Petar Orlic and Kathryn Dowsett look at the legal complications of selling commercial real estate overseas in light of reports that Marks & Spencer is reviewing its international retail estate
Marks & Spencer is expected to report on the shape of its international business next month. Some commentators are speculating that with the appointment of M&S lifer Steve Rowe as chief executive earlier this year and difficult trading in the international sphere, there may be a scaling back of the group’s overseas operations. Rowe described a decline in overseas profits as “not sustainable”. Like every multinational, M&S needs to monitor all aspects of its international set-ups to ensure its strategy is fit for the future.
The M&S international portfolio is vast and has more than 450 shops across many countries. It has, for instance, 52 stores in India, 48 in Egypt, 37 in Russia, over 30 in Central and Eastern Europe (CEE), four in Kazakhstan, 10 in China and 24 in the Philippines. Its overseas portfolio is a mixture of company-owned and franchised sites and will have grown organically as the deemed needs of the business demanded.
Managing an international portfolio covering so many jurisdictions brings with it certain administrative burdens. However, when a need is identified to rationalise internationally-held property, the administration and complications multiply, as there is no one-size-fits-all solution. Each country will have its own peculiarities not only in law and tax but also in customs.
This article will focus on the complications of disposing of overseas commercial real estate generally, and also touch on specific issues that will be encountered in the US and CEE regions.
It should be remembered that multinationals do not just have their “visible” property overseas, they may also have regional offices, logistics and distribution centres etc. In addition, functions such as IT, HR and finance might also be run from abroad. Consequently, portfolios are likely to include a diverse range of properties.
So why rationalise?
A driving impetus to rationalise an international portfolio may stem from any number of business-specific reasons. A company might need to move towards central distribution hubs as opposed to large retail sites, or simply want to focus on its core areas of success. However, at the same time that one organisation is looking to withdraw there will be others seeking opportunities in the region.
In the more advanced economies, such as the US, there may well be companies willing to take on the portfolio. These companies might, for an agreed fee (and success fee), be prepared to take on the financial and reporting obligations of the company in exchange for managing the disposals. This approach frees up the organisation’s resources to focus on its core business and helps fix costs. These specialist companies are fewer in CEE. The type of business model is quite advanced and, given the specialist country-specific knowledge required to make these solutions a risk worth taking, finding a partner to take on a portfolio in multiple jurisdictions (particularly if there are few properties in each jurisdiction) will be difficult.
This may result in decisions being taken on a country-by-country basis. The best financial turnaround for an individual property (for example, by redevelopment or change of use) will not always be the best solution for the organisation if it means huge in-house investment time and delayed returns. It is a fine balancing act to judge correctly how much resource and funds need to be invested in professional advice to investigate unlocking the potential value of a portfolio.
A small in-house team could easily become overwhelmed with the number of communication channels needed to manage the rationalisation process. Once a strategy has been established, it is usual to outsource the day-to-day handling of the rationalisation to professionals outside the organisation. Central legal and tax counsel will often be appointed to liaise on the company’s behalf with law firms, tax advisers and property professionals in the relevant jurisdiction.
Below we set out some of the challenges that may be faced when rationalising portfolios in the US and CEE regions.
When dealing with the work-out of a multi-jurisdictional portfolio, effort put in at the start of the transaction will reap dividends. If there are insufficient resources to deal with the disposal in-house, then realising that at the start will be far better than doing so further down the line. Otherwise the best solutions may no longer be available if agreements have been reached that cannot be withdrawn from.
US rationalisation
- Change of control provisions are far more common in US leases. This means landlord’s consent (usually not to be unreasonably withheld) may well be needed if the disposal will involve a change to the controlling interest of the company which holds the lease. This might delay, or in a worse case prohibit, a deal from proceeding, when in another jurisdiction it would have proceeded unhindered.
- US leases are more likely than UK leases to have more limited user clauses. The use may be limited to a specific tenant’s business. This arises where the tenant has agreed a relatively short-term lease with a number of options to renew (which is a common structure for a US commercial lease on a retail site). The issue here is that although the company will be able to vacate the site relatively easily, it will be more difficult for it to benefit from any increase in the value of the unit.
- Depending on the size of the transaction, a number of pre-clearances may be necessary under antitrust regulation. Deal-specific advice will be needed for significant disposals.
- Non-US investors will need to structure their investment to minimise the impact of the Foreign Investment in Real Property Tax Act 1980 (FIRPTA). This legislation was enacted to combat perceived unfair advantages for foreign investors in US real estate and imposes significant taxes on dispositions of US real property interests.
- If the transaction involves several states, the property will be recorded in a number of different county recorder offices and municipal land records.
- Not all states have the same land registration system; only a few have the Torrens land registration system (or equivalent) under which the state guarantees the owner’s title.
- As title in most states is not state-guaranteed, title insurance companies will need to be involved in the rationalisation process.
- If a property needs to undergo a change of use to release value, the consent can take some time to come through.
- Instead of relying on replies to enquiries, estoppel certificates will be required by the assignee of a lease from the landlord. These are certificates from the landlord accepting that it has no current right of action against the tenant.
- As in England, the level of representations and warranties will depend on the bargaining strength of the parties.
- Transfer taxes are generally paid by the seller (and vary by statute, local custom or contract). Each state and local government sets its own rate of tax and tax basis.
CEE rationalisation
- Notarisation is likely to be required.
- For certain CEE countries, real estate transfer tax is not paid by companies acting as sellers. However, in Romania, for example, the transfer of shares in a company holding real estate is subject to capital gains tax of 16% of the difference between the sale price and nominal value of the shares (subject to double tax treaties etc).
- In certain CEE countries, owners pay an annual building tax. The exemption from holding taxes in the CEE countries which have these will differ and need specialist advice. For instance, in Romania, there are certain exemptions for structures in industrial parks.
- The length of leases may be restricted. In many CEE jurisdictions, there is a restriction in lease length (in Romania the maximum lease length is 45 years).
- The warranties given (either by custom or statue) will differ between the CEE countries. For example, in Romania, warranties must be given for hidden defects relating to the property and the seller cannot waive the statutory warranty if the defects were (or should have been) known to the seller and were not communicated to the buyer.
Petar Orlic is a partner at Faegre Baker Daniels LLP and executive director and board member for the British-Serbian Chamber of Commerce. Kathryn Dowsett is an associate in the London real estate group at Faegre Baker Daniels LLP
