Family funded purchases

Buying a house or flat under the “right to buy” legislation is normally a relatively low risk transaction from the purchasing solicitor’s point of view but when the transaction is being funded by a family member the level of risk for the solicitor may be increased.

A typical transaction might be a purchase which is funded by a non-resident son or daughter of the tenant. While there is considerable variety in the exact nature of the rights and obligations of the parties, a transaction might involve no interest being charged on the loan and after the expiry of the discount period or on death of the parent the property being made over to the child. The details vary from case to case with the result that standard documentation is difficult to develop and may not meet the client’s needs. The answer is to ask the right questions at the outset.

Who is the client?
Are you acting for the purchaser, the funder or both?  It may be permissible to act for both parties where they come within the provisions of Rule 5(1)(c) of the Solicitors (Scotland) Practice Rules 1986. This Rule permits the same agent to represent family members, provided there is no conflict of interest. It is sometimes argued that Rule 5(1)(f) can also be applied. This states that in the case of a loan secured over property where the terms of the loan have been agreed between the parties before the solicitor has been instructed to act for the lender, and the granting of the security is only to give effect to such agreement, the same agent is permitted to act for both parties.  What is not clear is whether the ”terms of the loan” refers to the essential terms of the transaction or all of the terms of the transaction. If it is the latter it is seldom the case that the parties have thought through all the consequences. For this reason, it is suggested that only the family member exemption should be relied on. Remember that if there is a conflict, then the exemption will be of no assistance to you should you continue to act.

If you are to act for only one party, e.g. the purchaser, be clear exactly what you are retained to accomplish. It is all too easy to quote for a ”right to buy” purchase and find that you are then expected to advise on, what is, a complex transaction, albeit one which is now frequently encountered. You may find you are asked about not only the funding arrangements but also about structuring the transaction in such a way as would minimise the risk of exposing the property or the proceeds to liability for residential care charges where the purchaser subsequently has to go into a residential home or a nursing home.

The solution to this problem is to issue a letter of engagement setting out the terms on which you are prepared to undertake business. If this means acting for only one side set that out clearly. Dean v Allin & Watts [2001]2 Lloyds Rep 249 is a Court of Appeal case which has raised eyebrows. The agent was found to owe a duty of care in relation to the unrepresented lender in the creation of an equitable mortgage in England. Clearly the case cannot be directly applicable in Scotland where such mortgages are unknown. Given the decision in Holmes v Bank of Scotland (Court of Session website 21/02/02) which was mentioned in this column in March p51 it now has to be accepted that a duty of care may be owed by an agent to third parties. In Dean the problem arose because the debtor-proprietor wished to grant an effective security and the agent obliged by preparing defective documentation which was subsequently relied on by the lender. The answer is therefore to write to the unrepresented third party and explain that you are acting only for the other party, that signing any documentation may have certain legal consequences and that the unrepresented party should seek independent legal advice.

Where monies are advanced is it necessary to have a standard security?
While there is no necessity to have a security, the statutory ranking which permits a loan advanced for the purposes of the purchase or improvement will rank ahead of the discount. Should the property have to be sold inter vivos within the discount period the monies advanced  will only rank first on the proceeds where there is a security by virtue of s72(5) of the Housing (Scotland) Act 1987.

Is it necessary to have an agreement setting out the obligations of the parties?
It may seem self evident that there should be an agreement particularly where the obligations on the purchaser are not straightforward repayment of the loan. In McEleveen v McQuillan’s Executrix 1997 SLT (Sh Ct) 46 the terms of the agreement by which the daughter and her husband advanced the purchase price were never reduced to writing.  The applicable law was that pertaining prior to the Requirements of Writing (Scotland) Act 1995 and it was held that the agreement which involved the willing of the property to the daughter required to be in formal writing. Without such an agreement the funder is at risk.

Risk to the purchaser: during ownership
There is a risk that the purchaser may be forced out of the property and be unable to acquire another property at such an advantageous price. S19 and Standard Condition 8 in Schedule 3 to the Conveyancing and Feudal Reform (Scotland) Act 1970  permits the funder to call up the security at any time, without there being any requirement for a prior default by the purchaser. The funder should contract out of his right to call up by deed of variation under s16 of the Act. This may be absolute, but is often qualified so that a default by the purchaser would entitle the funder to call up the loan or serve a default notice. To do otherwise would leave the purchaser at the mercy of the funder who might call up the security on a whim.  If the obligation on the purchaser is not to repay the loan but to convey the property to the funder at some future point, either inter vivos or mortis causa then care needs to be exercised in working out exactly what should be repayable where the loan is to be called up or repaid as the result of a default. The obligations on the purchaser are normally to reside in the property and keep it fired and aired. Consideration should also be given in drafting to the consequences of a financial claim on divorce being  asserted against the funder as well as the insolvency of the funder.

