Contracting purchasers before completion: their interest and its limits

Contracting purchasers before completion: their interest and its limits Daniel Gatty Introduction Property lawyers know that a purchaser of land obtains an equitable interest in that land as soon as contracts are exchanged, and before payment of the purchase price. It has often been said that after exchange of contracts the vendor becomes a trustee for the purchaser until completion. The trust that is said to arise is usually considered to be a constructive trust. However, the nature of that interest, and its incidents, has long been controversial. For some commentators, the characterisation of a purchaser s interest as that of a beneficiary under a constructive trust is liable to lead to confusion: the purchaser s and vendor s rights and duties between contract and completion are different in several respects from those of beneficiaries and trustees under conventional trusts. The authors of Snell s Equity (32 nd Ed.) at para. 5-030 describe it as a fiction. Recently in, Scott v Southern Pacific Mortgages Ltd [2014] UKSC 52, the Supreme Court had to tussle with the nature of the purchaser s interest before completion, and in particular how it affects third parties. The Supreme Court s conclusions require a rethink by lawyers seeking to protect the interests of both sub-purchasers and vendors under sale and leaseback arrangements. A short(ish) historical survey The characterisation of the vendor as trustee for the purchaser between contract and completion, while long established has long been controversial. Lord Collins, who gave the leading judgment in Scott, had helpfully collected together some of the dicta on this topic in Englewood Properties Ltd v Patel [2005] EWHC 188 (Ch), [2005] 1 WLR 1961, when he was still Lawrence Collins J. In Lysaght v Edwards (1876) 2 Ch D 499 Sir George Jessel MR said at 506: "It appears to me that the effect of a contract for sale has been settled for more than two centuries; certainly it was completely settled before the time of Lord Hardwicke, who speaks of the settled doctrine of the court as to it. What is that doctrine? It is that the moment you have a valid contract for sale the vendor becomes in equity a trustee for the purchaser of the estate sold, and the beneficial ownership passes to the purchaser, the vendor having a right to the purchase-money, a charge or lien on the estate for the security of that purchase-money, and a right to retain possession of the estate until the purchase-money is paid, in the absence of express contract as to the time of delivering possession." And, at p 510: "It must, therefore, be considered to be established that the vendor is a constructive trustee for the purchaser of the estate from the moment the contract is entered into." In Earl of Egmont v Smith (1877) 6 Ch D 469, 475 Sir George Jessel MR said: "He is certainly a trustee for the purchaser, a trustee, no doubt, with peculiar duties and liabilities, for it is a fallacy to suppose that every trustee has the same duties and liabilities; but he is a trustee. For that I have Hardwicke Building, New Square, Lincoln s Inn, London WC2A 3SB T +44 (0)20 7242 2523 F +44 (0)20 7691 1234 E enquiries@hardwicke.co.uk @Hardwickelaw www.hardwicke.co.uk

the decision of the House of Lords in Shaw v Foster, which only re-stated what had been the well-known law of the Court of Chancery for centuries." In Shaw v Foster (1872) LR 5 HL 321, 338 Lord Cairns had said: "there cannot be the slightest doubt of the relation subsisting in the eye of a court of equity between the vendor and the purchaser. The vendor was a trustee of the property for the purchaser; the purchaser was the real beneficial owner in the eye of a court of equity of the property, subject only to this observation, that the vendor, whom I have called the trustee, was not a mere dormant trustee, he was a trustee having a personal and substantial interest in the property, a right to protect that interest, and an active right to assert that interest if anything should be done in derogation of it." In Clarke v Ramuz [1891] 2 QB 456, 459-460 Lord Coleridge CJ said: "in the case of a contract for the sale and purchase of land, although the legal property does not pass until the execution of the conveyance, during the interval prior to completion the vendor in possession is a trustee for the purchaser, and as such has duties to perform towards him, not exactly the same as in the case of other trustees, but certain duties, one of which is to use reasonable care to preserve the property in a reasonable state of preservation, and, so far as may be, as it was when the contract was made." On the other hand, in Rayner v Preston (1880-81) L.R. 18 Ch D 1 Cotton LJ said at 6-7 An unpaid vendor is a trustee in a qualified sense only, and is so only because he has made a contract which a Court of Equity will give effect to by transferring the property sold to the purchaser, and so far us he is a trustee he is so only in respect of the property contracted to be sold. And in the same case, Brett LJ said at 10-11 It becomes necessary to consider accurately, as it seems to me, and to state in accurate terms, what is the relation between the two people who have contracted together with regard to premises in a contract of sale and purchase. With the greatest deference, it seems wrong to say that the one is a trustee for the other. The contract is one which a Court of Equity will enforce by means of a decree for specific performance. But if the vendor were a trustee of the property for the vendee, it would seem to me to follow that all the product, all the value of the property received by the vendor from the time of the making of the contract ought, under all circumstances, to belong to the vendee... Therefore, I venture to say that I doubt whether it is a true description of the relation between the parties to say that from the time of the making of the contract, or at any time, one is ever trustee for the other. They are only parties to a contract of sale and purchase of which a Court of Equity will under certain circumstances decree a specific performance. In more recent times, the courts have been less willing to describe the interest that arises in the vendor unqualifiedly as a trust interest. In Berkley v Poulet [1977] 1 EGLR 86 Stamp LJ said at 93.These duties and rights arise from the contract of sale and it is because of their existence that the vendor is said to be a constructive trustee, or a trustee sub modo, of the estate for the purchaser from the time when the contract is constituted. But to say that it is the duty of the vendor as trustee for the purchaser to care for the property is to put the cart before the horse and may lead you into error. He is said to be a trustee because of the duties which he has, and the duties do not arise because he is a trustee but because he has agreed to sell the land to the purchaser and the purchaser on tendering the price is entitled 2

