Where a company holds land, ownership can change in one of two ways. The company may sell the land outright or, alternatively, the shareholders may transfer their shares to a buyer. Modern property transactions are often structured as share sale agreements to reduce the cost of stamp duty land tax. Fryatt v Preston Mellor Harrison [2015] EWHC 1683 (Ch) highlights one of the many risks that buyers run when they agree to enter into an option to buy shares in a “property rich” company, as opposed to entering into an option to buy the land itself.
During the course of negotiations to take an option over a parcel of land, the buyer agreed to enter into an option to purchase the entire issued share capital of the company that owned the land instead. However, the company went into liquidation before the buyer was in a position to exercise the option, and the liquidator sold the land to a third party.
The buyer complained that his legal adviser had failed to advise him that an option to buy shares does not confer any proprietary interest in land and of the effect of section 88 of the Insolvency Act 1986. This provides that any transfer of shares made after the commencement of a voluntary winding up, without the sanction of the liquidator, is void.
The buyer’s legal adviser argued that his client was an experienced and sophisticated property developer, who had instructed him to give effect to the transaction that he had negotiated. In addition, the buyer had ignored his invitation to discuss the increased risks involved when acquiring shares in a company. However, the judge accepted the buyer’s evidence that he had not appreciated that he would not be acquiring a proprietary interest in the land, which could then be protected by registration at the Land Registry or by an order for specific performance if the seller were to go into liquidation.
The judge ruled that the buyer’s legal adviser should have checked that his client understood the true nature and effect of the transaction that he had negotiated and the ways in which an option over shares differs from an option to buy land. However, the buyer’s claim was unsuccessful because he was unable to satisfy the judge that he would have entered into an option to acquire the land instead, or that he had lost any profit from a possible resale or development of the land in question.
Practitioners advising on the differences between sales of land and shares will generally explain that the risks involved in share acquisitions are very different to the risks run when contracting to buy land instead. They will explain that, when you buy the shares in a company, you will inherit the company’s liabilities and must rely on the information provided in the due diligence process to establish their extent (backed up by warranties and indemnities from the seller). They may also explain that purchasers who buy land instead can rely on property searches and on the process of land registration in order to secure title to the land. This case shows that additional warnings are required if buyers are negotiating share acquisitions that will not be completed immediately.
Allyson Colby is a property law consultant