KYC obligations on regulated entities in property transactions - guidance from Scottish courts

In Iftikhar v CIP Property (AIPT) LTD[1], the Inner House of the Court of Session considered the contract in relation to a property sold at auction, and whether the seller was entitled – or obliged - to resile based on concerns about the KYC information provided by the buyer. The case provides clarification in relation to whether a regulated entity, or its nominee, must withdraw from a transaction where it is unable to satisfy itself under anti-money laundering provisions.

Background

The seller, a nominee company holding property for a unit trust, sold a commercial property in Glasgow at auction for £500,000. The contract required the buyer to provide:

“KYC information … on or before 15 December 2016”; being “Such information as the vendor… require[s] in relation to the identity of the purchaser and the source of funds … including … the verification certificate and initial due diligence form”.

In addition to the verification certificate and due diligence form, the seller requested copies of the buyer’s passport and a utility bill. By the deadline, it had received emailed versions of these documents, and an assurance that certified copies were in the post.

It was expressly provided that a failure to pay the deposit amounted to a repudiation of contract, and the seller was entitled to deem that the deposit had not been paid until it had received the information.

The seller withdrew. The buyer sought specific implement to enforce the sale. The seller argued that the missives entitled it to resile, and that, even if it was contractually obliged to proceed, to do so would be unlawful, due to the application of the Money Laundering Regulations 2007 to the transaction.

The judge at first instance held that buyer had failed to produce the information required by the deadline. The buyer was therefore in breach of contract, and the seller was entitled to resile. The buyer appealed.

The contractual issue

The central issue was the interpretation of the articles of roup (auction) governing the transaction. The court had to ascertain the intention of the parties by determining what a reasonable person, having the background knowledge of the parties, would have understood from the language used.

In this case, the court said, the reasonable person would interpret the contract wording (above) to mean that the buyer had to supply the information requested by the seller. The seller had to set out the information required; although the buyer may be able to make an educated guess about the information, it could not know for certain.

The appeal court’s decision

The Inner House held that, as at 15 December 2016, the buyer had complied with the seller’s requirement for KYC information. The seller made no complaint about the information provided, and it had not elected to resile, even had it been entitled to do so. Instead, it requested further information – about the source of funds. The court said that this was a legitimate request, that could be made within the confines of the existing contract; it was open to the seller to request additional information, having first studied, and not been satisfied with that originally supplied.

The buyer’s solicitors responded that it might not be possible to provide information about the source of funds, following which the seller sought to resile. The Inner House said that this response might well have raised legitimate concerns, and the seller would have been entitled to fix a reasonable deadline for the production of the information. The deadline could have been relatively short. Instead, the seller asked for a “brief explanation” - but did not set a time limit, nor make the time limit an essential element of the bargain. As a result, rescinding the bargain, suddenly and without warning, because of the absence of information about funds, amounted to an unlawful repudiation of the contract.

Illegality: application of the Money Laundering Regulations 2007?

The judge at first instance held that the Money Laundering Regulations 2007 (now repealed, but having continuing effect) applied to the transaction, and that for this reason also, the seller was not obliged to proceed. The Inner House disagreed:

“…it is by no means clear why the [seller], as a nominee company holding property for a unit trust, should be regarded as a financial institution carrying out one of the defined activities referred to in Regulation 3. It is even less clear how the [buyer] falls within the description of a “customer”.

Even if the seller was a relevant person and the buyer was a customer, the parties had already entered into a bargain for the sale and purchase of the subjects, which was not itself said to be illegal. The seller was content to proceed with that bargain, provided it could be satisfied with the KYC information, including the buyer’s explanation of his source of funds. The Inner House said that it is only if the relevant person is unable to apply customer due diligence measures to the customer that he must “terminate any existing business relationship” (reg 11). In this case, the seller was able to carry out “customer due diligence”, as defined in regulation 5, by verifying the buyer’s identity on the basis of documents and information obtained from a reliable and independent source. It required to do no more than that. It had copies of the buyer’s passport and driving licence duly certified by a solicitor as true copies. It was entitled to rely on the solicitor’s representation (reg 17). In these circumstances, proceeding with this transaction would not have amounted to a breach of the regulations and therefore be illegal; the contract did not force the seller to act unlawfully and the court was not requiring it to do so.

The effect of the court’s decision

While the court held that the seller was bound by the contract of sale, it did not follow that it had to implement the contract in exchange for the purchase price. It was a matter of concession at proof (trial) that the seller was entitled to be dissatisfied with the information produced, and that it remained dissatisfied. In light of the court’s determination, the buyer had to be given a reasonable time in which to provide the information. Whether the information ultimately produced was satisfactory would be subject to overall considerations of objective reasonableness; it would not be open to the seller to resile, based on an unreasonable assessment of what had been provided.

Comment

From a contractual point of view, the Inner House provides further support for the view that the meaning of the contract is to be determined by looking at what a reasonable person, having the background knowledge of the parties, would have understood form the language used (Midlothian Council v Bracewell Stirling Architects [2018] CSIH 21).

The case also provides important guidance on the application of the Money Laundering Regulations 2007, particularly in relation to nominee companies.