Guaranteed to blow your mind

We have posted previously about the case of EMI Group Ltd v O&H Q1 Ltd, in which the court was asked to decide whether a tenant can assign its tenancy to its guarantor.  In this case, EMI Group were the guarantor of original tenant HMV, and were arguing that the lease had been validly assigned to it by HMV.

Somewhat controversially in the EMI case, the deputy judge decided that such an assignment could not happen, as it would frustrate the purpose of the Landlord and Tenant (Covenants) Act 1995 which, fundamentally, was to release the tenant and its guarantor on an authorised assignment of the lease (“the Act”).

The problem is that this interpretation of the Act goes against the concept of freedom of contract. Why should a tenant be denied the ability to assign a lease to a company that has guaranteed its obligations, if in all other respects it is an acceptable assignee to the Landlord?

The decision has been hotly debated and most in the legal profession hoped that the position would be clarified on appeal or by legislative reform. It would seem however that, for now, we are left with a very unsatisfactory and unresolved position.  Until this is addressed, the advice is that tenants remain unable to validly assign their lease to a guarantor.  All of the uncertainties we highlighted previously remain and if such an assignment has already happened, unscrambling the legal position is difficult.  Investment sales  and new assignments of leases are being held up where an assignment to a guarantor has previously been permitted.

 

Public Register of Overseas Companies – Now You See Me…..

If you are an investor currently using overseas entities to hold UK property you should be aware that the UK Government is putting together proposals for greater transparency of the beneficial owners of UK properties owned by overseas entities.

The regulations will have implications for:

  • the risk management, timing and due diligence in real estate investment transactions;
  • overseas entities who will need to ensure compliance is planned well ahead of closing;
  • sellers and mortgagees who will also need to ensure the overseas buyer has complied with the regulations; and
  • existing overseas landowners who are seeking to dispose of or grant a charge over their UK property.

How will the new register work?

The UK will be the first country to have such a register and if these proposals are implemented we will see –

  • overseas entities being prohibited from selling their existing properties or creating long leases or charges over the property without compliance with the new regulations. This will be enforced by automatic entries being added to the Land Registry’s title register; and
  • overseas entities buying property facing the complete reversal of any transaction if they cannot prove compliance at the time they register the land transfer or lease with Land Registry.

The UK Government are working to fulfill the promise they made at the International Anti-Corruption Summit in May 2016. We are in a consultation period at the moment as they look to ascertain how the proposals might influence those planning to invest in the UK and any impact on the UK economy. Should you wish to have your say, you only have until 15 May 2017 to submit your feedback. A link to the response form is here.

We in the Reed Smith Real Estate group will continue to follow and report on the development of these proposed regulations, so watch this space.

 

One year to go. Are you ready for the MEES Regulations?

It’s now less than one year to go until the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015, commonly known as the MEES Regulations (minimum energy efficiency standards) come into effect. It is time to act if you haven’t already.

The MEES Regulations (the Regulations) provide that:

  1. From 1 April 2018 landlords of commercial property will be subject to penalties (subject to some exemptions) if they grant a tenancy where the property has an EPC energy efficiency rating of F or G. This will apply to the grant of new tenancies and lease renewals.
  2. From 1 April 2023 these penalties will extend to continuing tenancies (subject to certain exemptions) even if there has been no change in tenant. The UK Government has recently issued guidance on the Regulations but there is little of significance in the guidance although not all of it is clear.

We previously posted a more comprehensive summary of the Regulations and the above exemptions in May 2015 which can be found here.

Implications of Breach 

  • Where a breach of the Regulations exists for less than three months, the penalty is up to £5,000 or, if greater, 10% of the rateable value (subject to a maximum of £50,000).
  • Where a breach of the Regulations exists for three months or more, penalties increase up to £10,000 or, if greater, 20% of rateable value (subject to a maximum of £150,000).
  • Non-compliant landlords’ details can also be published. Tenants, too, should be aware of the implications if they underlet non-compliant property. In that situation you are the “landlord” under the Regulations.

What should you do?

As we said before, if you are a landlord (or a tenant wanting to sub-let) you can –

  • Audit your portfolio to identify how many low rated buildings you have.
  • Investigate suitable improvements that can be made – the EPC Recommendation Reports make suggestions on how to improve energy efficiency.
  • If possible incorporate energy improvements into planned refurbishments.
  • Know whether the terms of the leases permit you to carry out any necessary energy efficiency works during the term of a lease and who pays for them.

