Exchanging contracts between buyer and seller is a key milestone of the commercial purchase or lease timeline that occurs between the Heads of Terms (HOTS), a drafting document that includes primary terms and agreements and completion, the moment at which the remaining balance of the property transaction is transferred and the transaction is completed.
Prior to completion, you will have:
- Lodged an offer on a commercial property and had it accepted.
- Drafted heads of terms (HOTS) that set out clauses and a loose timeline for the transaction.
- Carried out an inspection of the building with the service of a surveyor.
- Carried out property searches (that search out all information relevant to the property in question from local and national databases).
- Satisfied the financing of the property with regards to mortgages or commercial property loans.
- Planning permission has been granted on immediate future plans to build or modify.
- Created a contract agreed upon by both parties.
- Exchanged the contract and paid deposits.
- Settled the transaction.
There will be some nuances in this process depending on whether you are agreeing to a lease, leasehold purchase or freehold purchase but the fundamental process will be largely the same.
At any point before the exchange of contracts, the vendor can decide to abort the transaction and sell/lease to another buyer. This can be restricted by the placement of a lockout agreement (usually in the HOTS) that prevents the seller from aborting the transaction after an offer has been made, so long as the lockout agreement has been agreed to by both parties.
The contract represents the point of legal binding, the milestone at which the transaction is subject to contractual law, though the full legal process is not complete until entered up into the Land Registry. It’s crucial to work jointly towards a contract that is free from surprises for both parties. This largely hinges around the Heads of Terms that forms the backbone of the transaction process prior to the exchange of contracts.
The Heads of Terms
A crucial precursor to a formal and legally binding document is the heads of terms (HOTS). A proposed commercial property transaction, regardless of whether leasehold or freehold, will begin with the HOTS. This is created shortly after an offer is placed and accepted. The HOTS ensures that both parties start off on equal footing and provides a clear timeline and legal route towards completion. Without the HOTS, timeline expectations and other nuances involved in the transaction process, e.g. surveys and searches, may cause grievances.
Basic features of the HOTS
- Property Details – The HOTS must include complete and accurate property details including the address, freehold or leasehold and whether it is a part or whole lease/purchase.
- Parties – Names of individual parties, e.g. personal names, addresses and telephone numbers for individual buyers or business details for business purchases.
- Professional Advisers – Details of solicitors, agents, surveyors and accountants.
- Transaction Details – Rent or purchase prices, payment methods, tax (e.g. VAT) and other possible charges such as utilities and service charges.
- Term and Rent (lease only) – Length of the lease, rent payments and charges, and whether it is ‘contracted out of the Landlord and Tenant Act 1954’. This would mean the tenants forego their statutory right to renew the lease at the end of the lease period.
Advanced Features of the HOTS
The type of agreement and clauses.
The HOTS may include detailed information about the agreement and its various clauses. This may apply for both freehold and leasehold commercial properties.
- In the case of leasehold commercial property, the HOTS will outline information on the lease length, rent and payment dates. It will also contain information on break clauses, any fit-out works, covenants, easements and information concerning the Landlord and Tenant Act 1954, particularly whether or not the tenants retain the right to renew the lease when it comes to an end.
- In the case of freehold commercial property, this is usually more straightforward as there are fewer ongoing clauses to consider but easements and covenants may still apply.
- A Proposed Timeline For Completion.
The HOTS may contain a timeline for completing tasks on the road to exchanging contracts. This helps keep both parties on the same track whilst enabling each party to potentially hold the other to account on the timely completion of stipulated objectives. The legality of these terms is not guaranteed and Heads of Terms are not legally binding unless they meet specific criteria that will be explained shortly.
Some milestones in the HOTS may include:
- Dates for completion of structural and/or land survey for the commercial building/site.
- Dates for satisfying any pending finance (e.g. securing commercial loans).
- Dates for obtaining planning permission and/or fit-out works.
- Dates for exchanging contracts.
- Dates for completion.
Risks of Heads of Terms
Heads of Terms need to be treated as interpreted as they are – simply the headlines of terms. They are the skeleton of the contract helping to glue the process together prior to the formulation of full contracts which are then exchanged prior to completion.
With a detailed HOTS, the whole conveyance process should run more smoothly benefiting both parties.
However, a poor or incomplete HOTS is both disadvantageous and risky and there’s no guarantee that both parties will end up on the same page if the HOTS is not taken seriously. A HOTS that ends up as a pile of messy paperwork may lead to issues when it comes to formulating and exchanging contracts.
