A residential property lawyer’s guide to risk and insurance in sale contracts

Insight

13.11.2024

Exchange of contracts in a residential property transaction is the moment that a buyer becomes contractually bound to buy and a seller becomes contractually bound to sell the property in question. However, in most transactions, there will be a gap between exchange and completion (ranging from just a few days to many months). A seller will often continue to live in a property during this period and it is important to understand what happens in the event that a property suffers significant damage (ie beyond fair wear and tear) between exchange and completion.

What happens if a property is damaged between exchange and completion?

This will be governed by the risk and insurance provisions in the sale agreement. The risk provisions will set out whether it is the seller or the buyer who will bear responsibility for the state and condition of a property between exchange and completion, and the insurance provisions will set out which party is contractually obliged to insure the property during this period (and it will be for the insuring party to claim on their insurance in the event of damage). The parties can often conflate risk and insurance, but it is important that they do not do so as they are two entirely separate points.

Standard Conditions of Sale

The default position is set out in the Standard Conditions of Sale (5th edition – 2018 revision) (SC), which are incorporated into all residential property contracts unless specifically excluded. (Prior to 2018, the 4th edition had the opposite responsibility!).

Risk – The SC provide that risk passes to a buyer on exchange of contracts. This means that a seller will have no liability for the state and condition of property between exchange and completion. Therefore, if a property suffers damage or destruction between exchange and completion, a buyer cannot terminate their contract but must proceed to purchase a property in its damaged state. While the SC seems logical (why should a seller be responsible for a property that will shortly be transferred out of their ownership?) there are good reasons that a buyer may not be happy (or able) to accept this standard position.

Insurance – Under the SC the seller is not obliged to insure the property following exchange, except in two circumstances:

where the contract explicitly provides that the seller must insure; or
where the property is let on terms under which the seller (either as landlord or tenant) is obliged to insure the property against loss or damage.

This means that under the SC a buyer will take the risk and, unless an exception applies, will also have no ability to recover any insurance monies from a seller. A buyer should therefore put insurance in place on or immediately before exchange so they can claim on their policy if they are forced to buy a property in a damaged state.

Flipping the risk

It is sometimes possible to negotiate a reversal of the standard position under the SC so that risk for the property remains with the seller. As you can imagine, this is considered unusual given it flips the standard position on its head and can be particularly challenging to agree in a chain. However, if the negotiation is successful, the contract can provide that a buyer can walk away from the deal where a property becomes unusable due to damage beyond “fair wear and tear” occurring between exchange and completion.

So, when is it appropriate to flip risk?

Where buyers are using mortgage finance, it is important to consider whether to negotiate the contract to reverse the standard position so that risk remains with the seller. This is because a bank is highly unlikely to draw down mortgage funds if their intended security is significantly damaged or destroyed at the point of completion. If the bank does advance funds to pay for reinstatement works, they may only do so in tranches and may also charge a higher rate of interest while works are ongoing.

Insurance funds will also often only be made available in tranches as works are completed. Therefore, a buyer could end up in a position where they are contractually obliged to complete their purchase but practically and logistically unable to do so (as they are reliant on the mortgage and do not have cash reserves). In these circumstances, a buyer could lose their deposit and face a claim for compensation for breach of contract. This is far from ideal, and this is where a buyer’s lawyer needs to negotiate the contract and advise on it carefully.

Flipping the insurance

As anticipated by the SC, a contract will often be varied so that the seller must continue to insure a property following exchange. This is usually less controversial. For example, if a seller has a mortgage, they will need to maintain their property insurance up to the point of completion to comply with the requirements of their lender, so they will likely be happy to accept such a variation to the SC.

If the contract is varied so the seller is to insure property, then the seller must:

do everything necessary to maintain the policy;
permit the buyer to inspect the policy or evidence of its terms; and
deal with any insurance claim for damage to the property that arises between exchange and completion and pay the buyer the proportional insurance monies (or otherwise assign the benefit of the insurance claim to the buyer).

How can a lawyer help?

You should always discuss with your lawyer ahead of exchange what the risk and insurance provisions in a contract will mean for you. A lawyer will need a clear understanding of a client’s specific requirements and circumstances to be able to fully advise on the position.

If a seller is amenable, there are a few options a buyer can pursue:

The seller agreeing to vary the contract and retain the risk for the property and remain liable for the state and condition of the property between exchange and completion, but with no obligation to insure it. This means the buyer could terminate the contract if property damage renders it unusable, but the buyer should still insure the property so that they have the option to proceed with the purchase in a damaged state and to claim on their insurance policy to rectify any damage.
The seller agreeing to reverse the risk AND insure the property between exchange and completion (and assign the benefit of an insurance claim to the buyer). Here, the buyer will be able to terminate the contract if the damage renders the property unusable or they could proceed to purchase the damaged property, take an assignment of the seller’s insurance policy and use the proceeds to repair or reinstate the property. The buyer would not need to incept insurance unless and until completion takes place.

The exact wording of these provisions will of course depend on each party’s position on the negotiations. Often, sellers will be totally sympathetic with a buyer’s position and agree to the reversal, not least because the seller or the seller’s tenant will occupy the property and therefore have control of it until completion. However, where the seller is not amenable, the buyer must insure the property between exchange and completion and, where there is mortgage finance, the insurance must comply with the chosen lender’s insurance requirements. It is therefore important to work alongside a competent broker who will be well placed to advise.

What if the property is leasehold and the building is insured under a landlord’s block policy?

In this scenario, the seller must use reasonable efforts to ensure that the landlord’s insurance is maintained until completion and the seller must assign their rights in the policy. Whether the seller has any rights in the insurance proceeds will depend on the terms of the seller’s lease and the insurance policy terms.

What if the seller causes the damage?

If the seller is responsible for the physical state and condition of the property between exchange and completion, where damage is caused, they may be in breach of the seller’s common law duty of care as trustee of the property in that period and the buyer may be able to claim damages on that basis. Unless the standard position under the SC has been reversed, the buyer would however still be obliged to complete and would need to make a claim against the seller.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.