An endless challenge for the legal profession is to deliver ‘certainty’ for a client. As somebody who spent time working in an accountant’s office prior to undertaking a legal career, I have always found that this push for certainty in the legal world to be at odds with the fundamental risk-return principle that applies in the financial sphere. A key by-product of that difference is that solicitors are often asked to achieve certain, desirable contract outcomes from circumstances that do not lend themselves to that result.
Many buyers, irrespective of whether the party is a first time or return investor, have discussed with me during pre-contract discussions their preference for a provision that varies the consideration should the letting pool reduce in number (never the reverse). It is a rising trend, which also demonstrates a considered buyer. If we exclude off-the-plan transactions for the purpose of this article, there are a number of factors that have instilled this concept into existing business discussion such as:
In other words, a buyer is seeking to balance risk of the perceived overpayment for a business come settlement even before the transaction has commenced. Whilst the logic is completely understandable, in one sense I do find that approach to be somewhat perplexing because you are effectively asking a seller to accept your price and then in almost the same breath, seeking to push that price south or hedge the risk of buying (if circumstances dictate). With this approach a buyer is pursuing ‘value certainty’. There is nothing wrong with that, but there are other influences that need to be assessed.
The tips or observations that I want to provide in this piece are to demonstrate that there are several options available to achieve that ideal outcome of ‘value certainty’. In each case, attention should be turned towards these possibilities but always have regard to a seller’s attitude, which can and should vary.
At first, let us consider the bank attitude towards letting pool sizes. Banks naturally understand that variances are a part of the sector, which leads to their terms of offer permitting variances of anywhere between 5 and 20 percent in the letting pool size before a re-valuation is necessary. Overwhelmingly, the most common application is 10 percent. Such terms of offer apply notwithstanding the presence (or otherwise) of a clause that deals with a price variance. The point that needs to be remembered is that the bank applied variance relates to the letting pool size from the end date of the verification period until settlement. In only one instance have I experienced a lend whereby a bank drafted into the letter of offer a defined number of letting appointments being a pre-requisite to funding.
With the bank approach in mind, the legal options most utilised are as follows:
Settlement day adjustment.
Allowing for a price adjustment on the settlement day is by far and away the most common method. Sometimes this is referenced as a clawback. Strangely, I often find that risk averse buyers have no issue with working this type of provision into a transaction based on a seller’s purported net profit. This approach regularly needs to be re-considered. There are many and varied findings that can be interpreted from a buyer’s verification report, so the starting point must be to wait for the buyer’s report before determining the per letting appointment value. As alluded to in the introduction, an accountant’s work often contains elements of creativity with estimates applied to their assessment. Therefore, a buyer adopting this approach should expect a seller to scrutinise the accountant performing the verification procedure. Furthermore, and when negotiating, this method, consider questions such as: When is an appointment lost? Is it when a notice is served? Is it when a property placed on the market? Is it when a property has settled?
There are instances where the composition of a letting pool is known to have a concentration of ownership, be that due to the complex being newly developed or because a one or more parties’ own multiple properties within the complex. On these occasions, consider negotiating a retention for application on the settlement day so that time can be offered to ascertain whether, for example, property sales (pending or otherwise) are made and appointments lost or gained. Consider the timeframe for the post-settlement retention period, the time can and should vary all facts being considered. However, keep in mind that depending on the seller’s discharge requirements on the day of settlement, this proposal may not always be plausible.
Conditional letting pool size.
As mentioned earlier, banks very rarely stipulate that a minimum number of appointments must be available to the buyer on the settlement day, but that is not to say that a condition precedent to settlement cannot be established. If you do view this as a preferred method then consider that a loss of two or more letting appointments is probably the starting point from the seller’s perspective, as opposed to one.
My final tip for buyers is to stay positive during the thought process. The industry contains consultants that understand the concepts and seek to provide advice that help to offer value certainty. Note that I said “offer” and not “assured”. Good luck.
Peter Spranklin - Spranklin Legal