The risks of HOTS specifically relates to its legality. HOTS are not typically legally binding, but under the Law of Property (Miscellaneous Provisions) Act 1989, they may be considered as such so long as they:
- Are in writing and include identical details.
- Are signed by all parties.
- Include intentions to begin legal relationships, e.g. the offer, acceptance and timeline for exchange and completion.
Parties must be open in whether or not they expect the HOTS to have legal ramification. To exempt the HOTS from legal binding, it may include the words ‘subject to contract’ – this suspends the legality of the HOTS until contracts are created for exchange. Agents are usually the ones to draw up a HOTS but in large-scale or complex commercial property transactions, it’s best to involve a commercial property solicitor or commercial chartered surveyor.
Between HOTS and the Contract
Between HOTS and the contract and completion, it is mainly up to the buyers to take the next steps in ordering up surveys and searches of the building as well as making sure their finances are absolutely prepared for the transaction. The buyer can raise CPSE Enquiries (Commercial Property Standard Enquiries) with the sellers who are in their best interests to answer as thoroughly as possible.
You will then have to submit financial information to the seller’s agents including your mortgage deed for approval. This will assist the sellers in drafting up the contract and transfer deed. Note that in commercial property conveyancing a contract does not legally transfer the ownership of the property on its own. However, the transfer deed will be attached to the finished contract in most cases.
Once proceedings are approaching the finishing line, it’s time to draw up contracts.
- Heads of Funds drafted and agreed and proof of finance given.
- Due diligence exercised – searches and inspections carried out into the legal and physical state of the building – CPSE (Commercial Property Standard Enquiries) made where required.
- Organising the insurance both parties.
- Full finance granted ready for the transaction.
Once the following are complete/imminent to be completed, both party’s legal advisors will begin preparing the final contract.
A commercial property contract forms a contractual obligation between the two parties and once agreed and signed, it is legally binding. A commercial property contract obliges the transaction to take place on a specific date enclosed within the document.
The transfer deed will contain multiple clauses regarding easements, covenants, etc, many of which will have been outlined in the Heads of Terms. This is where the strengths of a good Heads of Terms shine, they help ensure there are no surprises in the final contract. On the flip side, any changes in the contract not included in the Heads of Terms can cause disputes.
A Detailed Look at Contract Clauses
Easements should be understood by the point of exchange. An easement is the right to use someone else’s land for specific purposes. In residential property, this is usually pretty simple, such as the right to walk over a private pathway or drive down a small privately-owned driveway to access your home. In commercial property, easements may be a lot more complex.
Commercial easements often concern access across a shared concourse and the use and maintenance of shared utility infrastructure. Easements are relevant to both parties here, the seller will also have to ascertain whether they require access to areas of the freehold that they still own and how they’ll be legally entitled to enter and exit these. They might include utility stations, such as electrical switch boxes, or control rooms for mixed-use industrial estates.
The seller will also have to consider whether neighbouring land they use nearby will be developed in the future and how this might be restricted by easements in the contract. These types of easements must be set out in the transfer deed and contract as expressed grants.
Covenants are more strongly associated with leasehold but they apply to freehold too. There are two types, a positive covenant – a promise to do something – and a negative covenant – a promise not to do something.
- In commercial leasehold, restricted covenants prevent the leaseholder from making certain modifications to a building or prevent them from using it for certain purposes. These are usually quite rigorous and highly enforced compared to covenants on freehold.
- Covenants can still apply to freehold and will be discovered in the due diligence process. In commercial freehold, covenants concern land surrounding the freehold that is still owned privately but can also concern the building and land itself. These might apply when you are acquiring a unit of an industrial estate, or a block within a larger complex of buildings. They are practical laws that prevent developers from doing whatever they want with commercial buildings acquired in tight-knit developments. Once they are attached to a transfer deed, they apply to all future owners – some might have existed for decades. These covenants will not always be enforceable and there are things you can do to repeal them if they are no longer relevant.
Positive covenants are things you must agree to do as either the leaseholder or freeholder. These might include contributions to the upkeep of an easement, e.g. pavements or roads not owned in the leasehold/freehold. Unlike negative covenants, these must be created for each transfer deed and contract so the seller must make sure they attach them to a contract accompanying a new transfer deed if needed.
The buyer may place retention provisions in the contract that allow them to retain amounts of the purchase price for various reasons. One such is service charge and ground rent retention.
