European Real Estate Finance: Market Update – Q2 2023

New Civil Code

On 1 January 2023, Book 1 and Book 5 of the Civil Code in Belgium entered into force following publication in the Belgian Official Gazette. The new legislation only applies to legal acts that occur following the commencement date; and will not therefore apply retrospectively. As a result, any contracts (and unilateral acts) entered into prior to 2023 will continue to be regulated by the old civil code. This also extends to any amendments made to such contracts.

An issue of note for our clients is that Book 5 now regulates the transfer of debt, which was previously not regulated by the old civil code and provides useful information for when commitments are being transferred under loan agreements. Book 5 sets out the following transfer methods:

• a "complete assignment" whereby provided that the assignor and assignee contractually agree to the assignment, the assignment takes place once notified to, and acknowledged by, the underlying counterparty creditor. Once this happens, the assignor is released from all future obligations. As a result, any security will be released, unless the grantor of the security consents to the security staying in place. Accordingly, it is imperative that this consent is sought for any secured real estate financings; and 
• an "incomplete assignment" whereby consent has not been obtained from the underlying counterparty creditor. The assignment will become “complete” once consent is obtained, but in the meantime, the assignor and assignee remain jointly and severally liable to the counterparty in the meantime. The security will accordingly also stay in place during this interim stage.

Directors' Duties on Insolvency

In November 2022, Germany enacted the Law on the Temporary Adjustment of Restructuring and Insolvency Law Provisions to Mitigate the Impact of Crises (the "Provisions"). The provisions have eased directors’ duties on insolvency in cases where insolvency is declared on the mandatory ground of ‘over-indebtedness'.

The Provisions shorten the forecast period that directors must analyse when considering if a company is over-indebted from 12 months to four months and the period for filing for insolvency has been extended from six to eight weeks. The provisions apply to all companies regardless of their financial situation.

Whilst the Provisions will only be in place until 31 December 2023, they can be incredibly helpful for directors, when making the difficult decision as to whether a filing is required. For creditors however, this may delay the point at which it is made aware of impending financial difficulties for the company and related enforcement and/or restructuring discussions.

However our clients should note that filing for insolvency on the mandatory ground of 'inability to pay its due debt' (the more commonly used ground) is not affected by the Provisions. Therefore, the current legal situation remains unchanged, i.e. an insolvency petition must be filed immediately upon the occurrence of insolvency, but within three weeks at the latest.

Extended Realization Rights (or lack of)

In a judgment passed down on 27 October 2022, the German Federal Court of Justice clarified that an insolvency administrator's right of realisation under s166 of the German Insolvency Code does not provide an ability to enforce share pledges or other immovable assets such as patents and IP rights. It was previously the view of leading insolvency practitioners that the administrator could enforce such security on behalf of the pledgee through a realisation agreement that was negotiated between the administrator and the pledgee. The German Federal Court has clarified that this is an incorrect interpretation of s166 and that the only person with the ability to enforce the pledged rights is the pledgee themselves; and not the administrator. As such, the rights of the administrator under this provision would be to realise movable property and assigned rights in its possession only. 

Non-possessory pledge

On 12 January 2023, the Italian Revenue Agency issued the necessary technical standards for the registration of the non-possessory pledge over movable assets. The non-possessory pledge is a new type of security in Italy (akin to England's floating charge) and is a security charge that can be established over current and future, tangible and intangible assets, that are used in business activity. 

The pledge allows the pledgor to retain possession over the assets and dispose of the assets in accordance with the business’ needs, whilst, at the same time, extending to newly purchased replacement assets. The security therefore allows the company the flexibility of continuing on with their business, without restriction. To be enforceable, the pledge must be registered and the registration expires after 10 years. As of today, this registration is not operational, since the last implementation step has not yet been undertaken by the Italian Revenue Agency. After full implementation of the register, this new form of security will be available for use on financing transactions. 

