Clarifying the classic letter of obligation

by Committee Conveyancing

Conveyancing Committee answers some common queries from practitioners

The Journal, April 2003, page 26

The Letter of Obligation was introduced into the conveyancing system by lawyers to meet a problem. That problem is twofold. First, there is always a gap between settlement and registration. Unless a settlement takes place at Register House there will always be at least a few days between delivery of a Disposition and its registration. Second, the Search Sheet is out of date. Even with the computerised presentment book, an up to date picture cannot always be achieved. The position on the Land Register is better but there can always be a last minute presentment which could be missed.

Reasoning

The idea behind the Letter of Obligation is that the solicitor guarantees that during that gap period, nothing will be done which would prejudice the transaction to hand. This guarantee is, of course, backed up by the master policy.

Without such a letter, the alternative was to have a settlement at Register House to examine the up to date picture on the title and immediately to record the Disposition in the knowledge that there was no competing title.

Further Obligations

Over the years, two further undertakings have appeared in a Letter of Obligation. First, there was an obligation to deliver the discharge of the Standard Security. The second was an obligation to deliver a receipt for the redemption of Feu Duty.

Other undertakings have crept into such letters such as the delivery of a building warrant, completion certificate or other items. Claims would often arise in these other cases mainly because implementation of the obligation was not within the control of the solicitor who granted it.

The classic Letter of Obligation

As a result of the number of claims in relation to these other obligations, the classic Letter of Obligation was formulated by the Conveyancing Committee of the Law Society of Scotland. Such a classic letter simply related to the traditional matters – the gap period in relation to title and, where funds were available, the obligation to deliver a Discharge and to deliver a Feu Duty Redemption Receipt.

The important thing about a classic Letter of Obligation is that if there is a claim on the master policy arising from it, there is no form of excess or loading. It is completely free of that type of penalty.

However for this to operate certain other conditions must be complied with:

(a) a search must have been carried out immediately prior to the date of entry, (including, in Sasine cases, a search in the Computerised Presentment Book). Paragraph 5.10.1 of the CML Handbook provides that the search must be no more than 3 days old.

(b) proper enquiry is made of the client regarding outstanding securities;

(c)the solicitor is unaware of any other security; and

(d) the solicitor has sufficient funds to pay the loans and the redemption of feu duty as the case may be.

If these conditions have been complied with then the Letter of Obligation is a classic one and in the event that there is a claim on it, there is no penalty, excess or loading under the master policy.

The failed classic

On the other hand if these conditions are not complied with, the Letter of Obligation is called a failed classic and the normal excess applies. It is “classic” because it contains the classic items but it is “failed” because these conditions (the search or enquiry) has not been carried out or the funds are not available.

The non classic

Where however the obligation contains other obligations particularly where the solicitor has no control of the situation, it is called a non classic. In such a case where a claim is made, there will be a double deductible – that is double the normal excess will be applied to it.

The grant of a Letter of Obligation where the matter is not within the solicitor’s control, however, should never be given at all. Obtaining a Building Warrant or a Completion Certificate are not normally matters within the solicitor’s control and solicitors should not undertake to supply them.

Letters of Obligation where missives are silent

Some people ask whether or not there is a legal obligation on a solicitor to give a Letter of Obligation at all. Obviously if one looks strictly in theory, if the missives are silent then there is no obligation to give one. However, while there may be no legal obligation on a solicitor always to grant a Letter of Obligation, there is a professional duty to give a classic Letter of Obligation unless the solicitor acting advises “at the earliest possible opportunity” that one will not be given.

This expression (“at the earliest possible opportunity”) does not have a particular meaning, but it is interpreted as being before conclusion of missives. This is because if a purchaser’s solicitor finds out before conclusion of missives that no Letter of Obligation will be given he or she can advise the client who can make an informed decision whether or not to enter into the missive. Indeed at that point he or she could be in a position to contract for a Register House settlement as part of the missives.

In some cases there is however no obligation at all to give a Letter of Obligation. This most commonly occurs in relation to a gift. Where someone conveys their property as a gift to another person then the grantee takes it “warts and all” and is simply obtaining what was within the ownership of the grantor of the gift and to the extent that the grantor had power to grant it.

