Commercial real estate law and rules in Scotland

In Scotland, any legal “person” may own real estate. This will include individuals, companies, entities established by statute and certain charitable bodies.

Entities which are not legal persons, such as unincorporated associations or partnerships, cannot own real estate directly. However, legal persons acting as trustees can own real estate on behalf of such entities.

Owners of commercial real estate include developers, insurance companies, pension funds, banks and other financial institutions, private or public property companies, charities, trusts, the government and local authorities.

There are no restrictions preventing foreign nationals or companies from owning real estate.

Legal ownership of property in Scotland is classed as either heritable or leasehold.

Heritable title (always) and Leasehold title (if the lease is for 20 years or more) will be registered at the Land Register of Scotland (the “Land Register”).

Land Registration was introduced in Scotland in 1979 and was updated in 2014. A Land Register Title Sheet is created for each “Plot” of land, being an area or areas of land which are owned by one person or one set of persons.

All land in the UK is ultimately owned by the Crown and passes back to the Crown if there is no owner. For example, where being a company is wound up without its land being transferred to a third party, the land will automatically pass to the Crown as “bona vacantia” (vacated property). Land may also be held on trust by a legal owner for a beneficiary.

Where more than one person or entity (or group of persons) has ownership in the same land they will hold their interests in one of three ways:

• Common Property – where property is owned by more than one person, with these persons holding a “pro indiviso” share in the common property. For example, where a husband and wife jointly own a property, it is common to see what is called a survivorship destination clause, where the one half pro indiviso share of the deceased transfers to the survivor on death.
• Joint Property – similar to common property (above) but pertaining to a right in property by virtue of membership to a particular group. If a person dies his interest will pass automatically to the survivors within the group. The group exists independently of the property and the property rights held by each member are only acquired through that membership.
• Common Interest – this arises where different properties are owned separately by two (or several) different people, and the properties exist so closely together that what one person does in his property can affect the other person in his property. This largely related to tenement (multi-occupancy) dwellings. For example what the owner des with the roof of a multi-occupancy tenement building affects the other owners in the tenement. Accordingly, all owners have a common interest in the roof. The ownership and rights in a tenement is now regulated (supported) by legislation where the title itself does not deal with such common interest and the rights to, and regulation of, the common areas.

It is also possible to acquire rights over land (such as a right of way) by exercising the right without challenge or interruption for a relevant period, normally twenty years.

Property in Scotland is classed as either heritable or leasehold. Heritable is akin to absolute ownership. Heritable or leasehold title will be acquired depending on the circumstances of the acquisition transaction.

Title to heritable land and leases (over 20 years) must be registered at the Land Register of Scotland on completion. They have their own Land Register Title Sheet. The maximum duration for a commercial lease in Scotland is 175 years. Any then-existing ultra long lease (i.e. over 175 years) can be converted into ownership, where the remaining unexpired period of the lease is over 100 years for a residential property, and over 175 years for all other leases. It is not possible to grant a lease a lease of a residential property in Scotland for more than 20 years.

Property interests which exist in Scotland include:

• Heritable title.
• Leases.
• Licences – contractual arrangements not creating any estate in land.
• Options and pre-emptions – rights to buy or first refusal.
• Servitudes – such as rights of way or for the use of services.
• Wayleaves – contractual rights to use land for limited purposes such as to site telecommunications equipment.

Unless the property is to be sold “as seen” the parties must make it clear whether the fixtures and fittings at the property are to be removed prior to the sale or are to form part of the purchase. If items are fixed to the property, the presumption is that they form part of it and belong to the heritable owner of the property.

Ownership extends to buildings on or beneath the land and the airspace above it, unless interests are described horizontally rather than vertically. (It is not uncommon for the minerals and mining rights within land to be reserved to another person). Reference to “land” generally includes the buildings and structures on that land – similarly “property” includes both land and buildings unless limitations are created.

