Use of ‘nominee’ in commercial contracts needs consideration

Press, 7 December 1988, Page 65

Use of ‘nominee’ in commercial contracts needs consideration

By

K. Jones,

Public Issues Committee of the Canterbury District Law Society

Although there is no doubt the commercial property market has suffered a downturn like many other sections of the economy since the share market crash, it is nevertheless true to say that the ownership of a well-tenanted commercial building in a good location still represents one of the best investments available to an investor who wants security, the prospect of capital growth and a competitive income return. Such investors, whether buyers or sellers, in future would do well to note some recent decisions of the Court of Appeal and the High Court involving contracts which provide for a “nominee” purchaser. During the boom when property prices were constantly rising it became increasingly common for purchasers to enter into contracts which described the purchaser and added the words “or nominee” to that description. Such purchasers and presumably the agents who prepared those contracts, saw a particular benefit in contracting in this way. In a buoyant market it was frequently possible to find another purchaser prepared to pay a higher price before settlement under the contract was due. In such cases the original purchaser would simply nominate the new

party as purchaser under the contract, take the difference in prices, and leave the vendor to deal with the nominee so far as completion of the contract was concerned.

Very often the same agent who signed up the original purchaser also found the nominee. The agent could make commission from the vendor and from the original purchaser, so in all cases the original purchaser and the agent were well served by these arrangements, Provided the nominated purchaser settled and paid the original contract price it could be said that the vendor received what was bargained for and had no cause for complaint.

However recent decisions have reinforced the view that there are very real risks in nominee contracts for the original purchaser and his nominee, and they have also highlighted a new area of substantial relief for vendors under nominee contracts. Firstly, from the original purchaser’s point of view one should be aware of the following potential problems:

1. A right of nomination is probably signalling to the revenue authorities an intention to sell at a profit so that if a margin is received over and

above the price to be paid to the vendor that windfall may be targeted for income tax.

2. If the nominee fails to settle there will certainly be a claim by the aggrieved vendor. Whether or not such a claim succeeds will depend on the particular circumstances but there is a real potential liability, and if the nominee cannot settle because of financial difficulty all the indemnities in the world will not help. From the nominee’s perspective there are also areas of peril: 1. The Court of Appeal has reaffirmed that there are two separate transactions involved and both are liable for stamp duty. Unless there is an indemnity arrangement between the original purchaser and the nominee, and these are not commonly provided, the nominee could end up paying a premium to the Inland Revenue Department of approximately 2 per cent of the aggregate purchase price including the margin paid to the original purchaser. 2. In the same decision it was held that if the original purchaser defaults when called upon to settle the vendor can cancel the contract leaving the nominee with no right to enforce it, even

with a caveat on the title. The nominee is then left to try and obtain from the original purchaser any premium paid, if the original purchaser is still about and is solvent. So far as the vendor is concerned, the Court of Appeal decision has clearly affirmed that an entitlement to require the original purchaser as the contracting party to take a transfer of the property direct failing which the contract can be cancelled, leaving the nominee out on a limb. While this article tries to present a fairly basic analysis of the positions of the various parties to nominee contracts in the light of recent judicial decisions without going into the subtleties, it should be clear to investors whether vendors, purchasers, or nominees that such agreements are fraught with hazard. What is more these risks can all be avoided by proper drafting which preserves to the original purchaser the right to assign the contract, to the nominee the right to enforce it, and to the vendor remedies in the event of default by either or both. You should be aware of these and other pitfalls and ensure you have a full understanding of any agreement you propose to enter.