As part of taking security over UK real estate a report on title is prepared by solicitors on the property being charged. This considers:
1. Title: who owns it, what type of ownership, other charges?
2. Rights and covenants binding the property (as these can impact use of the property and its value) and any third party claims against the property (e.g. as the quantum could affect the value of the property or affect its ownership)
3. Leases and headleases where applicable.
4. Real estate searches (covering the local authority register of binding interests, water and drainage, environmental and flooding, highways, infrastructure and searches specific to the property).
5. Planning matters where applicable.
6. Construction matters where applicable
As part of this assessment legal issues might be identified. Whilst occasionally the issue will be severe and prevent the transaction from proceeding, in most cases there will be a mitigating solution available. The most common mitigating solutions are:
- Indemnity insurance
- Confirmation by the valuer
- Covenants or other additional protection added to the finance documents
Indemnity insurance
Where the issue is a title defect (e.g. known rights or covenants affecting the property) then it is often possible to obtain a title indemnity policy to mitigate both the risk for future owners on enforcement and any lender. The policy should be stated to benefit successors in title and mortgagees and for an investment loan should have an indemnity limit ideally set at the property value but not set less than the loan amount (unless a more specific quantification of the risk amount has been calculated and agreed as acceptable). Indemnity policies are helpful in that they allow mitigation to be put in place quickly in order not to hold up a transaction. The premium of the policy will be priced on the risk level and often policies are inexpensive. However, where the risk is high the premium can be considerable and prohibitive or insurance not be available. Quotes are obtained on each occasion a policy is required to confirm the likely cost of a suitable policy. Indemnity policies can also be useful for some planning defects e.g. where it is not known whether there have been historic planning permission condition and/or listed building consent breaches. Again the policy premium is assessed depending on the level of risk and where the risk is high insurance may not be available. Approaching a third party (so the beneficiary of the title issue or the local planning authority in relation to a planning policy) usually invalidates an indemnity policy so such a policy will not usually be suitable for an issue that the borrower proposes to address and resolve. An example of this might be where there is an area of ancillary land where the borrower cannot show legal title but has occupied it for a sufficient period to the exclusion of others and can demonstrate that it has acquired possessory title. The act of applying to the Land Registry to demonstrate that the requirements are met to register possessory title (and later perhaps upgrade this title) may invalidate any indemnity policy in place but if the borrower has good prospects of obtaining possessory title they may prefer to do this and in the long term take steps to resolve the issue. It may be that more practical solutions are better considered rather than insurance in these circumstances e.g. it might be best to confirm with the valuer (see below) that the development is not being built on the land in question and that it is not key to anything else linked to value e.g. access.
Confirmation by the valuer
Legal reports often reveal matters which are technical legal issues but can often be resolved by applying the facts “on the ground” and/or considering what the actual level of risk is in terms of pounds and pence and how this might affect the value of the property (and therefore the real impact on the bank’s security). It may be that the legal issue identified is clearly historic when the property is inspected e.g. talking about rights relating to an adjoining property, physical features on the property/locality or a specific layout that no longer exist/s. In other instances although there might be a defect, e.g. an obligation to maintain specific fencing along a boundary that has been breached, but when the valuer considers the cost of complying with the obligation and remedying the defect (so here lets say the valuer said this was approximately £5k against a £10m residential property with a 50% LTV) the amount apportioned to rectifying the defect may be clearly a de minimis amount in the context of the loan to value and therefore not adversely affect the suitability of the property as loan security. In other instances it can help to think about the practicalities surrounding a defect e.g. if there are no collateral warranties for a basement extension of a high value residential property the valuer might comment that the most important aspect of these works was the damp proofing (or tanking) and that if a specialist surveyor attended the property, surveyed the works and signed off on them and issued a report to the lender and any purchaser on enforcement that this could provide comfort for both.
Covenants or other additional protection added to the finance documents
Thinking about amendments to the finance documents can be helpful for the type of things that come out of diligence where the lender wants some sort of control or assurance in relation to the property. For example where there is overage (an obligation to pay a third party a share of profit) and payment is triggered by obtaining a planning permission (rather than by making a disposal where the borrower would be receiving additional funds to pay the overage and/or redeeming the debt at the same time) the lender might want certainty that the borrower will not trigger an obligation to pay an obligation without its consent. The lender might therefore want a covenant in the facility agreement that the borrower will not apply for any relevant planning permission or trigger the overage in any way without consent. Equally there might be important obligations that have been identified and the lender might want specific covenants that the borrower will comply with these obligations or where there are timescales to be met the lender may wish to include an appropriate condition subsequent to ensure the obligations are met within the required timescales. Bespoke drafting can help to ensure that the borrower understands the importance of complying with specific obligations, meets important deadlines and keeps the lender updated. The diligence process is important in ensuring there are no issues that would invalidate security or adversely affect the value of the property. The steps followed are:
1. What are the issues?
2. What is the risk level and quantum?
3. Can we reduce the risk level to an acceptable level using mitigating solutions?
In most instances working through these steps allows the transaction to proceed to expected timings whilst ensuring appropriate risk mitigation for the lender.