The purchaser has often been a tenant for many years and has not been liable to pay buildings insurance and has an expectation that the landlord will maintain the property. It is not unknown for purchasers to think of the interest free loan and postponed obligation to convey the property as a whole whereby ownership is to pass to the funder in due course. When this thinking is applied, the purchaser may expect the funder to insure and maintain the property. Standard Conditions 1 and 5 place the obligations on the purchaser. If these are to be the obligations of the funder then again this will need to be addressed in the agreement. It is not unknown for the parties to object at the point where such issues are raised that the agent is “getting in the way of the transaction”. That of course is not the case, it is a question of making parties aware of relevant issues which they may not have addressed themselves. Where no provision is to be made then as usual this ought to be covered by file notes and letters to the clients.

Risk to the purchaser: after ownership
Arrangements may require the purchaser to make over the property after the expiry of the discount period or on death. In the latter format there is no risk to the purchaser, in the former there is a considerable risk . The purchaser has no security of occupation. If there is a written agreement between the parties it will bind the parties although the rights created will be personal rather than real. A middle course is to make over the fee of the property and retain a liferent interest. That secures the funder’s expectation of receiving the capital but reserves a real right for the purchaser.

There is a danger that the parties may have their eye on some other, often unexpressed, outcomes in such an arrangement in that otherwise the purchaser may find the value of the property acquired being taken into account in the assessment of capital or where there has been what appears to be a gift to the family member notional capital for calculation of contributions for residential care charges. The two reported cases dealing with the assessment of such charges, Yule v South Lanarkshire Council [No2] 2000 SLT 1249 and Robertson v Fife Council 2001 SLT 708 both relate to properties acquired under the right to buy.  One can only speculate but would the local authorities have reached the conclusion as to the purpose of the gifts where the obligation to convey was contractual as consideration for the interest free loan advanced to purchase the property in the first place?  It is arguable that if the client tells you that the purpose of the transaction is to mitigate liability to care charges the purpose of the transaction is express and there could be no claim but if the client asks you simply to structure the transaction in the most efficient way then there might be liability.

Risks to the funder
Where the agreement is that the purchaser will leave a will in favour of the funder then that agreement needs to be written. A will can be contractual and as such the contractual provisions are not capable of subsequent revocation [see Paterson v Paterson 20 R 484 where a mother who had borrowed sums from her son was held to have entered into just such a contractual obligation ]. In McEleveen v McQuillan’s Executrix noted above there was no written agreement and the funders did not get the property when the purchaser revoked the will and left the property to another family member.  It is thus essential that the obligation to convey the property is reduced to writing and subscribed by the parties and preferably made self proving.

There is a further risk and that is inter vivos disposal by the purchaser. In Smith v MacKintosh 1989 SLT 148 the owner of a property had conveyed a half share to her daughter. The daughter gave up her own home to reside with her mother and apparently had reached an understanding with her mother that the remaining half share would pass to her under the survivorship destination. The mother later conveyed her share to her son. It was held that nothing prevented such a disposal. The existence of a security will go a long way to prevent an inter vivos disposal but does not eliminate the risk if the obligation to convey is not secured.

Facility and circumvention
The question of facility and circumvention is one that agents are alert to in connection with the preparation of wills but it applies to arrangements such as these as well [ see for example Anderson v Beacon Fellowship 1992 SLT 111 where donations to a religious order were said to have been made in these circumstances]. A dominant child may bring pressure to bear on a parent to enter into such an arrangement. The risk here is that siblings may regard the making over of the property to one of their number as an unfair advantage and may seek to challenge the arrangement. Seeing parties independently to ensure the instructions are correct and having this confirmed at a later stage is a sensible safeguard. Asking whether there are other children and whether they could fund the transaction is a further precaution which might be taken to avoid subsequent disputes.

Conclusion
Family funded right to buy purchases are not uncommon but present a number of potential pitfalls which are not encountered with commercial lenders. Ask the right questions and record the answers. Confirm instructions with a letter of engagement and confirm in writing how issues are resolved. The ”all in the family” approach of not exploring and resolving potential difficulties may simply store up trouble.