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Property Articles

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ARE YOU A COMMERCIAL BUILDING OWNER?
WATCH THAT EARTHQUAKE.

Purchasers of commercial property should always address the cost of insurance and the insurability of buildings before committing to purchase. Without insurance cover you will not be able to uplift mortgage advances which may cause problems if you have settlement obligations to meet. Careful attention needs to be given to a mortgagee's requirements in respect of earthquake insurance. On occasions a building purchaser or owner may be caught between a mortgagee's requirements and the availability of cover.

The Earthquake Commission no longer insures commercial buildings. Insurance cover is available from the Commission only in respect of "Residential dwelling houses" and their contents up to a maximum of $100,000 plus GST in respect of a dwelling house and $20,000 plus GST in respect of contents. Limited cover is also available in respect of land slip and loss of land.

There are potential problems for the owners of commercial properties in respect of their earthquake cover. In most cases cover is now freely available from insurance companies but may be expensive where the site insured is regarded as earthquake prone or the building is in any way sub-standard. In some cases, buildings may not be insurable against earthquake at any price if the site is sensitive enough and the building is sufficiently badly constructed.

Money can be saved with good advice by, for instance, insuring widely scattered buildings on a "first loss basis". If, for instance, a building owner had substantial buildings in Invercargill and Whangarei, it is highly unlikely that the same earthquake would damage both buildings, so rather than pay a premium calculated on the basis of $10,000,000 of cover for two $5,000,000 buildings, it may be possible to insure the buildings simply for $5,000,000 on the basis of one loss and reinstatement. It would not, of course, be prudent in many cases to adopt that robust approach to premium saving in respect of fire insurance.

Based on recent Christchurch experience, in areas where there may be doubt over availability of cover, a prudent business might wish to make a contract to purchase conditional upon arranging satisfactory
insurance cover.

Failure to do so would have cause problems where, after an earthquake, insurers become nervous and refuse to grant cover on a property being purchased because, even though undamaged, it is in an earthquake prone area.

For all commercial and industrial insurance inquiries contact James Young on 04 570 4176 or jayoung@gywlaw.co.nz

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INSURANCE COVER
- SOME PITFALLS FOR MORTGAGEES

Most lenders adopt a cautious and risk averse approach to lending. The cautious lender, when taking security, will regard insurance cover as an important part of their security. There are some traps that have, from time to time, caught the incautious or poorly advised lender.

Lenders, whether their security is by way of mortgage over land, or a charge, or hire purchase arrangement in respect of a motor vehicle, or any other form of security, have an insurable interest in the assets covered by the insurance policy. The trick is to ensure that the lender has access to the insurance in the event of a claim without being placed at risk by the actions of a borrower.

An insurance company can decline claims on the basis of misrepresentation or non-disclosure by an insured party. Unless some elementary precautions are taken, a lender may find that insurance cover is not available in the event of loss. In one quite notorious New Zealand case a lending institution lending considerable sums of money on the security of a very expensive helicopter, found that because the insurance cover had not been properly taken to reflect the lender's interest and the borrower had misrepresented the skill and experience of the available pilot in an insurance proposal, after the helicopter crashed the proceeds of the insurance policy were not available to it.

There are some fairly simple rules to follow.

• Most properly prepared securities provide that insurance is to be taken in the name of the lender and the lender is to be the prime insured party. Get the securities right, and insist on the assertion of the lender's right to be the designated insured.
• Don't ever accept a policy with a lender described as an "other interested party", whatever the insurance company's computer tells you it can or cannot do.
• Make sure the description of insurable interest in the policy follows the requirement of the security documents.
• The optimum provision is to require the insurance to be directly in the name of the lender so that, for instance, the insured in an insurance policy is described as "Frederick Friendly as mortgagee of Ormond Overdrafts".

Some banks and institutions require that insurance stand in the name of "Alligator Consolidated Bank Limited as mortgagee of Modest Enterprises Limited for their respective rights and interests, loss if any payable to the bank whose receipt shall be a full discharge", or something similar. Insurance companies will frequently issue policies in a different form whatever their instructions and may then argue that it is their practice to do it their way. Insist on getting it right and don't take no for an answer.

Many lenders now adopt the practice of entering into what are usually called "Continuous Agreements" with insurance companies to provide for the continuation of cover in the event of non-payment of premiums or misrepresentation for non-disclosure by the borrower. Substantial lenders should always investigate that possibility, or alternatively, arrange their own stand-by and fall-back policies.

Special securities require special insurance. In appropriate cases, ensure that boats have adequate marine insurance cover, aircraft adequate aviation insurance and if you are relying heavily on cash flow from a business to cover your loan, make sure that good quality business interruption insurance is in place. Those are but a few examples of special circumstances that you may need to think about.

Finally, and to summarise, don't forget that when it comes to lending transactions, Murphy's Law frequently operates. The worst may well happen, and that in most cases, it is possible to insure against the consequences of "the worst".

For all insurance law inquiries contact James Young on 04 570 4176 or jayoung@gywlaw.co.nz

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DUE DILIGENCE CONDITIONS
– REVIEWING LEASE DOCUMENTATION

Due diligence is now an accepted and integral part of most commercial property acquisitions. What do we mean by due diligence? It is a relatively modern contractual concept. It reflects a shift that has occurred over time in the manner in which a purchaser in a transaction obtains assurance as to what is being bought.

