Tenant CVAs - what makes them acceptable?

This year has seen a new phenomenon being cemented on to the toolkit of the struggling retailer which, in my opinion, was not anticipated prior to 2009 - the large retailer Creditors Voluntary Arrangement (CVA).

For those not necessarily in the know a CVA is effectively a binding agreement reached between a company and its creditors where the creditors will agree a delayed repayment and/or write-off of debts. The agreement is limited in time (a maximum of 2 years) and is monitored by an independent party. For creditors generally (and most importantly unsecured creditors) the process is preferable over administration or liquidation since in those processes the likelihood is that the unsecured creditors will get little or no p/£ of debt. The attractiveness for secured creditors is that it is cheaper than administration and thus should protect the value of the secured assets within the business whilst they retain their security over them.

The year started off very badly for the CVA when, in February, a CVA proposed by the administrators of the Stylo Group (then owner of the Barratts and Priceless shoe chains) was voted down by its creditors and most vehemently by its landlords. At that point one would have been forgiven for thinking that the view following the Powerhouse decision that CVAs were not appropriate where significant leasehold property interests were involved.

However, since the Stylo CVA proposal was defeated quite the opposite has occurred with successful CVAs being agreed on a number of large retailers including JJB Sports and Focus DIY. The latest instalment is a vote today by the creditors of Blacks Leisure on its CVA proposal. It is anticipated that it will be successful (see FT.com article).

The question is what is different about the post-Stylo CVA proposals that have made them successful where Stylo failed? Is it that the market has changed? Is it that Stylo simply broke a taboo and after venting their anger at Stylo landlords have since been more agreeable?

The answer is most likely a mixture but when you look at the detail of the proposals there is a fundamental difference between the unsuccessful Stylo proposal and the other successful proposals. That difference is money and control.

In Stylo every single landlord would have lost out as the proposal involved changing all rents to a turnover rent initially at 3% increasing to 7% (very low levels compared to normal turnover rents) and without a floor. Landlords were invited to seek to obtain better deals in the market and if successful Stylo could either match the deal or surrender their lease. The good news on the Stylo deal was that there was no landlord immediately facing a closed store with irrecoverable cost. The bad news was that the income landlords would obtain was totally dependent on the performance of the tenant. For stores with little or no likelihood of re letting in the medium to long term this was probably okay as at least void costs were avoided. But for landlords of stores that were in good areas the reduction in rent was unacceptable.

Moreover, Stylo was not guaranteeing that every store would then be safe as it sought an ability to surrender those stores it chose during the life of the CVA. There was to be no compensation to landlords for taking back their stores and no protection from void costs. It is probably this exposure that was the ultimate issue for landlords.

Compare that to the successful CVAs which have some or all of the following features:

• No additional store closures over and above those that had already closed (i.e. landlords knew if their site was closed)
• No rent reductions although movement to monthly rent payments
• On closed stores the tenant would continue to pay the rates (landlords were protected from this oppressive liability)
• A pot of money (normally equal to 6 months' rent) was distributed between the landlords of closed stores as compensation

The difference is huge. On the successful CVAs Landlords knew where they stood immediately. Closed store landlords knew that in an administration they would get nothing whereas in the CVA they would get compensation and be protected from void rates whilst the lease subsisted. Open store landlords were asked for concessions which they would probably have given without a CVA.

What the above highlights more than anything else is that timing matters. Clearly, for Stylo to have proposed a CVA along the lines of the successful proposals it would have required significantly more cash to cover the large expenses. This would have meant a CVA being proposed a lot earlier than it was. In the end the timing was wrong. To have a successful CVA you need to have sufficient funds to "buy off" the worst off creditors (i.e. landlords of closing stores). This requires the directors to be brave enough to recognise the issues and see the potential for a better result for creditors and stakeholders alike by taking early pre-emptive action when the company can afford it.

Whether the successful CVAs will actually result in successful companies in the future only time will tell but, at least for the landlords, the CVA was a less bitter pill in the short term.

FRI Leases in a recession - not always the protection you expect

The Financial Times reported today that "Maintenance Cuts threaten property values". For those who cannot be bothered the article what it says it that whilst UK property is generally let on full repairing and insuring tenant covenants landlords are cutting back on repair and maintaining those parts of the properties for which they have responsibility and for which they recover the cost through the service charge due to fears over whether the costs are recoverable arising from tenant default and increasing voids. Meanwhile, landlords are facing an increasing number of void units in disrepair due to tenants failing to repair and then becoming insolvent.

The failure by landlords to carry out anything but the most urgent of repairs is, of course, a double edged sword for a landlord. It exposes the landlord to the risk of tenants seeking to enforce landlords' repairing obligations (although this might be unlikely save where the disrepair is likely to damage the tenant's business). More importantly, it makes reletting the unit at the best rent very difficult since the centre in which the unit is quickly becomes dilapidated and less attractive to potential tenants. Hence, one could argue that failing to repair is only prolonging the pain for the landlord. In truth, however, landlords will probably wait until real signs that the market is picking up before deciding to carry out repairs. The timing does need to be right since if a competing location is in better repair and condition it may prove more attractive and take away potential new tenants.