to have the contract specifically performed according to its terms. Nor does the relationship in the meantime have all the incidents of the relationship of trustee and cestui que trust. That this is so is sufficiently illustrated by the fact that prima facie the vendor is until the date fixed for the completion entitled to receive and retain the rents and profits and that as from that date the purchaser is bound to pay interest. And you may search the Trustee Act 1925 without obtaining much that is relevant to the relationship of vendor and purchaser. Thus, although the vendor because of his duties to the purchaser is called a trustee, it is wrong to argue that because he is so called he has all the duties of or holds the land on a trust which has all the incidents associated with the relationship of a trustee and his cestui que trust. In Jerome v Kelly [2004] UKHL 25, [2004] 1 WLR 1409 Lord Walker said at [32]: It would therefore be wrong to treat an uncompleted contract for the sale of land as equivalent to an immediate, irrevocable declaration of trust (or assignment of beneficial interest) in the land. Neither the seller nor the buyer has unqualified beneficial ownership. Beneficial ownership of the land is in a sense split between the seller and buyer on the provisional assumptions that specific performance is available and that the contract will in due course be completed, if necessary by the court ordering specific performance. In the meantime, the seller is entitled to enjoyment of the land or its rental income. The provisional assumptions may be falsified by events, such as rescission of the contract... If the contract proceeds to completion the equitable interest can be viewed as passing to the buyer in stages, as title is made and accepted and as the purchase price is paid in full. In Kern Corpn Ltd v Walter Reid Trading Pty Ltd (1987) 163 CLR 164 in the High Court of Australia, Deane J said at 192: it is both inaccurate and misleading to speak of the unpaid vendor under an uncompleted contract as a trustee for the purchaser... the ordinary unpaid vendor of land is not a trustee of the land for the purchaser. Nor is it accurate to refer to such a vendor as a trustee sub modo unless the disarming mystique of the added Latin is treated as a warrant for essential misdescription : The effect of the trust as between purchaser and vendor Despite the discomfort that has been expressed with the application of the words trust and trustee to the essentially contractual relationship between purchaser and vendor, there is no doubt that the contracting purchaser obtains a proprietary interest of some sort. Hence the risk of damage to or destruction of the property passes to the purchaser on exchange of contracts. And the vendor acquires equitable obligations to the purchaser, namely to protect the interest that the purchaser acquires under the contract (see Englewood Properties Ltd v Patel at [54]). While, of course, the vendor is entitled to continue to occupy the property and to take the rents and profits for it from himself until the date for completion, he is not entitled to relet the premises without consulting the purchaser (see Earl of Egmont v Smith 6 Ch D 469 and Abdulla v Shah [1959] AC 124). The trust and third parties The priority of a purchaser s interest under the contract (however that interest is characterised) can be protected against third parties by the entry of a notice on the register under the Land Registration Act 2002 and, in the case of unregistered land, as an estate contract under the Land Charges Act 1972. Does it follow that the purchaser has a sufficient interest in the property between exchange and completion to himself confer a proprietary interest in the property on a third party? That was the question at the heart of the Supreme Court s decision in Scott. The answer, according to Lord Collins and Lady Hale, with whom the other Justices agreed, was no. 3