Contracting out

In some cases, the missives specifically provide that no Letter of Obligation will be given. This is most commonly found in articles of roup where you take the title as you find it anyway. It might seem rather odd not to give a classic obligation in such circumstances since provided the Letter of Obligation is a classic one, it attracts no excess nor loading under the Master Policy. However for a classic Letter of Obligation to work there needs to be a search and in a roup situation it may be contracted that no search is given. Where it is agreed in advance that there is to be no search then it is probably not appropriate to give a Letter of Obligation. In such a case there is a clear notice in advance and the purchaser can take an informed view

Charges Register

In a commercial transaction, the Letter of Obligation may contain a provision to show a clear search in the Register of Charges and Companies File, but there is no obligation on a solicitor to give a personal obligation in that regard. Such an obligation in relation to the Charges Register should only be given on behalf of the client.

Breach of the obligation

A Letter of Obligation is a contract between the seller’s solicitor and the purchaser – not to the purchaser’s solicitor, and so the remedy for breach of such a letter is for the purchaser to sue the selling solicitor. If the obligation given by the solicitor mirrors an obligation in the missives, then the seller and the solicitor are jointly and severally bound.

Prescription

If a Letter of Obligation is an obligation in relation to land, then it has a twenty year prescriptive period, but if it is not, then it has only a five year prescriptive period. Gretton & Reid in their Book of Conveyancing are of the view that the obligation to deliver a clear search is an obligation in relation to the land and therefore has a twenty year prescriptive period (page 145). However, Johnston in his Books of Prescription and Limitation (also at page 145) thinks this is a more doubtful position and, following his logic, one could possibly argue a five year prescriptive period. The prescriptive period does not begin to run until the breach. However that is likely to be quite soon after its receipt since it covers only the gap period.

Specific Queries

Occasionally the Law Society of Scotland is asked for guidance by practitioners on specific aspects of Letters of Obligations and recent queries have included the following:

Period of Obligation

There are often comments on the length of time taken by Stamp Office and the Keeper to process deeds. The Stamp Office undertake to “turn around” deeds within five working days. That will not change in the near future. The Keeper is bound to issue a title number “forthwith”. Holiday periods can delay this. As a result the master policy insurers have agreed to extend the period of cover for a Letter of Obligation from fourteen to twenty one days.

Although practitioners must still take all steps to stamp and register deeds at the earliest possible opportunity, this additional period allows a bit of flexibility, for example, over a Christmas period. If the “gap” period within a Letter of Obligation is twenty one days then the period for the charges search (which is the client’s obligation) should probably be extended also.

Matrimonial Transfer and Adults with Incapacity

Until recently there was a feeling in some parts of the profession that a Letter of Obligation in matrimonial cases was not to be given. On one argument a conveyance of matrimonial property on divorce is in the nature of a gift because, simply put, the matrimonial property is being split and therefore there is no actual price or consideration being paid. However, sometimes it is more complicated than that and one party actually “buys out” the other party. In such cases one of the parties will take out an additional loan or perhaps even take a fresh loan over the property.

The Conveyancing Committee of the Law Society of Scotland, has recently considered this. Our conclusion was that a Letter of Obligation in the classic format should be given in all situations where there is a disposal for onerous, consideration. That includes transfers of former matrimonial homes between divorcing spouses.

Under the Adults with Incapacity legislation the transaction has to be effected both by the guardian and by the adult. Because of the way the law is structured (the title is held by the adult but it is the guardian who conveys) for the purposes of the Letter of Obligation both parties should be treated as client. The Letter of Obligation should contain both names and capacities in the heading, and should refer to “clients”.

High value transactions

Where one has a high value transaction one should always consider whether the PI cover of the firm granting the Letter of Obligation is adequate to cover that particular transaction. Although a classic Letter of Obligation may be given and the insurers may be expected to pay out on it, they will only pay to the extent of cover.

In the event of a claim in excess of the master policy limit of indemnity there is a possibility that top up insurance premiums would be loaded in the future.

