Buyer beware: Distressed sellers

An increasing number of property transactions are likely to involve a distressed seller. It is therefore important to consider the factors that need to be taken into account in these circumstances and how best to manage the risks.

What is a distressed seller?

There is no single definition but, in simple terms, it is someone who is selling their assets because they have to rather than because they want to. This could encompass a range of sellers, from property funds that are forced to sell assets to cover redemptions, to property companies or individuals who are selling to avoid a default under their banking arrangements. The seller does not have to be insolvent, but could be.

What are the main risks?

In many ways, the risks of buying property from a distressed seller are no different from any other purchase. For example, there may be issues with the seller’s title to the property, its construction or condition, or with planning and environmental matters.

The main ways in which the risks differ are that there is usually a much shorter time to exchange contracts (which means there is less time to review information, identify issues and find solutions) and there is often significantly less information about the property than usual.

Any other factors to consider?

A buyer needs to make sure the seller has not begun an insolvency process and that a winding-up petition has not been presented against a corporate seller – a sale would be void if a winding-up order is subsequently made, unless the disposal is sanctioned by court.

A buyer should also consider whether the sale might be considered a transaction at an undervalue, as this could allow a court to set it aside.

What if the seller is insolvent?

The buyer should check that the insolvency practitioner has the power to sell the property

Although the risks are similar when the seller is insolvent, there are three key differences.

First, there is likely to be even less information available, as insolvency practitioners often refuse to reply to enquiries. Even if they do, replies are likely to be of limited value, as the practitioner is not personally liable and the seller is insolvent. A buyer, therefore, has no real recourse if any information turns out to be incorrect.

Another significant difference is that no title covenants would be given by the insolvency practitioner, such as the usual full title guarantee that the property is owned by the seller and is free from encumbrances. This places an even greater emphasis on the due diligence process to extract as much information as possible and ensure issues are identified.

The third factor is that the buyer must check that the insolvency practitioner has been validly appointed and has the power to sell the property. If it has not, the transaction could be challenged by the seller’s creditors and could be set aside by the court. The Land Registry would also need evidence of the appointment to allow the transfer of the property to be registered.

How can these risks be managed?

The main way to manage these risks is to ensure that, as far as possible, all potential issues are identified during the due diligence process.

To do so, the buyer should obtain as much information as possible from the seller. Where the purchase is through an insolvency practitioner, it should be asked to provide whatever information it has about the property, even if this is given on a non-recourse basis. The longer the practitioner has been in place, the more information it should have, as it will have been managing the property during this time.

In addition, as much information as possible should be obtained from external sources, such as the Land Registry and the local authority. A site visit should also be made to see whether any issues are obvious from an inspection of the property.

Key points to consider

It is important to remember that a discounted price is not always good value if the risks connected with the property are not identified and reflected in the price. A buyer therefore needs to ensure any risks are identified and evaluated as early as possible so it can decide whether the price sufficiently reflects the additional risk.