Reform of Enforcement Proceedings

Legislative Decree No. 149 of 10 October 2022, which provided for major reforms of the justice system, also enacted significant changes for enforcement proceedings. In an effort to further simplify and reduce the length of enforcement proceedings in Italy, the new rules, applicable as of 1 March 2023, include the following:

1. certified copies of court decisions and notarial deeds shall no longer require the enforcement formula (formula esecutiva) to be used as an enforcement title (titolo esecutivo);
2. the filing by the creditor of any cadastral and mortgage documentation relating to the asset to be disposed of shall occur within 45 days from the date of the foreclosure (i.e. simultaneously with the filing of the sale request (istanza di vendita) rather than within 60 days from such request);
3. the custodian of the asset shall be appointed simultaneously with the expert appraiser. In addition, the appraisals and the notices of sale relating to the asset shall be prepared on the basis of standardised templates; and
4. the inclusion of a debtor’s ability to conduct a direct sale (vendita diretta) of the asset, i.e. a new process enabling the debtor to find a buyer of the property and sell it at a price no lower than the estimated market value.

110% Superbonus

By Law No. 38 of 11 April 2023, the regime for the '110% Superbonus' has been amended. The 110% Superbonus is a measure to finance the energy and seismic renovation of buildings, including social housing. The relevant legislation sets out the works which, subject to certain conditions and requirements, may be eligible to benefit from tax relief (a tax deduction for the tax-payer who carries out the intervention). 

Initially legislation provided for two different options to benefit from the Superbonus: (i) the application of a discount on the cost of the building improvements, as invoiced by the relevant supplier/construction company; and (ii) the conversion of the tax deduction into a tax credit, which is transferable to third parties. However, whilst the duration of the incentive scheme has been extended until 31 December 2025, a number of changes have been made: (i) the option to obtain an invoice discount has been severely restricted, as has the assignability of the tax claims; (ii) tax-payers are required to satisfy additional subjective requirements before they can benefit from the scheme; and (iii) the size of the incentive will be decreased over the next few years (i.e. from 110% to 65%).

The 110% Superbonus scheme contributed to economic recovery in Italy during and after the COVID-19, helped reduce CO2 emissions from buildings and provided for savings on energy bills. If further extended, this incentive scheme, together with such other similar measures, which may be implemented by the Italian Government, are expected to play an essential role in the implementation of the EU Directive on the energy performance of buildings and the achievement of the commitments on climate neutrality by 2050.

Capital gains of non-Italian entities in connection with Italian real estate investments* 

The 2023 Budget Law has introduced a new taxation regime applicable to capital gains of non-Italian entities in connection with Italian real estate investments. 

Under the new provisions capital gains arising from the disposal of non-Italian unlisted entities owned by non-Italian residents, and which derive more than 50% of their value from Italian real estate, will be considered to be taxable in Italy. Furthermore the tax exemption under article 5 of Legislative Decree No. 461/1997 will no longer apply to gains realised from the sale of unlisted entities (wherever located), which derive more than 50% of their value (even indirectly) from Italian real estate. 

An exception to the new regime may apply if: (i) the underlying real estate investments are assets which qualify as “inventory” of the relevant non-Italian entity (i.e. the corporate purpose of the latter is building or trading of real estate assets) or instrumental assets; or (ii) the gains are realized by certain foreign collective investment schemes located in EU and EEA countries if certain conditions are met. 

* With the contribution of external tax counsel 

In our previous update (available here), we mentioned that amendments to the double tax treaty were likely to take effect in 2023. However, since that update, whilst the UK ratified the new treaty in October 2022, Luxembourg are yet to ratify the treaty. The Luxembourg bill, approving the double tax treaty, was introduced in the Chamber of Deputies on 24 February 2023, but remains to be adopted. It is expected to be adopted at some point in 2023, but the effect of this is that the changes that were due to be implemented will now not take effect until 2024, at the earliest.

As previously noted, one of the most significant changes for our real estate clients is the change to the capital gains tax position. Under the terms of the new treaty, a Luxembourg resident disposing of a company would now be subject to UK tax rights on the sale of shares. The delay means that any Luxembourg investors disposing of UK companies continue to avoid incurring UK tax liabilities in the meantime.

New Restructuring Regime

Luxembourg is now the latest EU member looking to implement the EU Restructuring Directive 2019/1023 (as is the case with, for example, Italy, Spain and Sweden (see our previous update, available here, for more information on this)). On 28 October 2022, the Luxembourg Parliament adopted the law introducing the procedure of administrative dissolution without liquidation. The bill is expected to be adopted in 2023 but no further information has been announced at this time.

