02/04/2015

Real Estate Quarterly – Q1 2015

Real Estate Quarterly

In this issue, you will find summaries of hot topics discussed during our 2015 real estate seminars:

  • Soil aspects of corporate restructuring;
  • Indexation in question;
  • New environmental parking tax in Brussels;
  • Warranty & Indemnity insurance.

Download the pdf version of the Real Estate Quarterly – Q1 2015.

Soil aspects of corporate restructuring

When corporate law meets soil legislation…

By Wim Vande Velde and Jasper Verberckmoes

The interaction between the Belgian (federal) company law and regional soil legislations is not often discussed in legal works and, until recently, has only rarely been the subject of published case law. Nevertheless, it is clear that certain soil formalities might have a significant impact, both in terms of timing and costs, on proposed corporate restructuring processes.

In this context, it should be noted that the concept of ‘transfer of land’ is defined broadly in the applicable legislation in all three Regions in Belgium. It includes both mergers and demergers, as well as the contribution and the transfer of the whole of or a branch of activity, in so far as the legal entity(ies), whose property will be transferred, is/are the owner(s) of land or the holder(s) of certain rights in rem (exhaustively listed in the applicable legislations).

Compliance with soil formalities may have an substantial impact on the timing and costs related to an proposed restructuring. With mergers and demergers, in particular, attention must be paid to the moment at which the soil formalities must be complied with. Both mergers and demergers require specific approval by the companies concerned. The proposal, in question, must be filed with the clerk of the relevant commercial court and will be published in the Annexes to the Belgian State Gazette. The merger/demerger itself can only be approved after 6 weeks following this publication.

Flemish Region and Brussels-Capital Region

Prior to the approval and filing of the merger/demerger proposal, the transferring entity must, in principle, submit a recent soil certificate to the acquiring entity. The merger/demerger proposal must contain the full text of this soil certificate.

This implies that all soil formalities will, in principle, have to be complied with prior to the approval and filing of the merger/demerger proposal. This may seriously affect timing, especially in cases where the land to be transferred constitutes “risk land”. Depending on whether or not (i) there is an existing soil orientation survey report (Flemish and Brussels-Capital Region) or an approved end evaluation (Brussels-Capital Region), and the date thereof, and (ii) risk activities are being or have been carried out, an (additional) orientation soil survey report and, possible further soil investigations, measurements and, if necessary, soil remediation works may be imposed. These measures will then have to be completed prior to the approval and filing of the merger/demerger proposal.

In the Brussels-Capital Region, the merger/demerger proposal may be approved and filed subject to a condition precedent of receipt of the soil certificate and, as the case may be, the performance of soil remediation measures (including soil investigations). This possibility does not exist in the Flemish Region.

In addition, the relevant legislation in both the Flemish and the Brussels-Capital Regions, provides for an exemption procedure under which the merger/demerger proposal may be approved and filed prior to the transferring company having complied with all required soil formalities. This exemption procedure is, however, subject to strict conditions (e.g. acceptance of an unilateral remediation commitment towards the competent authority, the issue of a financial guarantee to cover the cost of the works) and is only possible if the competent authority for the orientation soil survey (Brussels Capital Region) or the descriptive soil investigation (Flemish Region) gives its prior approval.

In principle, once the merger/demerger deed is approved, no additional soil formalities need to be complied with. However, if “risk land” is to be transferred an (additional) orientation soil survey is required if the notarial merger/demerger deed is approved one or more than one year after the date of the existing orientation soil survey report (Flemish and Brussels-Capital Region) or the approved end evaluation (Brussels-Capital Region) which was used as a basis for the merger/demerger proposal.

Walloon Region

As Article 21 of the Walloon Soil Decree has not yet entered into force, no soil formalities apply to a transfer, in the framework of a corporate restructuring, of land located in the Walloon Region.

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Indexation in question

By Ariane Brohez and Sophie Van Berkel

One of the topics of our 2015 Real Estate Seminars was indexation. Last year, we received a series of enquiries about indexation and have summarised the main aspects analysed.

Is indexation (always) allowed?

On the real estate market, and especially in shopping centres, we have seen certain actors taking issue with the principle of indexation. On the basis of Article 57 of a Law of 30 March 1976 – now largely abolished – indexation of commercial and industrial prices is prohibited, with the exception of rent; clauses to the contrary are null and void by law.

