COMMERCIAL REAL ESTATE AND FINANCE UPDATE FOR LENDERS

TRAINING SESSIONMAY 2008

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Commercial Real Estate And Finance Update For Lenders

Energy Performance Certificates

Code of Practice for Commercial Leases

Property Case Law Update

Companies Act 2006

Endeavours

Mortgage Fraud

Valuation

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Energy Performance These regulations require:

EPCs (energy performance certificates) and recommendations for improvement of the energy performance of the building to be produced when buildings are constructed, sold or rented out

DECs (display energy certificates) to be displayed in larger buildings "occupied by public authorities and by institutions providing public services to a large number of persons and therefore frequently visited by those persons", and the production of advisory reports with recommendations for improvement of the energy performance of the building

Air-conditioning systems to be inspected at regular intervals not exceeding 5 years. This regulation came into force on January 1st 2008, so that larger units will require inspection by January 4th 2009, and smaller units by January 4th 2011.

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Energy PerformanceThe phasing of the measures is provided in the table below:

6 April 2008 EPCs required on construction for all dwellingsEPCs required for the construction, sale or rent of buildings, other than dwellings, with a floor area over 10,000 m2

1 July 2008 EPCs required for the construction, sale or rent of buildings, other than dwellings, with a floor area over 2,500 m2

1 October 2008

EPCs required on the sale or rent of all remaining dwellingsEPCs required on the construction, sale or rent of all remaining buildings, other than dwellingsDisplay certificates required for all public buildings >1,000m2

4 January 2009

First inspection of all existing air-conditioning systems over 250 kW must have occurred by this date

4 January 2011

First inspection of all remaining air-conditioning systems over 12kW must have occurred by this date

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DEC’s

Regulation 16 requires DECs to be displayed by the "occupier" of a building with a total useful floor area over 1,000m2, where the occupier is either a public authority, or an institution which provides public services to a large number of persons and is frequently visited by those persons.

The certificate must be displayed prominently in a place that it is clearly visible to members of the public. In addition, Regulation 16 requires occupiers to have in their possession (but not display) an advisory report containing recommendations for the improvement of the energy performance of the building.

The Government's explanatory memorandum states the latter category would include, for example, public museums and swimming pools but would exclude hotels and retail outlets.

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Questions about EPC’s

Q. Why is this relevant to Lenders?

There is no standard definition of a green mortgage, but some lenders offer a discounted interest rate for energy efficient homes or for loans to make energy efficient improvements. The government actually announced as far back as September 2006 that it is considering introducing measures that would link EPC’s to green mortgages in schemes run by energy companies.

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Questions about EPC’s continued

Q. What does “on the market” mean? Does the borrower have to have produced full sales particulars or can they just tell their colleagues that they propose selling the property?

A building is put on the market when it is first advertised or otherwise communicated to the public (or a section of the public) as being available for sale or rent.

Q. Who will pay for an EPC? Will it be the borrower?

If a landlord upgrades a property to ensure it enjoys a better rating it will seek to recover its costs from the tenants and the provisions of the lease, particularly service charge provisions will require close scrutiny.

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Questions about EPC’s continued

Q. What happens if there is no accredited energy assessor available to provide an EPC? Can they still put the property on the market?

The official guidance provides that there is a defence against a penalty charge notice if they commissioned an EPC at least 14 days before it was required and despite all reasonable efforts they have not received a valid EPC at the relevant time. They will need to provide evidence that a proper request was made to an accredited energy assessor.

Q. What are the penalties for non compliance

Who knows?

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Commercial Lease Code – What Lenders Should Know!

At a time when the commercial property market is holding its breath to see what the market will do in the light of the current credit crunch, an unlikely opportunity for some landlords may be found in the Code for Leasing Business Premises – new name!

The property market has historically operated within a narrow range of lease structures and generally based on what is known as the ‘institutional lease’. Broadly, these lease arrangements seek to pass on the whole of the risk in a property to the tenant enabling the landlord to see the rental return as a pure income receipt leaving the tenant responsible for the property repairs and maintenance etc. Banks are very familiar with the concept of the “institutionally acceptable lease”.

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Commercial Lease Code – an opportunity?

Although the length of leases granted to tenants has reduced significantly from a norm of 25 years to closer to 10 years often with break clauses, the content of the leases has remained fairly constant.

The Government has been looking to introduce great flexibility into the market’s offering in part through the issuing of the Code which deals with the manner in which negotiations about the terms and content of commercial leases are handled and how landlords and tenants work together.

Although currently voluntary, the Code (now in its third edition) does encourage landlords to offer variations from these institutional terms.

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Commercial Lease Code – an opportunity?

The Code is limited to 10 recommendations (rather than the 23 contained in the former version), and is expressed in more authoritative terms. The Code continues to recommend the practice of offering alternative lease terms - requiring the landlord to state whether these are available. However, a landlord is only required to price out alternative terms if a tenant requests it to do so.

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Code for Leasing Business Premises

4. RECOMMENDATION 4: RENT REVIEW

Rent reviews should be clear and headline rent review clauses should not be used. Landlords should on request offer alternatives to their proposed option for rent review priced on a risk-adjusted basis.

For example, alternatives to upward only rent review might include up/down reviews to market rent with a minimum of the initial rent, or reference to another measure such as annual indexation.

Where landlords are unable to offer alternatives, they should give reasons.

Leases should allow both landlords and tenants to start the rent review process.