As in England and Wales, typical employment issues which may be relevant to real estate transactions include the transfer of undertakings, redundancies and changing terms and conditions of employment. The employment related issues which affect real estate acquisitions remain the same in Scotland as they do in England and Wales.

The Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”) are likely to be the most significant employment issue. TUPE applies when an undertaking or business (or part of one) is transferred from one party to another or where there is a service provision change (either an outsourcing, change of provider or in-sourcing). It may therefore apply when there is the sale or transfer of a business or lease of a property, or when the management of a property is outsourced to a third party. For example, this might occur in the sale of a shopping centre having its own management and security staff.

The broad effects of TUPE are that:

• With effect from completion of the transfer, the buyer or new service provider assumes responsibility for employees working in the business, or the employees who are assigned to the services, that have transferred;
• Accrued continuity of employment is preserved;
• If the sole or principal reason for a dismissal is the transfer itself, such a dismissal will be automatically unfair. If the dismissal takes place for an “economic, technical or organisational reason entailing changes in the workforce (‘ETO reason’)” it may be fair;
• Employees transfer with their existing terms and conditions intact, except, in relation to certain occupational pension scheme rights;
• Generally speaking, if the buyer/new provider makes changes to employees’ terms and conditions following a transfer, such a variation will be void if the transfer is the sole or principal reason for the variation. Changes to terms and conditions are, however, permitted if (i) the sole or principal reason for the change(s) is an ETO reason and an employee agrees to the change(s), or (ii) an employee’s existing contract permits the buyer/new provider to make the particular change(s) in question. In addition, if an employee’s contractual terms are derived from a collective agreement, such terms may be amended one year after a transfer – provided that an employee’s terms will be no less favourable overall than they were prior to the transfer;
• If a trade union is recognised by the seller/outgoing provider, trade union representatives must be informed and, where appropriate, consulted about the transfer. If there is no recognised trade union, information and consultation should take place with elected employee representatives;
• If the seller/outgoing provider recognises a trade union, the buyer/new provider may be bound to recognise that union until detailed de-recognition procedures are completed; and
• Any attempt to circumvent the effect of TUPE is void.

Although the legal effects of TUPE cannot be avoided, it is possible to apportion TUPE liabilities by agreement between the seller and the buyer (or outgoing and incoming service provider). Normally the seller (or outgoing service provider) will agree to be responsible for all claims and liabilities relating to employees up to the date of transfer, and the buyer (or incoming service provider) will take on all post-transfer employment liabilities.

Redundancies may arise on the closure of a business or part of a business, or where there is a reduction in the number of employees required – for example on the merger of two businesses involving a TUPE transfer. Care should be taken to ensure that the redundancies are carried out in a procedurally fair manner, with particular regard to any applicable collective consultation requirements (which apply when 20 or more redundancies are proposed within 90 days). If the seller and the buyer (or outgoing and incoming service provider) are willing to work together, it is possible for collective consultation to take place before the TUPE transfer thus allowing redundancies to be effect more quickly after the transfer .

An employer may decide to change or harmonise terms and conditions of employment on the acquisition of a new business. This can be a difficult process, especially where there has been a TUPE transfer (see above).

The transaction process begins when a buyer identifies a property that the buyer is interested in.

For residential property, it is the responsibility of the seller to obtain a Home Report from an independent qualified valuer. The buyer instructs his solicitors to “note interest” with the seller’s property agents or solicitors – this is taken to mean that the seller will not sell the property without first giving the interested party the opportunity to bid. The seller’s property agents or solicitors will set a closing date for accepting offers; the buyer’s solicitors in turn will submit an offer on the buyer’s behalf.

For commercial properties the seller and the buyer (or usually property agents on their behalf) will negotiate and agree the principal terms of the sale and purchase and these will be documented in a “Heads of Terms” document or “Letter of Intent”.

If the seller is a foreign registered company, generally the buyer will require an opinion letter from an approved lawyer practising in the same jurisdiction confirming that the company is properly incorporated, has power to sell and has carried out appropriate authorisation procedures.