Here, the buying party can request funds to be retained from the final transaction fee to pay for outstanding service charges and management costs. This protects the purchaser from meeting balances incurred for ground rent and property management during the last freeholder’s or leaseholder’s occupance.
This may apply when:
- Completion is due before final service charges are paid by the previous owner.
- Service charge balances may then run over into the next year – to be paid by a new owner.
- Similarly, with ground rent, retentions allow the purchaser to retain money from the final transaction to pay costs incurred by the previous occupiers.
Careful buyers will find what charges are due – and what account balance is to be met – and retain some of the final payment in order to meet these costs.
Another possibility is if the buyers suspect the seller is avoiding completing a certain task and that they’ll then be left with the bill. For example, the seller may have been avoiding a legally required asbestos survey – the buyer can request to retain funds to pay for this as it should have taken place under previous ownership.
Confidentiality clauses are there to ensure that parts of the deal are kept between the involved parties only until completion. Sometimes, it’ll be in both party’s interests for parts of the contracts to remain confidential.
The buyer would become immediately responsible for the environmental properties of the site once the deal is completed but this responsibility is often altered in the contract. Environmental surveys are part of the due diligence process here and should reveal immediate issues like water damage, damp and contamination.
However, contract clauses can return responsibility to the owner who contaminated the land. Whilst the buyer should eliminate this issue with the survey, they will not want to be held liable for environmental issues they didn’t create.
Terminating and Rescinding Contracts
Finally, under certain circumstances, both parties may still need to terminate the transaction and will make provisions on how they can do so without breaking the contract. Triggers enabling this might be the seller’s failure to carry out crucial work or tasks in an agreed period, e.g. evacuating their equipment, or the buyer filing for insolvency. Triggering termination clauses often results in forfeit of deposit.
Once contracts are overviewed, signed, dated, sealed and delivered, completion begins to take place.
Completion is usually a short time after contract exchange, up to a month in some complex cases but usually, both parties will want to get it over and done with ASAP. The date will be on the contract. Stamp Duty Land Tax must then be paid – this is a requirement for the acquisition to be entered into the Land Registry. You will also need to now register your building for health and safety if required.
It is the buyer’s responsibility to transfer the entire sum by the completion date or face fines and penalties, as well as the possibility for the seller to terminate the transaction.
The transaction must be registered at the Land Registry for the entire deal to become 100% legally effective. This is always the case for freehold transfer, leasehold transfer where the lease is considered a ‘long lease’ with over 7 years, or rental leasehold with terms beyond 7 years.
The commercial property transaction timeline is not straightforward nor is it generally intuitive. Liaising with all parties in fine detail is your best bet of staying informed, always keep detailed records on the progression of the transaction making sure it aligns with timelines discussed with the seller as set out in the HOTS.
You may need to involve several parties ranging from accountants to specialist commercial property solicitors, chartered surveyors and agents.
Attention to detail is critical but working in a granular fashion to cover almost every base is time-consuming. You will likely have to work pragmatically to complete the process in a realistic timeframe. It’s always best to choose your professional representation early on and organise surveys, searches, etc, as soon as you can. Uncovering problems early is always better than uncovering problems late!
Glossary of Terms
- Covenants: Covenants are numerable for leasehold and primarily concern building modification and use, but they apply to freehold too. One such might be whether the new leaseholders or freeholders need to pay towards the upkeep of a shared road or pathway.
- Due Diligence: Property purchases and leases are subject to caveat emptor (let the buyer beware). This means it is in the purchasing party’s interests to exercise due diligence – this means checking every aspect of the property prior to purchase/lease.
- Easements: The right for the buyer to use neighbouring private land for certain actions, e.g. driving trucks over a private driveway that isn’t part of the freehold or leasehold plan.
- Fit-out works: The work that needs to be carried out on the interior of a building to make it fit and usable for the new occupier. An example would be installing lights and power outlets to make a commercial building suitable for offices.
- Rent-free periods: This leasehold-only clause acts as an incentive in the case of fit-out works or other repair works. The landowner may offer a rent-free period to compensate the leaser for needing to carry out work or maintenance that compromises their ability to use the building immediately after they take up the lease.
- Signage: Terms placed on the types of signage you can place on your commercial property, e.g. fascias and billboards.
- Searches: Part of the due diligence process. Discovery of records relevant to your building including not disclosed by the seller or their arrangements. These include past disputes or issues with the building, previous occupiers and their activities, full work and maintenance histories, reports of environmental damage, e,g, floods and redevelopments and changes to surrounding land that may affect easements.