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Code for Leasing Business Premises

6. RECOMMENDATION 6: SERVICE CHARGES

The RICS has published the Code of Practice for Service Charges in Commercial Property (which is based on the former Guide to Good Practice). The Code can be seen at http://www.servicechargecode.co.uk/

Landlords must, during negotiations, provide best estimates of service charges, insurance payments and any other outgoings that tenants will incur under their leases.

Landlords must disclose known irregular events that would have a significant impact on the amount of future service charges. Landlords should be aware of the RICS 2006 Code of Practice on Service Charges in Commercial Property and seek to observe its guidance in drafting new leases and on renewals (even if granted before that Code is effective).

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Code for Leasing Business Premises

7. RECOMMENDATION 7: REPAIRS

Tenants’ repairing obligations should be appropriate to the length of term and the condition of the premises.Unless expressly stated in the heads of terms, tenants should only be obliged to give the premises back at the end of their lease in the same condition as they were in at its grant.

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Court of Appeal upholds High Court decision denying bank the right to recover possession of mortgaged property

Ashe v National Westminster Bank PLC [2008] EWCA Civ 55

On 5th February 2008, the Court of Appeal held that a bank’s right to recover possession of property by enforcing its security over its interest in leasehold land was statute-barred.

This case looks at the meaning of “adverse possession” in the context of enforcement actions for the recovery of mortgaged land and, importantly for lenders, highlights the risk of enforcement claims becoming time-barred if lenders delay taking action against a borrower in default.

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Background

Two issues lie at the heart of this case:

whether the Limitation Act 1980 (LA 1980) applies to a lender’s right to recover possession of a mortgaged property occupied by the borrowers.

whether the borrowers, who were in exclusive possession of their mortgaged property for more than 12 years after the limitation period began to run, were in “adverse possession” of it for the purpose of the LA 1980.

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General rule on when a lender has a right to possession

The general rule is that a lender has a right to possession from the date of the mortgage (Four-Maids Ltd v Dudley Marshall (Properties) Ltd [1957] Ch 317).

Where the mortgage states that the lender is not entitled to possession until the borrower defaults, time for claiming possession does not run until there is a default (Wilkinson v Hall (1837) 3 Bing NC 508).

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Decision

The Court of Appeal dismissed the appeal by the bank and upheld the decision that an action to enforce the legal mortgage in favour of the bank was statute-barred (sections 15 and 17, LA 1980). The crucial issue was whether the actions of the borrowers and bank meant that the borrowers were not in "adverse possession" of the property as this was fundamental to the question of whether the LA 1980 applied.

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Reason

The judge held that:

The borrowers were in "adverse possession" of the property both at the time the mortgage was given and after the borrowers made the last payment to the bank.

The meaning given to "adverse possession" in Pye was of general application to actions for the recovery of land, including land that was mortgaged.

The lender had failed for more than 12 years to protect its security either by taking steps to enforce its right to possession or obtaining payments from the borrowers.

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Comment

This case has practical implications for banks and other lending institutions who have taken security over land and who delay taking enforcement action against a borrower for whatever reason and who take insufficient action to protect their legal interests during a prolonged period of borrower default.

The point of the LA 1980 is to prevent stale claims being taken and to end ongoing disputes. This case should remind secured lenders of the need to take action to protect their security interests when it is clear a borrower is in a position of ongoing default.

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Lender protection measures - What can you do? If a lender decides not to take immediate enforcement action against a defaulting

borrower, it may wish to take the following steps to protect its security interest over land to avoid falling foul of the limitation period:

Ensure that within the 12-year limitation period, part-payments of debt are made by the borrower, however small. This case highlights that the limitation period will only start to run from the date on which the last payment of debt is made to the lender. Any part-payments which the borrower makes mark the start of a new limitation period (section 29(5), LA 1980).

Check that the relevant security document includes a provision which states that the lender’s right to possession is dependent on payment default or linked to other events of default in the underlying credit agreement. A lender's right of action would then start when a default occurred rather than giving the lender an immediate right to possession which otherwise arises when the mortgage is created. A court will not imply a term into a legal mortgage restricting the rights of a lender to take possession of a property (see National Westminster Bank plc v. Skelton [1993] 1 WLR 72).

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Lender protection measures

Ensure that the borrower acknowledges in a signed statement that the lender has a continued legal interest in the land. The right to recover the land is then treated as starting on the date of the acknowledgement instead of when the lender’s interest in the land is first created (section 29(2), LA 1980).

Give the borrower express permission to remain in possession of the property even if he is in default. This should prevent the borrower claiming that he is in "adverse possession" (paragraph 8, Schedule 1, LA 1980). Time does not run unless the occupier of the land is in "adverse possession" of the property and means that the borrower is less likely to be able to claim the benefit of the LA 1980.

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Companies Act 2006 – Changes Affecting Lenders

Future

October 2009 – charge registration

October 2008 – financial assistance abolition

Current – April 2008

Document execution

Insolvency expenses

Filing accounts

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Companies Act 2006 – Changes Affecting Lenders

Past – October 2007

Litigation

Share security

Board minutes

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Endeavours

Best

All reasonable

Reasonable

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Mortgage Fraud – The Warning Signs

What are the warning signs?

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Valuation Clauses

Who is the Valuer?

What if he cannot act?

Circumstances of provision?

Basis?

Who pays?

Who is to receive the valuation?

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Contact Details

Jonathan LawrencePartner Banking GroupT +44 (0)20 7360 8242jonathan.lawrence@klgates.com

Bonny HedderlySenior Associate Real EstateT +44 (0)20 7360 8192bonny.hedderly@klgates.com