Reservation agreements – Paradigm shift or Scottish import as useful as a fried Mars Bar?
It’s the new tool being trialled to fuel the national obsession of speeding up the property buying process and reducing the risk of gazumping and gazundering.
Ministers at the Ministry of Housing, Communities and Local Government have indicated that they are likely to trial the use of ‘reservation agreements’ in the new year in the hope that they reduce the number of ‘fall throughs’ in the housing market.
What are reservation agreements?
Reservation agreements are not a new concept. They are already commonly used in the sale of new build properties.
Under this type of agreement, buyers usually lodge a sum of money upfront with the seller upon reaching agreement on price (usually around £1,000 to £2,000). In return the seller agrees not to actively market to anyone else for a certain period (commonly 28 days). In theory this gives the buyer and their legal advisors enough time to quickly arrange finance, check legal title to the property and offer an exchange of contracts while the reservation deposit is protected. If a buyer is not able to commit to exchange of contracts within the period then the seller is free to market to another buyer, although this is unlikely if the buyer is nearly ready in any event.
Importantly, if the buyer withdraws then the seller can keep the reservation deposit, which should cover what would otherwise have been wasted costs on an aborted transaction. If the buyer proceeds to exchange contracts, then the reservation deposit is used as part payment towards the purchase price.
It is hoped that the upfront non-returnable payments associated with reservation agreements will discourage unpredictable speculative buyers whilst rewarding genuine buyers for proceeding quickly. They would also protecting sellers from wasted costs in the event of an aborted transaction.
Lock out agreements
The proposed reservation agreements are essentially a type of ‘lock out’ agreement between a buyer and seller. Lock out agreements have been an available option to buyers and sellers for many years but have generally been unsuccessful and rarely used. Negotiation and agreement of the key terms between lawyers has proven to be slow and there has been a general lack of clarity and convention as to who the initial payment should be made to. Buyers are reluctant to make the payment direct to the seller. Agents and sellers’ lawyers have been reluctant to hold payments made by buyers on behalf of sellers.
If our experience of lock out agreements is anything to go by, it’s likely that reservation agreements will only make a difference if estate agents obtain the seller’s agreement to use them when the seller places a property on the market.
Agents have to become more comfortable with obtaining the buyer’s signature to standard form reservation agreements at the point that they negotiate agreement of the sale price between seller and buyer. In addition, it’s likely that they will have to take receipt of the buyer’s reservation fee. Proactive agents willing to adopt this approach now may hit on early success before having to wait for the results of trials conducted by the HCLG. Some agents have reported reductions in fall-through rates to 15% to 20% (from the more typical rate of 25% to 30%).
Rix & Kay’s Residential Property team is already working with agents to trial use of exclusivity agreements in an effort to speed up the buying process and reduce the threat of gazumping and gazundering.
Lock in agreements
Looking forward, it is possible that the use of lock in or reservation agreements may usher in a paradigm shift in how properties are bought and sold. Many estate agents admire the house buying process in Scotland where buyers are routinely locked in at the point of sale and required to pay a reservation deposit of around 5% to 10% of that price. Overall the common perception is that the Scottish system encourages a quicker buying process.
There are, however, key differences within the Scottish system. Sellers are required to supply much more information about the property upfront including an assessment akin to a survey. In addition ‘lock in’ agreements are enforceable north of the border. They are not enforceable in England, Wales and Northern Ireland.
A lock in agreement offers all of the features and benefits of a lock out agreement but, crucially, it requires the seller to sell the property to the buyer in the event that the buyer is ready, willing and able to purchase within the protected period.
Buyers are also committed to purchase and only able to walk away from a deal and get their deposit back in exceptional circumstances (where they are able to prove an adverse structural or legal defect). South of the border this arrangement is viewed by the Courts as an agreement to agree before the terms of the agreement are clear and therefore unenforceable.
Problems with reservation agreements
Critics of these agreements point out the following:
- Gazumping – The use of these agreements does not protect against the risk of gazumping in that there is no penalty on the seller (other than the return of the reservation deposit) if the seller does not proceed when the buyer is otherwise ready to offer an exchange of contracts within the protected period.
- Chains and fault – Usually the collapse of a chain is caused by the fault of only one link in the chain. If reservation agreements are to be routinely used, not just in a new build situation, it is likely that the default position will be that the seller is entitled to retain the reservation deposit if the buyer is not able to offer exchange within the protected period regardless of the reason. Most of the parties in the chain will lose a reservation deposit but also gain one. That could expose buyers at the bottom of chains to bearing additional risk as they have no-one to pass the no fault risk on to.
- Mediation / Dispute resolution scheme – Introducing reservation agreements necessitates creating a mediation or dispute resolution scheme to assist in resolving disputes as to returning reservation deposits in the event of no fault withdrawal from sales.
- Penalising sellers – If reservation agreement trials include sellers paying a penalty if they withdraw from a sale (on top of returning reservation deposits to buyers), then creating a mediation scheme or a dispute resolution scheme is almost guaranteed. Arguably, these schemes seem to have worked in the context of protecting rent deposits in property letting situations and so there is good reason to think that legislation can create a similar legal framework with respect to house sales and purchases.
The impact of reservation agreements
Making reservation agreements a routine part of the buying process is a serious attempt to speed up the house buying process. Buyers will lose out if they are not serious about proceeding quickly. Sellers will be compensated in the event that buyers are not ready to exchange contracts within a reasonable period of time. This should focus the parties’ attention on proceeding quickly within the protected period.
The experiment, however, will need estate agents and property lawyers to make significant working practice adjustments if it is to be given a fair trial. Ideally, agents will work closely with trusted lawyers to produce sales packs in advance of agreeing a sale and also in preparing reservation agreements / lock out agreements for buyers to sign upon reaching agreement.
In the long term reservation agreements could result in taking a big step towards reconsidering the enforceability of Scottish style lock in agreements. If the amount of the reservation deposit paid up front by the buyer increases over time to £5,000 to £10,000 then the need for dispute resolution schemes will increase. Equally, however, it’s more likely that parties will consider breaking chains earlier, resulting in smaller house chains… which is typical in many countries outside of England… and is the main reason conveyancers cite for turnaround times being longer in England than they are in other countries… like Scotland.
Ultimately, if these kind of piecemeal trials are not wholeheartedly trialled by estate agents and lawyers within the industry or evaluated within the context that other changes in the system that may be needed to enhance their value, then reservation agreements may prove unpopular in the Government’s search to improve the house buying process.
For more information about reservation agreements, exclusivity agreements or residential property purchases, please contact: