Welcome to the latest issue of Bell & Scott’s Strategic Land Update. Our Strategic Land Unit is the only team in Scotland to focus on legal advice on strategic land deals. For further information see our website.

This e-update is issued quarterly and will also be available to download from our website.

Strategic Land Update seeks to cover a wide range of topics of relevance to those interested in strategic land issues. In this issue, we comment on a case where a coal extractor lost out on a valuable option agreement to acquire land.

In addition, we include a number of other relevant news items.

If you wish to discuss any of the items in this edition or require advice on strategic land issues please contact either Bruce Anderson: DD: 0131 718 2399 e: b.anderson@bellscott.co.uk or Neil Fraser: DD: 0131 718 2499 e: n.fraser@bellscott.co.uk

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Recent Decisions

Black News from the Coalface
Option rendered worthless despite parties acting reasonably

Danish Forestry Company Limited (Danish) owned Dalrig Plantation. In 2007, Danish granted an Option to Purchase to The Scottish Coal Company Limited (Scottish Coal). The price was partly a capital sum, to be paid when Scottish Coal took ownership of the land, and partly ongoing royalty payments related to coal extraction. By way of security for the future royalty payments, Scottish Coal was to grant a Standard Security (mortgage) to Danish over its newly acquired land. If Scottish Coal failed to make the royalty payments, Danish could re-sell the land to another party to meet that debt.

It was expected that Scottish Coal would also grant securities to its funders, and so the Option Agreement provided for the Standard Security granted to Danish to rank before any other securities affecting the land. To give effect to this, Danish would need to enter into a Ranking Agreement with Scottish Coal’s other secured creditors at the time that Scottish Coal acquired the land. The Option Agreement said that:

"…Danish agrees to enter into an agreement with [Scottish Coal] and/or [Scottish Coal’s] bankers reasonably to regulate the relationship between the sums which will be recoverable under [Danish’s] Standard Security and the terms under which these sums will rank ahead of any other sums due by [Scottish Coal] to their bankers from time to time (“the Ranking Agreement”)…"

Agreement could not be reached on the terms of the Ranking Agreement. Scottish Coal’s principal funder was Royal Bank of Scotland (RBS). RBS wanted the Ranking Agreement to contain a clause stipulating that Danish would not enforce its Standard Security without RBS’ consent. That was not acceptable to Danish who wished to retain the power to enforce the Standard Security. Both RBS and Danish had reasonable concerns. In the absence of agreement, Danish intimated that it considered the Option Agreement to be at an end and then proceeded to sell the site to Scottish Coal’s competitor. Scottish Coal raised a court action.

Danish argued that the Option Agreement had ended because no agreement had been reached on the terms of the Ranking Agreement. Such agreement was necessary before Scottish Coal could acquire the land. The provision of the Option Agreement that required a Ranking Agreement to be signed was “an agreement to agree” and was unenforceable because, necessarily in the absence of full agreement, it could never be clear what was to be enforced. Scottish Coal argued that the wording of the Option Agreement meant that Danish were obliged to accept and to sign any reasonable Ranking Agreement that was presented to them. It was not an agreement to agree. RBS had presented a reasonable Ranking Agreement to them but Danish had not accepted it, therefore Danish were in breach of the Option Agreement which was still live.

The Judge decided that the wording of the Option Agreement did not support Scottish Coal’s interpretation. The wording of the clause pointed towards both RBS and Danish negotiating to reach an agreed position, not RBS presenting a reasonable Ranking Agreement to Danish which Danish would be obliged to sign. The Judge was also mindful that Danish would have been very unlikely, on a commercial basis, to have accepted an obligation to sign any reasonable Ranking Agreement. Even a “reasonable” Ranking Agreement could still fail to give sufficient weight to Danish’s interests. This much was demonstrated by the actual disagreement over the terms of the Ranking Agreement that led to the court action.

However, the Judge did not accept Danish’s interpretation either. Danish’s argument was that the requirement to agree a Ranking Agreement was an “agreement to agree”. The Judge pointed out that while “pure” agreements to agree would always be unenforceable, an obligation “to use reasonable endeavours to agree” could be enforceable. Danish’s argument did not acknowledge the presence of the word “reasonable” in the clause. For such a “reasonable endeavours” obligation to be enforceable, there would need to be some objective criteria by which “reasonableness” could be judged. There were no objective criteria in the present case.

Consequently, while Danish was under an obligation to use reasonable endeavours to agree the Ranking Agreement, it was still unenforceable owing to the lack of any measure by which that reasonableness could be judged. The Option Agreement was at an end and Danish were free to sell the land to a third party.

Neil Fraser, Associate, comments:

The word “reasonable” is so often simply a “fudge” favoured by the parties to overcome some impasse in negotiations, neither party being willing to suggest that they (or the other) could ever behave in an unreasonable manner, and provided everybody is reasonable, it will all be fine, won’t it? This case is a harsh reminder that even reasonable people can disagree. We imagine that Scottish Coal will have believed it had an option right to acquire the land, and presumably in reliance on that, will have incurred a great deal of expense in carrying out ground investigations and obtaining the necessary planning and licenses to mine the coal. Scottish Coal may also have made financial projections or taken advance orders on the basis of mining that coal. Instead, it has found that the seller could walk away and sell the land to its biggest competitor. This could be a commercial disaster.

It is well known that “agreements to agree” are not enforceable. What is less well developed is the notion that an obligation to “use reasonable endeavours to agree” can sometimes be enforced, provided that there is some objective criteria, either express or implied, with which to judge that reasonableness.

