Opportunities for the acquisition of residential land and property assets are increasingly being presented to potential purchasers.
This includes registered providers (RPs) and REIT vehicles, with the intention that the transaction is structured by way of the purchase of the company or other legal entity (the SPV) which holds the land or property interest rather than the purchase of the property asset directly.
Common reasons for this may include:
- The tax preference of the seller (in particular where individual shareholders in the SPV wish to realise a capital exit through the sale of their shares); or
- Structural preference of the purchaser, with a view to ring-fencing separate property investments within different vehicles; or
- Where the SPV has already entered into development agreements or option agreements relating to the land and there is a preference for these agreements to remain with the SPV rather than be novated to a third party purchaser.
In addition to SPV acquisitions, we are also seeing opportunities arise for the sale or purchase of equity interests in joint venture vehicles, either as a new party to the joint venture or where an existing party’s interest in the joint venture is being acquired. Whilst this article focuses primarily on the acquisition of the entire interest in an SPV, a number of the principles also apply, with variation, to such joint venture activity.
Whilst there may be good reasons for a corporate sale rather than a property sale, prospective purchasers will need to consider the proposed structure carefully from their perspective.
If the transaction involves the purchase of a company (or of a controlling interest in a company) then the purchaser will be acquiring a new subsidiary into its group. Internal governance and treasury teams should be consulted at an early stage to consider whether any third party lender consents may be required.
Holding a new subsidiary going forward will also entail ongoing administration and cost both in terms of filings (e.g. annual returns and accounts) and internal governance (e.g. separate board of directors for the SPV and reporting requirements). If there is no appetite to retain the SPV longer-term, prospective purchasers may wish to explore with their advisers to what extent it may be feasible following completion to transfer the land assets out of the SPV (but within the group) followed by a winding-up of the SPV.
Subject to the status of the SPV and the intention for the proposed development of the property, it may be a consideration to raise project specific debt directly within the SPV. This can potentially assist with avoiding on-lending restrictions whilst also potentially providing third party lenders with a cleaner funding structure self-contained to the SPV.
The viability of a corporate SPV purchase compared to a property purchase, including any post-completion structuring which that may entail, will require careful tax consideration and prospective purchasers should consult with their tax advisers at an early stage in the discussions.
This assessment from a tax perspective is expected to focus in particular upon the inherent tax liability within the SPV (which would be inherited by a purchaser) by reference to any “pregnant” gain arising on the difference between the current property value and the original land acquisition cost incurred by the SPV, and the circumstances in which such tax liability may crystallise.
Prospective purchasers should also consider with their tax advisers the extent to which any potential tax liability (actual or contingent) arising within the SPV may be offset by any stamp duty saving which arises for the purchaser by virtue of the difference in the stamp duty rates payable on the acquisition of shares in an SPV (0.5%) compared to the higher stamp duty land tax rates payable on the acquisition of land. If there is a stamp duty saving to be made, a seller may even seek to negotiate a share of that saving as part of the price.
Corporate due diligence
A purchaser of an SPV will be purchasing the SPV “warts and all” – i.e., all other assets and all historic or current liabilities which the SPV has will be coming with it, in addition to the underlying land or property asset which is the main subject of the transaction.
As such, in parallel with the usual title and property due diligence, prospective purchasers should also undertake a wider corporate due diligence exercise on the SPV. This will include financial due diligence (e.g. review of latest SPV accounts), legal due diligence (e.g. review of contracts, engagements and financing arrangements to which the SPV is currently a party) and a wider tax due diligence exercise on the SPV (e.g. checking tax returns all duly filed and tax liabilities all duly paid).
Share sale and purchase agreement
The principal transaction document will be the share sale and purchase agreement, often referred to as the “SPA”.
Much of the negotiation around the terms of the SPA will revolve around price and the extent of contractual protections given by a seller to the purchaser in relation to the SPV in the form of warranties and indemnities.
Whilst the “headline” price may have been agreed at the outset, in many circumstances this will be a price based on the value of the underlying property asset rather than a price reflecting the value of the SPV. Accordingly, it is usual to include a price adjustment mechanism into the SPA – often based on a balance sheet of the SPV drawn up after completion but as at completion – reflecting other assets (e.g. cash in the SPV’s bank account) and known accrued liabilities (e.g. taxation, professional adviser fees) of the SPV. The price for the shares will also be reduced by the amount needed by the purchaser to refinance any existing debt within the SPV.
Warranties and indemnities
Warranties and indemnities are typically included in the SPA to protect a purchaser from the unknown liabilities and/or contingent liabilities in relation to the SPV which may arise in respect of pre-completion matters, actions or omissions. Whilst the “caveat emptor” principle would typically continue to apply in respect of the property asset (a purchaser would be expected to undertake its own investigation on the property in the usual way as it would on a property acquisition), the customary starting position on a corporate purchase would be for the seller to give certain warranties and indemnities in favour of the purchaser on matters which relate more specifically to the company (e.g. taxation, accounts, compliance, litigation, contracts, etc.) rather than directly relating to the property.
Warranties would typically be given “save as disclosed”, so a purchaser cannot bring a claim for breach of warranty if the warranty was found to be untrue but the purchaser was already aware of the matter as it had been previously disclosed by the seller. Where a contingent risk or liability has been disclosed that risk can, however, be protected through a specific indemnity.
The scope of the warranties and indemnities, and indeed the scope of the seller’s exclusions and limitations on liability under them, often form the main basis of the SPA negotiations. There can often be a wide gap to be bridged between, on the one hand, the protections sought by a purchaser and, on the other hand, a seller seeking a “clean break” without potential exposure to future claims. Increasingly, we are seeing warranty and indemnity insurance policies being purchased as a means of resolving these divergent positions; however, insurance will come at a cost – often at the seller’s cost if the policy is intended to give it the clean break it desires, but possibly at the purchaser’s cost if, for example, it is seeking insurance due to concerns as to the seller’s own financial covenant strength to stand behind the warranties and indemnities. The parties will also need to allow for an additional layer of process within the transaction timetable for insurers to review the due diligence and the SPA before finalising the policy terms.
It is not uncommon for SPVs to be registered off-shore. If so, it is important that local advisers in the relevant jurisdiction are engaged at an early stage to assist with the due diligence process and other formalities.
With regard to RPs, it is recognised that there are wider social considerations to be taken into account and the presence of an overseas company within a group may need to be further considered by a Board.
There can often be good reasons to pursue a corporate SPV purchase, whether these may be for the benefit of a seller and/or a purchaser. However, from a purchaser’s perspective, there can often be more to it than may initially meet the eye, and it is important to take advice from the outset.
For further information please contact Corporate Partner James Lyons on 020 7880 4361.