But what is to be understood by “rent”? Is it only the rent, in the strictest sense, that can be indexed? Would indexation then be prohibited for the VAT royalty in shopping centres, usufruct fees…?

Rent is not defined in this Article 57. However this Law of 1976 did provide for an index hike, while freezing rent, and defined this term in section 3, articles 38 to 40. Under these articles and the parliamentary works, the legislator targeted any type of indemnity provided for in any type of agreement related to real estate.

The scope was broadly defined:

… les loyers, redevances, canons ou indemnités sous quelle que forme que ce soit, en vertu d’un contrat de loyer, de leasing ou d’une convention pour quelle cause que ce soit, en matière de biens immeubles, y compris entre autres l’établissement de droit d’emphytéose ou de superficie…

… de huurprijs, de cijns, de canon, de vergoeding, onder welke worm ook, verschuldigd ingevolge een huur-, leasing- of welkdanige overeenkomst betreffende onroerende goederen met inbegrip onder meer van een vestiging van erfpacht of van recht van opstal…

It should then be concluded that, as a matter of principle, the indexation of rent in the broadest sense is allowed.

Are the parties free to decide?

On the subject of indexation, Article 1728bis of the Civil Code makes provision for an indexation formula. Is this formula then compulsory?

When the parties decide not to link rent adjustments to the cost of living, they are free to determine another adjustment mechanism; those most commonly encountered, are variable rents based on turnover and sliding scale clauses.

If the parties to a lease agreement, as envisaged by the Civil Code, decide to adjust the rent in line with the cost of living, this formula is indeed compulsory. Note that for residential leases, the indexation must be agreed upon in writing. Outside the scope of a lease agreement (e.g. a usufruct, certain services), the parties might agree to apply a formula other than that contained in the Civil Code.

* * *

New environmental parking tax in Brussels

By Justine Thiry and Antoine Béchaimont

On 1 January 2015, the environmental tax on excess parking spaces, dreamed up by the Brussels legislative body, entered into force.

Off-street parking restrictions

Encapsulated in the Cobrace, the Brussels-Capital Region Code for Air, Climate, and Energy, the environmental tax is seen as a pillar of the legislation: reducing the environmental impact resulting from mobility needs. The tax applies to all (off-street)parking spaces, with the exception of spaces – (mainly) for housing, public parking facilities (e.g. Q-park, Interparking), hotels and retail establishments. It is clear that this law is patently target at offices with parking spaces.

To achieve its objective, the Brussels-Capital Region has split its territory into 3 different zones, according to their public accommodation accessibility. In a nutshell, Zone A corresponds to the city centre (easily accessible), Zone B to the main entry arteries, and Zone C to the suburbs.

In these zones, the threshold of “authorized” parking spaces are as follows:

  • Zone A: 2 parking spaces for the 1st 250m² and then 1 parking space / 200m² (floor surface);
  • Zone B: 1 parking space / 100m² (floor surface);
  • Zone C: 1 parking space / 60m² (floor surface).

If the threshold is exceeded, the owner may either (i) remove the excess parking spaces or reassign them to new activities, (ii) open the parking to the public (which might raise questions of security and insurance) or (iii) pay the environmental tax.

Description and scope of the environmental tax

The environmental tax is:

  • Due by the permit holder; co-holders of one environmental permit for parking are jointly and severally liable for the payment of this tax;
  • Calculated from the first full year in which the threshold is exceeded;
  • Calculated per excess parking space, at the following rates: zone A, 450 EUR; zone B, 350 EUR, and zone C, 250 EUR (as from 1 January 2022); these base amounts will be anually indexed (consumer price index);
  • Increased by 10% each year, as from the second year; this 10% increase is cumulated for a maximum of 15 years (maximum validity period of the permit).
  • Exemption mechanisms are nevertheless provided for in the Cobrace and are to be reviewed on a case-by-case basis.

Corporate income tax

The environmental tax on off-street parking spaces is a regional tax resulting from the “own” tax autonomy of the Brussels-Capital Region. It is, therefore, a non-deductible expense for corporate income tax purposes in the hands of the permit holder and taxpayer.