Scott was the last stage of the North East Property Buyers Litigation, a group of test cases concerning sale and rent back transactions. In sale and rent back transactions an owner-occupier sells their house to an investor who then rents it back to them. The issue in the test cases was whether a bank which lent money to fund such a purchase, not knowing that the former owner would continue in residence as a tenant, was bound by interests in favour of the former owner arising (under proprietary estoppel or constructive trust) from promises allegedly made by the purchaser to the vendor before the purchase. As a result of the decision in Abbey National v Cann [1991] 1 AC 56, a proprietary interest in favour of the former owner arising as a property interest at the time of completion of the purchase would arise too late to bind the bank providing a mortgage loan to fund the purchase. So in Scott the former owners argued that their interests arose before completion: they arose on exchange of contracts, carved out of the beneficial interests that the purchasers acquired on contracting to buy the properties in question. That argument was rejected, albeit with expressions of regret as to the consequences for the former owners who faced eviction as a result of the purchasers failure to pay their mortgages. In reaching that conclusion, Lord Collins analysed the nature of the interest acquired by a purchaser on exchange of contracts. He held at [65] [79] that the cases characterising the interest acquired by the purchaser as a trust interest were not dealing with the question whether a contract of sale can have a proprietary effect on parties other than the parties to the contract. He cited Lord Cottenham LC in Tasker v Small (1837) 3 My & C 63, 70, who said that the rule by which a purchaser becomes in equity the owner of the property sold applies only as between the parties to the contract, and cannot be extended so as to affect the interests of others. He concluded at [79] that the [former owners] acquired no more than personal rights against the purchasers when they agreed to sell their properties on the basis of the purchasers promises that they would be entitled to remain in occupation. Those rights would only become proprietary and capable of taking priority over a mortgage when they were fed by the purchasers acquisition of the legal estate on completion. In other words, the proprietary interest of a purchaser between contract and completion is not such that the purchaser can himself confer a proprietary interest in the property on another. The purchaser may be estopped from denying any interest that he has purported to grant as between himself and the grantee but that interest does not become proprietary and so capable of affecting third parties until the estoppel is fed on completion of the purchase. With some reluctance because of the harshness of the result for the former owners, Lady Hale came to the same conclusion, both as a matter of general law and under the Land Registration Act 2002. Her conclusion under the 2002 Act is at [112]: the purchaser could not create an interest which was capable of being a protected interest for the purpose of the 2002 Act until she had acquired the legal estate. It should be noted that for the purposes of this analysis, Lady Hale went on to hold that the key event is completion and not registration (the provisions in the 2002 Act providing that the legal estate passes on registration of a disposition being machinery, not substance ). The consequences The residential sale and rent back market was unregulated at the time when the transactions which gave rise to the North East Property Buyers Litigation took place. As soon as the Financial Services Authority stepped in and regulated it, the market died. It is understood that there are no or next to no such transactions taking place 4

nowadays. So the precise facts of Scott are unlikely to arise out of future transactions, although it is understood that there were many possession claims or intended claim on hold pending the decision of the Supreme Court. More interesting for the general property lawyer may be the effect of the decision in Scott on two other types of transaction: commercial sale and leasebacks and sub-sales. The relevance of the decision to the former is obvious. If a firm intends to sell its freehold of, say, a portfolio of shops to an investor and take a leaseback of the shops, solicitors acting for the vendor will have to take steps to ensure that those lending to fund the purchases cannot take free of the leaseback if the purchaser defaults. They will have to satisfy themselves that the terms of the lending agreement permit the leases which the purchasers have agreed to grant. That may be thought readily achievable and prudent in any event. More tricky is the position of a subpurchaser. Until now, a sub-purchaser of registered land has been permitted by the Land Registry to enter a notice against the title of the land to protect the sub-purchase against third parties. See Land Registry Practice Guide 19 at para. 6.3. By s. 32 of the 2002 Act, however, a notice is an entry in the register in respect of the burden of an interest affecting a registered estate or charge. If a purchaser is unable to grant a proprietary interest in the land that he is buying prior to completion, it would seem that a sub-purchaser does not have an interest affecting a registered estate or charge until completion of the head purchase. On what basis, then, can a sub-purchaser be entitled to enter a notice to protect his sub-purchase against third parties prior to completion of the head purchase? Sub-purchasers now appear to be rather vulnerable between exchange and completion. Daniel Gatty Hardwicke December 2014 +44 (0)20 7242 2523 daniel.gatty@hardwicke.co.uk 5