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Minimising liability to lenders in property transactions

Many different legal structures can be used when buying commercial property, whether to gain tax advantages or shield investors from individual liability. In the property sector, these are known as 'wrappers'.

Minimising liability to the bank, and others, is an important element in the range of factors which can influence the borrower's decision on the type of wrapper to use. For more information about the type of structures available and the advantages and disadvantages of each, see our separate Out-Law Guide to property joint venture vehicles.

Shielding liability

Well-advised borrowers will look to ring-fence their liability to repay debt to lenders. The best way to protect against individual liability is to set up a new company (NewCo) to borrow the money. NewCo could take the form of a limited liability company, a limited liability partnership or a limited partnership, providing certain safeguards are followed to shield the partners from individual liability for the company's debts.

In the recent past, lenders faced with a rising market and intense competition often had to accept that their borrower would be a NewCo. This would mean that in the event of default the lender would only have recourse to the property (and rent) owned by the NewCo, and not the assets of the individual investors standing behind it.

Being unable to pursue the investors for debt was never satisfactory but as the market became more difficult, borrowers were able to insist on this. Some lenders were more willing to accept this risk as the price of doing business, without reflecting that risk in their pricing.

Many lenders have come to regret this decision. As values have collapsed, the lender's only recourse to cure breaches of the loan agreement has been to a wrapper whose sole asset is the devalued property where the income generated is either at risk or has disappeared as tenants struggle to make payments. Often all of the initial equity in the property is gone and the value is now significantly less than the original debt. In this situation, the investors standing behind the NewCo might very well have no contractual liability to the lender.

Going forward

As the market drove one set of behaviours and decisions before, the decrease in individual investors' borrowing power drives a different set of behaviours and decisions now. Borrowers need to invest more of their own money as they will be unlikely to convince the bank to lend up to the full value of the property.

Borrowers are also much less likely to convince a bank to lend money to a NewCo. High net worth individuals and private property companies in particular now have to accept that banks will not provide funding without their customers accepting that, to generate the profits they want, they must take on a much more significant and appropriate share of the risk than they have done.

Some borrowers see and accept this new reality. Others say that the banks are frightened of risk. However, the changing market has given banks more control over their lending arrangements.