Historically, there was far greater reliance on a mix of pre-contractual review and vendor warranties. The problem with the historical approach was twofold:

1. there was a limit to how much detailed investigating and expense a purchaser was prepared to incur before they had a vendor contractually committed to a sale. Pre-contract, they were in competition with other prospective purchasers and remained at risk of being beaten to contract;
2. where reliance was placed on warranties, it was dependent upon the vendor’s first being available and worth pursuing and secondly, it was a very costly and time-consuming exercise, often involving litigation. The horse had bolted or cost precluded recovery action as a practical option.

Due diligence conditions evolved as a mechanism for overcoming the problem. It saw a shift in responsibility from vendor to purchaser. Both parties became contractually committed to each other and agreed fundamentals such as price, settlement date and the like based on Tenancy Schedules and general agent representations. With the benefit of a secure contract, purchasers were then able to embark upon as exhaustive and costly an investigation as they wished and on whatever aspects of the purchase concerned them (and for that matter, their financiers).

Where there is a due diligence condition the purchaser essentially takes principal responsibility for satisfying himself as to what is being bought. The vendor's role is limited to full disclosure and, typically, limited warranties. The consequences of not making full disclosure can be significant. In Jones v Black Horse Properties Limited late disclosure of a report on air conditioning left a vendor liability for in excess of $20,000.00 of due diligence costs and a similar level of litigation costs where the content of the report caused the purchaser to walk away.

In any given due diligence investigation, the scope will vary depending on the transaction, the vendor and the purchaser. Matters typically covered by due diligence include:

• Title review – a comprehensive title review is an imperative. This will include reviewing all easements, covenants and other registered interests.
• The building fabric - it is usual to have buildings inspected by someone with competence in the area.
• Building services – air conditioning and elevators in particular can be expensive to repair and replace.
• LIM reports - particularly in relation to compliance with the Building Act. Extant Compliance Certificates, heritage listings, earthquake requirements in particular are of concern. The implications of the Building Act on future development is also an area for enquiry.
• Finance and feasibility having regard to any post-settlement building works that may be required.
• Substance of tenants. Part and parcel of full due diligence is an investigation, not only of the lease documentation, but of the substance of the covenants of the tenants and guarantors. Any purchase involving a lease back to the vendor or related entity requires particular care. It can be part of an exit strategy. Attractive lease terms may distract from what is a failing business.
• Lease documentation.

When you are purchasing a tenanted commercial property, you are acquiring more than land, bricks and mortar. You are also acquiring a bundle of rights, entitlements and obligations that are part and parcel of the leasehold estates that have been formed by the vendor and its predecessors in title with tenants and their assigns.

The legal status of those rights, entitlements and obligations will in large part be determined by the extent and form of the documentation.

Before committing to a contract by confirming a due diligence condition, purchasers understandably wish to be fully informed as to the status of the documentation, the extent to which it is incomplete and the extent to which the rights and obligations they will be assuming on purchase depart from customary or their expectations based on sale promotional material.

Purchasers may not be the only ones interested. On large transactions is it not unknown for financiers to require their own solicitors to review and sign off on the adequacy of documentation. Their approach will inevitably be a more cautious one.

The same matters are, or should be, of equal concern to vendors. If you are putting your tenanted property on the market, you can expect it to be subject to a due diligence condition. The satisfaction of the condition may turn on the level of your property management in relation to lease documentation and the extent to which you have negotiated departures from customary when dealing with tenants. If it comes up short you may lose the contract or come under pressure to revisit price. You may also be asked to cover the cost or to provide indemnities in respect of deficiencies.

There is much to be said for vendors conducting their own due diligence type review of documentation prior to putting a property on the market. By identifying deficiencies and shortfalls, you can then fix them (invariably they will require documents to be signed by tenants) without the pressure of a contract deadline and any opportunistic tenants seeking to take advantage.

When we are instructed to do a due diligence review, we bring our extensive experience of commercial and industrial property to bear on the documentation. We have a detailed 23 point checklist and provide clients with a comprehensive due diligence report. It includes a "flashing light" category of matters fundamental to the decision to proceed with the contract.

Due diligence is a time-consuming and methodical exercise. There is no shortcut and it involves locking yourself away in a room and working your way systematically through the building floor by floor, tenancy by tenancy.

So what does it all cost? A lot or not that much. Depending on the number of tenancies the cost of legal due diligence on lease documentation can be considerable. Cost is usually a function of time and time a function of the volume of documentation to be reviewed and reported on. The cost of not doing it can also vary greatly. If you don't do a thorough due diligence you may find out the cost of not doing it the hard way.

conclusion

Ironically, a due diligence investigation that discloses multiple "flashing lights" is not always necessarily a signal for packing up tent and going home. Properties with poor documentation and other issues usually reflect poor property management. As such they often represent a significant opportunity. In such cases typically rent reviews will have been poorly carried out and rents will be below market potential. There will be a general disorderliness about the property which, once rectified, will be reflected in the increased value of the property. The exercise is more about understanding what is being bought and sold than finding a reason for not proceeding.

For all commercial and industrial property inquiries contact David Butler on 04 570 4172 or dwbutler@gywlaw.co.nz

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