Contracts and Exchange — SQE1 FLK2 Property Law and Practice

Your client is buying a house. Exchange this week, completion four weeks later. The house is empty, the seller having already moved abroad. You tell her to have buildings insurance in force from the moment of exchange, and she cannot see why. She will not own it for another month. Surely the seller's policy covers it until then. Suppose it burns down next week. Does she still have to complete, and pay the full price for what is left? Yes.

This is Contracts and Exchange, and that answer is the most reliable trap in the whole of property practice. It is also a recurring source of negligence claims against conveyancers. Keep her in mind. We are coming back for her.

Here is the route. What the contract has to contain to exist at all. The Standard Conditions, and the handful of them you must know cold. Special conditions, and when you need one. The deposit, and who holds it. Then risk and insurance, which is where the marks are. Then title guarantee and tax. And finally exchange itself, and the formulae that make it happen over the telephone.

Start with what makes a contract for land exist. Section 2 of the Law of Property (Miscellaneous Provisions) Act 1989. It must be in writing. It must contain all the agreed terms in one document. And it must be signed by or on behalf of both parties. Miss any of those and there is no contract at all, however clear the bargain.

On top of that sit the Standard Conditions of Sale, currently the 5th edition, 2018 revision. They are pre-drafted terms that apply unless expressly excluded or varied, and they are incorporated by reference. The contract simply says it incorporates them. You are bound by conditions that are nowhere in the document you are reading. Commercial deals use the Standard Commercial Property Conditions, 3rd edition.

Now the conditions worth knowing by number. Standard Condition 2.2, the deposit: the buyer pays 10%, and it is held by the seller's conveyancer as stakeholder. Standard Condition 3.1: the property is sold subject to incumbrances the seller does not and could not know about, and to entries on public registers.

Standard Condition 6.1: completion is twenty working days after the date of the contract unless the parties agree otherwise, and it happens by 2pm on the completion day. Time is not of the essence unless a special condition makes it so, which is high risk.

Standard Condition 7.1 deals with errors and omissions. For an error or omission in the contract or the negotiations the buyer is entitled to damages. Rescission is much harder. It needs fraud or recklessness, or property differing substantially, in quantity, quality or tenure, from what the buyer was led to expect.

And Standard Condition 7.2 onwards handles late completion. Compensation runs at the contract rate, the Law Society interest rate, currently 4% above base, against whichever party is in default. Delay has a price, and it is calculated rather than argued about.

Special conditions modify or supplement all of that for the particular deal. You need one to fix a completion date, to make time of the essence, to agree a deposit of less than 10%, or to deal with a planning problem. Draft them clear, unambiguous, and capable of being performed.

The deposit next. It is the sum the buyer pays on exchange as an earnest of performance, traditionally 10% of the price, and deducted from the balance due on completion. If the buyer fails to complete and the seller rescinds after a notice to complete, the seller may forfeit it and resell. Any further loss is recovered by damages, with the forfeited deposit brought into account.

In practice many buyers pay less, often 5%. That needs a special condition, and it weakens the seller. A reduced deposit means the seller must prove actual loss to recover more, and if the property has risen in value that loss may be less than the missing money.

Who holds it? The seller's conveyancer, as stakeholder. A stakeholder holds for both parties and neither can call for the money alone. It goes out only in accordance with the contract, or on the joint direction of both. To the seller on completion, or back to the buyer if the contract is lawfully rescinded.

Occasionally, in new build or at auction, the estate agent holds the deposit. That is less secure. The agent may not be regulated in the same way, and if the agent becomes insolvent the deposit can be lost. Many lenders prohibit it.

Now the part that decides more exam questions than anything else here. Standard Condition 5.1.1: the property is at the buyer's risk from the date of the contract. Not completion. Exchange. The buyer takes the property in the physical state it is in at the date of the contract. Damaged or destroyed the following week, and the buyer must still complete and pay the full price.

And it gets worse, because of the condition next door. Standard Condition 5.1.2: the seller is under no obligation to insure, and is free to cancel his own policy on exchange. The exceptions are narrow. A contract term requiring his policy to continue, or a letting under which he must insure. Otherwise, nothing.

Put the two together and the consequence is unavoidable. Risk has passed to the buyer, and the seller need not insure. So the buyer must have buildings insurance on risk from the moment of exchange, on a reinstatement basis rather than market value. Confirm the cover is in force before you exchange, not after.

Title guarantee is the next thing the contract fixes, and there is a myth to kill. The guarantee turns on what the seller can properly promise about the title. It does not turn on whether the interest is freehold or leasehold. The ordinary form on any sale, a flat included, is full title guarantee.

Under the Law of Property (Miscellaneous Provisions) Act 1994, a seller giving full title guarantee makes three promises. That it has the right to dispose of the property. That it will do all it reasonably can to give the title it purports to give. And that the property is free from incumbrances other than those it could not reasonably be expected to know about. Limited title guarantee is for a seller who cannot promise that much, such as personal representatives.

Tax briefly, because it changes the price. Most existing residential sales are exempt, and new residential builds can be zero-rated. Most commercial property is standard-rated at 20%. A commercial owner can opt to tax, which makes supplies of that property standard-rated and means the buyer pays tax on the purchase. And a property sold as part of a business may pass free of it as a transfer of a going concern.