 

Time for Plan B? Amending a planning scheme.

In today’s volatile markets the commercial viability of a project can change in the time it takes to implement a hard-won planning consent and even after works have begun.

It may therefore be necessary to amend a scheme to maintain its profitability and viability. To accommodate such changes, planning schemes are often amended or a new application made.

The case involving Vue Cinema’s challenge to York Council is a reminder of how difficult it can be for development to proceed smoothly when the consented scheme needs to be changed in order to ensure viability of the project. Developers have two choices if they can avoid a fresh planning application and the one they use depends on how significant the change is to the consented scheme.

Option 1: Apply for a “non-material amendment” under Section 96A of the Town & Country Planning Act 1990 (“TCPA”); or

Option 2: Apply under Section 73 of the TCPA to “develop land without compliance with conditions” that were previously attached to the consented scheme and/or to make “minor material amendments” to the consented scheme.

The differences between these processes are:

Non-Material Amendment (s96) Removal of Conditions/Minor Material Amendments (s73)

Administratively easier, standard form application and a relatively simple process reflecting the fact that the change is not material.

The application is treated as new planning application with all the usual time limits and processes including consultation, EIAs etc.
Local planning authority must have regard to the effect of the change on the planning permission as originally granted. The local authority consider the application against the development plan and usual material considerations as well as the original planning permission conditions and make their decision based on national and development plan policies which may be significant if any have changed significantly since the original grant.
The planning permission is amended so the existing permission with all its deadlines and dates remains unchanged and existing Section 106 and 278 Agreements continue to apply. A new planning permission is granted as a result which means new Section 106 and 278 agreements are required and although there are processes to re-state the  s106 agreements already in place, this is never as fast as developers really want it to be if the existing s106 is affected by the variation.

Crucially there is a right to appeal.

 

In R (on the application of Vue Entertainment Ltd) v City of York Council Vue Cinemas challenged a permission for the development of a community stadium.  Vue operated a (different) nearby 12 screen cinema and had commercial concerns about the cinema to be operated from the stadium development.

A s73 application was made to enable the development to proceed without compliance with the condition that required development in accordance with specified drawings. Those drawings showed a 12 screen and 2,000 capacity cinema.  The changed plans showed a 13 screen 2,400 capacity cinema.  Vue objected that this “minor amendment” should be permitted.  The court found –

  • the permission as a whole had to be considered to see if the change was so fundamental that the terms of the permission itself was changed by the variation;
  • this change was only to the part of the permission that related to the cinema;
  • Vue had been consulted and made representations. They were not prejudiced by the change; and
  • the planning authority had the power to grant this new permission.

In conclusion, developers are well advised to try to obtain a workable and malleable consent that has the capacity for minor (preferably minor non-material) variations in order schemes can be amended and altered to cater for ever changing market demand and volatility.

Dilapidations Claims: Repair or Despair?

How can landlords make sure they can claim for the diminution in the value of their reversion when the lease of a dilapidated property comes to an end? Doing no work but hoping to claim was not a successful strategy for the landlord in the case of Car Giant Limited and Acredart Limited v The Mayor and Burgesses of the London Borough of Hammersmith.  Landlords who elect, for whatever reason, not to carry out some or all of the works of repair for which a tenant is properly liable at the end of a lease term, run the risk that their claim for diminution to the value of the reversion will be lost.

It is well established that landlords can successfully claim for losses where they do carry out repair works for which a tenant was liable and the cost of those works is a very real guide to the recoverable loss. If the landlord hasn’t yet done the works, but can prove that he really intends to do works, then claims can succeed but often the tenant tries to prove that the recoverable cost is less than the landlord’s estimated cost of the works.

In the Car Giant case, which concerned 35 units on a secondary industrial site in Willesden, some works had been done by the landlord after the tenant’s 25 year lease expired and the court was able to value the loss in respect of those works, but no explanation was given as to why other works had still not been carried out even 6 years after lease expiry. Crucially, no evidence was given as to when or if they would ever be carried out.  The units had been let in the meantime, all of which strengthened the court’s view that the works could not have been important or necessary to maintain the value of the asset.

The judge was not impressed by the landlord’s valuer’s argument that the hypothetical purchaser would have derived a value for its bid based on the cost of remedying all defects, especially in light of Car Giant’s actions and inactions, which threw more light on the value of the reversion than pure hypotheses. The judge also noted that allusions by counsel to the reasons for Car Giant not carrying out the works could have been helpful to their case if only they had been supported by evidence.  On the limited evidence, the court was only able to award damages based on the cost of the works actually carried out and nothing at all in respect of the disrepair that still remained.

