Progressing to exchange of contracts - Consequences of exchange

Learning Outcomes

After studying this article, you will be able to explain the legal and practical consequences of exchanging contracts in property transactions. You will understand when a contract becomes binding, how risk and obligations shift between seller and buyer, the importance of insurance, and the remedies available if completion does not occur. You will also be able to apply these principles to SQE1-style scenarios and avoid common pitfalls.

SQE1 Syllabus

For SQE1, you are required to understand the consequences of exchange of contracts in property transactions. Focus your revision on:

• The legal effect of exchanging contracts and when the contract becomes binding
• The transfer of risk from seller to buyer at exchange
• The obligations of each party after exchange and before completion
• The importance of insurance from the date of exchange
• The remedies available if completion is delayed or fails to occur
• The effect of death or insolvency after exchange but before completion

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. At what point in a property transaction does the contract become legally binding on both parties?
2. Who bears the risk of damage to the property after exchange of contracts but before completion?
3. What is the effect of a party’s death after exchange but before completion?
4. What is the main remedy available to the non-defaulting party if the other party fails to complete after exchange?

Introduction

Exchanging contracts is a critical milestone in any property transaction. It marks the point at which the agreement between seller and buyer becomes legally binding, and significant legal and practical consequences arise for both parties. Understanding these consequences is essential for SQE1 and for effective legal practice.

The Legal Effect of Exchange

When contracts are exchanged, the parties move from negotiations to a binding agreement. From this moment, neither party can withdraw without incurring liability, except in limited circumstances provided for in the contract or by law.

Key Term: exchange of contracts
The point in a property transaction when both parties become legally bound to complete on the agreed terms and date.

Creation of Binding Obligations

At exchange, all essential elements of a contract (offer, acceptance, consideration, intention to create legal relations, certainty of terms) are satisfied. Both parties are now committed to complete the transaction on the agreed completion date. If either party fails to complete, the other may enforce the contract, including seeking the remedy of specific performance.

Key Term: specific performance
A court order requiring a party to perform their contractual obligations, commonly used in property transactions where damages are inadequate.

Transfer of Risk

A key consequence of exchange is the transfer of risk. Unless the contract provides otherwise, the risk of loss or damage to the property passes from the seller to the buyer at the moment of exchange. This means that if the property is damaged between exchange and completion, the buyer must still complete the purchase and cannot require the seller to repair the damage.

Key Term: risk
The responsibility for loss or damage to the property, which usually passes to the buyer at exchange of contracts.

Worked Example 1.1

A buyer exchanges contracts to purchase a house. Two days later, before completion, a fire damages the property. Who bears the loss?

Answer: The buyer bears the loss. Risk passes at exchange, so the buyer must complete the purchase at the agreed price and cannot require the seller to repair the damage.

Insurance Obligations

Because risk passes at exchange, it is essential for the buyer to arrange suitable buildings insurance to take effect from the date of exchange. The seller is not obliged to maintain insurance unless required by the contract or by a lease.

Key Term: buildings insurance
Insurance covering the structure of the property against risks such as fire, flood, or storm. The buyer should arrange this from exchange.

Revision Tip

Always advise clients to have insurance in place from the moment contracts are exchanged. Failure to do so could result in significant financial loss.

Seller’s and Buyer’s Obligations After Exchange

After exchange, the seller remains the legal owner until completion but holds the property on a constructive trust for the buyer. The seller must not deliberately damage the property and must disclose any new adverse matters that arise before completion. The buyer must pay the balance of the purchase price on completion and is responsible for insuring the property and arranging finances.

Key Term: constructive trust
An equitable obligation imposed on the seller to hold the property for the benefit of the buyer after exchange and before completion.

Remedies for Failure to Complete

If either party fails to complete on the agreed date, the non-defaulting party may serve a notice to complete, making time of the essence. If completion does not occur within the notice period (usually 10 working days), the non-defaulting party may rescind the contract and claim damages. The seller may forfeit the deposit if the buyer is in default.

Key Term: notice to complete
A formal notice served after a failure to complete, requiring completion within a specified period and making time of the essence.

Worked Example 1.2

A buyer fails to complete on the agreed date. The seller serves a notice to complete. The buyer still does not complete within 10 working days. What can the seller do?

Answer: The seller may rescind the contract, keep the deposit, and claim damages for any loss suffered.

Effect of Death or Insolvency After Exchange

If either party dies after exchange but before completion, the contract remains binding on their estate. The personal representatives must complete the transaction. If a party becomes insolvent, the contract remains binding, but practical difficulties may arise. Registration of the buyer’s interest can provide some protection.

Key Term: personal representatives
The executors or administrators responsible for managing the estate of a deceased person, including completing contracts entered into before death.

Registration of the Contract

If there is a significant gap between exchange and completion, the buyer should protect their interest by registering a notice (for registered land) or a land charge (for unregistered land). This prevents the seller from disposing of the property to a third party and protects the buyer’s priority.

Key Term: notice (registered land)
An entry on the register protecting a buyer’s or other party’s interest in the property.

Key Term: land charge (unregistered land)
A registered interest at the Land Charges Department protecting a buyer’s or other party’s interest in unregistered land.

Summary Table: Consequences of Exchange

Key Point Checklist

This article has covered the following key knowledge points:

• The contract becomes legally binding at exchange; withdrawal is no longer possible without liability.
• Risk of loss or damage to the property passes to the buyer at exchange, so insurance is essential from that date.
• The seller holds the property on trust for the buyer and must not damage it or conceal new adverse matters.
• If completion is delayed or fails, the non-defaulting party may serve a notice to complete and, if necessary, rescind the contract and claim damages.
• The contract remains binding on the parties’ estates if death occurs after exchange.
• The buyer should protect their interest by registering a notice (registered land) or land charge (unregistered land) if there is a delay between exchange and completion.

Key Terms and Concepts

• exchange of contracts
• specific performance
• risk
• buildings insurance
• constructive trust
• notice to complete
• personal representatives
• notice (registered land)
• land charge (unregistered land)