Following settlement (completion), the buyer’s lawyers need to deal with registration of the transfer documents (and any charging documents) at the Land Register and payment of land and building transaction tax (LBTT), which is assessed on the price paid for the property.

An agreement for the sale and purchase of land must conform to the Requirements of Writing (Scotland) Act 1995. This means the contract must be sufficiently clear, and executed according to the rules laid out in the Act.

The buyer has the opportunity of conducting a full title investigation or due diligence before exchanging agreements so is usually prohibited from making any objection to any matter of title after the date of exchange.

Provisions relating to value added tax will be included where relevant to ensure that the agreed tax position is preserved between exchange and completion.

Contracts for sale of property subject to occupational interests such as leases will include clauses to cover ongoing management matters, and provide for apportionment of occupational income and outgoings on completion of the transfer of ownership in the property.

If the property being sold is in the course of construction, the contract for sale and purchase will incorporate provisions dealing with the obligations of the seller to construct in accordance with an agreed specification and to provide to the buyer separate deeds of warranty from the building contractor and persons such as the architect in order to safeguard the buyer against defective design or workmanship.

Some of the most significant are as follows:

• Buyer Beware (“Caveat Emptor”) – the overriding point of principle under common law is “caveat emptor” – let the buyer beware. The buyer must satisfy itself in all respects as to the nature of the property it is acquiring. However, this does not absolve the seller from the obligation to provide truthful replies to enquiries raised by the buyer’s lawyers.
• Warrandice – this can be express or implied, and is a guarantee of a good and unencumbered title. There are three levels of warrandice – simple, fact and deed and absolute. Absolute warrandice is the highest level, and guarantees the buyer against defects and limitations in the title, whether caused by the seller or not. However it can be invoked only once the owner is evicted or removed from the property (or part) in respect of which the Seller has granted absolute warrandice.
• Misdescription and misrepresentation – there are both statutory and common law rules which protect against clear misrepresentations or misdescriptions of fact made by the seller to the buyer which have the effect of inducing the buyer to enter into a transfer of land. In such cases, damages may be payable to the buyer or the buyer may be entitled to withdraw from the transaction.
• Unfair terms – agreements for sale that include exemption clauses, which seek to allocate risk, are subject to the Unfair Contract Terms Act 1977. The Act operates to restrict or render void the effect of clauses that unreasonably attempt to exclude liability.

The onus is on the seller to show that he has the right to sell the property, and that there are no legal inhibitions to exercising that right to sell. Various Searches are carried out which confirm the physical extent of title and, if necessary, “map” it to the Ordinance Survey map. The seller’s solicitor will also instruct a Property Enquiry Certificate, which discloses planning applications, building warrants and statutory notices.

From the purchaser’s perspective, title to the property will be examined and investigated. The buyer’s lawyers will consider the entries on the Land Register or, if necessary, investigate the unlying title deeds.

Where the property is leasehold, or subject to lease or other occupational interests, as well as examining the owner or landlords’ heritable title, the terms of the relevant occupational documents need to be considered carefully to ensure they are not contrary to the buyer’s intentions for the property. The buyer’s lawyers will also need to check whether these documents require the consent of any third party to be given to the transaction.

The buyer’s lawyers will raise pre-contract enquiries (“preliminary enquiries”) of the seller’s lawyers to obtain information regarding a large number of practical mattes which may affect the property and ask any relevant questions in relation to the title to the property. Whilst a seller must not knowingly or negligently mislead a buyer the general rule of “caveat emptor” (buyer beware) will always apply. The seller generally gives replies, which may be actionable if wrong or misleading. During the due diligence process the buyer may often arrange that a survey is carried out at the property.

After exchange of agreements and before completion the seller’s solicitor will update the property search report. This search will show that there is no adverse entry on the title register for the property which prevents the seller being able to transfer good title at completion.

Before exchange of agreements the buyer’s lawyers usually report their due diligence findings to their client, raising any matter of particular concern.

