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When off-plan doesn’t go to plan – security issues in residential developments

  • United Kingdom
  • Banking and finance

26-07-2018

A recent High Court judgment provides a reminder of the rules governing the priority of security interests in an insolvency scenario, and also illustrates some of the potential pitfalls of purchasing apartments off-plan (Williams & Anor v Broadoak Private Finance Ltd & Ors [2018] EWHC 1107 (Ch)).

Background

A company (“B”) borrowed money from a lender (“L”) in order to purchase a property and develop it into a mixed-use site comprising commercial units and residential flats. The lender took a comprehensive security package over the property and B in the usual way, which was registered at Companies House and later at the Land Registry. The flats were sold off-plan during the course of the development, with the deposits being used to fund the project.

Each of the purchasers of the flats had an equitable lien over their interest in the property, in respect of which three purchasers (“Category A Purchasers”), out of a total of 54 purchasers, registered unilateral interests at the Land Registry (giving them a form of security) before L’s security package had been registered. The rest of the purchasers either registered unilateral notices after L’s security package had been registered (“Category B Purchasers”) or did not register unilateral notices at all (“Category C Purchasers”). Before the development could be completed, B became insolvent and entered administration.

The administrators asked the High Court for permission to sell the property free from the unilateral interests of the purchasers of the flats or L’s security interest. Under paragraph 71 of Schedule B1 to the Insolvency Act 1986 (“Paragraph 71”), an administrator may apply to the court for such permission, and the court may give it if it thinks that the disposal of the relevant asset would be likely to promote the purpose of the administration in respect of the company. Under the proposal, as required by Paragraph 71, the proceeds would then be applied to the secured creditors in the order of priority, after the costs of the administrators had been paid. As is usually the case in insolvency scenarios, it was highly unlikely that the administrators would be able to realise sufficient value for all of the creditors to be paid what they were owed in full.

Priority

The basic rule governing the priority of security is set out in section 28 of the Land Registration Act 2002 (“LRA”) - priority is not affected by whether the interest is registered or not. However, this is subject to two exceptions, one of which is relevant here. Under section 29(1) of the LRA, if a registrable disposition of a registered estate is made for valuable consideration, the registration of that disposition means that any other interest in the property that is not registered has lower priority than the interest that is registered. Under the rules, therefore, in theory the Category A Purchasers would be entitled to be paid first, then L, then the Category B Purchasers and then the Category C purchasers. In reality, the administrators considered it highly unlikely that enough money would be made from the sale of B’s assets for any of the Category B Purchasers or Category C Purchasers to be recover any money at all.

Objections

Two flat purchasers opposed the administrators’ application.

One of the flat purchasers (“P1”) who objected was not a Category A Purchaser and therefore was highly unlikely to get his deposit back under the administrators’ proposal. P1, a teacher, considered that the proposal to sell the property with clean title only served the interest of L, not the interests of the flat purchasers. He argued that the administrators had not considered either (i) building out the property and finishing the development or (ii) selling the property as it was, subject to the existing security interests, for another developer to complete.

The administrators countered P1’s first objection on the basis that it would be impossible for them to build out the property without substantial further funding, which would have to come from a third party, and that it was extremely unlikely that such funding could be secured (in part because of the existing rights of the flat purchasers). The administrators argued in respect of the second objection that a sale of the property as it was, subject to the security interests, would be unrealistic, as no developer would be likely to be interested in building out the site on that basis, in part because the existing rights of the flat purchasers would mean that any profits on the development would be heavily reduced. The administrators were able to show that while considerable interest had been generated in the site, not one potential buyer had expressed interest in buying the site with the flat purchasers’ rights attaching to it. The Court agreed with the administrator that the only realistic option was to sell the development free of the existing security interests.

Another flat purchaser, a married couple (“P2”), had exchanged contracts before L’s security was registered, but for some reason P2’s conveyancing solicitors has not registered the unilateral notice in respect of their contract until after L’s security had been registered. P2 argued that they should be entitled to an equitable lien from the date of the contract (rather than from the date that the unilateral notice was registered), which would take priority over L’s security and allow P2 to be a Category A Purchaser. P2 reasoned that L would have been aware of P2’s purchase contract and therefore that P2 had the right to have a unilateral notice registered, and that this would have been a factor in L’s decision to lend. The Court held that, while P2 had had the right to have priority against L at the time when they entered into the contract, they had lost the right to such priority when their solicitors had failed to register the unilateral notice before the registration of L’s security.

The Court allowed the administrators’ proposal to proceed.

Conclusions

While this case does not have any particular impact in terms of the development of the law, it is useful in illustrating what can happen in an insolvency situation in the context of a real estate development. This case underlines the importance to a secured lender of ensuring that its security is registered at the Land Registry as promptly as possible after the security is created – had there been any delay in registering L’s security in this case, more of the flat purchasers might have registered their unilateral notices ahead of the lender, meaning that there would be less money available to repay the lender when B entered insolvency.

In this case, the only flat purchasers who stood any realistic chance of getting their deposit back when the developer went into administration were those purchasers who had registered their unilateral notices before the lender had registered its security. In such a scenario, people buying off-plan would be well-advised to promptly register their unilateral notice and, if a lender has already registered its security interest, purchasers should be aware of the risk that they may be unlikely to recover their deposit if the developer becomes insolvent.

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