Freehold real estate law and practice - Exchange of contract...

Learning Outcomes

This article covers the exchange of contracts in freehold conveyancing, including:

• The legal function and binding effect of exchange and the precise moment a sale becomes enforceable
• The formal requirements for a valid land sale contract, counterpart exchange mechanics, and obtaining authority to exchange
• Stakeholder versus agent deposit holdings, the risks of reduced deposits, and the use of “top‑up” provisions
• Application of Law Society telephone exchange formulae (A, B and C), with appropriate undertakings and file notes
• The consequences of exchange: passing of risk and insurance obligations, equitable interests, and practical protections where completion is delayed
• Remedies for delay or non‑completion under the Standard Conditions of Sale, including notices to complete, deposit forfeiture, rescission, compensation, and specific performance

SQE2 Syllabus

For SQE2, you are required to understand the exchange of contracts in freehold conveyancing, including when the contract becomes binding, how deposits are handled, available remedies for delay or non-completion, and practical methods of exchange, with a focus on the following syllabus points:

• The function and formalities of exchange of contracts in freehold conveyancing
• When and how a contract becomes legally binding for buyer and seller
• Stakeholder and agent treatment of deposits: practical and legal differences
• Remedies for delay, breach, or non-completion after exchange, including deposit forfeiture
• Practical steps and recognised methods of exchange (in person, post, telephone, Law Society formulas)
• Common pitfalls, including the risks of reduced deposits and agency arrangements

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 precise moment does a contract for the sale of a freehold property become legally binding?
2. Why is it usually safer for a buyer if the deposit paid on exchange is held as stakeholder rather than as agent?
3. What main remedies are available to a seller if the buyer fails to complete after exchange of contracts?
4. What risks apply if a reduced deposit is paid or if the deposit is released to the seller before completion?

Introduction

Exchange of contracts is the central event in freehold property conveyancing. It marks the point at which a transaction moves from non-binding negotiations to a contract that binds both seller and buyer to complete on agreed terms. Understanding exactly when the contract becomes binding, how deposits are managed, and what happens if plans change or either side defaults, is essential for effectively advising clients and addressing practical SQE2 assessments.

Key Term: exchange of contracts
The formal process in a property sale where counterparts are exchanged, creating a binding contract upon both seller and buyer.

The Significance of Exchange

Before exchange, either party can withdraw at will (unless a specific penalty or contract says otherwise). At the moment of exchange, both parties become legally committed to complete on the agreed date and under the agreed terms. The transaction is no longer "subject to contract."

Requirements for a Valid Contract

For a freehold sale contract to become binding at exchange, the contract must comply with statutory and practice requirements:

• Be in writing and incorporate all the agreed terms.
• Be signed by each party (or someone with authority on their behalf).
• Be contained in one document, or, where counterparts are exchanged, each counterpart must contain all the agreed terms and be signed by the executing party.
• Be physically or formally exchanged (i.e., each party holds a counterpart signed by the other, or exchange is completed via a recognised formula).

In practice, solicitors must obtain express authority from their client to exchange; exchanging without authority risks negligence. Authority should be confirmed in writing and noted on the file, particularly where telephone formulae are used.

Key Term: completion
The moment when legal title passes from seller to buyer, keys are released, and the balance of the purchase price is paid on the agreed completion date.

Methods of Exchange

Contracts can be exchanged by various methods:

• In person: The solicitors meet, check counterparts match, insert dates, and hand over signed parts (and deposit if applicable). This has certainty but is rare in modern practice.
• By post: Less common due to uncertainty; deemed exchange typically occurs on the day the seller posts their part back to the buyer’s solicitor after receiving the buyer’s part and deposit.
• By telephone using Law Society formulae: This is the predominant method. Undertakings given during the call add certainty and are enforceable.

Key Term: Law Society Formula A
Used where one solicitor holds both signed parts. That solicitor undertakes to date both, insert the completion date, and send out the other party’s signed part that day (together with the deposit if they are the buyer’s solicitor).

Key Term: Law Society Formula B
Used where each solicitor holds their own client’s signed part and the buyer’s solicitor holds cleared deposit funds. On exchange, each undertakes to send the signed part (and deposit) the same day.

Key Term: Law Society Formula C
Used to synchronise a chain. It occurs in two stages: an initial “release” call (undertaking to exchange later that day) up and down the chain, followed by exchanges back along the chain.

Following a telephone exchange, a memorandum/file note should record the parties, the date and time, the formula used (including any agreed variation, such as electronic transfer of the deposit), the completion date and deposit details. In a chain release, note the start/end of the release period and the names of authorised alternates if someone is unavailable.

Once exchange is completed by any recognised method, the transaction becomes binding at law.

Binding Effect and Consequences

At exchange, the buyer typically pays a deposit (commonly 10% of the purchase price). After exchange:

• Neither party can withdraw without penalty.
• The completion date is fixed, and time will become “of the essence” if a valid notice to complete is later served.
• As between the parties, risk of damage or destruction typically passes to the buyer under the Standard Conditions of Sale, and the buyer must insure from exchange. The seller should also maintain cover until completion (particularly if they have a mortgage) to avoid gaps and manage lender requirements.
• The buyer acquires an equitable interest (an estate contract); the seller holds the property on a constructive trust pending completion and must take reasonable care of it so it can be transferred in the same condition. The seller remains liable for outgoings and may keep any rents or profits until completion.
• If the buyer needs early access, they do so strictly as licensee (by agreement and subject to lender consent), which preserves the incentive to complete and prevents unintended tenancies.