Repair of individual units is even more tricky for landlords. Is there any point in carrying works of repair to a vacant unit with little chance of letting. On the other hand what chance is there of letting a unit in disrepair and what effect will this have on rent. Some landlords may opt to wait until a potential tenant is found and then agree to put the property in repair (or pay a reverse premium to the tenant to do this). This means that the level of rent should not be affected. However, a tenant looking to move in quickly (especially in the run-up to Christmas to make the most of the holiday trade) is more likely to opt for a unit ready to go.

Finally, all landlords (and tenants when landlords are carrying out works) would be well advised to check carefully the terms of service charge provisions in the various leases to check what works are recoverable and what are not. How are voids treated? What are the obligations in terms of repair?

Insolvent Companies' Directors and TUPE - a small loophole with a big cost.

Here is a bizarre scenario for you. A company exists and it is run, as all companies are, by directors. They are the mind and decision makers of the business with ultimate responsibility for the success or failure of that business.

The business fails and falls into an insolvency process. On a sale of that business the directors will automatically transfer over to the owners of the new business with the same terms and conditions unless the new owner can agree a compromise with the directors.

This is all thanks to a wonderful piece of European legislation lovingly referred to as TUPE. This legislation has a very honourable purpose - it ensures that employees of a business are protected against losing their jobs or having their terms of employment unfavourably altered just because a business changes ownership. It is widely drafted to prevent clever lawyers finding loopholes for their clients and, rightly, applies even to the sale of parts of an insolvent business to a new owner.

However, what does not appear to have been considered is that this legislation results in every employee passing across. Directors are employees (often the highest paid ones). Where a sale is one sought out by the company and it is agree that the directors will leave this is not an issue (although it does potentially create a conflict of interest for the directors concerned).

But where a company is insolvent the directors are ultimately responsible for that failure. By TUPE applying to directors even in such circumstances it has inadvertently placed directors at the front of the queue to extract payouts from any potential suitor where the money involved could have been invested in the new business providing a better chance for the future success of the phoenix entity.

So, as with the bankers and their bonuses, those with most of the responsibility for the failure of a business are given the opportunity to be compensated for their failings whilst the less responsible employee faces an uncertain financial future. An easy loophole to close if someone would just pull the right strings.

Low interest rates - morphine for the terminally ill housing market.

The Financial Times reports today that the indications are that the low interest rates are helping house prices to rebound. Personally I am horrified by the fact that such a situation is not being highlighted with greater concern by the government, economists and sane people generally.
The article itself hardly highlights the worrying matrix of fundamentals that means that any such rebound is likely to simply result in more people overstretching themselves and house prices taking longer to correct to a more realistic level reflecting earnings, affordability and available finance.
At the height of the boom there were some who warned that the housing market was becoming overheated and that the Bank of England needed to consider raising interest rates to control the growth rate of house prices which was outstripping any increase in wages. The BoE, whose main point of reference for setting interest rates is an inflation measure which takes no account of house prices did not react (or certainly did not react sufficiently) and house prices continued to show hyper-growth. Compare this to inflation generally (whether CPI or RPI) which, whilst higher than the levels considered "safe" did not even come close to house price growth levels (and thankfully so). The fact is people who own houses are happy with double-digit growth in their value as it means more equity and therefore, with banks happily splashing the cash, more money for them to spend now and worry about paying back later.
House prices have now fallen slightly and may, in some areas, reflect a fair value. If you look at annual house price inflation on an annually compunding basis from 1983 until today the annual rate is 6.55%. Some might not consider this too high. For the period from 1991 until 2009 annualised wage inflation on a annual compounded basis was at 4.2% (based on the LNMM index figures from the ONS). House price inflation over the same period was about 4.63%. That difference in growth could even be a statistical error.
However the real issue now is one of liquidity and equity. The FT highlights this by referring to the fact that the rebound has been effectively caused by low interest rates. But rates will not remain low forever and when they increase all those people managing on SVRs at or below the fixed rates they took out will suddenly be faced with increases in their monthly outgoings. Apart from the handful of bankers with huge bonuses most of us are not anticipating any pay inflation this year! This at a time when many other costs will have already increased as a result of the fact that we have not seen the massively overanticipated deflation. The risk is that we then see a rush to sell up and downsize to a more affordable house with the oversupply finally bringing much needed liquidity to the market and almost certainly a reduction in prices. The number of people able to buy and the amount they are able to spend is reduced due to lack of finance and so house prices will have to fall.
Therefore, triumphally declaring that low interest rates have saved the housing market from collapse is equivalent to saying that giving morphine to the terminally ill patient has saved his life. You can take away the pain for a time but eventually time runs out.

Is the FRI lease manifestly unfair?

I sat in a very interesting meeting the other day which was a general discussion on various points in negotiating an agreement for lease and lease when acting for landlords and tenants. Much of the discussion focused on the inter-relationship between warranties, repairing obligations and service charges and then moved on to insurance and uninsured risks. However, what was most interesting was that the discussion touched on a more general issue about the English institutional fully repairing and insuring (FRI) lease - is the whole proposition of an FRI lease not manifestly unfair and unbalanced.

