How will the historical debt ruling impact the property market? Sotheby’s and Dykes Van Heerden weigh in on Property Professional

How will the historical debt ruling impact the property market? Sotheby’s and Dykes Van Heerden weigh in on Property Professional

A recent Supreme Court of Appeal (SCA) judgment confirmed a high court ruling that municipalities have a lien over a property for historical municipal debt incurred on it, regardless of who owns it at the time the debt is discovered. So how did this come about and what does it mean for your buyers and sellers?

Unless the Constitutional Court overturns the ruling, both buyers and sellers have been handed an additional headache in the already complicated process of concluding a property transaction.

Section 118 of the Municipal Systems Act exists to protect municipalities’ right to claim outstanding debt, explains specialist conveyancing attorney Elana Hopkins of Dykes Van Heerden Inc.

One mechanism created in Section 118 is a statutory lien over the property as security for the municipal debt incurred on it. This is a limited real right over a debtor’s property, which gives a creditor the right to sell the property in execution once the legal processes have been exhausted to collect outstanding debt, says Hopkins. This is what SCA ruling impacts: it confirmed that this security survives the transfer of the property to a new owner whether by private transaction or after a sale in execution.

“The Act also stipulates in Section 118(1) that a rates clearance has to be issued if the owner settles only the preceding two years’ outstanding debt,” says Hopkins. “And herein lies the problem as the property can therefore successfully be transferred without settling all the historical debt attached to it and in addition, the statutory lien will then survive such transfer.”

RAMIFICATIONS FOR PROPERTY OWNERS

The ramifications are serious for property owners, particularly if any municipality chooses to embark on a dedicated programme to recover historical debt, says Lew Geffen, chairman of Lew Geffen Sotheby’s International Realty.

“Considering more than 325,000 properties change hands each year, this judgment could extend the already arduous sales process because buyers can demand full due diligence on properties before they’ll sign on the dotted line,” he says.

“For most buyers this delay would be preferable to having their properties serve as a security for potentially hundreds of thousands of rand of debt at some indeterminate time in future and for debt that they did not actually incur themselves.

“The other question is, of course, whether municipalities have the resources to cope with scores of additional queries related to historic debt, because many buyers and sellers will in future want guarantees. My feeling is ‘no’.”

Another problematic point, says Geffen, is that buyers who insist upon protecting themselves through a due diligence process might lose the opportunity to buy their dream homes in the current market in which stock shortages are the norm.

“Most sellers have more than one interested buyer and more than a handful will be willing to sacrifice slightly on price if it means the minimum statutory requirement of providing a two-year rates clearance certificate, rather than an onerous and extended due diligence process that could delay the purchase of their next property.

“In our experience, few owners start the process of selling their properties without knowing where they’re going once it’s sold.”

In the worst case scenario, there are also implications for banks, which potentially stand to lose vast sums because municipalities could perfect their security and take the proceeds of the sale of properties to settle outstanding municipal debts.

“Only then would any remaining funds be paid to the bondholder and thereafter to the owner. It wouldn’t surprise me if this court judgment causes lenders to review their risk profile criteria or revise downwards the amounts they lend,” he says. “Needless to say those who’d be most affected negatively would be self-employed people, who are already considered by lenders to be high risk even if they own stable, successful businesses.”

Hopkins adds that, in addition to doing a thorough due diligence investigation into the historical debt attached to the property (as suggested by Geffen), it’s also possible to seek a contractual guarantee from the seller that there is no outstanding debt apart from that covered by the clearance certificate.

The problem still remains that the seller might – innocently – be unaware of any outstanding amounts owed, particularly if the municipality’s records are not up to date when the property is transferred. This occurs especially where the property was rented and includes debt incurred by tenants who neglected to pay for municipal services.

NOT ALL DOOM AND GLOOM

It’s not all negative, though, because perfecting their security against a property for the collection of historical debt is a municipality’s last resort, explains Hopkins. The municipality still bears the burden of proof regarding the amount of the debt claimed and they are still legally obliged to collect the outstanding debt from the person who incurred it.

She adds that it remains to be seen if municipalities will make full use of this interpretation and it is also doubtful if they still have all the historical records or even have the resources to engage in an undertaking of such magnitude to recover historical debt.

“In the Western Cape we do not often see sellers insisting on only paying the last two years of municipal debt to obtain a clearance,” says Hopkins. “Furthermore, the Water Bylaw in the City of Cape Town, has in my opinion gone a long way in making sure that water meters are registering correctly as a statutory requirement during the transfer of a property, as a plumbing certificate is required when a property is transferred, which specifically certifies that the water meter is reading.”

She concludes that this decision is likely to come before the Constitutional Court as the case raises questions regarding the constitutionality of section 118 (3) of the Act, but in the interim suggests the following clause is included in sales agreements to protect prospective purchasers contractually against the effect of this ruling:

The seller shall obtain the necessary clearance certificate from the relevant local authority in terms of Section 118(3) of the Municipal Systems Act 32 of 2000 (as amended). The seller hereby warrants and acknowledges that once the necessary clearance certificate figures have been obtained from the relevant local authority, full payment of the outstanding debt shall be made and shall not limit such payment in terms of Section 118(1) of the Municipal Systems Act (as amended) to an amount equal to the outstanding figures for a period of 2 (two) years preceding the application for rates clearances. The seller hereby indemnifies the purchaser against any claims, which may arise from the aforementioned.

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