If there is a longer interval (for example, more than six weeks) between exchange and completion, consider protecting the buyer’s interest by registration: a Class C(iv) land charge in unregistered land, or a notice in registered land.

Deposit Arrangements

Deposit Payment on Exchange

The deposit, nearly always paid by the buyer on exchange, serves two functions: it signals commitment and acts as security for any default. The usual amount is 10%, but the seller may agree a reduced deposit where practical.

Key Term: stakeholder
A neutral party (commonly the seller’s solicitor) holds the deposit after exchange, only releasing it to the seller on completion (or to the seller if the buyer is clearly in default after failure to complete). Stakeholder status protects both parties because the holder must pay out in accordance with the contract and relevant undertakings.

Key Term: agent (for the seller)
The deposit holder acts for the seller and may release the deposit to the seller before completion. This increases risk for the buyer, especially on the seller’s insolvency.

Stakeholder holding is the safer default. Under the Standard Conditions of Sale (Fifth edition), deposits are usually held as stakeholder unless expressly varied (for example, where the seller has a related purchase and chain mechanics require transfer). Under the Standard Commercial Property Conditions, electronic transfer of deposits is routine; where a cheque is contemplated under a formula, any variation must be noted in the telephone exchange.

In chains, a buyer’s deposit may be passed up the line in accordance with Formula C undertakings. Ensure the deposit movements (including any electronic transfers) are properly recorded.

Reduced Deposit and Top-up Provisions

A seller may accept a reduced deposit (e.g., 5%). To avoid erosion of protection, add a “top‑up” clause: if the buyer defaults, the seller can demand an additional sum so that the total forfeited equals 10% (or the agreed standard). Absent a top‑up clause, a seller will be limited to forfeiting only the reduced amount (subject to any further damages claim). Where a buyer’s deposit derives from their sale in a chain, ensure the contract mechanics allow this (chain deposit use is commonly addressed in standard conditions and by undertakings at exchange).

Remedies After Exchange

If the buyer fails to complete, the seller may typically:

• Serve a notice to complete, making time of the essence and setting a short period (often 10 working days) to complete.
• Forfeit the deposit if the buyer remains in default.
• Rescind the contract and claim damages, including the difference between the contract price and any lower resale price, plus consequential losses reasonably incurred.
• Claim contractual compensation/interest (the “contract rate”) for delayed completion.

If the seller fails to complete, the buyer may:

• Serve a notice to complete and claim interest for the period of delay.
• Sue for specific performance (compelling completion) or rescind (where the breach permits rescission) and recover the deposit with interest and damages for losses caused.
• Seek compensation for wasted costs and, where appropriate, consequential losses.

Key Term: notice to complete
A formal notice, served in accordance with the contract, that makes time of the essence and sets a fixed period within which the defaulting party must complete or face remedies (deposit forfeiture, rescission, damages).

Key Term: contract rate
The agreed interest rate in the standard conditions or special conditions, applied to compensation for late completion. It is usually above prevailing market rates to incentivise punctual completion.

Buyers defaulting after exchange risk losing the deposit and being liable for additional damages where the seller suffers greater loss. Sellers who default risk specific performance and damages; they must remain able and willing to complete once exchange has occurred.

Worked Example 1.1

Scenario: The parties to a freehold property sale exchange contracts by telephone using Law Society Formula B. The buyer has not yet received clear confirmation of mortgage approval.

Question: After exchange, can the buyer withdraw without penalty if mortgage funds are refused?

Answer:
No. Once valid exchange has occurred, the buyer is bound to complete. If the buyer cannot, the deposit may be forfeit and further damages could be claimed by the seller, depending on losses caused. Mortgage offer and funding should be in place before exchange (including any certificate of title steps if acting for a lender).

Worked Example 1.2

Scenario: The buyer pays a 10% deposit on exchange, but the contract states the seller’s solicitor holds the deposit as agent for the seller. The seller soon spends the deposit. Before completion, the sale falls through, with the seller at fault.

Question: Is the buyer's deposit protected?

Answer:
No. Because the deposit was released to the seller before completion (agent arrangement), the buyer’s chances of recovering the deposit if the seller is insolvent are much reduced. If the deposit had been held as stakeholder, the stakeholder would have been obligated to return it.

Worked Example 1.3

Scenario: Exchange has taken place. The buyer fails to provide completion funds on the completion date. The seller serves a notice to complete giving 10 working days and claims interest at the contract rate.

Question: What happens if the buyer still fails to complete by the notice deadline?

Answer:
The seller may rescind, forfeit the deposit (including any top‑up due under the contract), and claim damages for losses reasonably caused (e.g., difference on resale, bridging interest, additional legal costs). The seller’s claim to contractual interest for the period of delay remains available even if rescission follows.