The Land Register of Scotland was created in 1979 (and updated in 2014). It did not cover all of Scotland immediately. It was an incremental process which was completed over ten years ago. Any property that has been sold, or a long lease is granted, will trigger ‘First Registration’ in the Land Register. A lease granted for a term of more than 20 years is registrable. Once a heritable or leasehold interest is registered, any transfer or charge of that registered title itself has to be registered at the Land Register. Only when the registration is complete can the party properly prove its right of ownership.

The Land Register has the benefit of a warranty of accuracy by the Keeper in most cases. It is the definitive record of who owns what land, the nature of the interest and any registrable matters affecting that land. The title register for a particular plot comprises the following four parts, namely:

• Property – which gives a description of the property together with any rights benefiting the property
• Proprietorship – which gives details of the registered owner of the property and the price paid for the property by the current owner
• Securities – which lists all registrable matters that encumber the property such as rights benefiting other property, covenants, financial charges, contracts and registrable leases
• Burdens Section – which sets out burdens or conditions of title which affect the property.

The Registers may also contain, where appropriate, special entries that restrict the registered owner’s ability to deal with its title without obtaining the consent of another person.

Prior to registration the seller will lodge an “Advance Notice” in respect of the Disposition (conveyance) of the property or Standard Security (mortgage) or other deed being registered following completion. The Advance Notice will give the beneficiary of that deed a protected priority period against the same type of deed registered in advance of theirs.

Applications to obtain planning permission to “develop” land must be made to the public (local government) authority which has the responsibility for controlling the use and development of land in its area. Public authorities have statutory time periods within which a decision must be made as to whether or not planning permission should be issued. There are various statutory rights in relation to appeals, which can be made if an application is refused or not determined, and rights of challenge regarding the validity of any permission granted. For developments that are likely to cause significant environmental impacts, an Environmental Statement will need to be submitted with the application for planning permission, explaining the likely environmental impacts of the development.

Generally, planning permission will be required for the construction of a “new build” property, alteration to or refurbishment of an existing building, and where an existing use (for example office space) is to be changed to another distinct use (for example retail or licensed premises). Planning permission, when granted, benefits the land (although there are occasions when it can be personal) and will contain conditions which will regulate the impact of the development, for instance controlling hours of opening for a licensed premises or requiring landscaping surrounding a car park. Under the Planning legislation the terms “develop” and “development” have a much wider meaning than the construction or replacing of buildings. Minor building works or simple changes of use may amount to “development” requiring planning permission.

A different type of permit (called a “listed building consent”) is required when it is proposed to do work to historically or architecturally important buildings. Normally, planning permission will also be required, but listed building consent may be required even where planning permission is not (for example where works are not “development” but still affect the importance of the building as a heritage asset).

Larger districts or areas (called “conservation areas”) that have architectural or historical importance may also be subject to a separate regime of control that requires conservation area consent to be obtained before work is carried out that would damage the character and appearance of the area that the local public authority wishes to preserve and enhance.

During the consultation period that the local government authority must undertake when considering a development, third party groups are able to put forward objections (or support) that should be considered by the authority before deciding whether or not permission should be granted. In addition, even after a permission has been obtained, there will be a three month period within which a third party group is entitled to challenge (“judicially review”) the validity of granting the permit and this should be borne in mind before any work undertaking the development begins.

In addition to a planning permission, the building must also have approvals confirming that construction has taken place in accordance with applicable building regulations and health and safety legislation. Certain types of building may also have other kinds of certificate issued by independent bodies in relation to building or construction matters generally, such as BREEAM. Any property which is to be sold or leased must have a current Energy Performance Certificate (EPC) which rates the energy performance of a building (and makes recommendations for its improvement).

In relation to operations and activities on or within the property, various environment related permits may be required. This will depend upon the nature of such activities and operations. Most commercial activities will require a trade effluent consent or agreement with the local sewage undertaker. Where prescribed industrial or commercial activities are undertaken, environmental permits may be required from the Environment Agency or the local authority.

