by Peta Dollar and Christopher McGee-Osborne
Section 2 of the Law of Property (Miscellaneous Provisions) Act 1989 has caused considerable controversy in the property world. The section laid down new rules for the creation of a contract “for the sale or other disposition of an interest in land”, and questions have arisen as to how the new rules differ from the old and how this affects property transactions. In particular, readers will be familiar with the different views regarding options, as set out in previous issues by Professor Adams [0] 06 EG 59 on the one hand and Messrs Sydenham and Rodrigues [1990] 47 EG 48 on the other.
The argument about post-section 2 options illustrates the wide difference between the two basic polarised approaches to section 2 and its effect on everyday property transactions and procedures: a strict legalistic interpretation (producing a nightmare scenario in which many standard property transactions have become either invalid or unworkable) versus the “common-sense” approach (which refuses to accept that Parliament could have intended to frustrate the businessman and his freely negotiated commercial arrangements).
On one legalistic interpretation of the section, the property world would have to abandon or substantially revise some of the more popular tools of their trade, including:
Options
The problem here is that section 2’s requirement for the contract (containing all agreed terms) to be signed by both parties means that the notice exercising the option (which traditionally creates the contract) must also be signed by both parties. This has introduced an extra hurdle for the purchaser to clear: he must be able to compel the vendor to countersign the notice exercising the option, otherwise the option will not be exercisable. To avoid problems with a recalcitrant vendor upon exercising the option, various suggestions include powers of attorney (entitling the purchaser to sign the options notice for the vendor), provisions for a pre-signed option notice/contract to be handed over by the vendor on exchange (to be signed by the purchaser on exercising the option), and the use of contracts rescindable by the purchaser (rather than options exercisable by the purchaser).
Side letters
These are common when last-minute changes to a deal are agreed or where personal or confidential concessions are given to one party by the other. The problem with section 2 is the requirement for all the terms of the transaction to be incorporated into the contract, signed by both parties, whereas the side letter, itself containing agreed terms, is not usually part of the contract.
Deposit of title deeds
A quick way to obtain secured finance is to offer title deeds as security. Traditionally, this has created an “equitable charge” over the property, ie a contract to create a legal charge. Section 2, however, requires a written contract containing all agreed terms. A memorandum of deposit could be signed by both parties but unless it contains all the terms of the proposed charge, it may not comply with section 2.
Binding heads of terms
These have always been relatively unusual but enabled parties to enter a binding legal relationship before settling full detailed documentation. However, they had the disadvantage of leaving the precise terms of the contract open to doubt and determination by the specified arbitrator. They may now be challenged as not containing all agreed terms and not complying with section 2.
Last-minute contract changes
Amendments to the contract are often agreed just before or after exchange — too late even for a side letter — and are usually documented in correspondence between the parties’ solicitors. Again, the contract will not contain all agreed terms and thus will offend the section 2 rules.
Facility letters
The same problem arises here as in the case of memoranda of deposit: where the facility letter setting out the terms on which the banks is to lend the money is to be followed by a legal charge, the facility letter will itself not contain all agreed terms and hence will not comply with section 2.
This is certainly not a fully comprehensive list. Section 2 has created other problems, such as those faced by the auctioneer who now creates the contract on the fall of the hammer, and cannot cancel his acceptance of a bid if, for example, he has mistakenly accepted a bid below the reserve price; formerly, the successful bidder was bound instantly but the vendor was not until the auctioneer signed the contract on his behalf. There are now no formalities for auction contracts, which need not even be written.