One special condition worth its own moment. Where a chancel check shows the property is in an affected parish, the seller is usually required to take out indemnity insurance. But be precise about what the search shows. It reports the parish, not the title, so it neither proves nor disproves that this property is burdened.

And the liability is much narrower than it was. Since 12 October 2013 a buyer for value of a registered title takes free of chancel repair liability unless a notice is on the register. That is s.117 of the Land Registration Act 2002. Cover is still taken, because a notice could be entered before the buyer's disposition is registered.

Now conditional contracts, because clients ask for them. A contract expressed to be subject to the buyer obtaining a satisfactory mortgage leaves the central question undefined: satisfactory to whom, and on what terms. A materially identical condition was held void for uncertainty in Lee-Parker v Izzet, from 1972. The result is no contract at all, so the seller is not locked in.

If you must have one, it has to specify objectively the amount, the terms, the lender and a longstop date. Even then, conditional exchange is poor practice. The safer course is to hold off exchanging until the funding is in place.

Which brings us to exchange itself, the point of no return. Before it, either party can walk away without liability. After it, both are committed. The completion date is fixed and changeable only by agreement. Risk has passed. The seller must take the property off the market.

The modern method is the telephone, under one of the Law Society's three formulae. Which one applies depends on a single question: who is holding the signed parts at the moment of the call? Formula A, where one solicitor already holds both. Formula B, where each holds only their own client's part and undertakes to send it on. Formula C, for chains that must be synchronised.

And here is the point candidates miss. The choice of formula makes no difference to when the parties become bound. Under every formula the contract comes into existence at the moment of the telephone agreement, not when the parts are posted and not when they are received. What the formulae govern is the machinery.

Those undertakings are personal to the solicitor who gives them, and enforceable against him. So never use a formula unless you hold the signed part and you have your client's authority. Take an attendance note of the time, the formula and the terms, and follow it immediately with written confirmation.

A word on how SQE1 tests this. You will not be asked to recall case names or condition numbers. You get a scenario, five answers, and one instruction: pick the best. In this topic there is almost no case law. What there is instead is a set of default rules, and the marks come from knowing which way each default runs.

If you keep only three. Standard Condition 5.1.1 and 5.1.2 together, risk on the buyer from exchange and no duty on the seller to insure. Section 2 of the 1989 Act, writing, all the terms, both signatures. And the rule that under every Law Society formula the contract is made on the telephone call.

Four traps the examiners set. One: the Standard Conditions bind you whether or not you have read them. The contract may say nothing more than that it incorporates them, and that single line imports the lot. If a question turns on a default position, the default is in the conditions, not in the document in front of you.

Two: title guarantee does not track freehold and leasehold. It is tempting, and it is wrong. A seller of a flat who has lived there gives full title guarantee like anyone else. Limited title guarantee is for a seller who cannot make those promises, such as personal representatives.

Three: watch who drafted the special condition. An unclear condition may be construed against the party who put it forward. If you act for the buyer, read the seller's special conditions properly rather than assuming they are standard.

Four: tax mistakes are expensive and they land on the seller. If tax should have been charged on a commercial sale and was not, the seller remains liable to HMRC. Check the position, and make the contract say plainly how it is being treated.

Quick check, and it is our buyer. She is buying a house under a contract incorporating the Standard Conditions of Sale. Exchange this week, completion four weeks later. The house is empty, the seller having moved abroad. Her solicitor has told her to insure from the moment of exchange and she does not see why. She says the seller's own policy must cover it until she gets the keys.

Is she right that she need not insure until completion? Three candidate answers. One: yes, because risk passes only on completion, when the property is transferred to her. Two: no, because risk passes on exchange and the seller need not keep the house insured. Three: yes, because the seller must maintain cover until completion under the standard conditions. Pause here if you want a moment.

The answer is two. Under the Standard Conditions the buyer takes the property in the physical state it is in at the date of the contract. So risk passes on exchange, not on completion. That is condition 5.1.1. And condition 5.1.2 relieves the seller of any obligation to insure, leaving him free to cancel his policy on exchange.

So the assumption that the seller's cover will answer for that month is the very assumption the conditions defeat. An empty house whose owner has moved abroad is exactly where a policy has most likely lapsed. One states the opposite of the condition. Three is the same mistake in a different hat. And the seller's insurer would not pay and then recover from her. She is not its insured.

Five things to take away. One: a contract for land must be in writing, contain all the agreed terms in one document, and be signed by or on behalf of both parties. Two: the Standard Conditions are incorporated by reference and supply the defaults, including a 10% deposit held by the seller's conveyancer as stakeholder.

Three: risk passes to the buyer on exchange under condition 5.1.1, and under 5.1.2 the seller need not insure, so the buyer insures from exchange. That is what our buyer had wrong. Four: title guarantee turns on what the seller can properly promise.

Five: exchange is the point of no return, and under every Law Society formula the contract is made on the telephone call, not when the parts are sent. Next time, Pre-Completion, Completion and Post-Completion.

Practise this topic with exam-style questions at sqe1prep.co.uk. This episode is for education and exam revision only, not legal advice, and we are not affiliated with or endorsed by the SRA or Kaplan.