Please release me, let me go
Anyone who has worked in property finance for even a short period of time will have experienced the unhappy discord when negotiating releases. At a point when the finance documents are agreed and the conditions precedent are coagulating, the release mechanics have the potential to frustrate, if not obstruct, the flow of funds.
In some respects releases are a battleground where property lawyers and their finance counterparts clash. Where the understanding of what works from a property perspective may differ to what works from the viewpoint of a finance lawyer. But we shouldn't paint this as a grand conflict across the Law of Property Act divide, there is plenty of scope for finance lawyers to take up arms against each other.
So what are some of the areas of contention?
The Battle of the Forms
A property lawyer, focused on the Land Registration regime may be happy to receive a Form DS1, safe in the knowledge that filing that form (properly completed) will expunge the charge from the title at the Land Registry. However the security may not be limited to the charge over the property. Regardless of its status of registration at the Land Registry, the relevant security may extend to other assets, and it represents a contractual arrangement between the security provider and the creditor that survives, despite the filing of a DS1.
Where the charge is given by a company (or an LLP), the finance lawyer may find similar contentment in filing a form MR04 or MR05 (or their LLP equivalents) at Companies House. However those forms are arguably less effective than the DS1. English company law does not compel a chargor to inform the Registrar that its debt obligations are satisfied, that a charge has been released or that property no longer forms the subject of a charge. The forms are essentially a housekeeping/good governance exercise for the company, ensuring an accurate public record of the extent of its obligations to secured creditors.
Therefore, to ensure security is properly released – whether in whole or in part - and the extent of any residual obligations that might survive the release of certain property, it is always advisable to enter into a contractual agreement to release the security. In most instances this arrangement will be by way of deed because English law stipulates that obligations entered into by way of deed (as with all mortgages and most charges) must also be released by way of deed.
A release in name only
Arguments may arise as to whether, when acting for an outgoing lender (being repaid in full), you should accept language in a deed of release that fully releases the borrower from all of its obligations and liabilities under the finance documents. That is, rather than simply releasing the security or certain obligations under that security, and preserving other rights.
It's basically a commercial point, which is often wrapped up in legal arguments. Borrowers will argue that (i) the outgoing lender is being repaid and should have no residual rights and (ii) it needs to represent to any new lender that it is free from any ongoing or future liabilities.
But in some senses the full, unequivocal release is at odds with other commercial arrangements. That is, when other contracts are fulfilled or come to an end in accordance with their terms, the parties do not typically agree, as a separate obligation, to release the counterparty from all its residual liabilities/obligations (indeed, going back to DS1s, residential mortgage lenders rarely ask for additional deeds of release) . Moreover, a number of provisions in the finance documents are intended to survive, for example indemnities, confidentiality provisions etc. and there may be rights that accrue subsequently (including proceeds that can still be received by a lender after it has been repaid), where the terms that underpin those rights need to survive.
There is an argument that, even in the case of disposals of SPVs (that is, share sales as opposed to asset sales or refinancings), residual claims should more appropriately be dealt with in the sale/purchase agreement by way of warranties.
Insolvency clawback risk remains relevant (e.g. challenges against preferences, transfers at undervalue), and lenders will want to keep hold of their rights against the obligor until such risk has passed – which may be for a not insignificant period of time.
But what is the practical reality of these residual claims and rights that outgoing lenders are so protective of?:
1. An outgoing lender will invariably have to quantify in a redemption statement exactly how much the borrower needs to pay to be released from its obligations, including amounts accruing.
2. Finance documents are typically drafted to work all the while the debt is outstanding or during the commitment period. If the loan has been repaid, meeting the sums set out in a redemption statement (and is not being reborrowed), in practical terms what loss could the lender claim for breach of covenants after such repayment?
3. With some exceptions, a borrower's representations under the loan documents are usually only made on interest payment dates. If the loan has gone, there can't be an IPD, so subsequent claims for misrepresentation are unlikely.
4. Claims under the indemnities may not materialise, for the following reasons:
- "Events of Default": aren't relevant once the debt is repaid.
- Costs and expenses: usually covered in the redemption statement and are separately provided for in a typical deed of release.
- Tax liability: admittedly a risk but only insofar it relates to taxes other than tax charged on the income from the loan.
- Liability derived from holding the secured asset: for example, a 'mortgagee in possession' claim, environmental liability or section 106 liability. Comparatively unlikely in most non-enforcement cases.
- Late payments: usually covered off in the funds flow / redemption and closing mechanism.
- Currency conversion: typically a known quantity and calculated as part of the redemption arrangement.
5. Finally, insolvency clawback risk isn't a matter regulated by the borrower's obligations under the finance documents, so the lender's position is not preserved as such by retaining rights under the finance documents.
Clearly this, rebuttal (such as it is) is not a universal one and each release must be considered on its own merits. Indeed in portfolio transactions, for example, a smaller lender or a branch may be more resistant to a full deed of release. In such circumstances the parties may need to take a view about, for example, the relative size of that security compared to the portfolio and the risk in any residual liability. Furthermore, experience suggests lenders may be happier to agree a full release where there is an SPV share sale, so that the entity can be sold "clean".
In the case of a refinancing, arguably the incoming funder should bear the risk of any subsequent liabilities arising as a function of their due diligence on the borrower. Finally, the outgoing lender would only ever have an unsecured claim, which would rank behind the new funder's claim (assuming it is secured).
Funds flows and escrows
There is an inherent conundrum in the provision of releases by outgoing secured creditors. One metaphor for this is the monkey syndrome: the lender won't let go of one branch, until it has a hold of the next. That is, it will only release property from its security once the debtor has paid it the money secured by that security. Where the debtor can only pay the outgoing lender once it is funded by a third party (new lender or proceeds of sale), the party providing the funds won't do so until either it has clear title to the property or security over the property.
Solutions to this issue are usually built around a series of solicitors' undertakings and funds flow agreements, setting out the steps in which monies are paid in and out of accounts and documents dated and released to various parties. In some instances these may be enveloped in formal escrow arrangements. These mechanics can be complicated and require some thought from a legal as well as an operational/logistical perspective, particularly in cross-border transactions. They should be considered at an early stage in the transaction as the fraught final stages of completion are rarely conducive to the negotiation of such arrangements.
Alternatively and less commonly used, some deeds of release will contain an "effective date" concept, which will clearly set out the circumstances in which the release will be deemed to have taken place (e.g. the confirmation from the outgoing lender of the receipt of the redemption monies, in cleared funds). This allows the outgoing lender to provide the signed and dated deed of release ahead of completion.
It is inevitable that skirmishes over release provisions will continue to be a feature of property finance transactions however, as with all aspects of transactional finance law, being prepared, pragmatic and commercial should mean that all parties will be able to claim the victory.