Progressing to exchange of contracts - Consequences of excha...

Learning Outcomes

This article explains the legal and practical consequences of exchange of contracts in property transactions, including:

• Binding effect under section 2 of the Law of Property (Miscellaneous Provisions) Act 1989
• Risk allocation under the Standard Conditions of Sale and the Standard Commercial Property Conditions
• Insurance arrangements at and after exchange
• Seller’s and buyer’s obligations after exchange, including the seller’s constructive trust and duty of care
• Early occupation by the buyer and licence terms
• Remedies for delay or failure to complete: compensation for late completion, notice to complete, rescission, damages, specific performance
• Protection of the buyer’s position by registration: notice in registered land; Class C(iv) land charge in unregistered land
• Effects of death or insolvency after exchange

SQE1 Syllabus

For SQE1, you are required to understand the consequences of exchange of contracts in property transactions, with a focus on the following syllabus points:

• The legal effect of exchanging contracts and when the contract becomes binding
• The transfer of risk from seller to buyer at exchange and how the standard conditions address insurance
• The obligations of each party after exchange and before completion, including the seller’s constructive trust and duty of care
• The importance of insurance from the date of exchange and how dual insurance is dealt with
• The remedies available if completion is delayed or fails to occur, including compensation, notice to complete, rescission, damages, and specific performance
• The effect of death or insolvency after exchange but before completion, and the role of personal representatives and trustees in bankruptcy
• Protection of the buyer’s interest if there is a gap between exchange and completion (notice in registered land; Class C(iv) land charge in unregistered land)
• How deposits are held (stakeholder vs agent) and the consequences of default

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. Practitioners typically incorporate either the Standard Conditions of Sale (residential and general transactions) or the Standard Commercial Property Conditions (commercial transactions). These sets of conditions address risk allocation, insurance, remedies for delay or failure to complete, and the mechanics of early occupation, while the general law supplies further rules on damages, specific performance, and the effect of death or insolvency.

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.

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. For a land contract to be valid it must comply with section 2 of the Law of Property (Miscellaneous Provisions) Act 1989 (in writing, containing all the agreed terms, and signed). Exchange is most commonly effected by telephone using one of the Law Society’s formulae. Once exchange is recorded, the completion date is fixed, and any oral understandings not reflected in the written contract will not bind the parties.

Key Term: Law Society exchange formulae
Agreed procedures (Formulae A, B, and C) used by solicitors to exchange contracts by telephone, with undertakings that create certainty and a clear record of exchange.

Key Term: non‑merger clause
A contractual provision preserving specified rights and obligations beyond completion; under the standard conditions certain clauses do not merge into the transfer on completion.

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 and must do so even if circumstances become inconvenient. Time is not ordinarily “of the essence” of the completion date until a notice to complete is served; until then, late completion engages contractual compensation rather than immediate termination.

A buyer who breaches by failing to complete may face forfeiture of the deposit (subject to the contract) and liability in damages. Conversely, a seller who breaches may be compelled to complete, with damages for delay. Because land is unique, specific performance is a common remedy where damages are inadequate.

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

Contracts typically require a deposit at exchange. How that deposit is held matters for risk and remedies.

Key Term: stakeholder
The party holding the deposit on trust for both sides pending completion; the deposit cannot be released to the seller until completion or lawful forfeiture.

Key Term: agent (for deposit)
Where the seller’s solicitor holds the deposit as agent for the seller, allowing earlier release to the seller (usually only where the seller has a related purchase); higher risk to the buyer if the seller defaults.

Key Term: contract rate
The interest rate specified in the contract for calculating compensation payable for late completion.

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. The Standard Conditions of Sale and the Standard Commercial Property Conditions reflect this common law rule. The seller is generally under no obligation to insure the property (unless required under a lease or the contract), but the buyer must ensure adequate cover is in place from exchange. If damage occurs after exchange, the buyer must still complete and cannot require the seller to repair, subject to any contractual provisions about insurance proceeds.

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

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.

Where both parties hold insurance (for example, the seller maintains a policy and the buyer insures from exchange), the standard conditions address the “dual insurance” scenario by providing an adjustment to the purchase price if the buyer’s insurance payout is reduced because another policy also covers the risk. Occasionally, parties agree special conditions keeping the property at the seller’s risk until completion (common in some new‑build arrangements), in which case the seller must insure and may agree to assign policy rights or pay out insurance proceeds to the buyer if loss occurs.

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, subject to any contractual insurance provisions.

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. Lenders typically expect the borrower’s solicitor to confirm that insurance is on risk immediately after exchange. The seller is not obliged to maintain insurance unless required by the contract or by a lease; however, in practice many sellers keep existing policies in place until completion (particularly where a mortgagee requires it). If the contract includes a special condition requiring the seller to insure until completion, the seller must maintain the cover and either assign policy rights or account to the buyer for insurance proceeds if a claim arises.

Key Term: dual insurance adjustment
Standard conditions reduce the price if the buyer’s insurance payout is reduced because the seller’s policy also covers the same risk; the seller can then recover that reduction from their insurer.

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, must take reasonable care to preserve it in the same state (including safeguarding fixtures), and must disclose any new adverse matters that arise before completion. Case law imposes a duty of care during this period: a seller may be liable for loss caused by neglect or wanton destruction.

The seller continues to pay outgoings until completion and is entitled to any rent or profits arising before completion (unless agreed otherwise). The buyer must pay the balance of the purchase price on completion, insure the property from exchange, and arrange finances (including satisfying lender conditions). Time is not usually of the essence; if one party is late, contractual compensation at the contract rate may be payable.

