HKLII

Hong Kong Law Reform Commission
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Chapter 5 - Standard clauses of preliminary agreements


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Introduction


5.1 There is at present no standard form of preliminary agreement for the buying and selling of residential properties between private individuals in the second-hand market. Most preliminary agreements contain basic terms such as a brief description of the property, the price, payment schedules, the date of formal agreement for sale and purchase ("ASP") and the date of completion of sale and purchase. Other terms are a matter for negotiation between the parties. Whether particular terms are included or not will depend very much on the parties' relative bargaining power and the market condition at the time. If an estate agent is involved, the parties will invariably adopt the pro-forma provided by the estate agent. Such pro-forma preliminary agreements are not uniform though their main terms are essentially the same.


Standard clauses for protection of homebuyers


5.2 In Hong Kong, lawyers are usually appointed after a preliminary agreement has been signed. The usual practice is for vendor and purchaser to sign the pro-forma preliminary agreement prepared by the estate agent. The estate agent will then pass a copy of the signed preliminary agreement to the solicitors acting for the parties. The solicitors will prepare the formal ASP on the basis of the preliminary agreement and any further instructions from the parties.

5.3 As a preliminary agreement is signed without the scrutiny and advice of a solicitor, its terms may not be in the best interests of the purchaser. Even if the preliminary agreement has been drafted by a lawyer it may have been amended by the estate agent or by the parties themselves who are not legally trained. We take the view that certain standard clauses should be included in a preliminary agreement. Although homebuyers would be provided greater protection if there were certain standard clauses in the formal agreement, we are not in a position to conduct any study in that respect as our terms of reference are confined to pre-contractual matters. In any event, purchasers can obtain additional protection if standard clauses of potential benefit to them are included in the preliminary agreement.

5.4 The Sub-committee is indebted to the Property Law Group of the Australian Law Council for having supplied the Sub-committee with sample standard form of residential property contracts used in various states of Australia. The Sub-committee has considered some of the contract clauses in these standard form residential property contracts and is impressed with the Australian approach which gives considerable protection to purchasers.[41] Whilst the Australian approach is conducive to consumer protection, some aspects may not be feasible for Hong Kong.[42] Though not all Australian practices are suitable for use in Hong Kong, it is desirable to adopt some of their standard clauses selectively.

5.5 We have chosen to look at the Australian model as it is the only jurisdiction of which we are aware which satisfies both criteria of having (i) a conveyancing system similar to ours in that there is an immediate binding agreement; and (ii) standard clauses relating to such matters as a cooling-off period and a contract subject to finance.

5.6 We shall discuss below the desirability and feasibility of inserting into the preliminary agreement standard clauses relating to a cooling-off period, contract subject to finance, survey report and inspection of property prior to completion.


Cooling-off period


5.7 In Victoria, Australia, a purchaser is entitled to a three-day cooling-off period. In exercising the right to rescind the contract during the cooling-off period, the purchaser must give written notice of his intention to do so to the vendor or his agent. The purchaser must forfeit $100 or 0.2 percent of the purchase price (whichever is greater). The three-day cooling-off period does not apply in certain circumstances, for example, where the property is worth more than A$250,000; where independent legal advice has been obtained before signing the contract; or the purchaser has previously signed a similar contract for the same property.[43]

5.8 The question is what benefits a similar cooling-off period could bring for second-hand properties. In our view, a cooling-off period can afford purchasers the time to arrange for finance. In any event, a reasonable cooling-off period can afford the purchaser a better opportunity to ascertain the financing position. This will in turn assist the purchaser in making an informed decision on whether he should withdraw from the transaction.

5.9 It may be argued that a cooling-off period is unnecessary in the second-hand market. In the first-hand market, developers can afford to launch large advertising campaigns to create enthusiasm and attract potential purchasers. Potential purchasers could be vulnerable to the effects of such advertising campaigns and make hasty purchase decisions. A cooling-off period is therefore necessary to give purchasers in the first-hand market a chance to rethink on the transactions. Private vendors in the second-hand market however cannot afford such an advertising campaign and so it is unnecessary to give a purchaser a chance to opt out on second thought. On the other hand, though a private vendor is not in a position to launch an advertising campaign on his property, a purchaser can still be subject to pressure or persuasion to buy made face-to-face by the vendor himself or an estate agent acting for him.

5.10 Another major argument against a cooling-off period is that it will fuel speculation. However, a provision for the forfeiture of a specified percentage of the purchase price can work as an effective deterrent to potential speculative activities.