What those objective criteria might be is something of a mystery. In this case, the Judge helpfully said that implied criteria existed in an obligation to use reasonable endeavours to obtain planning permission (phew!) but, it appears, none will exist relative to an obligation to agree a Ranking Agreement unless those criteria are embodied in a contract between the parties.

The obligation to agree a Ranking Agreement is not uncommon in the kind of deal structure used by Scottish Coal and Danish. In fact, the deal structure used by Scottish Coal and Danish is not that uncommon either. Often, it is preferable to both purchaser and seller that part of the price is postponed and paid later. The purchaser receives a cash flow benefit and the seller, ultimately or hopefully, receives a higher price. It may be that the deal cannot be done in any other way – sometimes the value of the land depends on uncertain events that can only occur after the land transfers to the purchaser and so neither party wishes to commit to an assessment of capital value that might later turn out to be wildly inaccurate. But such a postponed price structure will raise the issue of how the future payment is secured against the default or insolvency of the purchaser. That raises the issue of a Standard Security (as could an ongoing non-monetary obligation owed by the seller to the purchaser). In turn, that raises the issue of a Ranking Agreement. How is a Ranking Agreement to be agreed at the time that the option is granted? Who knows how the funding position of the parties could change during the course of the option. And would the bank (or any party, for that matter) be willing to tie its hands and commit itself to a certain form of Ranking Agreement that may not suit it when the option is exercised? Would the bank or any other party be willing to incur the costs and delays involved in negotiating a Ranking Agreement at the outset that will not be required if the option is not exercised?

In the alternative, can any party feel comfortable accepting an obligation to sign whatever reasonable Ranking Agreement might be presented to it? Or can the seller live without a Standard Security at all? Can the purchaser offer another form of guarantee instead? Or can the purchaser commit itself from the outset of the option to only exercise the option without bank funding and without any other form of security affecting the land? These alternatives may well present solutions in some, but by no means all, cases.

The challenge, then, is to find an express form of objective criteria to assess the obligation “to use reasonable endeavours to agree a Ranking Agreement” which can then be inserted into the initial option agreement. The risk is that there is little guidance as to what form that could take.

The circumstances and wording of every option will be slightly different. It may be prudent for option holders to review their option agreements to see if they are likely to be affected by this case.

Case referred to : The Scottish Coal Company Limited v Danish Forestry Company Limited [2009] CSOH 171

A full text of the decision is available on the Scottish Court’s website accessible here

News

Strategic Development Plans Update
The process for agreeing and publishing the Strategic Development Plans (SDPs) for Scotland’s four largest city-regions around Aberdeen, Dundee, Edinburgh and Glasgow is well underway. At present, the stage reached in each area, as detailed by the Scottish Government on its website, is as follows:

Aberdeen City and Shire – following publication of the Development Plan Scheme (No.1) in April 2009, the Development Plan Scheme (No. 2) is expected to be published in April 2010 and thereafter the Main Issues Report and Interim Environmental Report will be prepared and issued for consultation by May 2011.

Details are available on the Scottish Government website accessible here

Glasgow and the Clyde Valley – the Main Issues Report is expected in March 2010 and the publication of the proposed SDP is anticipated in March 2011 with submission to the Scottish Ministers for approval to follow by October 2011.

Details are available on the Scottish Government website accessible here

Edinburgh and South East Scotland - the date for publication of the Main Issues Report has now been revised. It is now intended that the Main Issues Report will be considered by the SES plan Joint Committee on 26 March 2010 and, following this, there will be a ratification process by SES’s partner authorities. Consultation is expected to start in late Spring once the Plan has been printed. On 27 January 2010, SES invited interested parties to access its Housing Need and Demand Assessment by registering as a member of the South East Scotland Housing Market Partnership. The Partnership aims to engage stakeholders in the South East Scotland region on housing related issues. It brings together local authorities across the area to undertake housing need and demand assessments and to agree housing supply targets for inclusion in local housing strategies.

Details are available on the SES Plan website accessible here

Tay (Dundee, Perth, Angus and North East Fife) – the publication of the Main Issues Report and Environmental Report for consultation is expected in May 2010 and the proposed Plan, including Environmental Report is anticipated in May 2011 with the submission of the finalised SDP to Scottish Ministers in January 2012.

Details of progress can be accessed via the Scottish Government website accessible here

Vacant and Derelict Land Report 2009
The Scottish Government has published its report for 2009 on derelict and vacant land. The report can be accessed on the Scottish Government website accessible here.

Tax increment financing - a new tool for funding regeneration?
The British Property Federation has produced a paper examining tax increment financing (TIF) as a means of funding regeneration in the US and how it could be applied to similar projects in the UK.

TIF is a mechanism for funding development in which local authorities fund infrastructure at the start of a development from projected future income they will receive from rates once the development is completed. Drawing on the American experience, the BPF looks at the advantages and disadvantages of the TIF approach and examines the case for introducing TIF districts within the UK.

The BPF hopes to stimulate a debate within the UK about the merits of introducing a regeneration tool that has proved both popular and effective in other countries.

Details are available on the British Property Federation website accessible here

Planning Enforcement Charter – a guide to enforcing planning controls
The Scottish Government has published a “Charter” which explains how the planning enforcement process works, the role of Councils and the service standards they set themselves. It also explains what happens at each stage of what can be a lengthy process.

Enforcement is one of the most complex parts of the planning system. The aim of this Charter is to ensure that adopted procedures are fair and reasonable and that interested parties are kept informed and are made aware of what is required.

Details are available on the Scottish Government website accessible here