Landlords who wish to bring a claim for loss where they have elected not to do some or all of the repair works must ensure that they have robust evidence to substantiate and justify that decision.

(US) Payment and Performance Bonds vs Completion Bonds. What’s best for your project?

Several types of bonds exist in the development world. So, which type of bond is best for your project?

A payment and performance bond is a combination instrument. It’s first a payment bond that guarantees that the contractor will pay the labor and material costs they are obliged to pay. But it’s also a performance bond that guarantees satisfactory completion of a project by the contractor.  By design, a payment bond is designed to provide security to subcontractors and materials suppliers, ensuring payment for their project work, labor and/or materials.  A performance bond (also called a surety bond), is issued by an insurance company or a bank. It protects the owner from the contractor’s failure to perform in accordance with the terms of the contract.

A job requiring a payment and performance bond may require a bid bond just to bid the project. A bid bond (often required on public construction projects, but not exclusively) is designed to protect the owner in the event the bidder refuses to enter into a contract after the contract is awarded or if the bidder withdraws the bid before award. In short, a bid bond is an indemnity bond. When the job is awarded to the winning bid, a payment and performance bond is issued.   

Bid bonds, performance bonds and payment bonds are all indemnity bonds. Let’s be clear; these bonds are not insurance policies. If a claim arises and is paid out on a bid, performance or payment bond, the surety (the party issuing the bond) will look to the contractor to indemnify and defend it. If a claim is asserted against a contractor performance bond, the surety is going to look to the contractor to defend the lawsuit and to pay any damages.

A completion bond (sometimes called a completion guarantee) is a form of insurance offered by a completion guarantor company. In return, the guarantor receives a percentage fee based on the project budget.  The parties to the completion bond agreement are typically the developer/owner, the financier(s), the completion guarantor company and the contractor. If the bank requires one, a completion bond can be provided to give the lender the required level of security against the risk of non-delivery of the project by the developer or owner. The bond fee itself is negotiable depending on the risks as assessed by the completion guarantor.  The completion guarantor will require a regular flow of project schedule paperwork. Under the bond agreement, the completion guarantor has the contractual right to “take over the project” (which will include wide “hire and fire” rights over any personnel) since they are financially liable if the project goes over budget.

With several options available, what is the best bond choice? Cost is a consideration, as the premium for a payment and performance bond is about half the cost of a completion bond. We recommend clients pursue a payment performance bond linked where appropriate to a sub-guard insurance policy.

BloggeRS: Eva Lai ‘Proposal for new Chinese investment rules – Is UK property investment still attractive?’

Reports suggest that China proposes to impose greater monitoring of large outbound investments and potentially block state-owned enterprises from purchasing overseas property with a value of more than US$1bn in a single transaction. Additionally, permission may be required for the transfer of funds over US$5m. The previous threshold was US$50m. It is likely that more scrutiny will be applied to deals with more rigorous due diligence and a thorough formal approval process for any substantial investments. It is suggested that if a Chinese company has the intention to acquire projects or directly invest in overseas property, they would need to get approval from a number of different government departments which might prove to be a lengthy process.

Will Chinese investors be put off by these proposed changes? It is likely that if the proposed changes are implemented, some investors will seek returns elsewhere due to the hurdles to overcome just to get the money out of China. The lower threshold for transfer of funds might also see the system overwhelmed as the number of requests for approval could soar. In the highly competitive London market the delays caused by the additional layers of bureaucracy might see Chinese investors miss out on prime opportunities if they don’t already have funds in non-RMB currency.

Are the proposed rules a reflection of the Chinese government’s view on international investment? Politically it seems that the Chinese government continues to encourage and allow Chinese companies to ‘go global’ and diversify their holdings. The US$1bn threshold is relatively high; many Chinese outbound property deals over the last couple of years were below this limit. It may be that we see investors adapt by opting to acquire a higher number of smaller deals each below the stipulated investment amount. What is certain is that should the restrictions be imposed, Chinese investors will undoubtedly take a more cautious approach to larger transactions.