5.11 If there is to be a cooling-off period, it should be applicable to the purchaser only. The vendor will obviously know more about the property than the purchaser. The purchaser will therefore need more time to consider and so the cooling-off period should be of use to him. However, in order to be fair to the vendor, the purchaser should not have the right to sub-sell during the cooling-off period. A prohibition on sub-sale during the cooling-off period will also prevent speculation.

5.12Under the Lands Department (Legal Advisory & Conveyancing Office) Consent Scheme in Hong Kong, a purchaser who does not execute the formal ASP after signing a preliminary agreement is liable to forfeiture of five percent of the purchase price or the amount of the preliminary deposit, whichever is lower. The ASP must be signed by the purchaser within three working days of signing the preliminary agreement and by the developer within a further seven working days thereafter. We consider the level of forfeiture in the Consent Scheme is appropriate and should be adopted in respect of the proposed cooling-off period.

5.13 It is noted that in Victoria, the cooling-off period is not applicable to the sale of more expensive properties worth more than A$250,000. We see no good reason to confine the benefit of a cooling-off period to purchasers of lower-end properties as in the case of the Australian model. We would however like to hear the public's views as to whether any particular class of properties should be excluded from the cooling-off period.

5.14 The next question is the length of the cooling-off period. We think the period should be short but realistic. We see the choice as one between the Australian model of three clear days and the Consent Scheme of three working days. We prefer a cooling-off period of three working days in order to be consistent with the Consent Scheme. Three working days will be sufficient for a purchaser to check for the availability of finance or to conduct a property search.


Recommendation 4

We recommend that the preliminary agreement for the purchase of second-hand completed flats should contain a standard clause giving the purchaser a cooling-off period of three working days. In exercising the right to rescind the preliminary agreement during the cooling-off period, the purchaser is liable to forfeit to the other party an amount equal to five percent of the purchase price or the preliminary deposit whichever is the lower. The purchaser should not have the right to sub-sell during the cooling-off period.


Contract subject to finance

5.15 The standard form contracts of several jurisdictions in Australia contain a "subject-to-finance" clause. In Victoria, where a lender is nominated in the contract, the purchaser can end the contract if the loan is not approved by the "approval date". However, in order to exercise this right to end the contract the purchaser must, inter alia, have made immediate application for the loan and done "everything reasonably required" to obtain approval of the loan.[44]
5.16 In the Northern Territory of Australia, if a lender is named in the contract, the contract will be conditional upon the purchaser obtaining the named finance by an approval date. The purchaser must make immediate application to the lender for a loan on the "then prevailing conditions as to interest rate, term and rate of payment". The purchaser must "diligently pursue" that application, give such security, and "do all such acts and pay all such fees as the lender may reasonably require". If the purchaser fails to obtain the loan by the specified date of approval, he may rescind the contract by giving written notice within two days of that date.[45]

5.17 In Hong Kong sale subject to finance is already in place in some special form of contracts. For example, the standard ASP used in the Home Ownership Scheme (HOS) contains a "subject to finance" clause providing that the ASP is conditional upon the purchaser being able to obtain a loan by "using due diligence and completing the necessary formalities".[46] If the vendor is satisfied that the purchaser cannot obtain such a loan, the ASP will be rescinded and all money already paid by the purchaser will be returned without interest, costs or compensation. The vendor is entitled to charge an administrative fee, the amount of which is at the discretion of the vendor.
5.18 The idea of making the preliminary agreement subject to finance is controversial and the Sub-committee is divided in its views. Those in favour of a "subject to finance" clause would cite instances of banks pulling out of their original commitment to provide finance to purchasers during the onset of the recent recession. Purchasers were caught by surprise by the banks' sudden withdrawal of finance. The idea of contract subject to finance would be helpful to purchasers in such circumstances. If their loans were withdrawn by the bank, they could rescind the preliminary agreement and obtain from the vendor a refund of the deposit.
5.19 In contrast, banks are now keen to grant mortgage loans and compete intensely among themselves for mortgage customers.
5.20 Another argument in favour of a "subject to finance" clause is that HOS contracts are already subject to finance. HOS contracts are, however, of a special kind in that the Housing Authority will guarantee the purchasers' outstanding loan and interest. Hence, it is very unusual for banks to go back on their loan promises to HOS purchasers.

5.21 A "subject to finance" clause in the preliminary agreement will give a purchaser an additional opportunity to back out of the transaction. If the purchase turns out not to be to his advantage, a purchaser can convince the bank not to grant him a loan. Yet a carefully worded "subject to finance" clause may discourage this from happening.

