Property Joint Ventures Gone Wrong - Case Studies (2 Part Blog Series) - Part 2

This is a two part blog series. In this, Part 2, I write about two case studies, showing what can go wrong in a joint venture. In Part 1 of this blog post series, I wrote about some basics about structuring Property Joint Ventures.

As I alluded to in Part 1 of this blog post series, here are two examples of when property joint ventures goes wrong and why having a robust joint venture partner assessment policy followed by a comprehensive agreement in place is so vital.

Case Study 1 - Assisted Sale Agreement

This was an assisted sale deal. Now some of you reading this might think an assisted sale isn’t really a JV. I respectfully disagree. The JV partner here is the property owner, who the property investor is entering into a project or enterprise with, to enhance the value of the property in order to sell it for a profit and share the spoils. The investor is reliant on the property owner holding up their end of the JV by allowing or not interfering with the value add part of the project and (usually) for the investor to then handle the sale of the property and distribution of funds.

I acted for a property investor (on his first assisted sale deal) who had agreed with the property owner so that:

• the property owner would hand over vacant possession and the keys to the property

• the property investor would refurbish the property

• the property would then be sold by the investor and the funds shared between the parties, in accordance with the terms of the assisted sale agreement

Sounds simple enough right? What could possibly go wrong?

Despite signing the assisted sale agreement and receiving £10,000.00 as an upfront payment from the property investor for entering into the deal, the property owner took almost two weeks to handover keys to the property. During this time, the investor’s builder had taken on another job and was thus unable to start work on this property.

When the investor turned up at the property, he noted there were a few ‘red letters’ lying on the doormat, some of which were from the mortgage lender. Worried, the investor opened the envelope, read the letter and discovered the mortgage on the property was in substantial arrears and repossession proceedings would be heard in Court the following week! The investor called me in a state of panic and asked what he could do. (In the assisted sale agreements that I prepare for clients, I include a Power of Attorney, which allows the property investor to use it in scenarios just like this and even sign the paperwork on the sale of the property, in the event the property owner is abroad, etc.)

I told my client to send a copy of the Power of Attorney to the bank, wait a day or two for the post to arrive then call the mortgage lender to explain what he was doing with the property and then negotiate some time to sort things out. The mortgage lender initially did not accept the Power of Attorney so, some time was spent trying to convince them - this included having to send them a copy of the assisted sale agreement. Eventually, the mortgage lender accepted the Power of Attorney and communicated with my client but asked for a lump sum payment of the arrears before halting the repossession proceedings. So, even before the refurbishment works started, the property investor had to borrow additional funds, funds that were not accounted for when he first stacked the deal, to pay the mortgage arrears.

Fortunately, the assisted sale agreement that I drafted provided for the entire mortgage loan amount to be deducted from the property owner’s share of the profits of this venture. It just meant that the property investor had an unplanned cash flow issue to contend with.

First crisis averted - first set of grey hairs!

The builder starts and eventually completes the work. Usual delays for bad weather and unexpected repairs but otherwise, nothing too major. The property is fully refurbished and ready to be sold. The property investor lists the property for sale and because the finish was exemplary, a suitable buyer at the right price is found, relatively quickly. Good news … or was it?

The estate agent prepares and circulates the memorandum of sale. Naturally, the property investor comes back to me to act on the conveyancing, using the Power of Attorney. The property owner then resurfaces (apparently he had used the £10,000 to go on holiday to the Caribbean - rather than pay down the mortgage arrears!) and tells the estate agent and the buyer’s solicitor that he is the true owner and he will be taking over conduct of the sale. As his name is on the title, the estate agent and buyer’s solicitor accept this. The property owner thus appoints his own lawyer.

The property investor clearly sensing the property owner is up to no good, starts panicking again. I try to calm him, assuring him the restriction I registered on the title to the property should protect him, as will the Power of Attorney. There is also his goodwill with the mortgage lender, but as arrears have been paid by the property investor, who has also been making the mortgage payments, they are less fussed about being involved.

The property owner’s lawyer applies to the Land Registry to remove the restriction, claiming the time period in the assisted sale agreement had expired. Uh oh! Panic again for the property investor and this time, a slight panic for me too! Naturally, we object to the Land Registry, who, because of that objection, now has to instigate their investigation and arbitration process to determine whether our objection stands or the application to remove the restriction should be completed. Phew! We bought ourselves some time.

Now comes the hard part! Negotiating with the property owner by getting him to comply with the terms of the assisted sale agreement. He’s not having any of it - communication is difficult to say the least. After some swearing and threats by the property owner, all direct communication between the property owner and property investor breaks down. It’s left to me to negotiate with the property owner’s lawyer. Two lawyers negotiating a settlement? That’s surely a recipe for disaster!

I try, and after lots of to-ing and fro-ing, it comes down to us insisting we will not release the restriction until what is due to our client is paid to our client. Solicitors undertakings are exchanged - between the property owner’s lawyer, the buyer’s lawyer and myself. The property owner’s lawyer and the buyer’s lawyer then continue with the conveyancing, the sale completes and the property investor recovers all the money he put into the project but not much else. Not the profit and thus, because of all the aggro, hassle and opportunity cost of tied up funds - in fact a loss!

