The insolvency case reports have been littered with the fall-out from failed unitised property ownership schemes.
Article / 8 Mar 2022
Unauthorised collective investment schemes: reform needed
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This article outlines:
- a typical scheme and more details of the failure stories, such as the Carlauren Group;
- the different legal statuses of the investors;what happens when the schemes go wrong;
- the difficulties faced by insolvency office-holders when faced with such schemes (and the effect of the investors’ different rights); and
- suggestions for reform.
These see unlucky investors who have bought into schemes selling leaseholds of individual hotel rooms, storage units, parking spaces, garages, student flats and care home rooms often on the promise of high guaranteed returns and an option to sell back at attractive rates.
Some of these schemes no doubt are Ponzi schemes sold through glossy brochures, others, legitimate investments caught out by external forces. Attracted by the relatively stable UK property market, these schemes have been popular both in this country and abroad.
They are often referred to as ‘unauthorised (or unregulated) collective investment schemes’ because they are not Collective Investment Schemes (CIS) which the Financial Conduct Authority (FCA) regulates. Whilst the Financial Services Compensation Scheme (FSCS) provides some protection to investors in failed CIS, investors in unauthorised schemes are not so fortunate. Typically, these schemes work as follows:
Company buys premises (or land) on which to build or develop a property. The property is readily divisible into units. For example, this could be individual hotel rooms (within a larger hotel), individual studios (within a care home or student hall of residence) or individual garages (within a garage block).
Investors buy long leases of individual units at each property.
Investors receive (or are promised) a relatively high guaranteed percentage annual return through an underlease with the company (or another group company).
The return is often promised whether the unit is occupied, renovated or even built. Typically, until the units are occupied, the proceeds of further sales to other investors fund the return.
Sometimes the schemes involved a payment from the investors to the company of annual charges under the leases. Often include a generous option to sell back the lease. This assumes the scheme will be successful and demand for the units would remain high.
Often, those marketing these schemes targeted overseas investors, attracted by the seeming stability of the English property market and currency; backed by ‘bricks and mortar’ investment opportunities.
Failed Schemes
The Carlauren Group (the ‘Group’) bought hotels with plans to convert them into and run them as luxury care homes. Investors bought 125-year leases of individual rooms or suites, paying around £80,000. The Group promised investors a fixed annual return of 10% from the time of investment with a guaranteed buy back at 110% of the price after five years, rising to 125% after ten years.
In total, the Group granted 781 leases to investors, of which 687 were registered at HM Land Registry. Special purpose vehicles (SPVs) owned the hotels, but other group companies held the funds invested (around £79m in total). The Group used the funds for purposes other than those of the relevant SPV, leaving the SPVs unable to convert, refurbish and run the properties. The Group companies went into liquidation and administration. We discuss the difficulties faced by the office-holders in resolving the chaos below.
Aronex Developments Ltd (‘Aronex’) is another recent failure. Its first schemes developing accommodation and selling leasehold units of student accommodation were successful. Planning issues and rising professional costs, coupled with less overseas investment following Brexit meant its final project, based in Leicester suffered cash flow issues and eventually caused the decline into administration for the company.
Various companies in the Signature Living Group failed after the hotel owning company defaulted on its liabilities to the bedroom leaseholders of the prestigious Shankly Hotel, which other entities in the group had guaranteed.
The rights of the investors
When schemes have failed, because of the complex structures and competing rights of investors and creditors, they can be difficult to ‘unravel’ in a standard insolvency scenario, as highlighted by the Carlauren case (Re CHF2 Ltd [2020] EWHC 2685 (Ch)). This can be contrasted with the much easier solution the Administrators of Aronex had in Campbell & Anor v Purchasers of Flats at 47 Clarence Street and 44 Conduit Street, Leicester [2021] EWHC 2807 (Ch). These five classes explain the likely types of interest investors in a typical unitised property scheme are likely to have, depending on the stage of their investment and contractual paperwork at the time of an insolvency:
An investor who has a registered lease over an identifiable unit. They have a legal estate which is a term of years absolute as referred to in s 1(1) Law of Property Act 1925. The lease takes effect at law (and not merely in equity) because the lease results in a registerable disposition as provided by s 27(2)(b)(i) and (ii) Land Registration Act 2002 (LRA 2002) and the lease has been registered as s 27(1) LRA 2002 requires.
An investor who has a registered lease but where the underlying unit (sufficiently defined in the lease) either does not exist or has not been converted. They also have a lease taking effect at law, similar to the first category. It makes no difference the unit does not exist or has not been converted.
An investor who has paid money to buy a registered lease in a property, who has been granted a lease which has not been registered but the unit the subject of their contract exists in physical form. They will have an equitable lease, but no legal interest, simply because their lease has not been registered (s 27(1) LRA 2002).
