MacRoberts e-update 27/08/08

Housebuilders may be PRICELESS BUT should never LACK INTEREST

Maybe some of the remoter tribespeople of Papua New Guinea are blissfully
unaware of the credit crunch, but for the rest of us it’s a stark reality, and nowhere
has the pinch been felt more than in the housing sector. Lenders are reluctant to lend
so borrowers are struggling to borrow. Houses are up for sale but supply is
outstripping demand. Developers of new houses are struggling to find buyers, in part
because buyers are struggling to sell old houses.

If a housebuilder concludes missives with a purchaser who then struggles to raise
the wherewithal to pay the price, what are the options open to the housebuilder?
Most housebuilders will contract with purchasers on the basis of "builder's missives",
a form of purchase contract which, it is fair to say, has traditionally been weighted in
favour of the housebuilder. One feature of builder's missives which does not appear
regularly in private sales is the deposit on the price, and perhaps in addition a
reservation fee which the purchaser will pay to the builder to secure a period of
exclusivity. If payable, these tend to be non-refundable in the event that the sale
does not proceed, unless the failure is on the part of the housebuilder. So reservation
fees and deposits can act as a significant incentive to purchasers to proceed to
completion. And if the purchaser does not pay the price, at least the builder has
some measure of compensation it can recover without any additional effort.
Penalty interest on late payment is a common feature of all missives. Properly
drafted, penalty interest clauses can act both as an incentive to complete and, if
necessary, an effective, if only partial and temporary, compensation mechanism for
sellers.

Some care needs to be taken with penalty interest clauses. In order to allow for a
claim of penalty interest, there has to be a discernable point at which the debt of
interest crystallises and can be calculated. The adequacy of the penalty interest
clause which used to be favoured by almost all conveyancing lawyers in Scotland
was called into question in a case in 2006. Since that case, all lawyers acting for
sellers should be making sure that penalty interest clauses are drafted to allow
penalty interest to be claimed. In a market where there is a greater risk of defaulting
purchasers who will be keen not to pay penalty interest, housebuilders do not want to
be giving them grounds not to do so.

A seller cannot rely on penalty interest forever, though. In order to mitigate their loss
they should actively seek to resell the property. That means bringing the missives to
an end. Termination of the missives also means terminating the contractual right to
claim interest on late payment. However, competently drafted missives will allow the
builder to claim, as damages, any shortfall between the resale price and the original
sale price, plus any other competent heads of damages. That should include a sum
to account for the interest which would have been payable but for the termination.
Whether or not it is good PR for a housebuilder to sue for damages is another
question.

Other than keeping the reservation fee and deposit, none of the available options are
that attractive to a builder. Each involves some element of administration, and in
most cases further expense, e.g. raising a court action for damages. Nonetheless,
they are options, and must be reserved to, and considered by, a housebuilder if they
want to ride out the storm.

If you require any further information please contact Frances Sim on 0131 229
5046

© MacRoberts LLP 2008