Overview (December 2000)

Land System
Registration
Types of Sale
Taxation and Charges
Mortgages
Leases

Land System

Administration and government sales
On July 1 1997 sovereignty over all land in Hong Kong reverted to the People's Republic of China, which now administers Hong Kong through the government of the Hong Kong Special Administrative Region (SAR).

Sales of land by the government continue to be by public auction, although tenders or private treaty grants may be used in special cases. Sales are by grant of a lease. New leases are granted:

• for a term of 50 years from the date of grant;
  
  
• at a premium; and
  
  
• subject to payment of an annual rent equivalent to 3% of the rateable value of the property from time to time.

The terms on which the government sells the land are recorded in conditions of sale. When all the conditions have been satisfied, the government should execute a lease. In practice, this formality is rarely complied with and a buyer of land relies on the conditions of sale as proof of title. Under Hong Kong law, once the conditions have been complied with, the interest of the lessee under the conditions is the same as if a government lease had been formally executed.

There are different types of conditions:

• conditions of sale, where land is sold for development;
  
  
• conditions of extension, when an owner acquires additional adjacent land;
  
  
• conditions of exchange, where the owner exchanges land already held for (i) land which the government grants to him or her, or (ii) land exchange entitlements;
  
  
• conditions of grant, when land is granted for a particular purpose; and
  
  
• conditions of re-grant, when a lease which is due to expire is renewed or when a lease has been lost.

Basic Law
The Basic Law of the Hong Kong SAR provides that all leases of land granted, decided upon or renewed before July 1 1997, and which extend beyond that date, will continue to be recognized and protected under Hong Kong law.

New Territories land
Special rules apply to leases of land in the New Territories (ie, the mainland part of Hong Kong beyond Kowloon that was leased to the United Kingdom for 99 years from July 1 1898). Most of these leases expired on June 30 1997 but were automatically extended until June 30 2047, without payment of an additional premium, under the New Territories Leases (Extension) Ordinance.

Purchases by foreign persons and companies
There are no restrictions under Hong Kong law as to the ownership of property by foreign companies or individuals. No government approval is required. Property may be bought directly or through a company incorporated in Hong Kong or overseas. There may be tax or other advantages to be gained by using a corporate structure set up for this purpose. The structure might be one of:

• direct ownership;
  
  
• a Hong Kong branch;
  
  
• a Hong Kong subsidiary;
  
  
• a joint venture; or
  
  
• a trust.

The most appropriate structure will depend on the type of property to be purchased, the proposed use of the property, the buyer's relationship with other investors and tax implications. Before acquiring property, all foreign persons or corporations should take advice as to the most appropriate structure to be used.

Subsequent sales
A transfer of land from an individual or corporate owner is made by means of an assignment of the balance of the term of the lease from the seller-leaseholder to the buyer.

Joint or common ownership of property
Two or more buyers of a property may purchase as tenants in common in specified shares or as joint tenants. Where property is owned jointly, title passes automatically to the surviving joint tenant(s) on the death of a joint tenant, whether or not the deceased has made a will and whatever that will might say. This does not apply to tenancies in common, where each tenant's share of the property passes according to the will or the law of intestacy. Common owners are advised to make wills or to consider the adequacy of their existing wills.

Registration

Current system
Hong Kong has had a deeds registration system since 1844 but it is not satisfactory. A deed, even though registered, does not prove title. An owner is still required to show that the deed was properly executed. If there is any defect in the execution of any title deeds, past or present, it will render the title defective. Failure to register a deed will render the deed void against a subsequent purchaser who in good faith who registers its deed, but registration itself will not ensure good title. Many developed countries have adopted a title registration system, under which a title is guaranteed by the state. In other words, the person who appears on the land register as the registered owner is an absolute owner. Any instrument or interest not registered on the land register can be ignored.

Land Titles Bill
The Hong Kong government introduced the Land Titles Bill in 1994. Since the bill was first gazetted, drastic changes have been made to it following consultation with interested parties.

Conversion from deeds registration to title registration will take place gradually over 15 years. Registration will take place on the first transfer of a title after the bill becomes law. New developments will be registered and voluntary registration of title will be permitted. After 15 years, any land that is still unregistered will be deemed to be converted to registered title.

A registered owner will have absolute ownership of its property, free from all interests and claims, except:

• covenants contained in the government lease;
  
  
• any encumbrances or interests registered in the land register; and
  
  
• any overriding interests.

The title will not be affected by any interests that have not been protected by registration. But the courts will have power to rectify the land register if satisfied that a failure to do so would be unjust.