For the uninitiated, in England and Wales the starting point with a lease which will be acceptable to institutional investors is one in which the investor receives all the rent and the tenant is financially liable for every cost associated with the property (apart from "income" tax on the rent). This works by imposing full repairing obligations on the tenant, requiring the tenant to fully re-imburse the landlord for the cost of insuring the building and requiring the tenant to pay, through the service charge, for the cost of repairing parts of the building outside the tenant's demise.

Now let us examine the relative positions and aims of the parties.

The landlord owns the property for the purposes of investment. It receives income in the form of rent and the potential for capital increases resulting from rent increases and/or yield compression. It is very much interested in the long term existence of the property.

The tenant is renting the property as a place from which to conduct its business. It does not care about the building per se. Its income is generated out of the property but not from the property and it does not, in general terms, specifically have to be located within a specific property. It does not benefit from changes in yields and only sufferes from rent increases.

Now let us consider where the risk in relation to the property should lie. The tenant requires occupation to run his business but has no interest in the long term existence of the property and sees no benefit from any increase in value. The Landlord benefits not only from the existence of the property but also from the continuing ability of the property to meet the tenant's needs. As the tenant's business flourishes so does the value of the property as it is likely to be let to a tenant with greater covenant strength. Therefore you would expect that the landlord would bear the risk of need to repair the property or it being destroyed; he is the owner afterall.

However, the FRI lease is such that the only risk the landlord is taking is that the tenant goes bust. All other risks are placed firmly at the tenant's door. Repairs within the demise the tenant will be required to carry out itself. Repairs outside the demise the landlord will carry out but recover the cost from the tenant. If the building is destroyed by an insured risk there is likely to be a rent cesser but this will only be for the period for which the loss of rent insurance is available and after that the rent restarts even if the building is still unbuilt. Uninsured risks, all things being equal, can fall completely on the tenant with the landlord being able to recover the cost of rebuilding through the service charge. So a tenant who decided against being an owner/occupier could actually find itself in a worse position as a result with higher annual costs and the potential for huge liability when something goes wrong.

Of course, the above is a worst case scenario but it is one which is likely to represent the legal position on a significant number of leases in the market today. The UK is unusual in its total lack of legislation in seeking to prevent landlords from placing the full burden and risk on the tenant. In Germany, for example, it is against the law for landlords to seek to recover the cost of structural repairs through the service charge; this is a risk the landlord took when he bought/developed the building.

Matters have in the last 20 years moved somewhat from the position highlighted above. Tenants have seen much success in toning down liability for things such as uninsured risks and liability to repair latent defects but the the risk is still most firmly with the tenant. So all you tenants out there, a little less criticism of the tenant lawyer who seeks to negotiate a lease and is reprimanded by his client for delaying the deal; the detail could very well matter.

Is this fair? As always it depends on who you ask. In reality it is market forces and perhaps as a result of the current downturn tenants and their lawyers will use the opportunity to further push the pendulum back towards the landlord in terms of carrying the risk. However, I doubt very much that it will swing too far. The fact is that tenants don't appear to care that much - maybe that is because occupiers are businesses who are used to taking larger risks than the institutional property owner funds who tend to be risk averse. Fair it might not be but so what.

Commercial Lease Code - let's be radical

The news that the 2007 Commercial Lease Code has not proved any more well known than its predecessors has been met with dismay by the Government. Larger, institutional landlords did embrace to some degree the Code and did their best to publicise it. However the fact remains that much of the country's commercial estate is owned by small landlords and managed by small agents who have no interest in publicising the code as all it would do is damage their negotiating position and, in the case of agents, raison d'etre. So the prospect of legislation looms closer.
What I am about to say may shock you but . . . bring on the legislation. But not in half measures. Let's not tinker around the edges. Let's be radical.
I propose that for all leases of an area less than a certain minimum and/or a rent below a certain level (eg. £50k per annum) there should be a statutory prescribed form of lease. It could have the following:

• a minimum 2 year and maximum 10 year term
• Index-linked upwards only rent
• Security of tenure
• Repair to standard at date of first lease
• Assignment with consent not to be unreasonably withheld ("ntbuw")
• Underletting of whole with consent ntbuw
• Specific user with change permitted within same use class ntbuw subject to estate management considerations
• No alterations apart from internal non-structural with consent ntbuw
• Service charge drafting would be fixed by reference to the RICS Code

These are just suggestions but you get the idea. It may be that a few variations of the leases would be needed for different types of property and rental structures but all of this is achievable.
Why do this? Well the amount of time and money that is spent in the negotiation of heads of terms and subsequent documentation of those heads is one good reason. All landlords and tenants would need to agree would be the rent and term.
But the benefits go further. When an investor is reviewing a portfolio of properties low value leases would not need to be reviewed for consistency as the terms would be dictated by law. Certificates of Title could be reduced in size. Lawyer review time would be cut leaving more time to do the deal. Disputes would be dealt with more easily since the wording could quickly be interpreted by the courts and the number of disputes would fall. Everyone would benefit to some degree at some point.
The downside? Mainly in reduced flexibility although quite how much flexibility would be lost is questionable. Agents might need to reduce fees to reflect the lack of terms to negotiate but they would still be needed to find the tenants and get them signed up. Lawyers would lose out on fees as our services would not be required for straightforward leases but we would still be needed to negotiate agreements for lease, licences for alterations, etc.
So I say let's legislate, let's be radical, let's create the standard lease.