Worked Example 1.4

Scenario: A chain of three sales exchanges under Formula C. The buyer at the bottom of the chain pays a 5% deposit, and each contract provides for a top‑up to 10% on buyer default. The bottom buyer later defaults.

Question: How is the deposit security managed up the chain?

Answer:
Each seller can call for top‑up to the full 10% (or agreed figure) under their contract so that forfeiture matches the standard protection. The undertakings and special conditions must make clear that deposit sums sent up the chain are held appropriately (usually as stakeholder) and that top‑up obligations bite if any buyer in the chain defaults.

Worked Example 1.5

Scenario: After exchange, a fire damages part of the property. There is no special condition altering risk.

Question: Who bears the risk, and what practical steps should each party take?

Answer:
Risk usually passes to the buyer on exchange under standard conditions, so the buyer must claim on their insurance and proceed to complete. The seller should maintain their own policy until completion and cooperate reasonably with the buyer’s insurer. If special conditions required the seller to insure until completion, the seller would pay over any policy proceeds to the buyer or assign the claim to them (as agreed).

Practical Steps Before Exchange

Robust pre‑exchange checks reduce post‑exchange risk:

• Confirm the buyer’s funding is in place and that the lender’s requirements (including any certificate of title) are satisfied.
• Make sure both parties have signed the correct version of the contract and that any agreed amendments are reflected.
• Agree the completion date and time with all parties (and any chain); consider whether earlier cut‑off times are required to manage same‑day transfers.
• Ensure the buyer has appropriate buildings insurance arranged from exchange (unless a special condition alters risk).
• Verify occupancy and obtain any required occupiers’ consents/waivers (to avoid overriding interests and lender issues).
• If a longer gap to completion is expected, consider protecting the buyer’s equitable interest by registration (notice in registered land; Class C(iv) land charge in unregistered land).

Key Term: stakeholder
A neutral deposit holder for both parties, accountable to release or refund only in accordance with the contract and exchange undertakings.

Key Term: agent (for the seller)
A deposit holder acting solely for the seller; they may release funds before completion at the seller’s direction.

Key Term: Law Society Formula A
Exchange where one solicitor holds both signed parts, with undertakings to date and send the counterpart.

Key Term: Law Society Formula B
Exchange where each solicitor holds their client’s signed part and the buyer’s solicitor holds cleared deposit funds.

Key Term: Law Society Formula C
Exchange in chain transactions using a release and re‑exchange mechanism to synchronise all linked sales.

Key Term: notice to complete
A formal notice making time of the essence and setting a deadline for completion; non‑compliance triggers remedies.

Key Term: contract rate
The interest rate payable on sums due for late completion, defined by the standard or special conditions.

Exam Warning

For SQE2, ensure you distinguish between stakeholder and agency deposits. If the exam scenario (or real-life client) wants maximum security for the deposit, recommend stakeholder status. Always address the service of a notice to complete and the consequences (deposit forfeiture, rescission, damages) in delay scenarios.

Revision Tip

Do not allow clients to exchange contracts until all financing and satisfactory due diligence are complete. After exchange, withdrawal is legally difficult and costly. Where a chain exists, ensure you understand and document the deposit movements and any variations to the exchange formulae (for example, electronic transfers).

Summary

• Exchange of contracts creates a legally enforceable agreement tying both parties to complete on the agreed terms.
• The buyer pays a deposit at exchange. Stakeholder arrangements give greater protection to the buyer; agency arrangements increase risk for the buyer.
• Risk and insurance typically pass to the buyer on exchange under standard residential conditions, but the seller should maintain their cover until completion.
• Completion is fixed for a set date after exchange; failure to complete exposes the party at fault to remedies: notice to complete, deposit forfeiture (buyer), rescission and damages, specific performance (buyer against defaulting seller), and contractual compensation/interest for delay.
• Reduced deposits cut security; protect the seller with “top‑up” clauses so the seller can recover a full 10% on buyer default. In chains, deposits and undertakings must be tightly managed.

Key Point Checklist

This article has covered the following key knowledge points:

• Exchange is the binding point; ensure all agreed terms are incorporated and counterparts match before exchanging.
• Authority to exchange must be obtained from the client and recorded; undertakings given at exchange must be complied with.
• Deposits are safest held as stakeholder; agency holdings risk unrecoverable loss for the buyer if the seller becomes insolvent.
• A reduced deposit should be backed by a top‑up clause to restore standard protection on buyer default.
• On delay, serve a notice to complete to make time of the essence; consider contract rate interest, rescission, and damages where default persists.
• Risk and responsibility for insurance usually pass to the buyer at exchange; advise on immediate cover and, if relevant, special conditions requiring the seller to insure.
• Where exchange–completion gap is long, consider protecting the buyer’s equitable interest by registration (notice/land charge).
• In chains, use Formula C correctly, record release periods and deposit undertakings, and synchronise exchanges to avoid mis‑alignment.

Key Terms and Concepts

• exchange of contracts
• completion
• stakeholder
• agent (for the seller)
• Law Society Formula A
• Law Society Formula B
• Law Society Formula C
• notice to complete
• contract rate