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The use of the ‘Subject to Contract’ formula

publication date: Oct 18, 2007
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Many agents will be familiar with the phrase ‘subject to contract’ or some similar formulation as a method of avoiding accidentally making a representation to the tenant which was not intended. This way any offer made is subject to its incorporation in the final lease agreement. However, there some other consequences of the use of this phrase which are not so favourable and it may not always be the best course of action.

First it is worth examining precisely what the Courts understand the situation to be when the ‘subject to contract formula is used. The Courts construe the formula in accordance with the conveyancers understanding of the phrase. This is that a negotiation for a conveyance of land which is expressed to be ‘subject to contract’ is not complete until there is an exchange of contracts. There is an entire set of procedures for such exchange which are set out and agreed between solicitors. It is this position that allows for such situations as ‘gazumping’ where the seller suddenly pulls out of a deal because they have had a higher offer.

In the case of Salomon v Akiens, the Court of Appeal had to consider whether this formulation should also be applied to a lease agreement. The Court was clear that there was practically no circumstances in which a negotiation for a lease should be seen as any different from that for a sale and therefore the ‘subject to contract’ formula should apply equally to both.

Practical Consequences

What does this mean in practice? In the case of Longman v Viscount Chelsea the Court made clear that this means that the “relationship does not become binding … until there is an exchange of lease and counterpart, before which either party can withdraw”. In other words, until both the landlord and tenant have signed the agreement, the agreement has been executed, and the signed agreement has been passed to the other side then either party is free to withdraw.

Ending the Formula

Of course, there are other ways in which the ‘subject to contract’ formula can be dealt with. The parties could agree that the formula should no longer apply which is a common device in commercial or high-value leases where the parties will enter into an agreement to make an agreement. Alternatively, the parties can perform an action which sets the formula to one side. The most obvious of these is provision of the keys and the acceptance of rent and deposit payments. The formula comes into force once either party expresses an offer or acceptance of an offer as being ‘subject to contract’ and will remain in force even if following correspondence does not bear the same formulation until it is specifically brought to an end as described above.

Recovery of Expenses

The use of the formula also has implications for the recovery of costs and expenses. Where a party expends monies on the basis of an agreement which is subject to the formula it will be very hard to recover any monies expended on the basis of that agreement. As the High Court made clear in Regalian Properties v London Dockland Development Corpn each party must accept that any monies spent are a calculated risk and there will be no recompense if no contract results. This is not to say that agents cannot take steps to ameliorate this risk and a welldrawn up holding deposit agreement is a great help in this regard. Despite the fact that costs cannot be recovered in respect of actions taken under a belief that a contract that is subject to the formula was to be entered into there is no reason why a separate agreement taking a holding deposit from an applicant cannot be enforced.

Such an agreement would typically cover the costs of referencing, preparing the agreement and would therefore protect the landlord from incurring agents costs with no prospect of recovering them. Such an agreement has the added benefit of ensuring that the agent will be paid for their time as well!

Other Formulas

There are other, more limited, formulas of a similar nature which may also be of value. The most commonly seen of these is probably ‘subject to references’ or some such phrase. This will have an effect similar to the ‘subject to contract’ formula but will be more limited and will effectively expire once satisfactory references have been received or the parties make clear that they have moved beyond that stage. By choosing to ignore them and agreeing a finalised contract, for example. The exact point at which these more limited formulas cease to be effective is not as certain due to the lack of Court decisions on the topic. In each case it will have to be decided at what point it was intended that the formula should come to an end and whether actions were taken to make it clear that it should no longer be effective.

Practice Points

Agents should consider in every case what is best for their client. In higher value properties where the landlord is unlikely to wish to pull out of the deal unexpectedly it may be best to avoid use of the ‘subject to contract’ formula to ensure that the tenant is tied into the contract as early as possible. In other circumstances, where the landlord is uncertain of the tenant or may want to pull out of the deal it may be wise to use the formula in order to preserve the landlord’s position.

Alternatively, it might be best to start negotiations ‘subject to contract’ but then agree at a later stage that the deal is finalised and that the formula should no longer apply, although this may be difficult where a deal is moving fast. As always, agents should take great care in the representations they make and how they are made to avoid invoking or rescinding the formula unintentionally.

Points to note

● Once the Subject to Contract formula has been invoked it will stay in force until it is specifically rescinded or the lease or tenancy has been signed and exchanged.
● Either party can withdraw from the contract without penalty while the formula is in force.
● Agents holding deposit agreements are not affected and therefore recovery can be made from this for expenses such as referencing etc.
● The formula should not be used automatically in every case and should be tailored to the specific requirements of each letting.
● Make sure you have a solid holding deposit agreement setting out what charges the tenant is liable to pay.

Dr David Smith is a trainee solicitor with PainSmith Solicitors, a niche practice specialising in residential landlord and tenant law. He can be contacted on 01420 565310 or by email at david@painsmith.co.uk

Landlords warned following disability discrimination case

A recent Court of Appeal judgement has dramatically extended the reach of legislation aimed at preventing disability discrimination, law firm Browne Jacobson warns.

Property litigation lawyer, Sarah Freeston points out ‘the case deals with the conflict between a landlord’s absolute rights and the rights of people with disabilities and the decision appears to indicate that in conflicting circumstances landlords will need to be prepared to make special allowances for any tenants with disabilities. Importantly, the implications are not just related to residential tenancies but could also affect commercial landlords as well.’ In the case itself, Mr Malcolm was a secure tenant of a flat owned by Lewisham Borough Council and as such had a statutory right to buy the flat from the Council. Shortly before completing the purchase, Mr Malcolm sublet the flat breaching one of the tenant’s covenants and losing his status as a secure tenant and with it the statutory right to buy.

As a result the Council refused to complete on the purchase and instead gave Mr Malcolm valid notice to quit. Mr Malcolm refused to vacate and the Council issued proceedings for possession. This should have been a fairly routine case but it was compounded by the fact that Mr Malcolm had long been diagnosed as schizophrenic. As a result of failing to take his medicine, he had become psychotic for a period and it was during this period that he sub-let the flat. Mr Malcolm defended the possession proceedings by relying on the Disability Discrimination Act 1995 that states that “it is unlawful for a person managing any premises to discriminate against a disabled person occupying those premises… by evicting the disabled person, or subjecting him to any other detriment”.

Under the terms of that Act, a disabled person is defined as a person having ‘a physical or mental impairment which has a substantial and long term effect on his ability to carry out normal day-to-day activities’ The Court of Appeal’s decision was that granting a possession order would constitute discrimination against Mr Malcolm and therefore be unlawful as Mr Malcolm’s decision to sublet did relate to his disability even though they held it did not need to be the cause of it. As a result, effectively possession could not be obtained unless Mr Malcolm provided other grounds for obtaining possession of his flat unrelated to his disability.

The Court of Appeal highlighted that the fact that the Council did not know about Mr Malcolm’s schizophrenia was irrelevant and in fact, suggested that in a case such as this a local authority was under obligation to make enquiries as to whether the subletting was related to any disability, it being a breach of covenant with such serious consequences.

As Sarah continues ‘Landlords need to be careful how they interpret this decision as the answer is not of course to avoid letting premises to people who are protected by the Act as that itself would be unlawful. In addition to inhibiting landlords’ rights, disability discrimination in cases such as these may lead to an award of compensation to the victim of discrimination which may prove even more costly for landlords.’