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Warranty & Indemnity insurance

By Ariane Brohez, Bénédicte Deboeck and Wim Vande Velde

Those with experience of negotiating share or asset purchase agreements will know that the negotiation of “representations and warranties” and “specific indemnities” and of the related indemnification arrangements, is a time-consuming, yet often crucial part of those negotiations. One of the aids for reaching an agreement on these issues, is the use of “Warranty and Indemnity Insurance”. Although not commonly used in Belgian M&A practice, it is now being increasingly used in other European countries (such as the United Kingdom but also in the Netherlands).

Some general M&A concepts

The main M&A concepts to be taken into account in the framework of Warranty and Indemnity Insurance are:

Representations and warranties can be described as (general) statements made by the seller with respect to (i) the state of affairs of the target company (e.g. relating to compliance with legislation, ownership of assets,…) and (ii) the capacity of the seller to enter into the sale and purchase agreement. If one or more of these representations and warranties proves to be incorrect, the seller will have to indemnify the purchaser (or the target company) for its losses.

The seller’s duty of indemnification will, in most M&A transactions, be subject to a number of limitations and exceptions. The most frequent of these are:

  • Limitation in time: (a claim for a breach of representation will typically have to be made within a certain period of time);
  • Limitation in amounts : often (i) a minimum threshold of losses (“de minimis” / “basket“) will be agreed, below which, seller’s obligation to indemnify is not triggered and (ii) seller’s maximum liability will be capped at a certain level (often a percentage of the purchase price) (“cap“);
  • Disclosures: a sale and purchase agreement typically contains a number of exceptions to the representations and warranties (“disclosures“). They can be listed in a Disclosure Letter (listing the exceptions to the different warranties) but sellers will often try to obtain a general disclosure of all information provided to the purchaser in the framework of its due diligence (“data room disclosure“).

Specific Indemnities usually refers to the seller’s duty to indemnify with respect to specific risks, discovered by the purchaser during its audit (due diligence) of the target company. The limitations, mentioned above, do not normally mitigate the seller’s liability related to specific indemnities.

Often the purchaser will try to guarantee its rights under the representations and warranties and/or the specific indemnities. Several options are available, such as a bank guarantee or an escrow arrangement (whereby part of the purchase price is paid on a blocked bank account to serve as a guarantee for the seller’s indemnification obligations).

Negotiating all these issues can be a complex and tricky exercise. Warranty and Indemnity Insurance may be a useful tool in this respect, as it enables the purchaser to obtain (additional) protection from an insurance company (rather than from the seller) while avoiding additional guarantee mechanisms (such as an escrow), which may be hard to accept for the seller. A (significant) part of the risk relating to the representations and warranties, and sometimes certain specific indemnities, can thus be shifted to the insurer.

Warranty and Indemnity Insurance : main features

Warranty and Indemnity Insurance may be described as coverage against losses that could arise from breaches of the representations and warranties, and sometimes certain specific indemnities, contained in a sale and purchase agreement.

In general, two types of Warranty and Indemnity Insurance exist:

  • Seller-side policy: insures the seller for the loss resulting from claims brought against it by the purchaser as a result of a breach of the representations and warranties (or certain specific indemnities). The coverage under this type of policy often mirrors the coverage, including the limitations, referred to above, agreed in the sale and purchase agreement, with a possible extension to the sellers’ defence costs;
  • Buyer-side policy: covers the purchaser (or the target company) for the loss resulting from breaches of the representations and warranties and/or specific indemnities.
  • Buyer-side policies are most often used in M&A transactions, as they offer advantages to both the seller and the purchaser. For the seller, the use of such a policy enables it to significantly reduce its own contingent liabilities towards the purchaser. In addition, the seller may avoid the burden of having to consent to a guarantee (such as an escrow agreement), which would otherwise limit its ability to freely use the proceeds of the sale. The purchaser, on the other hand, may obtain, through the insurance, an increased entitlement to compensation (e.g. in terms of amount or duration) than it would have been able to negotiate with the seller. In addition, in some cases, the insurance policy may also address the purchaser’s concern about the solvability of the seller.