Planning for flexibility

It appears that the Government wants to listen to the British Chambers of Commerce's wish to improve the planning system (see my blog of 19 June 2009) but it would appear that they are not quite on the same page when it comes to what is required.
On 18 June 2009 the Department for Communities and Local Government issued a consultation paper called:

Greater flexibility for planning permissions - consultation

The consultation considers two issues:

1. Extension of time limits for existing planning permissions; and
2. Minor material amendments to existing planning permissions.

Interestingly the issue regarding time limits has arisen because the recent legislation cut the time limit for implementation from 5 to 3 years. Now faced with an uncertain economic climate developers are not rushing to implement permissions and the 3 year limit means that applying for permission without any certainty that a development could be let/sold in the short term is unappealing. This means that planning authorities are likely to be deluged with planning applications.

Bearing in mind Gordon Brown's favourite phrase during his tenure as Chancellor: "Goodbye to Boom and Bust", it is not surprising that the implementation was lowered. Why allow five years for implementation time as surely once permission is given a developer will jump at the chance to develop.

So, yet another climb-down for the Labour Government from its previous policies is proposed. Although it does not propose a complete climbdown (or really a climbdown at all). The measure proposed would be temporary and only apply to major developments. Further an extension application would be considered a new application in terms of the need to obtain an Environmental Impact Assessment and result in supplemental planning agreements (at least in the form of a confirmatory deed). Whether or not the local planning authority decides to consult on the application is intended to be discretionary.

I can't see these proposals being greeted that warmly by the developer community.

As for the proposal for minor material amendments, well, the legal community are likely to be rubbing their hands together with glee - I can feel the warmth generated by BLP's planning department already. The interim proposals are that LPAs could approve a minor material amendment "if its scale and nature results in a development which is not substantially different from the one that has been approved". If that is not a proposal for dispute and litigation then I do not know what is.

One question I have is once you have made a minor material amendment can you then make another one? If so, is the reference point the unamended permission or the amended permission? If the amended permission then it is possible to envisage a situation whereby a permission, through minor material amendments, results in a development which is substantally different from the one that has been approved - I am assuming the legislation would not be that carelessly drafted!

Who's a Jew -v- Who's a Brit

Interesting Fact: I am not British. I am Irish, born to an Irish father and a British mother. Despite having lived in the UK for most of my adult life, having paid taxes and observed and paid the price (only minor motoring offences) for breaking British laws I am not automatically entitled to be classed as a British citizen or to become naturalized as a British citizen.
In order to be apply for naturalization in Britain there is a seven part test as follows:

• you are aged 18 or over;
• you are of sound mind;
• you intend to continue to live in the United Kingdom;
• you can communicate in English, Welsh or Scottish Gaelic to an acceptable degree;
• you have sufficient knowledge of life in the United Kingdom;
• you are of good character; and
• you meet the residential requirements

Exact details can be found on the UK Border Agency web-site

The two most interesting ones are the requirement of knowledge of life and being of good character. If you can show you know what it is to be British and are law-abiding you should be fine.

Yesterday, the Court of Appeal issued a ruling that a Jewish school was in breach of Race laws by refusing entry to a boy whose mother had undergone "conversion" under the auspices of Progressive Judaism. This judgment has been lauded by civil liberties campaigners and the reform and liberal jews. However, without wishing to disrespect the Lords of Appeal, their judgment is flawed and will hopefully be overturned by the House of Lords.

The real question that this case is considering is:

Who defines who a Jew is?

And it is for this reason I have set out above the criteria for deciding whether someone can become a British Citizen. I do not argue with those criteria nor with the fact that it is for the British Government to decide who can and cannot become British citizen.

Similarly, I would strongly argue, it is not for the British courts to decide who and who is not a Jew. The Court of Appeal did not rule that it was unlawful to have a school who only admitted Jews. Rather it decided that the basis on which the school decided who and who is not a Jew was unlawful. If allowed to stand such a decision undermines the basis of any faith. But ignoring that argument, the Court of Appeal's decision that the school's basis was unlawful was also wrong.

JFS (the school in question) is bound by the Court of the Chief Rabbi in deciding on the eligibility of a proposed student. The Court of the Chief Rabbi likely defines a Jew as someone:

• whose mother was born Jewish; or
• whose mother converted to Judaism; or
• who has him/herself converted to Judaism

True, on that basis someone whose mother was born Jewish but not practicing in the slightest would be allowed in whereas someone whose mother was not born Jewish, had never converted but kept all the laws would not be allowed in. But this does not preclude someone from converting and therefore does not, of itself, amount to discrimination.

As part of the conversion process which takes, I believe, up to 7 years (not disimilar to the minimum period of residency in the UK required for British citizenship) convertees must agree to abide by all the laws and regulations and show that they mean it (not dissimilar to the requirement of knowledge and good character for British Citizenship).

Now, would you expect a conversion to be allowed of someone who is not prepared to commit to all the laws and regulations? I assume not in the same way as you would not expect citizenship to be granted to someone who refused to agree to follow the laws of Britain or club membership to be given to a member who refused to follow the club's rules.