At the moment UK property investment still remain attractive because of the significant currency discount on offer. Examples of recent Chinese deals in London:

  • Shun Tak Group acquisition of 7 and 8 St James’s Square in London for a reported £245.9m;
  • Hong Kong-listed Emperor Group’s acquisition of the Ampersand building for £260m;
  • A private Chinese investor acquired 88 Wood Street for £270m;
  • AGP Group acquired 20 Moorgate for £155m;
  • Chuang’s China Investments acquired 10 Fenchurch Street for £80m;
  • Beijing Capital Development Holding offering more than £200m for 30 Crown Place in the City of London; and
  • China Life acquired the Aldgate tower for £346m.

Chinese investors will continue to invest in overseas assets but will be more selective towards deals and closely scrutinise the underlying performance of potential acquisitions.

BloggeRS: Introducing Eva Lai ‘Mastering the art of “guanxi” for Chinese outbound investments’

As many of you are aware when doing business with Chinese investors you will need to come to terms with “Guanxi” – meaning relationships or connections outside the family. This is the core of Chinese society and culture. It is important for the Chinese to get to know the person with whom they wish to conduct business before business is conducted.

I have been working with Chinese clients for several years and have acted for numerous Chinese clients ranging from individual private clients, financial institutions, corporate clients and developers. Being one of the few Chinese nationals qualified as a UK property lawyer, my background, language skills and understanding of the culture allow me to successfully establish excellent guanxi with my clients. We work closely with our Asian offices in Beijing, Shanghai and Hong Kong to provide our clients with greater accessibility and ease communication due to time difference. We are committed to providing a full service to our clients to ensure their outbound investment in the UK goes as smoothly as possible.

Reed Smith has a broad range of experience working with Chinese clients over the years which covers all aspects of real estate transactions including:

  • assisting with finding target acquisitions;
  • working on large scale development projects;
  • dealing with related financing;
  • dealing with acquisitions and disposals;
  • dealing with assets management; and
  • advising on litigation and disputes.

We are a full service law firm offering advice on all areas of law relating to our client’s investment in the UK and also globally through our international network of offices. We are experienced in managing and bridging the cultural difference with our counterparties and our clients. Our lawyers are able to communicate in Mandarin and Cantonese and explain any English law concepts and draw comparisons with Chinese local laws, where necessary, as well as professional interpreters to translate complex legal documents.

Examples of our work include:

  • Acting for one of the largest Chinese developers for its development project in London. The project involves a high profile mixed use development including almost 500 residential apartments, commercial units and a hotel;
  • Acting for a joint venture company, a Chinese developer and a French property company, on a large scale redevelopment project worth €3.1 billion;
  • Acting for a Hong Kong listed company for its acquisition of a chain of hotels in the UK; and
  • Acting for a Hong Kong company to acquire a high value property asset in the heart of London at Fitzrovia.

Supreme Court Likes Reality in Business Rates

The disputed rates in Newbigin (Valuation Officer) (Respondent) v S J & J Monk (a firm) (Appellant) relate to building works in 2012 and the question was whether the rating list could give the building a £1 nominal value or whether it had to assume a market value based in an assumption of repair.

The Judgment

In determining whether or not a commercial building which is in the course of redevelopment has to be valued for the purposes of rating as if it were still a useable office, the Supreme Court decided that the principle of reality applied. It was not displaced by the assumption that the hereditament is in a state of reasonable repair (excluding any repairs which a reasonable landlord would consider uneconomic) set out in paragraph 2(1)(b) of Schedule 6 to the Local Government Finance Act 1988.

The Supreme Court regarded as “helpful” the intervention by the Rating Surveyors’ Association and the British Property Federation that, where works were being carried out to an existing building, the correct approach was to proceed in this order:-

(i)         to determine whether a property is capable of rateable occupation at all and thus whether it is a hereditament,

(ii)        if the property is a hereditament, to determine the mode or category of occupation and then

(iii)       to consider whether the property is in a state of reasonable repair for use consistent with that mode or category. Only at this third stage should the valuation officer apply the statutory assumption of paragraph 2(1)(b) if the reality is otherwise.

In addition, the Supreme Court pointed out that there is no basis for the argument that a building can be listed as being under reconstruction only once the works have proceeded so far that it is no longer economic to restore the hereditament to its former state by means of repair.

As a result, the fact that the premises in question were undergoing reconstruction on the date of assessment should be reflected in a reduction of the rateable value of the premises in the rating list to £1.

The Facts

The facts are important as there has to be an objective assessment. All other cases will turn on their particular facts as to the condition of the building.