Amendment to Spanish Stamp Duty

Effective from 24 November 2022, amendments to Spanish Legislative Royal Decree 1/1993 governing Transfer Tax and Stamp Duty, have been made, providing for an exemption to stamp duty in the case of certain mortgage novations covered by the newly approved Code of Good Practices for the restructuring of mortgage debt on habitual dwellings. The exemption, preliminarily intended to be of a transitory nature (two years), is aimed at reducing the increased cost burden specifically associated with interest rises on mortgage loans related to first residences of troubled individuals. It is interesting to note that this exemption is now available both to financial credit institutions, and also, by contrast, to the past, to other qualifying professional lenders, which may now consider the economic impact of this benefit in the event of facing this type of restructurings.

Register of Overseas Entities

As detailed in our last update (available here), the Economic Crime (Transparency and Enforcement) Act 2022 (the "Act") received royal assent, with most of the provisions relevant to our clients taking effect from 1 August 2022. The Act requires overseas entities who wish to acquire certain real estate in the UK, to register with Companies House by providing certain information about their beneficial ownership, before they acquire the property. However, the Act also had retrospective effect, such that the Act required overseas entities, which owned registered property before 1 August 2022, to register with Companies House on or before 31 January 2023. However, by 24 April of this year, only 27,500 of the 33,000 estimated overseas entities had successfully registered.

Now that this deadline has passed it means, any overseas entities that have failed to register will be unable to sell, lease or grant a charge over its land until they successfully register (with the Land Registry obligated to place restrictions against the title in the meantime). In addition to this, civil and criminal sanctions apply, such as a daily fine of up to £2,500 can be imposed; as well as prison sentences. Clients are therefore advised to act swiftly to register to avoid any unintended consequences. Further details are available here.

EPC Ratings

From 1 April 2023, changes were introduced to the Minimum Energy Efficiency Standards Regulations. It became unlawful for landlords to continue to let out commercial properties with an EPC rating of F or G. Accordingly, if a landlord wishes to rent a property that does not meet these requirements, they will either need to complete renovations to increase the rating to an E (at least) or they will need to register a valid exemption on the Exemptions Register. Some of the exemptions include:

• the consent exemption, where there are third-party restrictions prohibiting the completion of works; 
• the devaluation exemption, where a surveyor believes the market value will decrease by 5% or more as a result of the works; and 
• the seven-year test, where it will cost the landlord more than seven years of energy savings to recover the cost of the works.

Penalties have also been introduced for any landlord that continues to let properties failing to meet the requirements. They could face a fine of up to £150,000, and any breaches will be entered onto the Exemptions Register.

There is an expectation that landlords will start divesting themselves of properties, given the potential cost of undertaking their improvements. With suggestions of the UK government’s aim is to increase this rating to a C by 2027, before rising to a B by 2030, divestments in these properties could be a longer-term problem. From a buyer’s perspective though, this could be an opportunity, especially given that a buyer purchasing a property failing to meet the EPC requirements can apply for a six-month exemption (or potentially a longer term exemption of up to five years to complete any works required to upgrade the property). Further details are available here, including the ability to obtain funding to assist with such projects.

Pay Now, Argue Later

The case of Sara & Hossein Asset Holdings Ltd v Blacks Outdoor Retail Ltd [2023] UKSC 2 concerned a dispute between a landlord and tenant as to the amount of a service charge payable by the tenant. According to the terms of the lease, the landlord was expected to provide a certificate of the total costs and the sum payable by the tenant; and that in the absence of manifest or mathematical error or fraud, such certificate would be conclusive. The tenant challenged the certificate on the basis that this only showed the landlord’s costs; and not the amount payable by the tenant. The tenant contended that they should not have to pay the full costs incurred by the landlord, especially where there were disagreements on the necessity of works carried out. 

The Supreme Court stated that an objective interpretation of the lease (taking into account the operation of other clauses in the contract), was that the certificate was conclusive of the total costs incurred by the landlord, but not of the tenant’s liability. However, they suggested that the tenant should have first paid the sum, but then relied on other dispute resolution clauses within the contract to raise a grievance as to the amount of the charge. This effectively suggests that such service charge clauses operate as a ‘pay now, argue later' provision. According to the Supreme Court, this approach assured the landlord of payment without delay, yet still allows the tenant to dispute the charge. 

