This is the second part of my series of articles on creative contracts. If you haven’t already, please do read my first article in this series, published in last month’s edition. As I’ve already written about the background in the first articles, I thought I would dive right into other creative contract structures in this article, along with some case studies.

Conditional Contracts

A conditional contract usually adopts the standard form of contract used in residential or commercial property sale & purchase transactions. One or more conditions are included in the contract which makes completion of the sale and purchase contingent on the condition(s) being satisfied.

Most standard sale & purchase contracts usually include some standard and special conditions. The one that tends to stand out more often than not is the condition that the property is sold with vacant possession on completion. There have been a great deal of cases argued in court (too many in my personal view) about whether there was in fact vacant possession of the property on completion. In one case, the buyer sued the seller for failure to provide vacant possession on completion because a couple of paint cans and brushes were left in an otherwise completely empty property!

What I am referring to with Conditional Contracts is where a specific condition or conditions are introduced into the contract because the nature of the deal is that the buyer is only willing to purchase the property once that condition is satisfied. Some of the more common ones I come across are the grant of planning permission or the seller ensuring a right of way (that may be crucial to access the planned development of the property) is expressly documented and protected or a restrictive covenant being released or extinguished or the property is built to pre-agreed specifications. The latter is commonly used by housebuilders selling their new-build property off-plan or landlords letting built-to-demand property to tenant occupiers, usually for warehousing purposes.

Since a conditional contract appears very similar to an option agreement, you may be wondering why go down the conditional contract route, rather than an option agreement. The reason that I come across most often is the buyer is obliged to complete the purchase if the condition is satisfied. You may recall from my first article that an option gives the buyer a right but not the obligation to buy the property. A seller may dislike this proposition and would prefer something more certain but accepts that the buyer is only willing to buy the property if certain conditions are satisfied. Hence, in some deals, a conditional contract is the best route to take.

The most important issue to be wary of when entering into conditional contracts is the wording and definition(s) used in the condition. The more important the condition to the objective for the property project being successful, the more careful you have to be with the wording and definition of the condition. For example, if the condition relates to planning permission, the precise nature of the planning permission granted must be carefully considered. Simply stating, “completion of the purchase is conditional on planning permission being granted” just will not do. If the objective for the property, in this example being development, is only viable if planning permission is granted for the construction of 5 units measuring 50 sqm. each on the land but instead planning permission is likely to be granted for 4 units measuring 40 sqm., would the buyer be happy to complete the purchase given the greatly reduced GDV? Probably not. Given how loosely the condition is worded, the contract would become unconditional as soon as any form of planning permission is granted. This would run contrary to the buyer’s objectives, hence the need to be accurate and comprehensive when drafting the condition.

I will run through a case I came across when researching cases on this topic a few years ago. It is a fairly extreme case study but also representative of how such cases end up in litigation. The property in discussion is the rather large former office block in Colliers Wood, London SW19. Known as the Brown and Root Tower, it was once voted London’s ugliest building in a 2006 BBC poll. The case reached all the way up to the Court of Appeal, as the disputed sum was large - £13.75 million was the sale price and if the contract was lawfully terminated, the seller could keep the deposit of £1.37 million. For ease of reference, the parties involved were Knightsbridge Green Ltd - the seller (“KGL”) and London Green Developments Limited - the buyer (“LGD”).

KGL and LGD entered into a contract under which the LGD would buy the property from KGL, would develop it in accordance with a planning permission, and would then lease parts of it back to KGL. The planning permission was defined by reference to a draft resolution which the London Borough of Merton (“Merton”) had approved as planning authority, subject to a suitable agreement being entered into under section 106 of the Town and Country Planning Act 1990 (“Section 106 agreement”). KGL was obliged to use all reasonable endeavours to secure a completed Section 106 agreement, substantially in the form of the draft then in existence and was appended to the contract. LGD was under no obligation to complete in the absence of such an agreement. Soon after the contract had been entered into, Merton's requirements in respect of the Section 106 agreement changed, affecting the transaction adversely.

The question that came before the courts is whether KGL was still bound under the contract with LGD, or whether, having used all reasonable endeavours to overcome the two problems as regards the Section 106 agreement, it was able to regard the contract with LGD as at an end. 

In April 2002 Merton produced a planning brief in order to encourage potential redevelopment of the site. As part of the development, Merton wanted a community use, such as a public library, on the ground floor of the tower. On 30 January 2003 architects submitted a planning application for the development of the property, the key elements of which were: conversion of the tower into flats, erection of two six storey extensions to the tower (north and south), demolition of a multi-storey car park on the site and its replacement by a ten storey building and creation of a public park. Overall the development would consist of 226 residential units, 370 sqm. of retail space, 629 sqm. for "a new public library facility", a café/bar and 876 sqm. of business and office space. Merton's planning officers recommended the grant of the application subject to the completion of a Section 106 agreement and various conditions. Merton was particularly keen on the library, which its officers later described as one of the Council's key aspirations. On 11 March 2004, Merton resolved to grant planning permission subject to the completion of a Section 106 agreement and to various conditions. Heads of terms listed 16 items that were to appear in the Section 106 agreement. None of those terms related specifically to the library.