An investor who has paid money to buy a registered lease in a property, who has been granted a lease which has not been registered but the unit the subject of the lease does not exist in physical form. This investor also has an equitable lease (but not a legal interest); it makes no difference the unit does not exist or has not been converted.
An investor who has contracted to buy a lease and paid money to the seller company but the seller has not yet granted a lease. Their status will depend on how much they have paid of the premium payable for the lease:
If they have paid all the premium (assuming their contract with the seller complied with s 2 Law of Property (Miscellaneous) Provisions Act 1989)) the investor will have a claim in equity for specific performance. Because ‘equity looks on that as done which ought to be done’ the investor will have the benefit of an equitable lease (Walsh v Lonsdale (1882) 21 Ch D 9);
If the investor only paid part of the premium (for example the deposit usually payable on exchange or the reservation fee), the investor will only have an equitable lien over the unit, securing the sums paid (Eason v Wong [2017] EWHC 209 (Ch)).
It is only in the final category (5(b)) that the investor will not have a lease of the relevant unit, and the investor will be merely a creditor of the company they invested with (though with a security interest). In Aronex, the investors fell into this category, which meant their interests could be dealt with under para 71 Sch B1 Insolvency Act 1986 (IA 1986) (and the administrators’ fees under the Berkeley Applegate principle (see below)).
In the Carlauren case, the investors fell into categories 1-5(a), and the administrators had no legal route to undoing their leases (without their consent), and no recourse to these assets for the costs and expenses of the administration.
Administrators to the rescue?
The courts have recognised that, where such a scheme fails and the property owning company is insolvent, an administrator, as office-holder, might in reality be the only party able to resolve the situation. Their unique status as officers of the court, and their powers deriving from the IA 1986 mean they can, among other things:
reconstruct the Company’s books and records, which may be incomplete and out-of-date at their appointment; use their powers under ss 234 to 236 IA 1986 to formally require the directors of the Company and the Company’s former solicitors or advisers to assist in that process; find all purchasers and investors, who may be based around the globe; remove restrictions registered at HM Land Registry to improve the prospects of a sale of the company’s assets and increasing the return to its creditors; preserve, protect and insure a company’s properties until sale; take advice on funding and completing a development where the valuation evidence and availability of funding supports this; market the company’s properties; ensure that all investors, wherever they might be in the world, can engage with the insolvency process and with the court’s involvement; take specialist legal advice and seek directions from the court on how to apportion sale proceeds; investigate why the company failed, the directors’ and advisers’ conduct and potential antecedent transactions the company has entered into.
Where suitable, the administrators can bring legal proceedings to increase the potential pot for creditors.
For example, in the Carlauren case, the administrators got a £40m worldwide freezing order over the assets of its founder Sean Murray. They reported seizing or identifying various luxury assets (including a Rolls-Royce, a Bentley, a Ferrari and a Lamborghini, a yacht, a private jet and two lavish homes) with a view to selling them; prevent individual creditor action against the assets; and sell properties subject to security interests.
Obviously, an institutional secured creditor, such as a bank, may be able to exercise a power of sale of the whole of a development, depending on their security interests. But where there is no such creditor, or no creditor willing to do this, an administration seems the most obvious solution.
Where a development is unfinished, the investors themselves would have been in an impossible position seeking to sell their leases or secured interests (depending on their status) in empty plots of land or unmarketable units individually.
The only alternative to administrators exercising the rights and powers set out above to resolve the situation might be for the court to appoint receivers. Receivership is often a more expensive process, which reduces the amount available for creditors.
That said, the Carlauren case shows the task for office-holders is not a straightforward one. Insolvency practitioners need to examine carefully the basis for the insolvency process, the likely investor rights they face and where they will have recourse for their fees.
The office-holders’ valuation advice in this case was that the group’s properties might be worth £24.75m if sold ‘unencumbered’ by the investor leases; the implication being that as freehold reversions, with the investor leases in place, the value was much different. The office-holders unsuccessfully tried to persuade investors to surrender their leases.
The office-holders had incurred fees of over £2.6m, £1.3m in legal costs and had no obvious route to be paid or reimbursed. They incurred some of these costs directly, holding and selling the properties. Some were the general expenses of the insolvencies (including the litigation against the company’s founder). They applied to the court for directions to allow their fees and expenses to be paid from the sale of the freeholds. This assumed the investors’ leasehold interests could be dealt with without the consent of the leaseholders and the unencumbered valuation achieved.