Ah, you will say, but this person's mother did convert. Wrong, she converted to a religion called Progressive Judaism which is fundamentally different from Orthodox Judaism. In doing so she did not agree to be bound by and follow all the laws orthodox Jews are bound by. Should I be entitled to set-up a new religion which has some similarity to Islam but changes the rules to suit my feelings and views and then claim that anyone who says I am not a Muslim is discriminating against me? Of course not - the only people who can define who is a Muslim are the Imans and religious leaders.

That progressive judaism started some time ago (reform judaism started in the early 18th century) does not change the fact that it is a new religion that has sought to throw off the boundaries and restrictions imposed by orthodoxy to appeal to the masses' need to assuage their guilt on failing to follow the rules and laws.

In summary, if the law allows a school to permit entry only to Jews the Courts have no right to turn that position on its head by ruling that anyone who calls themselves a Jew must be permitted entry. Anyone is entitled to convert to Judaism but they must agree to accept the laws that come with the name - M's mother was not prepared to accept such laws and so chose to become a Progressive Jew. If I created a new country and called it New Britain (sic) and named its citizens British I think they would be given short shrift if they tried to enter Britain claiming to be British citizens. Being Jewish is no different.

IFAs and the end of the commission income (See FT.com)

As reported in the FT the FSA are intending on putting an end to commission based compensation for independent financial advisors (IFAs). Instead all IFAs would need to agree a fee with the client and that fee could either be paid upfront or deducted from the investment. It has been hailed as a wonderful step forward for the man on the street seen as adding further protection. However, as someone who uses IFAs I am not quite so sure the benefits of such regulation outweight the downside.
I have had an IFA for a number of years. When I first started out with my current firm remuneration was, at my option, commission based. This meant that I paid nothing for their services and they got nothing from providing services unless I actually bought some form of investment. As a result of their advice I purchased life insurance, critical illness cover and started saving properly into a pension. I would never have done this without the advice of my IFA and I am pretty certain I would never have gone to see an IFA if I would have needed to pay.
However, a couple of years ago my IFA changed the basis of our arrangement so that it no longer received commission. Instead I pay an annual retention fee (£1,200 plus VAT) and then if they place investments for me I pay a lump sum for their advice (they may still be able to get commission if I agree but I cannot remember).
I must say that the service and advice I am getting has improved since this new arrangement was put in place (although this might be more a result of my personal advisor changing and the new advisor simply being a lot better). However, £1,410 is a lot of money to pay just to have someone meet with you 2 or 3 times a year and tell you that you should try and save more, utilise your ISA allowance to the full even when you have no liquid assets and that cutting your pension contributions risks ruining your ability to retire.
True I have received helpful advice. They arranged for my pension investments to be changed; they drafted the letter to HMRC to ensure I was benefitting from tax breaks on my pension contributions. Does this justify the cost?
Very difficult to say and when things are tight is this not just a luxury that I should get rid of? I could have done these things myself but just didn't get round to it - why should I when they were being paid for it!
One thing I can say is that if I was contacted by an IFA for the first time and invited to come for a free chat but warned that if I did want to instruct them I would have to pay I would say, "Thanks but no thanks - I can manage on my own".
Therefore, whilst the Government's move might save some people from the clutches of unscrupulous poor advisors making bad recommendations purely for the commission, it will also likely lead to an increased number of people who do not have adequate protection in place for emergencies or retirement both of which will ultimately mean a bigger tab for the Government to pick up.

CML slashes repossession forecasts - are they right to?

The FT this morning carries the news that the CML has slashed its repossession forecasts for the year. Let me give you a brief precis of what it says:

The CML lowered its forecast for property repossessions in 2009 to 65,000 from its previous estimate of 75,000

The CML said:

Although the economic backdrop remains challenging, the vast majority of homeowners continue to meet their monthly payment obligations. The large cuts in interest rates have benefitted many, making it easier for households who suffer a loss of income to continue to pay their bills.

This is all very nice and, indeed, the CML may be correct that their original forecast was wrong. However, do not read into this message, as many undoubtedly will, that, to quote the song by Yazz, "The only way is up" for residential property prices - I think that there must be at best stagnation and at worst (or even better for those hoping to buy) further falls to come.

The fundamentals

The boom in residential property prices was caused by a number of different factors. The most important of these were:

• demand (especially within London and the South East)
• disposable income (bonuses)
• cheap lending
• belief that values could continue to grow
• lack of housing stock

Let's consider some of these fundamentals in turn and the outlook

1 Demand

Demand for property was very high towards the height of the boom. This demand was fuelled by:

• more people looking to buy their own home
• the buy-to-let market
• expectations of windfall profits
• immigration and migration to London and surrounding areas

Most of these factors no longer exist. The buy-to-let market is still available if you have the cash to invest and are prepared to take the risk. There is no longer an expectation of windfall profits as people will be happy just to make a reasonable profit and keep a roof over their heads. Large job losses in the financial and services sectors and general downsizing resulted in and will continue to result in a decrease in movement into the UK and we may even see emigration and certainly migration away from densly populated and expensive areas such as London.

