An onerous obligation?

Purchasers in insolvency sales do not expect to receive title warranties. Insolvency practitioners (IPs) normally have no information about the properties they sell. But should a letter of obligation (LOb) nonetheless be granted on a sale by an IP? Some firms refuse to grant a LOb in insolvency sales, but is refusal justified when Law Society of Scotland guidelines indicate it can be granted?

Background

A LOb covers the period between the date a property search is brought down and the date a disposition is registered. It covers a period within which an IP has control, but would cover documents created pre-appointment that are unknown to the IP. Accordingly, the IP’s lack of information could be a valid point. Yet the Society’s guidelines suggest a LOb should be granted. Why is this?

A “classic” LOb must satisfy three conditions:

1. A search must be carried out immediately before completion, no more than three working days old.
2. Solicitors granting the obligation must be unaware of any other security (or, by implication, of any other competing deed).
3. Proper enquiry must be made of clients to check for any outstanding securities.

There is a fourth condition – the solicitor must have sufficient funds to pay off the loan if there is an obligation to deliver a discharge. However, this does not apply in insolvency sales, as there will never be enough funds to pay off the loan.

Can an IP’s solicitor comply?

Points 1 and 2 are straightforward. Point 3 is harder to satisfy. The Society’s guidelines require “proper enquiry” to be made of clients. The guidelines narrate that a solicitor acting for the IP (their client) should make proper enquiry of both the IP and the original owner. Accordingly, to ensure that any LOb maintains its “classic” status, the solicitor should write to the previous owner (or the directors if a company), either directly or through the IP, and ask them to confirm that they are unaware of any security signed but not registered. The guidelines only refer to a check being made for outstanding securities, but it would be sensible also to ask for confirmation that there are no other unregistered competing deeds (e.g. dispositions).

If such confirmation is received, there appears no valid reason why a solicitor acting for an IP cannot, on the face of it, grant a “classic” LOb.

What are the consequences of granting a LOb?

A claim could arise if a third party, unknown to the IP and the previous owner, held an unrecorded deed dating from a time before the appointment of the IP and then registered it within the short window between the date of the property search and the registration of the purchaser’s title (which should only be a period of a few days).

The risk is low but a claim is possible. Assuming the LOb is “classic”, even if there is a loss and a successful claim, the granting solicitor will not suffer any penalty excess, double deductibles or premium loading under the Master Policy. Accordingly, the granting solicitor suffers no detriment and, more importantly, the commercial deal progresses smoothly in the best interests of the client.

In certain circumstances (the Society’s guidelines narrate), a seller could be jointly and severally liable with his/her solicitor where a breach of the LOb mirrors an obligation in the missives of sale. This should not arise in insolvency sales. The seller in insolvency sales should be obliged to do no more than deliver searches and a validly executed disposition, given the purchaser requires to satisfy themselves as to title. As long as the missives reflect normal insolvency practice, the potential risk of joint and several liability should not be an issue.

Information from previous owners

A difficulty may arise following the solicitor’s enquiry when the previous owner (or directors of a company) do not respond, or respond with an answer which is unclear, unhelpful or incorrect.

If the previous owner gives no response, the Society’s guidelines state that the LOb will still be “classic”. This leads to a practical issue. If the granting solicitor makes an enquiry, at what stage can he/she be content that the lack of a response satisfies the criteria? It might be that a period of 14 days would be reasonable. This has not been tested, nor is there guidance from the Society (or the insurers) confirming the position. However, given that the guidance does say that no response is required, then provided a reasonable period has passed, it follows that any LOb granted in this situation remains “classic”.

If the previous owner responds in an unhelpful or unclear manner, this should not be an automatic bar to the LOb being a “classic”. Each case depends on its own facts – the objective legal point is whether there is any indication of a competing deed.

In the case of an unhelpful response (such as “I have already disclosed everything to the IP”), as long as the IP confirms (again) that nothing was disclosed by the previous owner then that would indicate a set of circumstances where any LOb would be “classic”.

The other situation (such as “I have signed many deeds but you will never find them”), where there is a lack of clarity, would not, however, qualify for a “classic” LOb, given that there is an indication (whether true or not) that there is another deed. So the LOb would be a “failed classic”.

There cannot be any set rules or guidelines in such situations, given the diverse range of possible responses from the previous owner, so each circumstance will and should be determined on its own merits. In the latter situation, no LOb should be granted.

Granting LObs in practice

In practice, missives should not be concluded unconditionally until the selling solicitor is satisfied that any LOb would be “classic”. Concluding missives and completing at the same time allows this to happen, but there are situations (e.g. drawing down money) where a concluded contract is required before completion. Wording has been used in some transactions whereby a LOb is to be delivered but only if the seller’s solicitors have satisfied themselves as to the conditions necessary to grant this. If not, then a purchaser has the option to walk away (far from ideal), or to decide to progress with the purchase without the LOb, bearing in mind the minimal risk involved (and this risk diminishes the longer the IP has been in office).

Alternatives to a LOb

One possibility is that the seller’s solicitors put the price on deposit, the purchaser submits their application for registration, and the seller retains the price on deposit pending delivery of a clear search a few days later. If there is a competing interest, the purchaser is bound to withdraw their application and return the papers to the seller, with the seller in exchange returning the price. Both parties enter a short form missive to reflect this. This is a convoluted, time consuming, impractical and expensive way to progress transactions, and clearly is not in the best interest of the IP.

Another option is title insurance. Title indemnity insurance providers will readily provide insurance to cover this, which is not expensive (reinforcing the point that the risk is very low). Again, however, given that there is a cost – albeit modest – and a time implication, this may not be in the client’s best interest.

Onerous position?

IPs tend to focus on quick cost-efficient sales. To achieve this, granting a LOb is the preferred way forward. Based on the Society’s guidance, refusing to grant a LOb just because a transaction is an insolvency sale is not justifiable. The guidance gives no reasons not to grant a LOb, and the solicitor will not suffer financially (no excess or premium weighting), nor will the client incur any additional liability. In view of this, granting a LOb in insolvent matters should become the norm to ensure IP clients get the best service.

Granting a LOb is not an onerous obligation for solicitors or IPs as long as due process is followed.

Not granting a LOb can, however, be onerous for IP sellers, as a refusal to grant often leads to delays in completing transactions.

Advance notices

Practitioners should be aware that the introduction of advance notices under the Land Registration etc (Scotland) Act 2012 may supersede the need for a letter of obligation once the Act is in force.