5.22We have mentioned above some of these formulae to prevent abuse by purchasers. For instance, the clause used in Victoria requires the purchaser to make immediate application for a loan and to do "everything reasonably required" to obtain approval of the loan. The clause in the Northern Territory requires the purchaser to "diligently pursue" the application for a loan, give such security, and "do all such acts and pay all such fees as the lender may reasonably require". The HOS clause requires the purchaser to try to obtain a loan by "using due diligence and completing the necessary formalities". It should however be borne in mind that the Australian approach which requires the name of the lender bank to be inserted in the agreement is unworkable in Hong Kong since banks seldom come into play at such an early stage of the transaction.

5.23 Another principal argument against a "subject to finance" clause is that banks are less likely to go back on their loan promises in the case of completed properties. According to the professional experience of some members of the Sub-committee, the majority of transactions are completed within one month of the preliminary agreement. It is unlikely that banks will change their loan promises within such a relatively short period of time. It could however happen in a turbulent economic downturn such as that experienced in late 1997.

5.24 A "subject-to-finance" clause may not be necessary if purchasers have the benefit of a cooling-off period of three working days as recommended above. The cooling-off period provides purchasers with an opportunity to arrange finance. If they cannot get a positive response concerning a loan from the bank, they can take advantage of the cooling-off period to rescind the agreement. The other side of the argument is, however, that the bank can still back out before the facility papers are signed.

5.25 We wish to put forward the idea of a "subject-to-finance" clause in the preliminary agreement for public consultation. It has been a subject of considerable debate among the members of the Sub-committee. It is the preliminary view of the Sub-committee that such a clause is not necessary though there is a stronger case for it where the period for completion of sale and purchase is long.

Survey report

5.26 The standard form contract in Queensland, Australia provides for the purchaser a right to obtain a building report on the property. The contract is subject to the purchaser's obtaining a building report on the property by the "Building Inspection Date". The purchaser must take all reasonable steps to obtain the report. The purchaser may terminate the contract by notice at any time before 5 pm on the Building Inspection Date if the report is "unsatisfactory to the buyer". However, if the purchaser does not terminate the contract by 5 pm on the Building Inspection Date, he will be treated as being satisfied with the building inspection report.[47]

5.27 It has been suggested in Hong Kong that a vendor of second-hand property should provide a survey report of any refitting that might affect the internal structure of the premises. This has arisen from the judicial attitude[48] that the vendor's solicitors should check with the help of a surveyor to find out whether there is any illegal structure in the property. If there is any, the vendor can then qualify the title. This judicial attitude strengthens the argument for permitting a survey report at least in relation to illegal or unauthorised structures. Whilst we consider that a surveyor's report is useful in relation to the existence of illegal structures, the problem with such a suggestion is that a surveyor cannot tell whether there are illegal structures or have been structural alterations without the original building plans, and these may take some time to obtain.

5.28 It has been suggested that it may instead be possible to rely on the Assignment Plan to figure out the partition wall and the core wall with a view to ascertaining only unauthorised alterations. However, the Assignment Plan shows only the thickness of the walls. Moreover, no professional would be willing to rely upon the Assignment Plan alone to make an assessment of the building structure. They will always go to the Building Authority for the original building plans as the Assignment Plan is meant for the identification of the property only.
5.29 Furthermore, the vendor when asked by the surveyor may not know whether there are illegal structures in his premises. The surveyor can only determine this from the building plans but it takes a long time to obtain the building plans. Furthermore, the Building Authority does not necessarily have plans of buildings built before the 1950s. If the Building Authority suspects that there are defects in these buildings, they have to send independent consultants to investigate the structural safety. Also, some more recently-constructed properties such as village type houses in the New Territories do not have approved plans.

5.30In addition to illegal structures, problems of dampness or water leakage in the unit may be another possible reason in favour of survey reports. Water leakage is a common problem in Hong Kong, even among newly built units. However, a common inspection report may not always reveal such leakage. In order to detect water leakage, a detailed survey report is necessary and it could be costly.
5.31 Another practical difficulty of having a standard clause in the preliminary agreement requiring a survey report is the question of deciding which party should bear the costs of the survey report. There will be much resistance if vendors are required to bear those costs. Likewise, not many purchasers in Hong Kong are willing to bear the additional costs of a survey report even though it is in their interests to do so. Some purchasers might waive those right to a survey report for reason of cost.
5.32 Furthermore, the requirement of a survey report will lengthen the time it takes for sale and purchase of properties. In Hong Kong, time is nearly always of the essence in property transactions. Such a requirement will also effect substantial change to the present system and is likely to be opposed by owners and estate agents.
5.33 We have considered that as an alternative to a survey report, a standard clause might be inserted into the preliminary agreement to the effect that the vendor warrants that there are no illegal structures. The problem with this is that the vendor will not know if there are illegal structures unless he has the building plans. Some alterations to the building itself could be legal.
5.34 It is our preliminary view that survey reports are not feasible for Hong Kong due to cost and practical reasons. However, we are aware of the fact that illegal or unauthorised structures as well as water leakage are common phenomena in second-hand properties. Moreover, it is recent judicial attitude that illegal or unauthorised structures are likely to affect title. These factors weigh in favour of survey reports. We would like to hear public views on the feasibility of having a standard clause in the preliminary agreement entitling the purchaser to a satisfactory survey report.