2 Disposable Income

Apart from Tube workers who believe they have a right to inflation busting pay-rises whilst the rest of the world goes to hell, most people are facing stagnant pay (or pay cuts in real terms). At the top level of the market (the banking, legal and other professionals) where pay was boosted by bonuses for so many years the size of the important bonus (if it exists) is significantly lower. Therefore, in terms of ability to pay monthly interest and/or repayment sums the amount that can be paid is less. Further the lack of job security means that the inflexible nature of owning a property with a mortgage is less attractive to, otherwise, mobile individuals.

Put in simplistic terms, there is significantly less money out there even before you consider the availability of debt.

3 Cheap lending

Not sure I even need to spell this one out. However there are actually two factors to this. First there is the fact that prior to the credit crunch the margins banks imposed on their mortgage deals were paper thin. Tracker rates below base rate were available. The reason for this was that with the magic of securitisation banks did not expect to hold on to their loan book for long so what did they care if the initial rates were 'loss-making'.

However, the Government and the Bank of England (along with other world economic leaders) have forestalled an immediate crisis caused by a sudden jump in the cost of borrowing by cutting interest rates drastically (0.5% in the UK). For those on base rate tracker deals this has resulted in them paying almost nothing (some are literally paying nothing). For those on fixed rate deals, when those deals have ended they have come on to a standard variable rate on average between 4% and 5% (about the level their fix was at in 2007). The CML has expressly stated that this is a major factor in their expectations being revised.

But interest rates cannot stay this low for too long. Predictions of deflation and very low inflation (below the BoE target of 2%) have thus far proven false. CPI is still above the target rate of 2% although the BoE have justified avoiding any rises on the basis that deflationary risks outweigh inflationary ones. This is probably correct in the immediate short term but as inflation begins to creep in (petrol prices are up significantly and at the end of the year VAT reverts to 17.5%) how long will the BoE be able to sit back and not act?

When the BoE does react (and even if it is not for a year from now) those homeowners who have been sitting on standard variable rates are in for a rather nasty surprise. Those rates will go up quickly (and quite possible faster than the base rate). Many who bought or refinanced in 2007 will find themselves in difficulty. New mortgage deals will not be open to them as the equity in their homes is likely to fall below the 25% level required to get a decent affordable deal and those fixed rate deals will continue to increase in expense. Meanwhile the interest payments will seem unaffordable as incomes stagnate and the cost of living rises.

In such circumstances will a bank avoid repossessing whilst there is potentially some profit in a sale which would cover its expenses when waiting will mean triggering a real loss on its books as values potentially fall and arrears mount? Will borrowers avoid selling to realise a small amount of equity whilst the arrears begin to rise and renting is a realistic option?

Conclusions

There is some inevitability that interest rates will rise again. Many suggest this might happen sooner than expected. When this does homeowners, loaded up with debt from the boom years which they are unable to refinance at affordable rates, will be forced to consider selling or defaulting. This will result in more properties coming on to the market on a distressed basis and this will further depress prices.

House prices in London and the South East may have cooled off but they have not really fallen. That fall will happen unless someone can wave a magic wand to make the debt disappear. As someone looking to buy I selfishly hope that magic wand does not work!

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Addendum: Check out the FT on Fitch's report that 10% of borrowers are now in negative equity. If you classed negative equity at 90% LTV (on basis that you cannot borrow 90% today) I wonder how many then fall into the trap?

Pinsents – first firm to offshore work of qualified UK lawyers | News | The Lawyer

Pinsents - first firm to offshore work of qualified UK lawyers News The Lawyer

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Am I about to be outsourced to South Africa?

I awoke this morning to read in The Lawyer that Pinsent Masons is the first firm to send real legal work (i.e. work that qualified associates would do) to a company in South Africa. Outsourcing is not new to law firms and nor is outsourcing off-shore. However this is a first as it means real legal work going off-shore and judging by some of the comments made by my peers on TheLawyer.com they are not happy about it!

This is a fascinating development in the provision of legal services. I think that there is little argument that to a large extent geographical location is no longer an important factor in the provision of any services apart from those requiring you to be in a specific place (e.g. a plumber). So why did lawyers possibly consider themselves different? Afterall, in some ways our jobs are even more easily transferable across the globe. I could be writing this blog, reviewing and drafting documents and reports and generally conducting my work life from anywhere on the planet (and, I suspect, from the International Space Station as well) - my clients do not care where I am as long as they can get hold of me when they need to!

So what is the big issue?

Well I think that there is a difference between a firm based in another country with limited or no office in the UK providing legal advice from a cheaper base and a firm existing properly in the UK and outsourcing legal work to another company in another country to cut costs. In the first case, from trainee up there is the potential to get exposure to all parts of transactions. The only thing that might be partially lacking is client contact although this would increase as you became more senior and your skills would develop accordingly.

However, in the second form, which Pinsent Masons has adopted, there is a whole chunk of work experience that is now being removed from trainees and junior lawyers. One cannot play down the importance of that kind of experience in developing a well-rounded lawyer. The ability to run a transaction well can only come from the experience of being a tiny part of a similar transaction and seeing the effect that decisions made at the higher level have further down the chain.

Am I surprised?