A common-sense approach
Notwithstanding the bleak picture painted by the above interpretation, there is an alternative view which, if correct, will allow continued use of many basic tools of the trade, with little or no revision. The common-sense view relies heavily on the basic assumption that Parliament did not intend, when section 2 was enacted, to permit a party to renege on a deal after the deal has been freely negotiated and documented. With this in mind, the proponents of the common-sense view argue that the courts will interpret section 2 in such a way as to bind parties who have clearly intended to be bound. Let us then re-examine each of the items affected by the nightmare scenario following the common-sense approach:
Options
Common sense suggests that two parties should be able to agree that one of them has the right to require a sale of a property to him by the other without any further consent or action by that other. On close inspection, section 2 offers a means of achieving this based on the actual wording of the section, and without the need to alter the traditional form of options and notices exercising them. Section 2 requires “a document” to contain all the agreed terms and be signed by both parties: there is no requirement for that document to constitute the contract. Accordingly, the option notice simply triggers the coming into effect of the contract, the terms of which are contained in the option agreement (which must, of course, have been signed by both parties).
Side letters
It is first necessary to bear in mind that section 2 affects only contracts for sales and other dispositions of interests in land, and not actual dispositions. Thus unless a side letter itself contains such contractual provisions, any side letter handed over on completion of, eg a lease, legal charge, conveyance or land transfer is not affected by section 2 and the lease etc need not refer to it. Any contract for a lease, legal charge, conveyance or land transfer, however, must include all agreed terms, including a term that a particular side letter will be handed over on completion. A manuscript amendment to the contract to refer to the giving of a side letter, and attachment of the form of side letter to the contract, is perfectly adequate.
Second, an appropriately drafted side letter will contain a reference to the main contract document, and will be signed by both parties (in one or two identical parts), and will be stated to incorporate the terms of the main contract. Such a letter will then be “the contract” for the purposes of section 2.
Finally, if all else fails, the side letter may constitute a “collateral contract”, ie a distinct legal arrangement separate from the main contract. If it does not relate directly to the disposition of an interest in land, section 2 will not apply to it and ordinary contract rules apply. If it does, then so long as it complies with section 2, two separate valid section 2 contracts will exist, the main contract and the side letter. It is, however, difficult to prove that a contract is collateral to another agreement especially where the side letter contains a fundamental term of the main transaction.
“Confidential” side letters, which necessarily cannot be referred to in the main contract, are more difficult and will normally offend section 2 unless they constitute a collateral contract.
Binding heads of terms
The common-sense approach must be to argue that any terms not set out in the heads will, so long as provision is made for arbitration, be determined by the arbitrator, and hence are ascertainable. Accordingly, there is no breach of section 2.
Deposit of title deeds
Even on the basis of the common-sense approach, the deposit of title deeds without a written memorandum cannot now create a contract to grant a legal charge. Memoranda of deposit are now unsafe and, until there is a specific authority on this point, great care should be taken by both parties.
Last-minute contract changes
Again, an identical manuscript amendment to both parts of the contract will not offend section 2. Section 2 requires a “document” to be signed by or on behalf of both parties, and so there is nothing to stop the parties’ solicitors writing to each other in identical terms, the letters being expressly stated to incorporate the terms of the main contract, and being signed by each solicitor on behalf of his client. That exchange of letters will then itself be “the contract” for section 2 purposes. Alternatively, the exchange of correspondence may itself constitute a collateral contract or, if carefully worded, a variation to the existing section 2 contract.
Facility letters
The common-sense approach is that so long as the terms of the loan agreement are set out in the facility letter, a borrower who has taken advantage of the facility will not subsequently be able to avoid granting the charge. It is important, however, that the charge properly incorporates the facility letter, if any of its terms continue after completion of the charge.
Recent cases
In view of the risk that the “nightmare scenario” approach will be adopted by the courts, it is encouraging that the judicial attitude shown in the only two decided cases to date leans heavily towards the common-sense approach. The first case, Spiro v Glencrown Properties Ltd [1] 02 EG 167, dealt solely with the options and confirmed that there is no need for countersignature of the option notice. The common-sense approach of Hoffmann J, when he said “… it seems plain enough that section 2 was intended to apply to the agreement which created the option and not to the notice by which it was exercised … it would destroy the very purpose of the option if the purchaser had to obtain the vendor’s countersignature to the notice by which it was exercised”, speaks for itself.
