Buying a Real Estate Company
Tue 29 Sep 2015
In a standard real estate transaction, a buyer will normally commence the acquisition process by raising enquiries in relation to the property it intends to purchase, usually in the form of the Commercial Property Standard Enquiries (“CPSE”). Depending on whether the buyer is satisfied with the replies, it will then enter into documentation to facilitate the transfer of the title to the property. This article examines the situation where title to a property is held by a company and a buyer is considering purchasing the shares in that company, rather than the property directly. It will look at the key additional factors that a buyer needs to be aware of and some of the questions it will need to ask. A significant factor, as set out below, will be the need to mitigate from the outset the potential tax disadvantages that can otherwise arise for a buyer.
At completion of a share acquisition, the buyer will own the real estate company as a whole – that is, all its assets (including the property) but also, importantly, all its liabilities and obligations. Accordingly, the enquiries it will need to make, whilst including the CPSEs, will need to cover a significantly broader spectrum – this information gathering process is referred to as due diligence. Legal due diligence takes the form of a questionnaire submitted by the buyer’s solicitors to the seller. It will cover the entire spectrum of operations of a company, however, in a real estate company, these are likely (in addition to the property) to focus on corporate matters and share capital, accounts, contracts and trading, other assets, litigation and disputes, employees and pensions, environmental issues and, importantly, tax.
Title to the shares will, of course, need to be confirmed as this constitutes the transferrable asset in the context of a share acquisition, and the buyer will also need to be satisfied that there are no trusts or other encumbrances affecting the shares it is proposing to acquire.
Nevertheless, a buyer’s key concern will be to ascertain the real estate company’s tax position. Although there may be some SDLT and VAT savings in buying the shares of a real estate company instead of making a direct purchase of the property, such a purchase can trigger significant tax disadvantages for a buyer. This is because, by buying the shares of a company, the consideration paid will be attributed to the shares in the buyer’s hands (for tax valuation purposes) but, in this case, the buyer will inherit the historic base cost of the property (i.e. the company’s original base cost in acquiring the property, which may be lower than the purchase price of the shares). From very early on in the transaction, the buyer needs to carry out the analysis to ascertain the potential tax implications which will then inform the price it is willing to pay for the company’s shares and flow through to the Heads of Terms.
Specifically, the differential between the acquisition cost of the shares and the company’s acquisition cost of the property may give rise to a ‘latent tax charge’ in the hands of the buyer (again, where the base cost of the property is less than the purchase price of the shares). This is because any subsequent disposal of the property will give rise to a higher tax charge (by virtue of the ‘latent tax charge’) than would have been the case had the buyer originally made a direct purchase of the property. Both property development businesses and property investment businesses should be clear as to the fiscal consequences attached to the ‘latent tax charge’, and seek professional assistance in quantifying this as at the date of the proposed acquisition and negotiate a reduced purchase price accordingly.
In addition to the share capital and tax, the buyer will also be concerned with any other aspects of the findings of the due diligence that could affect the valuation of the company. Normally, in a real estate company, the value of the shares broadly corresponds to the value of the property. However, this can very easily be eroded if, for instance, the company is facing potential litigation. In addition, the buyer would want to ensure that the real estate company does not have other liabilities, such as in relation to employment and pensions (this should not be the case as the company will usually have been formed specifically to hold the particular property, however, on the occasions where it is the case, the buyer needs to be aware).
Share Purchase Agreement
The acquisition of the shares will be governed by a Share Purchase Agreement and the findings of the legal due diligence will feed into the inclusion of specific warranties to be given by the seller to the buyer as to the state of the company. While the quality of responses to the due diligence questions are dependent on the seller’s willingness to provide the information, the warranties will constitute contractually binding statements which, if untrue, can lead to liabilities on the seller for breach of contract. Therefore, this normally results in a disclosure letter being prepared by the seller setting out any facts that would otherwise make the warranties untrue.
Where there is a clearly identifiable risk, a buyer will usually also seek the protection afforded by an indemnity given by the seller. An indemnity is a specific obligation on the part of the seller to provide monetary compensation for a loss or damage incurred by the buyer post-acquisition in relation to the matter covered by the scope of the indemnity. It is commonly used in relation to potential tax liabilities of the company up to the date of transfer and it is market practice to obtain indemnity protection in respect of pre-completion liabilities (including any outstanding tax liabilities).
A common negotiation point is the level of the limitation of a seller’s liability to the buyer. While a buyer will wish to achieve a high limit, for example, at least the purchase price, a seller
(especially where the real estate company just holds the property) will seek to argue that the acquisition of shares is not too dissimilar in terms of risk to buying the property directly. Accordingly, it will seek a lower limit. The circumstances of the particular deal will determine the eventual level.
Otherwise, the Share Purchase Agreement sets out any other agreed commercial terms of the deal, the mechanics of the transfer and the purchase price (including when and how this is paid), together with any restrictions on the parties.
Unlike where property is acquired directly, completion of the acquisition of shares in a real estate company does not involve any registration requirements with the land registry. Rather, it involves the registration of the buyer in the company’s books as the new shareholder, the issuance of a new share certificate and the resignation of the incumbent officers of the company and the appointment of new ones, together with the consequential filings at Companies House.