Author: David Turschwell
A buyer is always best advised to pay a deposit at exchange of contracts to a stakeholder, usually the seller’s solicitor. A stakeholder is under a fiduciary duty to hold the deposited money and to pay it in accordance with entitlements when the contract either completes or is lawfully terminated. If the transaction does not complete through no fault of the buyer, the deposit remains safe in the hands of the stakeholder and is able to be returned to the buyer if the contract is lawfully terminated. In new development sales, however, it is not uncommon for the deposit to be paid to the seller’s solicitor as agent for the seller. Receipt of a deposit into the hands of the seller’s agent enables the seller to ask for the deposit to be released before completion, often to enable the funds to be deployed in progressing the new development. This creates a risk for the buyer. If the development fails, and the seller becomes insolvent, the buyer will find it difficult to recover the deposit unless the deposit is protected in some way. For example, in residential development, the deposit can be protected against the insolvency of the builder if the property is being constructed under the NHBC Buildmark Scheme. Deposits of up to 10% (subject to a maximum of £100,000) are protected by the NHBC Buildmark Scheme against the builder becoming insolvent or acting fraudulently.
Where such cover is not available and the seller insists that the deposit is paid to the seller’s solicitor as agent for the seller, the buyer will only have the general law to fall back upon. Payment of a deposit to the seller’s agent gives rise to an equitable charge. The buyer may claim a lien against the property for the recovery of its deposit in the case of a seller default (the lien being a form of equitable charge against the seller’s property to secure recovery of the deposit). However, the lien will provide insufficient protection if the property is subject to a prior mortgage or has a value that is less than the value of the deposit received.
Further, for the lien to provide any form of binding security, the buyer must protect its equitable right by way of registration – usually, a unilateral notice entered in the seller’s registered title. Protection by way of a unilateral notice provides the buyer with priority protection for its lien and ensures that if the property is later sold or charged, the buyer’s equitable charge will be binding. The general position at law where there is more than one charge affecting property is that a later chargee who exercises a power of sale will have to ensure that earlier chargees with priority are paid off first. Matters are not quite that simple, however, where insolvency strikes. It is possible that a later chargee, who holds a qualifying floating charge over the assets of its borrower, appoints an administrator. An administrator has power to seek an order of the court to dispose of property which is subject to security as if it were not subject to the security. This would free the title from any other charges, including a buyer’s lien, in order to facilitate a sale of the property. In such circumstances, the court should (under paragraph 71, Schedule B1, Insolvency Act 1986), direct the net sale proceeds to be applied in relation to recognised registered land priorities. It is therefore important that a buyer with an equitable lien ensures that its interest ranks in priority.
In Sky Apartments 2018 Limited and others  EWHC 763 (Ch), a number of off-plan buyers of long leases who had exchanged contracts and paid deposits found themselves with a lack of priority by reason of their failure to protect their equitable liens arising at exchange. Sky Building Limited (“SBL”) had commenced construction of student apartments in Newcastle-under-Lyme. An agreement was entered into to consolidate the debt liabilities of the owner of SBL which involved a transfer of the freehold of the site in May 2018 for a stated transfer price of £2.5m to a company called to Sky Apartments 2018 Limited. Unfortunately, Sky Apartments became insolvent and, after entering administration, an order was obtained under paragraph 71, Schedule B1, Insolvency Act 1986 enabling the site to be sold free from secured rights, including the equitable liens that had arisen in favour of the off-plan buyers. The administrators brought the current proceedings to obtain an order determining who was entitled, in order of priority, to share in the net sale proceeds. This depended upon which interests were binding upon Sky Apartments at the time of the May 2018 transfer. It was accepted that those buyers who had already completed their leases at that time and who had registered their leases against the freehold title had interests that were binding on Sky Apartments. But what of those buyers who had paid deposits but who had not yet completed? Some of the buyers under the pre-let agreements had protected their interests by way of unilateral notices, but others had not. Those who had sought such protection prior to the May 2018 transfer had interests that ranked in prior to the interest of Sky Apartments. However, those who had not registered a unilateral notice did not.
Priority of interests affecting registered land is governed by section 29 of the Land Registration Act 2002. Under section 29, where a transfer of a registered estate is made for valuable consideration, completion of the disposition by registration has the effect of postponing to the interest of the transferee (i.e. the freehold) any interest affecting the estate immediately before the transfer (e.g. an equitable lien) whose priority is not protected at the time of registration. What this means in simple terms is that an unprotected equitable lien would rank behind the transferee’s interest and is therefore effectively not binding. By “protected”, we mean that priority is protected by registration of a notice, although (not relevant on the facts of this case) an interest may also be protected as an overriding interest by actual occupation. Accordingly, if there is no notice in the register to protect the lien, a transferee for valuable consideration acquires the land free from the lien and its priority is lost.
Was the May 2018 transfer made for “valuable consideration”? There was no evidence that the stated transfer price was ever paid over. However, the court felt that the underlying agreement between the parties to consolidate debt liability amounted to a collateral agreement under which valuable consideration was promised. Alternatively, consideration would have been provided by the assumption of liabilities by Sky Apartments as landlord of the partially developed site. Sky Apartments therefore had acquired priority over any unprotected liens. Further, arguments as to the existence of a constructive trust (i.e. that Sky Apartments had acquired subject to buyers’ liens in equity) were rejected on the basis that the Sky Apartments had not expressly agreed to receive the land subject to the rights of the buyers and had not expressly undertaken to give effect to them. The buyers who had not registered unilateral notices were therefore likely to be left empty-handed.
Payment of a deposit to a seller’s agent is not to be recommended. However, if it has to be done, and if there is no insurance scheme such as the NHBC scheme to cover the risk of loss (a) advice on the risk of loss must be given to a buyer client and (b) priority protection must be obtained. In addition, checks should be made see if the property is already subject to the rights of prior mortgagees.
This content was provided by Alan Riley, Property Law Consultant.