The more recent case of Record v Bell, The Times, December 21, 1990, demonstrates an equally practical judicial approach to section 2. This case concerned an exchange of letters between solicitors immediately after exchanging contracts, confirming agreement between them on a number of outstanding title points, which had been settled over the telephone, but which were not dealt with in the contract. The two solicitors’ letters, although not containing identical wording, were found to have substantially the same meaning.
His Honour Judge Paul Baker QC held that the exchange of correspondence itself created a collateral contract, which did not result in the main contract falling foul of section 2. Adopting a broad, common-sense approach, the judge said: “The particular area I am concerned with is where a contract in two parts has been duly signed by the … parties and is awaiting exchange. Then some term is orally agreed immediately prior to exchange and confirmed by the exchange of letters. That … is a very common situation”. He went on to say “…it would be unfortunate if common transactions of this nature … should nevertheless cause the contract to be avoided”.
In view of the fact that the judges in the only two decided cases on section 2 to date have made such clear attempts to ensure that the section is applied so as to uphold the original intention of the parties (at the time they try to contract) and preserve normal business practices, it is apparent that the risk of the nightmare scenario coming about is probably academic and that common sense is likely to prevail. The Spiro case is currently being appealed and it will be interesting, bearing in mind the debate as to Hoffmann J’s reasoning (see “Legal Notes” January 12 1991), to see what the higher courts make of section 2.
“Subject to contract”
It has been suggested that section 2 obviates the need for correspondence to be headed “Subject to contract” and, indeed, section 2 could be argued to have that effect. This argument is not an attractive one as any open letter could, if surrounding circumstances permit, create or acknowledge a contract. An example would be correspondence concerning fixtures and fittings — section 2 need not apply to this as fixtures and fittings (unless affixed to the building) are not “land”. Side letters can create separate binding obligations collateral to a contract for the sale of land and it follows that any precontractual correspondence could have the same effect.
Given the tradition of mentioning previous correspondence at the start of most letters, section 2 could be used by a court (keen to find a binding relationship between litigating parties) to construct a contract from open correspondence between the parties, their surveyors or solicitors. It is not difficult to imagine circumstances in which, in order to do justice to a party against another who has acted in bad faith, the court will be prepared to “find” a contract even though this may not fit a strict interpretation of section 2.
It is therefore important that subject to contract continues to be used as before and it is becoming increasingly common for the parties, their surveyors and solicitors to commence pre-contractual correspondence with a general statement that all correspondence is intended to be subject to contract pending a formal exchange of professionally drawn contracts. Simply inserting the words subject to contract will not, however, be guaranteed to defeat a contract. Where the terms of the correspondence are clearly intended to be binding, these words may be disregarded.
Points to watch
To take advantage of the relatively generous approach of the courts (so far) to the interpretation of section 2, it is important to ensure that all agreed terms are clearly recorded in an unambiguous manner in one document signed by or on behalf of the parties, either by setting out the terms in the document, or by referring to another document which contains them. Used with care, the vast majority of the tools of the property trade we have mentioned can still be used effectively.
Points to watch include:
- Option agreements should always be signed by both parties.
- Side letters should be avoided if at all possible — last-minute manuscript amendments to a contract are preferable. If essential:
(1) refer to them in the main contract (and attach a draft); or
(2) draft them to incorporate the main contract itself and ensure that identical letters are signed by both parties.
- Side letters with leases are not usually affected by section 2 unless there is an agreement for lease or the letter contains terms regarding the sale or other disposition of an interest in land.
- Do not accept a deposit of title deeds by way of security, or expect a bank to do so — if essential, ensure that the memorandum of deposit contains all agreed terms and is signed by both parties.
- Avoid using binding heads of terms.
- Last-minute contract changes should, if possible, be made on the contract itself, even if this is messy (it can always be retyped and re-executed later).
- Facility letters should be as full as possible.
- Always use “Subject to contract” on precontractual correspondence.