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.

Early occupation raises further questions. The standard conditions provide that if the buyer goes into occupation before completion, they do so as a licensee (not as a tenant), on terms restricting alterations, requiring payment of outgoings and a licence fee calculated at the contract rate, and allowing either party to terminate the licence on short notice. Mortgagees’ consent is usually required and early occupation is rarely recommended because it can reduce the buyer’s incentive to complete and complicate remedies.

Key Term: licensee (pre‑completion occupation)
A buyer permitted into possession before completion occupies as licensee under the contract terms, not as a tenant, preserving the seller’s remedies if completion fails.

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 and recover losses flowing from the breach, subject to mitigation and credit for any contractual compensation received. The buyer can seek specific performance against a defaulting seller and claim damages for late completion (including wasted costs and other foreseeable losses within the contemplation of the parties).

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.

Damages are assessed under established contractual principles. The starting point is the difference between the contract price and the market value at the breach date (if relevant), plus consequential losses naturally arising or within the parties’ reasonable contemplation when the contract was made (such as wasted conveyancing fees, storage, removals, alternative accommodation, interest on bridging, and similar). Loss of development profit may be recoverable only if the seller knew of the buyer’s specific plans at the time of contracting. Parties must mitigate loss, and any contractual compensation for late completion is credited against damages.

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, subject to mitigation and credit for any contractual compensation received for late completion.

Worked Example 1.3

A buyer pays a reduced 5% deposit held by the seller’s solicitor as stakeholder. The buyer defaults after a notice to complete expires. Can the seller keep only 5%?

Answer:
The seller may forfeit the deposit actually paid (here 5%). The seller may also claim damages to recover further losses (which can include the shortfall against a customary 10% deposit), subject to mitigation and the terms of the contract.

Worked Example 1.4

The buyer is allowed into early occupation before completion to carry out minor works. The buyer then fails to complete. What recourse does the seller have?

Answer:
The buyer occupies as licensee under the contract. The seller can terminate the licence on short notice, recover possession, forfeit the deposit (if the buyer is in default after a notice to complete), and claim damages for resulting losses.

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. Delay may occur while a grant of representation is obtained; the other party may choose to serve a notice to complete (making time of the essence) or to await completion and claim compensation for late completion.

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

Co‑ownership may affect who can convey or receive the proceeds. For example, where co‑owners held beneficial interests as joint tenants, survivorship will operate; where held as tenants in common, the deceased’s share passes under the will or intestacy and overreaching arrangements must be respected on completion.

If a party becomes insolvent, the contract remains binding as a matter of law, but practical difficulties may arise. A seller’s assets may vest in a trustee in bankruptcy or a company’s liquidator; the insolvency office‑holder may attract statutory powers to disclaim onerous contracts. A buyer should protect priority by registration (see below) and consider searches to detect insolvency risks close to completion. In registered land, a buyer acting in good faith may be protected even where there was a pending bankruptcy not noted on the register. In all cases, urgent advice and engagement with insolvency office‑holders is required.

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 for completion and registration.

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.

For registered titles, an agreed or unilateral notice can be entered to protect the estate contract. Buyers also carry out an official search (OS1/OS2) before completion, which gives a 30‑working‑day priority period to register the transfer and charge free from intervening entries. For unregistered titles, a Class C(iv) land charge should be registered against the seller’s name; without it, the contract is void against a purchaser of the legal estate for value who completes before the buyer and without notice. Where the buyer expects to be in occupation for a prolonged period before completion, actual occupation may confer an overriding interest in registered land, but reliance on this should be avoided; protective registration remains best practice.

Key Term: overriding interests
Certain interests (for example, some rights of persons in actual occupation and legal easements) that may bind a purchaser of registered land even if not entered on the register.

Revision Tip​

If completion may be delayed beyond a few weeks, protect the buyer’s priority: register a notice for registered land or a Class C(iv) land charge for unregistered land, and ensure an OS1/OS2 search is renewed if the priority period is expiring.

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; dual insurance may result in a price adjustment.
• The seller holds the property on a constructive trust and must take reasonable care to preserve it; the seller continues to pay outgoings and is entitled to pre‑completion rents.
• If completion is delayed or fails, the non-defaulting party may claim contractual compensation, serve a notice to complete making time of the essence, and if necessary rescind and claim damages; specific performance is commonly available against a defaulting seller.
• Deposits are typically held by a stakeholder; holding as agent carries additional risk for the buyer. Forfeiture of the deposit is possible when the buyer defaults after a valid notice to complete.
• The contract remains binding on the parties’ estates if death occurs after exchange; personal representatives must complete. Insolvency introduces practical issues, so protective registration and urgent liaison with office‑holders is key.
• If there is a delay between exchange and completion, a buyer should protect priority by registering a notice (registered land) or Class C(iv) land charge (unregistered land), and use OS1/OS2 searches to secure a priority period.
• Early occupation by the buyer is as licensee only, on contractual terms, and should be approached with caution.

Key Terms and Concepts

• exchange of contracts
• Law Society exchange formulae
• non‑merger clause
• specific performance
• risk
• buildings insurance
• dual insurance adjustment
• constructive trust
• licensee (pre‑completion occupation)
• notice to complete
• personal representatives
• notice (registered land)
• land charge (unregistered land)
• overriding interests
• stakeholder
• agent (for deposit)
• contract rate