Fiona Pearson outlines the facts of a recent case involving an insolvent seller, and provides a practical guide to the role and duties of the conveyancer in advising a buyer where the seller is insolvent
A number of headlines following a recent high-profile professional negligence case suggest that there is no duty on a purchaser’s conveyancer to check a seller’s solvency. It is, of course, part of the normal pre-contract searches and enquiries to check on the solvency of the seller, and in the majority of cases, the property solicitor will become aware of the seller’s bankruptcy, as a notice or restriction on the title will show up on the official search of the registered title.
What the court was considering in the case concerned (Kandola v Mirza Solicitors LLP  All ER (D) 26 (Mar)), was how far beyond this the conveyancer should go in circumstances where the usual title investigation gives no cause for concern.
In Kandola, a bankruptcy petition was registered against the property the day after exchange. The timing meant that, unfortunately, the official copies supplied pre-contract did not reveal the creditor’s notice, which would otherwise have shown up on the title. Had a bankruptcy search been undertaken at the land charges department of Land Registry, this would have revealed any registered or pending bankruptcy petition against the seller.
In addition, the buyer, Mr Kandola, had agreed to pay the deposit of £96,000 on exchange to the seller’s solicitors as agents for the seller, rather than the usual position whereby the seller’s solicitors hold the deposit as stakeholder. Mr Kandola’s solicitors had warned him of the risk of paying the deposit on this basis – namely, that he could lose it if the seller became bankrupt or was otherwise unable to complete – but Mr Kandola proceeded against this advice. As a result of the bankruptcy petition, the sale failed to complete, and Mr Kandola lost his deposit.
Mr Kandola, who was a successful and experienced property investor, brought a claim against his solicitors for breach of duty. His key complaint was that his solicitors should have undertaken a bankruptcy search prior to exchange, which would have revealed the bankruptcy petition.
Mr Kandola’s barrister accepted at trial that it was not normal procedure for either search to be carried out by a buyer’s solicitor before exchange, and there was no recommendation to do so in the Law Society’s Conveyancing Handbook (hereafter called the Handbook). However, it was argued that the circumstances of the transaction required the solicitor to go ‘beyond the Handbook’ and take steps to assist in gauging the extent of the credit risk being run. He argued that any reasonable solicitor would have taken such steps.
The solicitors argued that Mr Kandola was fully and properly advised throughout the retainer, including specific advice in writing not to exchange contracts on the basis agreed, but that he elected not to follow that advice. In addition, they argued that they were not aware of all aspects of the transaction, and that much of the negotiation process was going on directly between Mr Kandola and the seller.
The court concluded that in such circumstances, there was no duty for the solicitors to have delved further by making a pre-contract bankruptcy search or Land Registry priority search, unless they had been expressly instructed by their client to do so. The judge specifically commented that just because a solicitor could take a particular step, did not mean that it was their duty to do so.
Indeed, it is not usual procedure for either search to be carried out by a buyer’s solicitor prior to exchange, and no advice to do so is provided in the Handbook.
If acting for the lender, however, the conveyancer must always carry out a bankruptcy search against an individual buyer as one of the standard pre-completion searches. A lender will require a clear bankruptcy search against the name of the buyer and any guarantors of the mortgage before releasing the mortgage advance.
Where a solicitor is acting for a commercial client, there is a greater expectation that the client would be astute and would appreciate the risks in property transactions
Notwithstanding the standard procedure and the Kandola decision, the prudent solicitor may consider it sensible to carry out a bankruptcy search (on form K16) prior to exchange of contracts. This is particularly important to consider in circumstances where the deposit is to be released to the seller or where the sale is at undervalue, and there is a risk that the transfer might be set aside.
A bankruptcy search at the land charges department of Land Registry will identify whether there are any registered or pending bankruptcy petitions, or other similar orders against individuals or companies. Every bankruptcy petition in England and Wales will be registered at the land charges department. A search is valid for three weeks from the date of issue, and given the cost is just £2 per name searched, a cautious approach would be to undertake a search at the outset of the transaction, again just prior to exchange, and again before completion.
The search will identify whether the name searched against was subject to any of the following within the previous five years (unless the entry was subsequently cancelled):
- petitions in bankruptcy in the register of pending actions;
- receiving orders in bankruptcy and bankruptcy orders in the register of writs and orders; or
- deeds of arrangement in the register of deeds of arrangement.
Note that these entries expire automatically after five years, unless renewed.
Care needs to be taken where a search is carried out on a common name and is likely to result in numerous entries. Steps should therefore be taken to ensure that any entry does not relate to the seller. To do this, the conveyancer should obtain the seller’s date of birth and then contact the Insolvency Service to check whether the results match.
The search will not show individual voluntary arrangements (IVAs). These are recorded on the individual insolvency register, which is available on the Insolvency Service website. There is no fee for an online search. Enter the name or trading name of the individual to be searched. The result will show IVAs that are current, or which have terminated within the previous three months.
Under standard conditions, stakeholder deposits are, of course, the norm. Clearly, payment of the deposit to the seller’s solicitor as agent for the seller creates a significant risk for the buyer, since the agent is permitted to release the deposit to the seller immediately following exchange of contracts. This means that if the seller becomes bankrupt (if an individual), or goes into liquidation (if a company), the buyer will rank as an unsecured creditor in relation to the deposit, even if the deposit is still sitting in the client account of the seller’s conveyancers.
How a deposit should be held is an important issue to be discussed with the client before exchange of contracts. There is always a risk when the money is paid over as agent, but the client may have little option if the bargaining position of the seller dictates this. Housebuilders, for example, frequently require deposits to be paid as agents. However, if there is an National House Building Council (NHBC) warranty in place, this will usually reimburse a deposit of up to 10% of the purchase price in the case of insolvency or fraud. There are various rules in relation to this, however, and the conveyancer should ensure that these are checked carefully as part of the purchase due diligence.