Before a sale is contemplated, insurance is generally the responsibility of the owner of the heritable interest in a property. However, where such property is the subject of a long lease or the property is a leasehold interest, the terms of the lease will prescribe which party has responsibility to insure. It is common for owners of long leasehold interests to insure rather than the landlord/heritable owner. Whatever the length of the lease, the tenant will generally insure the contents of the property belonging to the tenant and in some cases certain parts of the property for which the tenant is contractually responsible, such a plate glass.

The insuring party should have a fully comprehensive buildings insurance policy to protect the structure and fixtures and fittings of the property in the event of damage or destruction by any of a comprehensive list of insured risks, such as storm, lightning, fire and water damage. The policy may also cover additional special heads of cover such as subsidence, heave, earthquake and, if available, terrorism.

Generally it is the buildings, and not the land, which are insured for the reinstatement cost rather than the reinstatement value.

Insurance policies (the insurance contracts containing the contractual terms between the insurance company and the insured) may either comprise a single policy for one particular property or a block policy designed to cover a portfolio of properties.

Occupying owners generally have separate policies to cover the contents of the property, especially if the property includes costly plant and machinery. They will also be public liability insurance to cover liability to third parties arising from the property. These public liability policies will exclude most pollution and contamination risks (except those caused by a sudden and accidental event). Whilst not common, it is possible to purchase specialist cover for pollution and contamination risks.

On occasions where the seller has little or no knowledge of the property, such as an insolvency practitioner, or a particular issue is discovered, it might be possible to insure against any challenge to the title. This is called title indemnity insurance.

Insurance policies (except title indemnity policies) are personal and not transferable on sale. Where a sale is taking place, timing of the transfer of risk is normally prescribed by the sale agreement. Agreements for sale of leasehold land will still be governed by the insurance terms of the lease. It is common market practice for the parties to agree that the seller will continue to insure occupied property until completion.

Environment related sustainability issues are becoming more important. Currently, the most prevalent of these is the extent of greenhouse gas emissions attributable to the use of buildings and the potential impact of climate change on buildings. Considerable new legislation, policy, and voluntary commercial measures are being implemented. These are likely to have potentially far reaching impacts on development and refurbishment, although there is no consensus yet on whether there will be a significant impact on investment values of new and/or existing building stock.

Traditionally, the prime environment consideration has been potential soil and groundwater contamination as a result of current and former uses. Applicable environment law is a mix of common law and statutory law. Strictly, it is not unlawful for land to be contaminated and there is no absolute obligation to remediate contamination. Generally, legal obligations will attach if the contamination is causing, or has the potential to cause, harm or damage at particular levels (and these differ depending upon the applicable law). In principle, legal responsibility follows the “polluter pays” principle (i.e. the person who spilled, released or discharged the offending substance will normally be liable) but there are important qualifications to this. Environment laws may operate to make future owners and occupiers liable for contamination already present at the real estate when they acquire it. For instance, this may occur if the new owner fails to remediate harmful contamination of which it is aware or should be aware, if the original polluter can no longer be found or, by statute or contract, the risk is transferred by one party to another.

Acquisition due diligence may involve the appointment of environment consultants to consider documentary information and to carry out a site visit. If considered necessary, further, intrusive investigations may then be undertaken. It is important to identify potential problems early so that there can be negotiation on terms and/or price and the need for and scope of any remediation. This can include contractual allocation of risks, obligations to remediate (contamination discovered pre or post-acquisition), indemnities in respect of first party loss or third party claims, or purchasing specialist historic liabilities environment insurance to cover any of these risks. If development is proposed, then planning permission may be made conditional upon the proper investigation and remediation, if necessary, of potential historic contamination.

If planned development is of a type considered potentially detrimental to the environment, the application for planning permission may need to be supported by an assessment of the development’s likely future environmental impact.

The presence of nuisance weeds (such as Japanese Knotweed) or protected species (such as badgers or newts) are due diligence and potential planning issues. They may impede on-site activities; have cost implications and impact on the duration of development.

