Cross hoarders

The growth in property financing in Europe has led to the need for a better understanding of overseas security transactions, say John Fordham and Clare Maunderis

Pan-European property transactions are becoming increasingly important. It is now commonplace for investors and lenders to look beyond their borders to expand portfolios and spread risk.

The importance of pan-European financing transactions to global companies is illustrated by ProLogis. ProLogis has built the first global network of distribution facilities that enable companies to streamline critical supply chain operations across the world. In Europe, it has approximately 280 distribution facilities across 11 countries. But as both investors and lenders continue to expand their scope of interest, so the demand increases for legal advisers that can field international teams. Not only do law firms need experts in each of the relevant jurisdictions, they also need lawyers experienced in cross-border transaction management.

Real estate security is one of the more difficult areas for lawyers and their clients to gain a working understanding of the legal issues in different jurisdictions. It is linked intrinsically to local laws governing ownership of real estate and local insolvency regimes. While the EU Insolvency Regulation (Council Regulation (EC) No 1346/2000) that came into force in 2002 has introduced principles of mutual recognition and co-operation, it has not introduced a single European insolvency law. The ‘Holy Grails’ of a European mortgage and single insolvency regime are still a long way off.

The type of investment vehicle, its place of incorporation, tax status, location, nature of the real estate assets and of the borrowing are a number of the factors that will need to be taken into account when structuring pan-European property financing. Typically, the principal security will be over the shares of the asset-owning special purpose vehicle (SPV), but with additional security over the underlying real estate assets in order to give the lender the option of direct recourse to the assets.

Useful considerationsIssues that arise when putting in place pan-European real estate security include:

  • Cost: in some countries, such as Germany, Italy and France, there is a material cost involved in taking security over real estate. In France costs include mortgage registration duties of 0.615 per cent of the amount of the loan, together with a registrar’s fee of 0.05 per cent and notary’s fees of 0.55 per cent (although this is negotiable). A mortgagor may wish to consider whether it qualifies to use a PPD (privilège de prêteur de deniers), as opposed to a mortgage, in order to benefit from lower fees.
  • Enforcement procedures: these can be more time-consuming and complex than a UK lender is accustomed to. In some jurisdictions enforcement procedures are considered to be more ‘debtor friendly’ than in others (for example Italy and France – although in France recent reforms on security and seizure of property are reversing this trend). In Italy enforcement has traditionally taken several years, depending on the efficiency of the local court where proceedings are being brought. Recently implemented legislation means that the length of foreclosure proceedings may be reduced to between two or three years – still a considerable length of time.
  • Control of enforcement: it is essential to understand who has control of any enforcement procedures. Standard & Poor’s, in its European Legal Criteria 2005, considered lack of control to impact on the viability of a secured loan-structured financing. An example of this is that in some jurisdictions, on enforcement, the asset may have to be sold at auction. In France, this is one of the options available to the insolvency judge who has control of the enforcement process when the debtor company is subject to insolvency proceedings (although new reforms will make it possible for creditors to be allocated the property in a more straightforward way). This means that the lender, who would ordinarily expect to continue to service debt from cashflow produced by the assets, will have to rely on the sale price to repay the debt.
  • Tax: when considering the security position across a number of European countries, a lender needs to be advised about the local tax regime where the underlying real estate assets are located, in particular any withholding tax requirements. The local tax practice may give rise to specific issues that need to be covered in the security documents. For example, in Italy the lender may look for a security assignment from the borrower of any VAT credits that have arisen on acquisition of the property.
  • Alternative structures: one needs to consider the appropriate security structure in each jurisdiction. It may not always be appropriate to take a mortgage over the underlying real estate assets as we do in the UK. For example, in Spain lenders have started to take ‘conditional mortgages’, whereby only a limited percentage of the loan is secured at the time of the creation of the mortgage in order to minimise stamp duty. The rest of the coverage is conditional upon certain events. If the condition is fulfilled, and the higher coverage triggered, the increased mortgage is put in place, which will have the same rank as the original. It should be noted, however, that this new structure has recently been questioned by a non-binding ruling issued by the tax authorities.

    The above complexities have been one factor in a recent trend towards ‘synthetic’ transactions, in which debt investors can obtain exposure to the performance of the underlying real estate assets through a credit default swap, rather than the traditional loan and security.

    John Fordham is a partner and Clare Maunderis a senior associate at Freshfields Bruckhaus Deringer