Once the resolution to grant planning permission had been passed, work started on a Section 106 agreement. By September 2004 a draft Section 106 agreement was in existence. At this stage KGL put together a sales pack inviting buyers for the property. At the same time as looking for a buyer for the property, KGL's solicitors worked towards finalisation of the Section 106 agreement. By December 2004 the Section 106 agreement appeared to be close to its final form. Clause 15.2 of the draft Section 106 agreement then read (so far as material):

“the Developer covenants not to cause or permit occupation of the Affordable Housing Units and the Market Residential Units until the Class B1 Business Units and the library are constructed to shell and core.”

LGD offered £13.75 million for the property, which KGL accepted. A sale contract was negotiated. When the parties' solicitors met to exchange contracts, LGD and their solicitor explained to KGL and their solicitors that the Section 106 agreement had to be in place in order to enable LGD to obtain funding for the purchase. They therefore required a term in the agreement which deferred LGD's obligation to complete the purchase until there was a completed Section 106 agreement; otherwise exchange could not take place. At the meeting, the parties believed that the Section 106 agreement was in its final form and ready to be completed. Merton’s lawyer even confirmed this by phone to KGL’s solicitor.

A condition was thus inserted into the sale contract to deal with the Section 106 agreement. It is that clause which is at the heart of the dispute. Following exchange of contracts in May 2005, both parties expected that the Section 106 agreement would be completed within a relatively short period of time, and without substantial amendment. This was not to be.

In June 2005, Merton raised two new points, of which one was pivotal to the ultimately failure of the transaction - a requirement that the new library be transferred to the Council at a peppercorn rent and without a premium. You would expect that some provision for the library would have been necessary, if Merton was to be sure of getting its new library, but nothing had been said about the proposed terms until then. Eventually this requirement was reflected in a later draft Section 106 agreement, in December 2005, under which the relevant clause imposed an obligation:

“not to cause or permit occupation of the Affordable Housing Units and the Market Residential Units until the Class B1 Business Units and the library are constructed to shell and core and a lease of the library [had] been granted” to Merton.”

Discussions as to the terms of the transaction as regards the library continued between the KGL and Merton during 2006, which were difficult for KGL. There were also complications with an adjoining parcel of land that was required for the development, which was not owned by KGL.

The difficulties were so large that in February 2006, KGL’s solicitor wrote to LGL’s solicitor, stating:

“... it will not be possible for [KGL] to procure a Section 106 Agreement substantially in the form attached to the [Contract] between our respective clients. Would you please explain the position to [LGL] and see if [they are] willing to complete in the same terms and conditions contained in the [Contract] but without any Section 106 Agreement being in place. If [LGL] does not wish to complete or is not able to complete on this basis then I am instructed that [KGL] will have no option but to treat the [Contract] as at an end and return the deposit to your client.”

LGL contended that KGL had not done all it was obliged to by way of its reasonable endeavours to get the Section 106 agreement into place. In February, KGL explained why they had done all they had to, and concluded that unless LGD was willing to complete the purchase without a Section 106 agreement, KGL would rescind the contract. After inconclusive further correspondence, KGL rescinded the contract on the basis that they were unable to procure a Section 106 Agreement substantially in the form attached to the contract. Communication finally broke down altogether and court proceedings commenced in June 2006.

In the High Court, the judge decided:

1. The revised draft Section 106 agreement that Merton had requested was not substantially in the form of the draft appended to the sale contract; and

2. KGL had not discharged its obligations to use all reasonable endeavours to complete the Section 106 agreement in the form of the draft appended to the sale contract and thus could not rely on the non-satisfaction of the condition as having terminated the sale contract.

In allowing the appeal by KGL, the Court of Appeal, decided that the issue of the adjoining parcel of land was so crucial to the Section 106 agreement in the form of the draft appended to the contract being finalised that the lack of ownership of this land ultimately led to the inability to complete the Section 106 agreement in its original form. KGL had, said the Court of Appeal, used all reasonable endeavours to complete the Section 106 agreement but because this required the ownership or control of the adjoining parcel of land, which was owned by a third party, it was no longer possible to complete the Section 106 agreement in its initial form.

One of the judges in the Court of Appeal commented that the issue at the heart of these proceedings could easily have been resolved if the condition in the contract was much more absolute. If the condition merely stated “completion is conditional on the Section 106 agreement in the form of the draft appended to this contract being completed between the parties named therein”, then it would be clear how important this Section 106 agreement was to the success of the project that completion of the contract was wholly conditional on a very clear condition - namely, the Section 106 agreement actually being completed.

The decision to word the condition in the contract with the caveat ‘use reasonable endeavours to complete the Section 106 agreement’ was in my view, the decisive failure in this matter. What ensued was years of litigation with a huge legal costs bill! It serves as a potent reminder that words used in such contracts must be very clear, precise and well thought out.

If you would like to discuss the above or other creatives deal structures, feel free to to get in touch.