Property and Banking & Finance Newsletter - Edition 1: October 2007

First Rights of Refusal and Options to Purchase…

Who has the Right to Buy?

A landlord may grant a tenant either an Option to Purchase or a First Right of Refusal (also known as a pre-emption right). However, depending on the nature of the right granted by the landlord, either party may be exposing themselves to commercial risks. This article examines the distinction between these rights and the pitfalls and benefits .

The Distinction
The distinction between an Option to Purchase and a First Right of Refusal centres on who decides whether the property is to be sold. The person receiving the benefit of the right that is granted is known as the grantee and may receive the right as a tenant under the terms of a lease, or under a separate agreement.

In this scenario, the tenant is the grantee of the right and also the prospective purchaser while the landlord is the grantor of the right and the prospective vendor.

Option to Purchase
The grant of an Option to Purchase means that the grantee/tenant has the right to exercise the option and trigger the sale of the property on the terms agreed. The tenant can effectively force the landlord (subject to the pre-conditions being satisfied) to sell the property to them.

Once a grantee/tenant validly exercises the option (eg. where all conditions are satisfied within applicable time limits), this constitutes a binding contract of sale between the landlord and the tenant. The relationship between them also becomes one of vendor and purchaser, just like under any contract for the sale of land.

Important matters to consider before entering into an option agreement are:

• An option often contains specified pre-conditions which must be observed strictly.
  A failure on the part of a grantee/tenant to adhere to the conditions may result in the loss of the right.
  
  
• Grantees are often caught out if they fail to exercise the option within the specified time. This leads to a loss of the option, and the grantee must then attempt to re-negotiate the purchase, possibly for a higher purchase price. The exercise date for any option should be noted carefully in a diary.
  
  
• The terms of an option (including the terms of the sale contract of the property) must be certain. If there is uncertainty about the terms on which the property is offered for sale, the option may be unenforceable. For this reason, it is recommended that a copy of the proposed contract of sale should be attached to the option.

First Right of Refusal (pre-emption right)
Under the terms of a First Right of Refusal, it is the grantor/landlord who will determine whether (and on what terms) the property is to be sold. There is no obligation on the grantor to sell the land and the grantee/tenant does not have the right to trigger the sale of the property. The grantee merely has the opportunity, in priority to others, to accept an offer to purchase the property on the terms specified, when and if the grantor decides to sell. Only when the grantee exercises their right to refuse to buy the property, or if the right is not validly exercised, can the grantor sell the property to others.

Important considerations of entering into an option agreement:

• It is common practice to require that, where the grantee does not accept the offer to purchase the property, a sale to another buyer must be on no less favourable terms than the offer made to the grantee.
  
  
• A first right of refusal that does not specify the terms upon which the grantee of the right may purchase the property may be void for uncertainty.

Enforceability of the right
The most important legal consequence of this distinction is that a first right of refusal does not create any interest in the land, whereas an option to purchase does.

A right of pre-emption can only be enforced through the contract (such as a lease or tenancy agreement) in which it is granted.

In contrast, an option to purchase, giving an interest in the land, affords greater protection and enforceability for the grantee, as the grantee can not only enforce the option under the contract or agreement, but it also has a right to lodge a caveat at the Land Titles Office on the property the subject of the option to protect their interest in the land.

In summary

• It is important for a grantor/landlord to understand the nature of the right they intend to grant to a tenant and to ensure that the terms upon which the option or the right may be exercised are sufficiently certain.
  
  
• For the grantee/tenant, it is important to ensure that all of the pre-conditions for exercise of the option or the right of pre-emption are satisfied, as well as the time limits for exercising them.
  
  
• From the point of view of a tenant, an Option to Purchase is the preferred legal right because it gives the tenant the ability to oblige the landlord to sell the property to the tenant and pending exercise of that right gives a caveatable interest in the property.
  
  
• From the point of view of a landlord, a First Right of Refusal is the preferred legal right to grant because it provides flexibility to the landlord in determining the timing and conditions of the sale.
  
  

For further information, please contact Dean Katsavos on +61 3 9608 2130 or d.katsavos@cornwalls.com.au or Michael Gough on +61 3 9608 2232 or m.gough@cornwalls.com.au

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Borrowers will be better protected against unjust and exploitative lending practices if amendments are passed to the Uniform Consumer Credit Code (Code) through the Consumer Credit Code Amendment Bill 2007 (Qld). While the amendments have been introduced through a Queensland Bill, as a result of enabling legislation, the Code and any amendments to it have force in all Australian states and territories.

The aim of the proposed legislation is to ensure fringe lenders are more widely covered under the Code, but these changes may also have an impact on mainstream lenders. The changes are likely to be more onerous on lenders, but will ensure better protection for consumers through several mechanisms including:

1 Exemption from the Code – Short term loans
Currently, section 7 of the Code provides that lenders of short term credit are not subject to the Code where the maximum amount of fees and charges do not exceed five percent of the amount of credit.

However, a new section 7(1A) would require the calculation of the five percent to include fees paid to the lender or anyone else including brokers, irrespective of whether or not they are payable under the contract. This amendment will not apply to authorised deposit taking institutions.

2 Disclosure of annual interest rate
The proposed amendment on interest rates requires disclosure of an annual percentage rate including charges which are in the nature of interest charges, even if not portrayed as such by the lender.

However, it should be noted that while ‘in the nature of interest charges’ has not been defined, potentially it may affect all lenders.

3 Prohibited Securities
This amendment would prohibit the taking of security over essential household property. The definition of such property would mirror the description under the Bankruptcy Act 1966 (Cth) for non division among creditors. The amendments also grant the power to prescribe other property as essential household property. Mortgages would, however, be able to be taken over antiques.