Of course not. The increasing dichotomy between partners' needs to keep profits growing and clients' needs to see fees fall meant that something had to give. Law firms have to find a cheaper way of conducting business especially in the current climate and this is one way to go.

Will it affect quality?

This is an impossible question to answer as often quality is dependent on the individual as much as the company employed. However, the fear of failing to impress a given supervisor will be lost as will concern regarding damage to brand. Again, these are not tangible things which can be measured.

Is this the end (or at least the beginning of the end)?

Who knows. I do not see it as being possible to remove the human touch, certainly at the higher value end of the spectrum. Clients want specific lawyers for specific deals. The problem is, as pointed out by a number of comments on TheLawyer.com, what effect will the outsourcing of the low value work to cheaper locales have on the experience required for the next generation of lawyers just starting out? Could it ever be positive?

Don't the partners and clients know this?

I think they do but at the end of the day we now live in a short-term view society. This has been highlighted as one of the main causes of the financial crisis. Partners and managers are not worrying about the effects of something in 10 years' time but rather the benefits that will be achieved in 2-4 years' time. Some may also suspect that the whole fees issue is a short term one and once the economy recovers it will disappear.

The problem is that whilst it might be true that law firms will not be expected to further cut fees it is highly improbable that they will be able to significantly increase them either. Further, if you were a partner in a firm who had outsourced work to South Africa and you could now increase your fees and either (i) bring more work back on-shore at a higher recoverable cost or (ii) keep it off-shore and make more profit, which would you opt for?

Reform the planning system . . . again!

Those of you who follow me on Twitter will already know that The British Chambers of Commerce have just released "Planning for Recovery" which is their views on the problems with and solutions for the planning system in the UK if we are to get out of the current doldrums.
The report is very well set out highlighting in separate chapters:

1. The relationship between the planning system and its effect on businesses
2. The current planning system and its shortcomings
3. Reforms to the planning system already on track
4. Recommendations for further reforms to help speed recovery

There is little doubt that the need for planning regulation will automatically result in delays and frustration. The report highlights a number of cases where the delays have been hideous, for example, Heathrow Terminal 5 where a formal planning application was lodged in 1993 but consent was only finally given in 2001.

Broadly the idea of reforming the planning system to enable applications to progress more quickly especially on large infrastructure projects where the needs of the many can often outweigh the needs of the few is one with which I agree. Further, on a street level removing the obstacles to sensible extensions and loft conversions to enable families to grow within houses rather than having to move would hopefully help keep house prices better regulated. However, I do wonder the deliverability of any such reform. It seems to me that loosening the reins in order to speed things up will only lead to minority views being totally ignored. Also, contrast the current calls for greater regulation in the financial industry as a result of the credit crunch with the calls for the loosening of regulation (not necessarily in planning) in the construction industry to help it get back on its feet - is the construction industry not partially to blame for the current situation?

On a slightly separate point, I do not feel that the current predicament of much of the construction industry is, of itself, any justification for reforming the planning system to enable them to get back on their feet. Factors in developers getting into so much trouble were taking on too much debt, being overly optimistic in their predictions and forecasts, overvaluing their assets and generally not doing a good enough due diligence and financial plan job. Should we really reward such poor judgement?

So, whilst I support reform to reduce delays it should not be at the cost of the minority voice nor merely to save those who showed poor judgement but rather to benefit those who acted with due care and attention. Now if someone can come up with such reform I will be impressed. Any ideas let me know . . .

The Power of Sale - what use if not used?

I have been advising on a lot of insolvency transactions of late; now there's a surprise. One thing that does continue to surprise me is banks' unwillingness to sell by use of their power of sale. Let me explain . . .
When a bank takes a mortgage over a property it will, normally expressly in the mortgage and also by statute, have a power to sell the property. If it sells the property then not only will this automatically release its own mortgage but it will also overreach (get rid of in layman's terms) subordinate charges and other encumbrances created after the bank's mortgage and without it's consent. A sale by a receiver or administrator will not have this effect. Therefore, on the face of it a sale by the mortgagee is the most effective way to transfer the property clean. So why not always use it?
I think there are two reasons. One is incorrect and the other is a case of shutting the gate after the horse has bolted.
The first is that mortgagees are rightly concerned about becoming a mortgagee in possession as this creates a real risk of liability. This is a big reason why mortgagees appoint receivers. During the boom banks became so unused to the idea of powers of sale that they now misunderstand and think that exercising a power of sale requires a mortgagee to be in possession - it does not.
The second reason is that banks do not want the bad publicity that goes with foreclosure, repossessions, etc. They believe that if they sign the transfer deed they will be outed as the nasty bank repossessing peoples' homes.
Why is this a case of "shutting the gate after the horse has bolted"?
Well for starters I am not sure that banks collectively could do much more to damage their current reputation (rightly or wrongly) of being greedy, short-sighted and generally responsible for the disastrous global financial mess we are in.
However, on a more individual basis, does a bank really believe that hiding behind a receiver protects its reputation? Do they really believe that, when a receiver sells, we don't know that it was the 'nasty' bank that put them in place.
So come on banks, if you are going to repossess peoples' house at least have the guts to do it in openly - we know who you are anyway - at least that way the buyer has a better chance of getting a cleaner title.