Although this type of policy is typically “tailor made”, some general insurance features will apply to Warranty and Indemnity Insurances, such as:

  • The insured will have to pay a premium. Although this will vary on a case by case basis, (depending, amongst other things, on the risks to be covered, the (tipping) retention, the remaining liability for the seller under the sale and purchase agreement, …), the premiums for this type of insurance usually vary between 1% and 2.5% of the limit of the amount insured;
  • The insurance policies will also provide for a “retention”, (or “deductible“,or “excess“), being the amount of losses to be borne by the insured before the insurance policy can be called on. Again, the amount of the deductible will depend on specific variables, but will often be around 1% of the total value of the transaction. A “tipping retention”, similar to an aggregate de minimis, might also be envisaged;
  • The insurance policy will typically contain a number of exclusions (matters which are not covered by the insurance). This will depend on the negotiation of the insurance policy but “typical exclusions” include: all disclosed matters, knowledge of the insured, fraud on the part of the insured, criminal fines, forward looking warranties and transfer pricing warranties. The exclusion of all disclosed matters may, of course, significantly reduce the scope of the coverage if a data room disclosure has been agreed in the sale and purchase agreement. However, in these cases, requesting coverage for certain specific indemnities (even if disclosed in the data room) appears to remain negotiable for insurers;
  • Procedure: The insurance policy will provide for a specific claim procedure which the insured will have to comply with in order to make a valid claim under the policy.
  • Warranty and Indemnity Insurance as an M&A structuring / negotiating tool

As shown by its increasing use in European M&A practice, Warranty and Indemnity Insurance can be an interesting tool in structuring and negotiating M&A transactions.

For sellers, Warranty and Indemnity Insurance allows them to (significantly) reduce their contingent liabilities under a sale and purchase agreement. An effective insurance policy may even allow a “clean exit” for a seller. This can be particularly interesting for private equity funds or closed-end real estate investment funds (who wish to distribute the proceeds of a sale without having to retain part of the purchase price against potential claims by the purchaser) or sellers who require (the entire amount of) the proceeds to pay back existing debts.

Purchasers may also benefit from Warranty and Indemnity Insurance, as it may enable them to increase the level and duration of the compensation terms as compared to those under a straight sale and purchase agreement. In certain cases, it may also protect them against potential sellers’ solvability issues. Furthermore, in private auction processes, the use of Warranty and Indemnity Insurance may distinguish a bid from competing bids, as an effective insurance policy will enable the bidder to seek less indemnification from the seller under the sale and purchase agreement.

The effectiveness of Warranty and Indemnity Insurance will, to a large extent, be determined by the terms and conditions of the insurance policy itself, and more specifically by the scope of its cover. In order for it to represent real added value, the main risks will need to be covered by the policy and should not fall within the excluded risks.

The use of a Warranty and Indemnity Insurance will have an impact on the negotiation process itself.

The insurance company will want to make its own risk assessment (by reading due diligence reports, requesting advice from its own advisers on certain topics,…), which may have a (limited) impact on timing. When considering the use of Warranty and Indemnity Insurance, the party/parties involved should, therefore, contact the insurance company early on in the process and provide them with a realistic set of representations and warranties / specific indemnities for which they request coverage.

The use of a Warranty and Indemnity Insurance implies a number of additional commercial and technical questions which will have to be dealt with during the negotiating and drafting stages of the sale and purchase agreement. For example, the (possible) impact of the insurance premium and of the retention amount on the price, the applicable law (the same law should apply to the insurance policy and the sale and purchase agreement), the legal subrogation right of the insurer (which may be waived but this will of course increase the premium), the choice of the insured party (being the purchaser and/or the target company), the benefit for the insurer of some clauses regarding the determination of the loss, the tax treatment of an insurance payment received by the purchaser and/or the target company and the related possible impact on tax gross-up clauses, the conduct of claims, the transfer of the arbitration clause,…

Conclusion

The use of Warranty and Indemnity Insurance in Belgian M&A practice is still exceptional. However, the focus on risk management and the growing use of Warranty and Indemnity Insurance in other European countries, may cause it to be used more frequently in Belgium than has been the case up till now.

Whether a Warranty and Indemnity Insurance is appropriate for a given transaction will depend upon the terms of that transaction, taking into account its context (private auction process or not), the (financial) situation of the parties, the scope of insurance that can be obtained (in the light of the risks discovered during due diligence),…

Warranty and Indemnity Insurance will not, therefore, replace negotiations between seller and purchaser about representations and warranties, specific indemnities and indemnification, but may, in certain cases, offer an effective tool in finding a solution acceptable to all parties involved.