4 Business Purpose Declarations
Credit providers currently fall outside the ambit of the Code through a Business Purpose Declaration.

However, under the proposed amendment, such special evidentiary status would be removed and lenders will have to show that they have taken active steps to ascertain, and have ascertained, that the consumer’s purpose for seeking the loan is for business or investment purposes. This proposed amendment will affect all lenders.

5 Unreasonable charges
Currently, the court has power to review transactions containing “unconscionable” charges. The proposed amendment will provide the court with power to review “unreasonable” fees and charges.

The provision will set out when a fee is unreasonable, which will depend on whether it exceeds the lender’s loss or costs, depending on the fee. The following fees and charges will be subject to court review for unreasonableness:

• Interest rate changes
  
• Change in manner in which interest is calculated or applied
  
• Establishment fees
  
• Early termination charges
  
• Prepayment charges
  
• Default fees
  
• Any other credit fees or charges
  
• Combination of the annual percentage rate and any credit fees or charges.

Furthermore, the proposed addition of section 72A will allow applications for review by the court to be brought by the Government Consumer Agency to represent the public interest, a particular borrower or a group of borrowers over unreasonable fees and charges.

For further information, please contact Carolyn Falcone on +61 3 9608 2252 or c.falcone@cornwalls.com.au, Jessica Huberman on +61 3 9608 2277 or j.huberman@cornwalls.com.au

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The failure to advertise a sale or not to advertise it adequately are amongst the most common grounds for complaints and litigation in mortgagee sales. This is because before any auction advertising is the most visible and probably the best documented conduct of a mortgagee.

Recent Decision – Failure to Advertise
Whether or not advertising has been adequate will be judged after an examination of all the relevant circumstances. A recent appeal before the Supreme Court of Victoria in the matter of Vasiliou v Westpac Banking Corporation 2007 VSCA133 dealt with a number of issues including whether a mortgagee sale can take place by private treaty without any advertising. In that case Westpac Bank elected to sell the security property to a tenant who was in occupation of the security, and who had made an offer to purchase the property for $400,000.00. Valuations obtained by the bank valued the property in the range of $320,000.00 to $390,000.00.

On the basis of the sworn valuations obtained the bank accepted the tenant’s offer to purchase the property without an auction and without any advertising.

The sale by the bank was subsequently challenged by the mortgagor on a number of grounds including allegations that there had been a failure to act in good faith and corruption. As part of its finding the court provided the following summary of its findings on the adequacy of the advertising.

"Whether advertising is required in such a case depends on the circumstances.

The mortgagee is obliged to obtain the best price consistent with its entitlement to realise its security.

Whether advertising is a necessary step in the securing of that price will vary from case to case. By itself, the presence, or absence of advertising will rarely be decisive. What matters is the price obtained. If the price is satisfactory, a failure to advertise will be immaterial.

Conversely, if the price is unsatisfactory, as a result of the mortgagee’s acts or omissions, the fact that the property was advertised would be unlikely to be an answer to an allegation that the duty under s77(1) had been breached."

The court found that in the case of Vasiliou the price was satisfactory and therefore the failure to advertise was immaterial.

The Australian Banking Industry Ombudsman has provided practical guidance to mortgagees on advertising in a Mortgagee Sale Bulletin No.38 which is freely available at its web site www.bfso.org.au.

The bulletin provides guidance on what the Ombudsman considers to be good practice on a mortgagee’s obligation to advertise and the adequacy of such advertising.

Obligation to Advertise
In the bulletin the Ombudsman states that whether there is sufficient advertising will be determined after considering the circumstances of any particular sale, the type of property and the normal practice for the locality of that type of property. It is important that mortgagees document and keep careful records of the advertising campaign because the Ombudsman can have reference to:

• any marketing proposals obtained by the mortgagee;
  
  
• the actual advertising itself;
  
  
• comments contained in valuations and/or marketing appraisals where they have advised how to advertise, to whom and for how long;
  
  
• the mortgagee’s policies and procedures on sales.

Furthermore, case law provides that a mortgagee should be extremely careful in monitoring the advertising of properties particularly in checking the description in advertisements. While it is mandatory for the description of the security to be accurate it is also critically important that the mortgagee disclose every facet of the security property which could improve its sale value. For example, this will include any planning or building permits which can be sold with the land and which should be brought to the attention of a potential purchaser.

Interestingly, the Ombudsman states that, “a failure to advertise in what may be regarded as an adequate manner will not always mean there has been a breach - provided of course that we are satisfied that the price obtained reflected the correct market value. Ascertaining the value of the property will be a crucial part of this assessment.”…

Practical Recommendations
To reduce the risk of a mortgagee sale being challenged it is recommended a prudent mortgagee should:

• Proceed with a sale by way of a public auction properly advertised.
  
  
• Select a reputable agent who is experienced with that type of security and locality.
  
  
• Ensure form and content of the advertising are reviewed carefully by the mortgagee rather than allow the agent to have the sole and complete control of this part of the sale process.
  
  
• If proceeding by way of auction obtain at least one sworn valuation as well as at least two marketing appraisals.
  
  
• If a property is to be sold by private treaty, it is recommended at least two sworn valuations be obtained to support a mortgagee’s decision to sell without going to auction.
  
  
• While the most recent Supreme Court of Victoria authority confirms that it is possible to proceed with a mortgagee sale by private treaty and without advertising this is generally not recommended except in exceptional circumstances because this course of conduct is prone to challenge.

For further information, please contact Gino Potenza on +61 3 9608 2270 or g.potenza@cornwalls.com.au