The Handbook also advises solicitors to warn clients of the risks of paying a deposit as agent for the vendor.
Advice should therefore be given about the risks to the buyer of the seller not completing the sale, having received the deposit money and either not returning the deposit, or becoming bankrupt. In Kandola, the buyer had been clearly advised of the risk and signed an express waiver, which stated: ‘I have also been advised against releasing the deposit of £96,000 to the seller. I am also aware that I risk losing my £96,000 if the seller is unable to complete the sale…’.
Transactions at undervalue
Another reason for carrying out a bankruptcy search against the seller (or previous seller) is where there is a risk that the transfer (or previous transfer) might be set aside as a transfer at undervalue.
The following transactions are identified under the Insolvency Act 1986 as being capable of displaying undervalue:
- a gift or transaction to a person on terms that provide for the company / individual to receive no consideration;
- a transaction for a consideration the value of which, in money or money’s worth, is significantly less than the value, in money or money’s worth, of the consideration provided to the company / individual; or
- a transaction with a person in consideration of marriage or the formation of a civil partnership (bankruptcy only).
The risk of buying a property at a discount is that if the seller is declared bankrupt in the period up to five years following the sale, the transaction could be set aside by the trustee in bankruptcy.
This should be at the forefront of the conveyancer’s mind if it is known that the seller is in a distressed situation – for example, if their lender is threatening to take possession – or where the sale or proposed transfer is by someone related to the buyer.
Insolvent seller indemnity insurance is usually available to cover this risk, and it is considered good practice to take out such a policy in addition to the bankruptcy search. The policy will usually cover loss incurred by the buyer (and the lender, if applicable) up to a selected limit of indemnity, as well as the costs of any action that might be taken by the trustee in bankruptcy. It will also cover subsequent owners of the property and mortgage lenders, remaining in force from the date of issue without any time limit.
There are established defences for buyers if they proceed in good faith and for value, without notice of the seller’s insolvency. However, being informed prior to the transfer, and taking protective steps as set out above, is clearly a far better option.
Single or joint proprietors
Another consideration for the conveyancer in an insolvency situation is ensuring that the transfer is executed correctly. If the seller becomes bankrupt prior to completion, different rules apply in relation to execution of the transfer, depending on whether the property is held by the seller as a sole proprietor or whether there are joint proprietors (for example, where the sellers are a husband and wife but the husband has been declared bankrupt). So how can you distinguish between the two?
In the case of a sole proprietor, the bankrupt’s property forms part of their legal estate, and passes to the trustee in bankruptcy. Accordingly, the trustee in bankruptcy must sign the transfer for the title to pass to the buyer. If necessary, the trustee in bankruptcy could be forced to complete the sale, although they would have a right to refuse if the contract were at undervalue. Land Registry will accept a transfer executed by the trustee in bankruptcy, with bankruptcy evidence as set out in paragraph 5.2 of Land Registry practice guide 34, namely:
- the bankruptcy order;
- a certificate signed by the trustee in bankruptcy that the property is part of the bankrupt’s estate; and
- where the trustee in bankruptcy is not the Official Receiver, the certificate of appointment of the trustee in bankruptcy by the meeting of the bankrupt’s creditors.
Trustees in bankruptcy do generally like the bankrupt to also execute the transfer, to prevent any future argument from the bankrupt that the property was sold at less than market value.
If the seller were to sell the property after the bankruptcy petition was presented and without the trustee in bankruptcy being joined as a party, then the sale would likely to be void, unless the court had validated the transaction either before the contract was entered into or after the event, and the buyer entered the contract:
- in good faith;
- for value; and
- without notice of the bankruptcy.
Where there are joint proprietors, while the bankrupt’s beneficial interest in the property passes to the trustee in bankruptcy, the legal title remains vested in both proprietors as co-owners. The bankruptcy will serve to sever the joint tenancy, but the legal interest remains in the bankrupt and the other co-owner/s. Therefore, both proprietors, including the bankrupt, must sign the transfer.
Although not strictly necessary, it is good practice to also require the trustee in bankruptcy to execute the transfer (if they agree to do so), to show that they consent to the transaction. This will also avoid any future argument about the transaction being entered into in good faith.
It will be clear from the above that acting where the seller is insolvent can be a legal minefield, and while the conveyancer is not under a duty to go above and beyond the usual checks (as identified in the Handbook), a diligent solicitor should take all relevant steps to protect themselves from criticism. These steps should be flexible and fact-dependent, to reflect the circumstances as they arise in the transaction. By undertaking appropriate due diligence and evidencing this clearly on the file, exposure to a complaint or professional negligence claim should be minimised.
One of the key points in Kandola was the fact that Mr Kandola was considered to be an experienced and commercially astute client. In such circumstances, the court considered that the level of advice required was different to where a solicitor advises an inexperienced client, or one dealing in matters with which they are not familiar.
It is clear that when an explanation regarding the relevant risk is given, the solicitor should appropriately tailor it to fit their knowledge of the client’s level of understanding. Accordingly, where a solicitor is acting for a commercial client, there is a greater expectation that the client would be astute and would appreciate the risks in property transactions once these were adequately explained to them.
If the client asks for further explanation or appears not to understand, the solicitor might have to go into more detail. However, the solicitor is not a guarantor of the client’s subjective understanding; the solicitor will have fulfilled their duty if they give an explanation in terms the client reasonably appears to them to be able to understand, and to have understood, even if the client later alleges that they did not in fact understand what was said.