Back to basics – corporate wrapped real estate transactions

United Kingdom

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

Summary and implications

So you read our first briefing on "corporate wrapped" real estate structures, and have decided to acquire and hold UK real estate assets through a special purpose corporate vehicle (SPV) instead of via direct ownership. This second briefing looks at the key documents and considerations involved in your corporate wrapped (or "indirect") real estate transaction, and touches on how it will differ from a direct acquisition.

Recap – why wrap?

You will remember from our first briefing that tax efficiency and ring-fencing risk are among the main reasons for holding a property indirectly. There may also be other important reasons, such as creating a structure that is readily accessible to different types of investors, whether based in the UK or abroad. In any case, the choice of structure is highly situation-dependent.

Less situation-dependent are the issues that present themselves during the transaction. Most considerations are also equally relevant to transactions involving SPVs structured as limited liability companies, as they are to transactions using Jersey property unit trusts (and we include these other structures under the term "corporate wrappers" for the purposes of this briefing).

Heads of terms

Heads of terms set out the key terms agreed between the potential buyer and the seller at a high level, and are commonly entered into at the beginning of a transaction, before detailed due diligence starts. They can be helpful in laying out a baseline understanding of the key terms to help move the parties closer to signing. Although evidence of serious intent and containing moral force, they specifically state that they do not legally compel the parties to conclude the deal on those terms, or even at all. However, it is common for the heads of terms to include a legally binding exclusivity period for the buyer, which can range from 30 to 90 days. Sellers want shorter exclusivity and buyers longer. The heads of terms (or separate confidentiality letter) may also include legally binding confidentiality obligations relating to the transaction and information provided to the seller.

Due diligence

Buyers need broad access to information relating to both the SPV and the property in order to carry out effective due diligence prior to purchase. This information is typically gathered in an online deal room set up by the seller's solicitors. The deal room contains the key documents and contracts to which the SPV is a party, as well as financial and tax matters. It also contains the usual information for a direct real estate transaction such as title information and replies to CPSE (Commercial Property Standard Enquiries) and other property enquiries. The contents of the deal room are usually deemed disclosed in the disclosure letter (see below) and form the subject of appropriate warranties in the sale and purchase agreement.

Sale and purchase agreement

The principal transaction document in a corporate wrapped real estate transaction is the sale and purchase agreement (SPA). It sets out the terms on which the sale and purchase of the target shares (or units or limited partnership interests) will take place. It is usual for the SPA to include a range of specific property provisions as this document will not incorporate the standard commercial property conditions, which is otherwise the case in a direct property sale contract.

The complexity of the SPA will vary depending on the nature and circumstances of the transaction, but typically it will be a lengthy document, half of which can be devoted to a schedule of warranties. The SPA also needs to address matters such as any subsidiaries, employees and third party debt which may or may not be repaid at completion.

Where there is a gap between exchange and completion (which is usually the case where there are contingent matters such as agreements for lease of parts of the property being signed) the seller may sometimes require the payment of a deposit and include provisions restricting the seller’s management of the property up to completion (e.g. restrictions on granting consents, settling rent reviews and granting leases without the buyer's consent).

Whilst an agreed purchase price is always included in the SPA, it is fairly usual for the consideration to be subject to adjustment following completion on the basis of an agreed mechanism whereby the parties will agree completion accounts to fix the net asset value of the SPV. Using a completion accounts mechanism allows the parties to apportion the benefit of rental income and expenses, as well as matters such as third party debt, shareholder loans, VAT and trade debtors. Once the completion accounts have been agreed, the consideration paid at completion is then adjusted either upwards or downwards, as appropriate.

As with any corporate transaction, the seller is expected to give extensive contractual statements in the form of warranties to provide the buyer with legal recourse in the event that any of those statements prove to be untrue. However, the property warranties are unlikely to be extensive. This is because, in an SPV acquisition, the seller will expect the buyer to carry out due diligence in respect of the title to the property, and to receive replies to property enquiries, as they would when buying the asset directly.