The office-holders relied on the Berkeley Applegate principle, which was described in Re Sports Betting Media Ltd [2007] EWHC 2085 (Ch) at para 10 as being that:
‘the court has an inherent jurisdiction to require persons beneficially interested in property to subject their beneficial entitlements to a right of payment to persons who have come otherwise than by officious intermeddling into the position of fiduciaries in relation to the relevant fund and have incurred time and cost in realising the fund and identifying the entitlements of the beneficiaries and paying out to those beneficiaries their entitlements.’
They recognised the investors’ leasehold interests were legal interests in land. However, they could not identify a mechanism or jurisdiction for the court to ‘cancel’ these legal interests to allow them recourse to the funds that would be available on an unencumbered sale.
Their position changed at the hearing. They asked the court to declare the officeholders’ rights over the freehold reversions (without adjusting investors’ rights) and to apportion the group’s insolvency costs across the property owning companies.
ICC Judge Prentis decided the new directions reflected what would happen in the normal course and refused to make the order. The office-holders could sell the freehold reversions subject to the investor leases and then seek to charge their fees and expenses to the insolvent estates in the usual way and subject to the usual controls.
This is not the first attempt by office-holders to solve the problem created where unitised property ownership schemes fail. In Re Caer Rhun Hall Hotel Ltd [2019] EWHC 2617 administrators sought the court’s permission under para 71 Sch B1 IA 1986 to sell the freehold of a hotel, free of 57 long leases over individual rooms in the hotel. Again, this was flawed – para 71 allows the court to enable an administrator to sell assets free from security, not free from registered legal interests. They abandoned the application following criticism from the investors.
Thus far, the courts and office-holders have not found a legal solution to the problem from the officeholders’ perspective. Investors with leaseholds effectively hold the power to unlocking the value and cannot be forced into relinquishing their interests. From their perspective, leaseholders are often the biggest ‘victims’ of failed schemes and want to retain control over the outcome – the idea of giving up their leases for the greater good of all creditors will be resisted without adequate safeguards in place for the value they hold.
Currently, without legal reform, the only viable option is a consensual solution in an insolvency of the freehold owning company where investors hold leaseholds. In Australia, the courts have confirmed that a liquidator can disclaim a lease granted by the company to a tenant (Willmott Growers Group Inc v Willmott Forests Ltd (receivers and managers appointed) (in liquidation) [2013] HCA 51). The statutory protection in place for such tenants is that a challenge could be made to a disclaimer where the prejudice caused to the tenant by the loss of the leasehold interest in the land is ‘grossly out of proportion to the prejudice that setting aside the disclaimer would cause to the company’s creditors’ (s 568B of the Corporations Act 2001). The disclaimer provisions in Australia are different to those in the IA 1986, and it is generally accepted that the IA 1986 disclaimer provisions cannot deprive a party of their proprietary rights.
Whilst the administrators of Caer Rhun Hall Hotel Ltd were unsuccessful, we wonder whether para 71 of Sch B1 IA 1986 could be extended to encompass leasehold interests as well as security interests in limited situations. The valuation method to be ascribed to a ‘ransom’ leasehold is likely to be key if such an idea was pursued.
Regulatory Supervision
So where can creditors find recourse? The FSCS will only pay compensation (up to a statutory limit) where there has been evidence that a regulated activity took place. In the context of schemes of this type, typically, this is where: a customer received advice from a company to invest in particular bonds or an investment scheme, rather than being simply shown information about them. This was found to have happened in the case of some creditors of London Capital & Finance plc; or the scheme was a ‘collective investment scheme’ – sometimes known as a pooled investment scheme; a fund which has several people contribute to it and a fund manager who invests their money into assets.
This is not an exhaustive list. So far, the investors in the Carlauren scheme have been refused compensation on the grounds that it was a ‘unitised property ownership scheme’ (an individual buying an individual property) rather than investing in a fund which then invests in the property. Carlauren and its agents deny they were selling collective investments because customers were buying individual rooms and suites. Investors argue that their returns appear to have been paid by a management company that rented the rooms using funds from the Carlauren group, effectively a pool of all the investors’ funds.
As well as the FCA, other regulators are interested in the impact of these schemes. The Solicitors Disciplinary Tribunal (SDT case number 12175-2021) recently struck off two solicitors who purported to act on an execution only basis for nearly 7,000 clients who were victims of a dubious investment scheme involving parking spaces and storage pods. The Tribunal found the solicitors had ‘deliberately failed to provide clients with full advice so as to preserve the income generated from the schemes’.
In light of the apparent lacuna in the insolvency legislation, the proliferation of these types of schemes and many failures, this is likely to occupy the courts for some time whilst they grapple with the balance of interests in play.
This article was first published in the Lexis Nexis Corporate Rescue and Insolvency journal