Time limits in the practice book

The practice book in the style of Letter of Obligation being granted by borrower to lender contains an obligation to deliver the land certificate within a specific period. Sometimes the title is complicated and it is quite clear that the land certificate will not be available for some time. In those circumstances it is quite reasonable to try to renegotiate the period (in one recent case, the period was negotiated to five years) in conjunction with the best estimate from the Keeper

Where no Letter of Obligation may be given – Specific Instances

In some cases it may be inappropriate to give a Letter of Obligation at all. These are very exceptional and should not affect the vast majority of transactions but the following are some examples:

(a) In one case a lender’s solicitor asked for a Letter of Obligation from a borrower with an in-house legal team. No external solicitor had been instructed (and there was therefore no master policy cover for the grant of the Letter of Obligation because the in-house legal team were not covered by the master policy). In such circumstances as it was a commercial organisation and as the lender had been made aware of the circumstances at the earliest possible opportunity it had to be accepted that no Letter of Obligation would be given. (This case did fall within the “contracting out” parameters in any event).

(b) When buying from an insolvency practitioner a client will normally buy the property “as it stands”. Given the status of the law and the very limited rights to challenge a liquidator’s or receiver’s title it is unlikely that a Letter of Obligation would give very much additional benefit. Subject to the comments in the next paragraph, if the searches are up to date there is very little further that can go wrong.

Solicitors for an insolvency practitioner should be encouraged to give such letters of obligation since they are not subject to any loading or excess if it is in the classic format, although in a commercial transaction the “contracting out” situation could apply. Some receivers’ solicitors are concerned that there might be a “Sharp v Thomson” type disposition in a drawer, delivered but unrecorded. The Keeper has confirmed that he will not exclude indemnity on that ground and the insurers do not add any further loading or penalty, although they do expect the lawyer acting for the receiver at least to make enquiries of the former directors (even though there may be no response.

However, where the purchaser is granting an obligation to the lender’s solicitors following such a sale there is no penalty under the master policy just because there is no “back to back” obligation from the receiver’s solicitor, so long as that (purchaser to lender) obligation complies with the “classic” rules.

(c) Frequently house builders’ solicitors refuse to give letters of obligation. They insist upon purchasers obtaining their own searches and accepting the position without a Letter of Obligation. This is an unsatisfactory situation and has been raised with Homes for Scotland although there is no immediate prospect of the situation changing. If a Letter of Obligation is not to be given to a domestic client in such a case the possibility of the builder going into liquidation and receivership should be discussed with the client.

Leases

Very often tenants take entry on missives but the lease is not signed up until later. A Letter of Obligation can be granted at entry. If there is any doubt arrangements should be made to have the lease signed by all parties in time for entry. If that is not possible then the Keeper will in those circumstances accept the missives (provided they are self-proving and comply with all the other formalities) for registration in the land register. Very often clients will take the risk and the Letter of Obligation can then be left until the lease is signed up.

Selling a company

If property is acquired on the sale of a company then there is no conveyance of the property and in theory no Letter of Obligation need be given. However sometimes the purchaser’s solicitor has to give a Letter of Obligation to its clients’ funder. That is treated no differently from any other so long as it is in classic format and the checks have been carried out. In many cases there will be property warranties available from the seller of the shares.

Registration of Title

One practitioner raised a query regarding the giving of a Letter of Obligation where on a second registration the Land Certificate had not been issued. The obligation to deliver a Land Certificate with no exclusion of indemnity is a clients’ obligation. It does not matter in relation to the solicitor’s Letter of Obligation whether or not the Land Certificate has been issued. The Letter of Obligation only covers the gap period and that is no different from any other transaction.

Property Standardisation Group

The Property Standardisation Group is currently looking at letters of obligation and are about to publicise a set of styles that they have agreed between them . This group comprises members of Dundas & Wilson, Shepherd + Wedderburn, Maclay Murray & Spens and McGrigor Donald. The Conveyancing Committee has met with them, and has looked at the styles. The Committee’s position is that while these styles may be of use to the profession that will be for each individual practice unit to decide.