CRC is coming - time to take action

The Carbon Reduction Commitment is about to bite. It will place obligations on owners and occupiers of buildings to reduce the use of energy thereby reducing the carbon footprint. This will have cost implications and will also need to be addressed in the landlord and tenant relationship.
The BPF has just brought out a guide to the CRC for Landlords and Tenants. All landlords and tenants are urged to read this guide - it's contents may surprise you. Judgement is entity based not property based and once an entity is caught by the rules it will be responsible in respect of any property for which it has the supply contract with the energy provider. A Landlord would be wrong to think that it will be for its tenants, as the main user of the electricity supply, to comply - who is responsible depends on who is the counterparty with the electricity supplier for the property even if the landlord has installed sub-meters so he can recharge tenants based on use.
The guide provides useful tips on how to set-up oneself administratively to ensure compliance can be achieved. The work involved is likely to be time consuming and landlords and tenants should ensure that their leases allow for recovery of such costs through the service charge.
Further questions on recovery need to be considered in respect of the purchasing of "allowances".
The fact that CRC is based on group entities and not on buildings adds significant further complications. This has major ramifications in terms of the need to anticipate changes during a year and also how JV interests are dealt with. For tenants this can mean that as their landlord's identity changes the relevance of CRC and potential cost to it will also fluctuate.
Another issue for tenants who fall within the legislation is the difficulty of managing their energy use in properties where their leases restrict the work they can do. Time for rent review surveyors to sharpen their arguments on this front.
There seems little doubt that the implementation of CRC will greatly increase the burden (both administratively and financially) on owners and occupiers of property. The cost of saving the planet continues to rise - the cost of not saving it is, most would argue, far greater!

Setting the Landlord Free

English land law has a lot of idiosyncrasies; mainly as a result of how it has developed over many centuries. Two of these are the idea of privity of contract and privity of estate. In very simple terms these ideas mean that once you sign up to a lease (whether as landlord or tenant) you remain bound to comply with the terms of the lease even after you have disposed of your interest (either selling the reversion or assigning the lease) and that in order to ensure any new tenant would be directly liable to a landlord direct covenants with the landlord are advisable.
Now any slightly bright spark might notice that this could create a bit of a problem. For example, imagine you (A) take a new lease for 20 years of an office. After 10 years you have outgrown your offices and so you take some new offices and assign your lease to someone else (B). Seven years later that someone else goes bust. You remain liable for the rent in respect of your old premises and whilst you will have, if properly advised, received an indemnity from B since B is now bust this is of little value.
In recognition of this fact an act was passed in 1995 called the Landlord and Tenant (Covenants) Act. The first thing to note about this Act is that it only applies to leases created on or after 1 January 1996. The main effect of this Act was to make it so that Tenants were automatically released from their covenants on assignment of the lease. As a sop to the Landlord lobby a mechanism was inserted so that the landlord could keep the outgoing tenant on the hook as a guarantor of the incoming tenant but this could last for one assignment only.
In terms of Landlords being automatically released the Act did not provide for this - the logic being that leases rarely (if ever) give a tenant any control over a landlord disposing of its reversionary interest and so a tenant could find itself with a straw-man landlord failing to perform significant obligations. However the Act does provide for an ability for an outgoing Landlord to seek a release which must be given if reasonable.
Whilst at one point it was considered that as a result of the Act it was now impossible for Landlords to avoid continuing liability in advance a case in which went to the House of Lords in 2005 confirmed this was not so. In London Diocesan Fund v Avonridge Property Co. Ltd [2005] 1 WLR 3956 the House of Lords confirmed that with the correct drafting there was nothing to stop the Landlord and Tenant agreeing (as was the case before the Act) that once the Landlord has disposed of his reversion to the Lease he would not longer have liability for breaches of the landlord covenants.
Surprisingly, use of this mechanism is not automatic in the market. The most likely reason for this is that very few leases contain particularly onerous landlord covenants so the risk to the landlord of a lease coming back to haunt it is relatively remote. However where a landlord is granting a lease which does contain more onerous landlord covenants consideration should quite probably be had to including such a clause. Lawyers acting for tenants should pick up on the clause and advise their clients of its effect. I suspect most will not be bothered as many might be surprised to have learnt that without this clause they did have a claim.
Another example where this clause may be considered is where an Insolvency Practitioner is granting a lease and wants to ensure that the liability is limited to the period that the reversion remains vested in the insolvent entity.

Buying and selling land . . . without proof of title

Conveyancing! Thanks to a wonderful organisation called the Land Registry the process of deduction of title has generally been a lot easier of late. But there are still large parts of the country which are unregistered and even many small pieces of land which have been in the same corporate ownership for many decades. For these pieces of land the Land Registry does not hold much information (maybe details of some Land Charges).
No for these properties we must rely on the deeds. On that basis you would assume that those deeds would be treated as gold by the owners of such property for without the deeds there is no proof of title and without proof of title you are going to struggle to sell the land.
So I am now in the rather unhelpful position of acting where the deeds appear to have been lost with no copies available and the client wanting to sell a piece of land. When I come up with a solution to this problem I will let you know . . .