Fire and Building Safety

On 23 January 2023, the Fire Safety (England) Regulations 2022 (the "Regulations") came into force. The Regulations implement the majority of the recommendations from the Grenfell Tower Inquiry in the aftermath of the Grenfell Tower disaster and introduce a number of changes to the existing law. The Regulations impose more obligations on the ‘responsible person’ (which, would include the building owner, but could also include persons in control of common parts of the building) and apply to all multi-occupied residential buildings in England with common parts.

As such, the impacted buildings can include real estate assets commonly seen in real estate financings, such as student accommodation and mixed-use properties that have a residential element. 

The duties vary according to the size of the buildings but, at minimum, will require the provision of information to tenants on fire safety instructions and fire door information on an annual basis. For high-rise buildings over 18m in height or with seven storeys or more, the duties are most stringent and include monthly checks on evacuation routes and keeping in communication with the local Fire & Rescue Service. However, more critically, for residential buildings over 30m in height, the results of a consultation (which closed on 13 March 2023) are pending, seeking views on whether an additional second staircase should be built to provide alternative exit routes in the event of a fire. Both our real estate and lender clients should keep abreast of this point, as there are likely to be substantial additional costs for impacted properties, which may need to be factored into any real estate financings. 

LIBOR Discontinuation

After years of discussion in this area, the end is in sight for LIBOR. On 30 June, the remaining few (USD) LIBOR settings will cease or become unrepresentative (with all other settings having already ceased). For new contracts therefore, parties should now be using one of the five successor rates that are available, depending on the currency in use. In the case of sterling, SONIA is now actively used in the market, with the compounded in arrears formulation used for calculating interest in documentation, given the limited use cases permitted for term SONIA.

However, a different course was taken in the US, with borrowers and lenders given more scope to choose between term SOFR and a compounded in arrears formulation. As such, we are now seeing an increased use of term SOFR in our transactions.

The UK's Spring Budget

On 15 March 2023, the chancellor issued the UK’s budget plan, which builds upon the mini-budget that was introduced in September 2022. The introduction of the spring budget is intended to help revitalise the UK economy and support growth across the country. In its latest report the Office for Budget Responsibility confirmed the economic outlook of the UK has improved since its last forecast in November and that despite previous concerns, the UK would avoid falling into a (technical) recession later this year. Whilst a number of new policies were put forward, the changes likely to affect our real estate finance clients were the following:

• it was confirmed that the main rate of corporation tax on taxable profits over £250,000 has increased from 19% to 25%. Profits of less than £50,000 will attract 19% tax and businesses earning profits between £50,000 and £250,000 will be taxed at the main rate; but may be eligible for marginal relief;
• companies will be able to deduct investment in new machinery and technology to lower their taxable profits. There will be a 100% capital allowance on investment in new plant and machinery and a 50% first-year allowance on investment in special rate plant and machinery, with the remaining 50% deductible in subsequent years; and
• new investment zones will also be introduced across 12 sites in the UK. These zones will benefit from tax incentives, including tax breaks, and will each receive £80m in funding across the next five years.

The Collapse of Silicon Valley Bank and Others

News of Silicon Valley Bank’s ("SVB") demise in mid-March sent shockwaves across the finance sector, with many considering implications under their loan documentation; as well as wider implications of the collapse.

For those holding deposits with this institution, thankfully in the US, the Federal Deposit Insurance Corporation (FDIC) stepped in to protect depositors and in the UK, the takeover of the UK subsidiary by HSBC ensured the same. Otherwise depositors would have had to rely on national provisions on this, which equate to $250,000 and £85,000 respectively, in the US and UK.

If SVB were a lender under your loan agreement, thought was being given to whether defaulting lender (and possibly impaired agent) provisions were activated; and whether this had the knock-on effects of potentially downsizing commitments under your loan. Again however, FDIC’s actions in the US and the acquisition by HSBC in the UK meant that the status quo was to be preserved and borrower groups were expected to continue to service their loans.

Since then, there has been other collapses and takeovers in the US and Europe (most notably, that of Credit Suisse), but thankfully regulators have stepped in speedily to avoid too many issues from a documentation stand-point.

Certain of our recent discussions on this topic are available here and here.