Those who have control of places of work have a duty to assess the risk of asbestos being present in the fabric of the building and to manage the human health risks posed by any asbestos found. Buildings built before 1999 are presumed to contain asbestos unless there is good evidence (such as building plans or asbestos survey) to the contrary.

Pricing of real estate investments is a combination of the aggregate rent being paid by occupational tenants of the property and the value that investment buyers consider that a property of the specific type and location is worth at the time of valuation taking that income into account.

The rent for a particular property is likely to be assessed by multiplying the area of the property by the market rental value per square metre (although in the UK square feet are still used as an alternative measurement). The market rental value will take into account factors such as the location of the property, its type and condition, rents payable for similar properties in the same area, and the length of the lease term. The area of the property will be calculated by reference to the UK recognised Code of Measuring Practice, which uses generally accepted methods of calculation by reference to several core definitions, the most common of which are Gross Internal Area (used, for example, in relation to warehouses and industrial buildings) and Net Internal Area (used, for example, in relation to offices and shops).

In the case of retail shops, it is common for the rent of the property to have differential values according to the positioning of the floor space – that nearest to the frontage is the most valuable and will be described as “Zone A”. The rental values of the various areas will be added together to provide an overall rental value for the property.

The value of the property for investment purposes will generally be assessed by reference to the methodology laid down in the UK recognised Appraisal and Valuation Standards Manual, universally known as the “Red Book”. This governs the way in which a valuer will calculate the value, on the basis of a list of accepted assumptions according to the statements of practice. These apply to the specific use for which the valuation is made and in the case of investment property the valuation will be of “Market Value” as defined.

Investment properties are commonly referred to as being sold on a particular yield, meaning the investment return that will be gained from the capital sum which it is necessary to pay to buy the property. For example, where a property with an aggregate rent of GBP 100,000 is sold for GBP 2m, it will have a yield of 5%.

In short, the open market will decide the price of a property; whereas a fixed methodology – which will look at existing pricing – will set the valuation.

The main tax on acquisitions of property is Land and Buildings Transaction Tax (LBTT). LBTT is a tax applied to residential and commercial land and buldings transactions (including commercial purchases and commercial leases). LBTT is designed so that the charge is proportionate to the actual price of the property. The percentage rate for each band in LBTT is applied only to the part of the price over the relevant threshold and up to the next threshold. The rates and bands for LBTT are as follows:

LBTT must be paid by the buyer within 30 days of completion of the acquisition. Failure to pay within the prescribed time is subject to significant penalties and interest. LBTT must be paid before the Land Register will process the buyer’s application for registration. If the interest being sold is the creation of a new lease, extra duty will be payable according to the amount of rent payable under the terms of the lease.

Value added tax (VAT) may also be payable, where the property is either “new” (less than three years old) or is the subject of a valid option to tax.

The exception to the rule that VAT is payable on the sale of an opted property is where the transaction constitutes a “transfer as a going concern”, where the property is let and operated as a business unit. Subject to satisfying certain conditions, this will usually mean that no VAT is paid on the sale of a property which is subject to leases granted to occupiers.

During the due diligence for the acquisition, the seller will also pay the costs of conducting searches, including in particular of the local authority (which includes zoning matters, building regulations and general municipal consents, notices, etc), and, if relevant, companies providing utilities, the Environment Agency and coal authority. The buyer will pay for any additional valuations and surveys of the physical state of the property which are required.

The seller and the buyer will pay the fees (or commission) of any land agent or broker employed by them.

Occasionally, the negotiated heads of terms for a transaction will provide for one or other party to pay the other’s costs. Generally each party pays its own expenses. If the property is leasehold, the tenant is usually responsible for paying the costs of obtaining any consent required from any landlord in order to sell.

Finally, the buyer will be responsible for the payment of the Land Register fees associated with registration of the transfer to the buyer. As no notarisation is required, no notary fees are payable.