This case study goes to show that humanity can be mean and hard or interesting times will bring more of the ‘dark side’ out. Be wary, be careful but in the round, do not fear entering into JVs. Life and business is all about taking calculated risks, hedging the downside and having the wherewithal to see you through the hard times.

Case Study 2 - Buy-Refurb-Sell

This was a Buy-Refurb-Sell deal involving a hotel. The plan was for my friend to source the deal, acquire and refurb it using the JV partner’s funds in a SPV limited company then sell each individual unit, on a title split basis. The JV partner has a relatively high profile, operates a property education business and thus attracts a lot of other JV partners and investors. (I did not act on any of the conveyancing or the JV structure nor agreement. In fact, my friend and I didn’t know each other well at this point so the trust hadn’t yet been established for me to be in a position to guide my friend.)

Initially, the sourcing and acquisition of the deal went fine. The JV partners soon realised that the initial plan would no longer stack because the resale values of each unit would be lower than the refurb costs. Perhaps it was a change in market conditions or possibly inexperience of the JV partners in either that type of project or that local market. Regardless, the original model/plan was no longer viable and an alternative plan had to be formulated. The JV partners decided on a Buy-Refurb-Refinance to hold longer term. Such a pivot in business is nothing unusual, sometimes the original plan doesn’t work out and you need to go to plan b.

The problem was, both JV partners did not have strong credit profiles so, whilst they did secure some lending to acquire the property, with some difficulty; a refinance of the property would be slow and challenging. What’s more, my friend’s JV ‘investor’ partner, it appears, had either borrowed his funds from his students or had been placed in funds by his students as his JV partner investor. To an outsider, this looks like a ponzi scheme but since we do not know the detailed inner arrangements of how these funds were ‘moved around’, it would be difficult to ascertain whether there was indeed a ponzi scheme. What we do know is that other students/investors/lenders have had bad experiences with this individual.

In short, the funds that were available for this project were limited and short term. More funds couldn’t be raised easily and the funds that had been raised, were meant to be returned in short order.

Then my friend discovered a hole in the roof. An unaccounted for cost. He approached his JV partner ‘investor’ who became ‘indisposed’ and wasn’t communicating. Worried that the leaky roof will cause further damage to the property, my friend borrows the funds and fixes the roof. No discussion nor agreement is reached with his JV partner on whether my friend’s financial contribution is to be treated as a loan to the SPV limited company - with a fixed rate of return or as equity - with a return linked to the profit that the JV project generates.

The two JV partners incorporated the SPV limited company with their respective investment holding companies as the 50/50 shareholders. My friend has full control of his investment holding company, i.e. no one else is involved. His JV partner on the other hand had his wife (at the time) as his co-director and shareholder. On one occasion, when there was insufficient funds to meet the monthly finance payment, the wife of my friend’s JV partner (who was in control of the finances) decided to cancel the direct debit mandate. This made the finance lender pay closer attention to the property and the JV, which meant an increase in monitoring and reporting administrative hassle.

Remember I mentioned above about the various factors to consider before entering into a JV? The experience and business-like or rather lack thereof of the co-director and co-shareholder of your JV partner should form the basis of your pre-JV due diligence.

Then came the interim charging orders. It transpired that my friend’s JV partner had over-extended himself. Borrowing funds from quite a few of his students and others in his network meant scaling too big, too soon. (I speak from experience that growing too big, too quickly, without having the correct procedures, policies and personnel in place can be very challenging in business.) For my friend’s JV partner, this appears to have been disastrous. The JV partner was being sued on multiple fronts. Some of those were successful which enabled the ‘investors/lenders’ to secure Court orders to register interim charging orders on my friend’s hotel project. That in turn has put the finance lender on notice of major issues on this property and as a result, they are likely to call in the loan, unless a substantial lump sum payment is made to the finance lender to reduce the borrowing on the property.

Did I mention the divorce? The JV partner’s wife was divorcing him, on the grounds the JV partner was promiscuous. Due to the breakdown in the relationship, the (now) ex-wife wasn’t willing to sign any paperwork for the JV partner’s investment holding company nor on the JV SPV limited company with my friend. So, even if my friend was able to find an investor to replace his JV partner, his JV partner’s wife is unwilling to sign the paperwork to give effect to this. As a result, my friend is stuck and appears unable, without resorting to litigation (which will be expensive), to extract either himself or his JV partner from this JV. The success of the litigation of course assumes there is a decent JV/shareholders agreement in place - well there isn’t!

Two quite different nightmare situations!

Is your JV agreement robust and comprehensive? In light of the above case studies, do you need to revisit your JV agreement? 

I recently ran a webinar on the fundamentals of successful property joint ventures and the pitfalls to look out for. If you would like to watch the replay of that webinar on my Training Academy.

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