There will also typically be a number of tax warranties and a tax deed for any tax liabilities not reflected in the completion accounts.

The warranties will be subject to agreed limitations as to maximum liability, thresholds and time limits for a claim with separate periods for general and tax claims. The warranties will also be qualified by general and specific disclosures made by the seller in the disclosure letter.

Disclosure letter

The disclosure letter is closely linked to the SPA. It allows the seller to disclose matters of fact against the warranties it has given to the buyer in the SPA. Disclosure is an important feature in any transaction as it effectively operates to limit a buyer's ability to sue the seller for breach of contract, but it also operates (as a result of the warranties being disclosed against) to flush out information at an early stage of the transaction. No claim will lie if the facts which give rise to the breach were fairly disclosed. In reality, claims for breach of warranty are very rare for a number of reasons including the requirement for buyers to show loss arising from the breach, the limitations within the SPA and the fact that litigation is time consuming and costly.

Warranty and indemnity (W and I) insurance

W and I insurance is an increasingly common feature of corporate real estate transactions. In the event of any warranty or indemnity claims arising against the seller under the SPA, insurance offers both the seller and buyer a practical solution to risk and liability issues. Where W&I insurance is taken out, the seller's liability under the SPA is typically capped at £1, with the insurer covering the claim (up to an agreed limit, typically between 10 and 20 per cent of the purchase price). The premium payable is generally around 0.5 per cent to one per cent of the maximum exposure on the warranties. Click here for more detail on W&I insurance.

Key differences between direct and indirect property deals

To conclude, below is a brief comparison of some of the key differences between direct and indirect property deals.

Issue Direct real estate transaction Corporate wrapped (SPV) transaction
Price Agreed price with apportionments on completion for rental income, service charge and arrears. Agreed price but adjusted to take account of assets and liabilities of the SPV.
Delay between exchange and completion Usual and a deposit will be paid. Simultaneous exchange and completion more common. A delay to completion is possible. A deposit is less common.
Insurance Sellers will generally keep insurance in place and will be obliged to do so under the landlord’s covenants when the property is subject to leases. Buyers also often insure from exchange. SPV should have own insurance and this may or may not continue with the SPV on completion.
Indemnities Not typical but may relate to specific issues. As all SPV’s liabilities will remain, warranties will be wider and a tax deed (especially for corporate SPVs) will be common. Indemnities may also apply to specific issues.
Mortgage Discharged at completion. Unless terms of mortgage require and/or bank debt is repaid, completion does not necessarily mean that mortgage will be discharged.
Apportionments of income and outgoings Rents paid in advance will need to be apportioned from completion date to next quarter day. Any arrears assigned to buyer. The buyer acquires the SPV and an adjustment needs to be made to the purchase price to reflect all apportioned income, expenses and liabilities of the SPV.
Preliminary enquiries Usually in the form of commercial property standard enquiries (CPSEs). Requisitions on title and Land Registry checks made before completion. Warranties and a disclosure letter are typically used although these will be supplemented by due diligence enquiries and searches where possible. CPSE will also typically be provided.
Warranties Not usual. Buyer relies on enquiries and any claim would be on the basis of misrepresentation. Usual and extend to SPV’s business generally. They are typically subject to limitations as to the amount and time for claims.
Standard conditions Contract normally includes standard commercial property conditions. Contract does not normally include any standard conditions.
Management between exchange of contract and completion Usually carefully spelt out in the case of investment property with buyer having control. Ongoing business means the level of control of the buyer is subject to negotiation.
Transfer taxes Stamp Duty Land Tax using a slice system of: £0 - £150,000 at 0%; £150,001 - £250,000 at 2%; and £250,000+ at 5%. Different rates apply for residential property. Stamp Duty at 0.5 per cent of price for shares (for UK corporate SPVs). Stamp Duty Land Tax, or no charge at all, may apply to other vehicles.

Deal done!