In this case, at the relevant date for assessing the facts and applying the assumption referred to above, the premises were vacant and the building contractors had:-

(i)        removed the majority of the ceiling tiles and the suspended ceiling grid and light fittings and also 50% of the raised floor;

(ii)       removed the cooling system and the sanitary fittings and demolished the block walls of the lavatories and stripped out the electrical wiring;

(iii)      erected and plastered plasterboard partitions to form the outline of the proposed communal lavatories and erected and plastered a partition across the floor at the east side of the premises;

(iv)      completed first fix electrical installations to the lavatory area and altered the drainage to accommodate the new location for the lavatories.

This was part of a scheme of renovation and improvement of a three storey office building (which had been occupied by tenants as a single office suite) with a view to making it more adaptable for use as either three separate suites of offices or as a single suite in order to attract replacement tenants.

What can we take away from this case?

Where a property is subject to significant building works, ratepayers may be able to seek an amendment to the rating list so that rates will not have to be paid whilst the property is being redeveloped. However, what amounts to “significant” building works will still be a question of fact and degree in each case. Intention will not be relevant.

(US) There are two New York real estate transfer tax proposals to watch in Governor Cuomo’s proposed budget

New York Governor Andrew Cuomo introduced his FY 2018 budget proposal on January 17. The proposal includes several significant revenue-raisers, including a few that could impact the New York  real estate market.

  • Income Tax – Sourcing of Gain From Sale of Interests in Entities Holding Co-op Shares – Currently, if an individual who is not a New York resident sells shares in a cooperative housing corporation that holds New York real property, any resulting gain is treated as New York-source income, subject to New York personal income tax. However, current law is unclear as to whether a similar sourcing rule applies to gain from the sale of ownership interests in other legal entities where more than 50% of the entity’s assets consist of shares in a cooperative housing corporation that owns New York real estate. As a consequence, some nonresidents planning the sale of shares in a New York co-op will first contribute the shares to an entity, such as a partnership, and then sell the interests in the entity, taking the position that the resulting gain is not New York-source income. The proposal would end this sourcing play by expanding the definition of New York real property for personal income tax purposes to include ownership interests in entities that own shares of cooperative housing corporations that own co-op units located in New York.
  •  Real Estate Transfer Tax – Elimination of Partnership “Loophole” – Under current law, New York real estate transfer tax applies to transfers of a controlling interest in certain legal entities that hold an interest in New York real property. New York Tax Law § 1401(e). This provision does not prevent property owners from conveying a less than controlling interest in New York real property free of transfer tax by first contributing the property to a legal entity, and then selling a less than 50% interest in the legal entity to the intended transferee.   The proposal would close this “loophole” by expanding the definition of “conveyance” for purposes of the transfer tax to include all transfers of interests in partnerships, limited liability companies, S corporations and certain closely held C corporations, where New York real property constitutes 50% or more of the assets of the entity.  In addition, the proposal provides that “consideration” for such a transfer would be calculated by multiplying the fair market value of the New York real property owned by the entity by the percentage ownership interest in the entity conveyed. (For example, if 10% of the ownership interests in a partnership are transferred and the partnership owns New York real property with a fair market value of $1 million, under the proposal, the transfer would be treated as a conveyance subject to transfer tax for a consideration of $100,000.)
  • Real Estate Transfer Tax – Addition of General Anti-Avoidance Rule to “Mansion Tax” – Finally, the proposal would make it harder to avoid the 1% “mansion tax” imposed on transfers of residential real property with a consideration of $1 million or more, by authorizing the Department of Taxation and Finance (the “Department”) to impose the mansion tax on any conveyance “structured in a manner intended to avoid or evade the tax”.   For example, under current law, if a developer constructing a new residential building were to enter into separate contracts conveying the vacant land and the building, the developer could claim that that the mansion tax did not apply to the land transfer, because the land was vacant at the time of the conveyance. The legislation would authorize the Department to treat both contracts as conveyances to the mansion tax if the purposes of the separation of the contracts was to avoid or evade the tax.

We will provide additional updates in the blog as the budget proposal progresses.

Today’s guest blogger, Michael Jacobs is a member of Reed Smith’s State Tax Practice Group,  composed of lawyers across seven offices nationwide. The practice focuses on state and local audit defense and refund appeals (from the administrative level through the appellate courts), as well as planning and transactional matters involving income, franchise, unclaimed property, sales and use, and property tax issues.

 

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