Right of inspection


5.35 In the Australian Capital Territory, the standard contract for sale contains a clause providing that the buyer may on reasonable notice and at reasonable times inspect the property before completion of the sale and purchase.[49] The way in which the clause is worded seems to imply that the purchaser is entitled to inspect the property more than once before completion.

5.36 In Hong Kong, a purchaser of a completed unit in the second-hand market is usually allowed to the view the unit at least once before completion of the sale and purchase. This however may not the case where the property is sold subject to an existing tenancy. Ideally, there should always be a right of inspection in order to give better protection for purchasers. Purchasers of units with vacant possession and those buying units subject to existing tenancies should be treated alike. However, the problem is that sometimes even the landlord himself does not have an opportunity to inspect the unit. The landlord's right of inspection depends on the terms of the tenancy and even if that right exists, a tenant may choose to make it difficult for the landlord to exercise. The tenancy invariably provides for the tenant's peaceful enjoyment of exclusive possession.

5.37 It could be argued that the right of inspection would be unnecessary if there were a cooling-off period of three working days. The purchaser, after signing the preliminary agreement, can take advantage of the cooling-off period to afford himself time for reflection and to view the property. However, even if there is a cooling-off period, it does not necessarily mean that there is always a chance to view the property within the cooling-off period.

5.38 We have come to the view that there should not be a right of inspection in respect of second-hand sales due to its impracticality, especially in the case of property sold subject to an existing tenancy.


How should a standard clause be inserted into the preliminary agreement?


5.39 We concluded earlier in this chapter that a standard clause providing for a three-day cooling-off period should be incorporated into preliminary agreements for sale and purchase of second-hand completed residential properties. This could be achieved in one of three ways:

(a) introducing a standard form of preliminary agreement;
(b) awaiting the adoption of a uniform practice by solicitors and estate agents; or
(c) introducing an appropriate implied term to the agreement by statutory provision.

We have concluded that the third option is the most appropriate.


Recommendation 5

We recommend that the standard clause allowing a three-day cooling-off period to purchasers should be implied by legislation into preliminary agreements for sale and purchase of second-hand completed residential properties.
[41] In Australia, for example, there are standard clauses in the formal contract relating to such matters as cooling-off period, contract subject to finance, survey report, inspection of property prior to completion.
[42] For example, legislation in New South Wales requires that an estate agent must have a contract, containing all required attachments, available for inspection by prospective purchasers when a property is offered for sale (Conveyancing Act 1919 (New South Wales, Australia), section 52A.) The result is that the vendor's solicitors will generally prepare the contract before a buyer has been found. Such a practice is unlikely be acceptable to vendors in Hong Kong for reason of cost.
[43] Law Institute of Victoria and the Real Estate Institute of Victoria Ltd, Contract Note (May 1993), see "Important Notice to Purchasers".
[44] The Law Institute of Victoria and the Real Estate Institute of Victoria Ltd, "Contract of Sale of Real Estate", Estate Agents Act 1980 Form 2 (May 1993), see clause 3 of General Conditions.
[45] Northern Territory standard form of contract for a residential sale, clause 23 of "Conditions of Contract".
[46] See clause 26 of standard HOS agreement for sale and purchase.
[47] The Real Estate Institute of Queensland, Contract for Houses and Land (1st Ed, 1996), see Clause 4 of terms of contract.
[48] In Spark Rich (China) Ltd v Valrose Ltd (1999) CACV No 249/98 Godfrey JA said that a prudent vendor should always consider, before attempting to sell his property, whether his title to the property may be affected by some unauthorised building work. If so, the vendor should not enter into any contract for sale of the property unless the contract contains full disclosure of the problem and also the purchaser's agreement not to raise any requisition or take any objection to the title on the basis of the unauthorised work. The learned judge also pointed out that cases in which a purchaser may safely be advised that he can safely disregard unauthorised building work are likely to be rare.
[49] The Law Society of the Australian Capital Territory, Contract for Sale (Crown Lease and Unit Title)(1998), see clause 10.