenant is not yet in occupation. In such cases, a sale of the property will be neither a supply of goods nor of services for VAT purposes, and there will accordingly be no VAT to account for on the sale.

To benefit from TOGC relief certain conditions must be satisfied, including:

both the buyer and the seller must be VAT registered (or, in the case of the buyer, be required to register immediately after the transfer)
the buyer must use the property in the same kind of business as was carried on by the seller prior to the transfer
if the seller has opted to tax, the buyer must also exercise an option to tax in respect of the property effective before the date of the supply for VAT purposes, and the buyer must not revoke that option before the transfer.

There is, therefore, reliance on the buyer to comply with the conditions to benefit from TOGC relief (this would usually be dealt with by way of appropriate warranties in any sale contract), but there is a risk that failure to comply by the buyer will jeopardise TOGC status and trigger a VAT liability on the seller. Applying the same approach as above, provided a receiver takes all appropriate measures and complies on their part with the TOGC conditions, there will be no obligation on the receiver to account to HMRC for the uncollected VAT. It will be down to HMRC to claim the VAT from the taxable person directly, the mortgagor, who in turn will have a contractual claim against the buyer.

Accounting for VAT

Section 17 of VAT Notice 700/56[5] sets out HMRC’s views on the status of receivers and gives brief practical guidance for accounting for VAT. HMRC accepts in the Notice that a receiver’s liability to account for VAT is limited to the net amount of VAT which the mortgagor would be required to account for. This means that, from any VAT collected, the receiver is entitled to deduct input tax on eligible expenses incurred provided that the mortgagor would have been entitled to claim the same credit. Eligible expenses for this purpose are those incurred in the making of the supply in question. In the context of the sale of a property, this could include the sale agent’s fee, or conveyancing solicitor’s fees. VAT on other expenses not connected to the sale would not be deductible.

As previously mentioned, it is the mortgagor who remains the taxable person and obliged to submit VAT returns. A receiver therefore ought, as a matter of good practice, to inform the mortgagor of the amounts of output and input VAT and the supplies to which they relate. A receiver cannot make a claim for a VAT repayment on a mortgagor’s behalf (even if that income would be charged to a lender). This has to be done by the mortgagor, or by its liquidator or administrator.

Summary

Despite a common misconception that a receiver may have to account for VAT out the proceeds of sale from a property if it has not been duly collected, it would in fact be very rare for a receiver to become personally liable. The mortgagor remains the taxable person and so any liability for VAT remains with them.

Where a receiver has collected VAT from a tenant or buyer, the receiver must account for this to the tax authority, and it cannot be used towards the receiver’s own expenses or towards the debt of the appointing mortgagee.

_____________________

[1] VAT Notice 700/56, paragraph 2.5.2
[2] VAT Notice 700/56, paragraph 7.1
[3] [1995] STC 398
[4] receivers who wish to enquire whether there is an Option to Tax on a particular property should contact HMRC’s Option to Tax service
[5] https://www.gov.uk/government/publications/vat-notice-70056-insolvency

Are receivers obliged to obtain the best price when selling property?

The case of Centenary Homes Ltd v Jon Howard Gershinson and Victoria Liddell [2017] highlights […]

The case of Centenary Homes Ltd v Jon Howard Gershinson and Victoria Liddell [2017] highlights the relatively high threshold that must be overcome by a borrower seeking to bring a claim against receivers if they believe that they have sold property for less than market value.

In a nutshell, Centenary Homes Limited defaulted on a loan which was secured against several properties, including one property (Warne Court) which comprised a number of residential flats.

The lending bank appointed receivers who proceeded to sell several properties within the borrower’s portfolio realising sufficient funds to discharge the debt owed to the bank in full and the receivers’ appointment ended. Warne Court was sold as a single block for £3.25 million rather than as individual flats which the borrower contended would have achieved a higher price.

Centenary Homes Ltd subsequently issued a claim against the receivers alleging that they had acted in breach of their duties. The company claimed that the receivers had a duty to take reasonable steps to obtain the best price reasonably obtainable. The company’s argument was that Warne Court should not have been sold as a block but as individual flats and that the combined market value for the flats sold separately was £3.885 million representing a loss of £635,000.

The receivers applied for summary judgment and strike out of the claim arguing that sale of the flats as a block was preferable due to factors such as the increased length of time it would take to sell the flats individually and the risk that market conditions could worsen over that time.

What did the court decide?

The court found in favour of the receivers and in doing so set out existing case law restating the duties owed by receivers including:

a receiver’s primary duty is to realise the security in the best interests of the bank
a receiver has only a secondary duty to the borrower to exercise care to avoid preventable loss
a receiver is only required to protect the interests of the borrower where doing so is consistent with the primary duty to realise the security
a receiver is free to sell a property in the condition it is in
in exercising a power of sale, a receiver will owe a duty to the borrower to take reasonable care to obtain the best price reasonably obtainable at the time of sale and to exercise his powers in good faith and for a proper purpose.

On the basis of the above, the master concluded that it was not enough for the borrower to simply identify alternative strategies or decisions that the receivers might have made. The master was not convinced that the borrower could obtain any expert opinion that could sufficiently establish at trial a breach of duty and therefore struck out the claim.

WM comment

Receivers will welcome the decision as recognition that the primary duty of receivers is to realise the security to recover the secured debt. In order to protect themselves however, receivers should ensure that they document any decisions as to sale strategy and that they give appropriate consideration to the all the options available.

Contacts

Karl Anders - Partner, Housing Litigation & Management Team at Walker Morris LLP.

Karl Anders
Partner
Learn More

Owen Ormond
Director
Learn More

Zoe McLean-Wells, Senior Associate, Real Estate & Banking Litigation at Walker Morris LLP

Zoe McLean-Wells
Senior Associate
Learn More