A seller will only be required to produce the following to a buyer on the sale of property:

• a copy of current entry in the land register;
  
  
• copies of instruments referred to in such entry;
  
  
• a copy of the plan; and
  
  
• particulars of any overriding interests of which he or she has, or ought reasonably to have, knowledge (including Chinese custom or customary rights, public rights, leases for a term not exceeding three years and adverse possessory rights).

The seller will no longer be required to produce any previous title deeds.

The government will indemnify an owner if he or she suffers loss by reason of any entry in the land register arising from fraud. The indemnity will be capped at HK$30 million per claim.

It was anticipated that the bill would be re-introduced in the Legislative Council at the end of 2000, but it seems that this is not likely to happen for at least another year.

Types of Sale

Sale of units in multi-storey buildings
Due to the limited amount of land available, there are many multi-storey buildings in Hong Kong. Typically, developers have bought land from the government, erected multi-storey buildings and sold individual units to different buyers. The developer does this by assigning to each individual unit-owner a certain number of undivided shares in the land and the building as a whole, with an exclusive right to use a particular unit.

Each owner's rights and liabilities towards the other owners are set out in a deed of mutual covenant. The building is managed by a manager appointed by the developer or by a committee of the owners under the deed. The deed also sets out the rights and duties of the manager. In most new developments, units are sold by the developers to buyers before the developments are completed.

Sale of units in uncompleted buildings
Sales of units in certain uncompleted buildings are subject to governmental regulation. These are buildings on specified land, the development of which the government can control. The extent of that control is usually to be found in the land grant and is implemented through the Land Authority's consent scheme.

Under the consent scheme, the developer is restricted from selling units in affected buildings until the director of lands has given his consent. The conditions normally imposed on the developer for this consent include:

• that the development must have reached a certain stage;
  
  
• that the developer must be able to prove its financial ability to complete the development;
  
  
• that the developer must adopt a standard form of sale and purchase agreement that has been approved by the director of lands. This includes certain provisions for the buyer's protection (eg, relating to the release of the purchase price); and
  
  
• that the government lease term must have at least 10 years to run.

Even where no consent is required for the sale of units in uncompleted buildings (ie, the consent scheme is not applicable), the buyer's interests are not without protection. The Law Society of Hong Kong has stipulated that if the buyer and seller are represented by the same firm of solicitors, the form of agreement must contain certain clauses that closely follow those prescribed for consent scheme agreements. This is known as the 'non-consent scheme'. However, if the consent scheme is not applicable, and the seller and buyer are represented by separate solicitors, the non-consent scheme will not apply.

Taxation and Charges

Government rent
Any leases of land in Hong Kong and Kowloon granted after May 1985 (other than those pursuant to a right of renewal contained in an expired lease), and most leases of New Territories land, require payment of a standard government rent from July 1 1997. The rent is calculated at 3% of the rateable value of the property, adjusted whenever the rateable value changes. As rateable values are based on the annual open market rental value of properties, the rents payable to the government in respect of these properties have become significant.

For other leases, the government rent is nominal.

Property tax
Property tax is charged on income derived from land or buildings in Hong Kong. An owner-occupier therefore is not liable for this tax. The owner is charged at the standard tax rate (15%) on the net assessable value (NAV) of the land or buildings.

The property's assessable value is the rent receivable for the year of assessment in respect of the right to use the land or buildings. This includes any money payable for the provision of services or benefits in connection with the use of the property (eg, management fees), provided it is payable to the owner or for its benefit. The NAV is then calculated by taking the assessable value, less the amount of rates paid by the owner (if payable by him or her) and an allowance of 20% for repairs and outgoings after deduction of the rates.

A corporation is exempt from property tax if:

• it is carrying on trade or business in Hong Kong;
  
  
• it includes the profits from its property assets in its computation for profits tax; and
  
  
• it has obtained the relevant exemption from the Inland Revenue Department.

Rates
Rates are levied on the occupation of land or buildings. Liability for payment of rates to the government rests jointly with the occupier and the owner ('owner' includes mortgagee). If the owner and occupier fail to reach agreement as to who is responsible to pay rates, the occupier is primarily liable. From January 1 2000 rates have been 5% of the rateable value of the premises.

Management fees
If the property is only part of a building, monthly management fees will be payable to the manager of the building. The fees will cover the general expenses of managing and maintaining the common areas and facilities of the building, and provide a fund for capital expenses.

Stamp duty
A major expense of a property acquisition is the stamp duty payable to the government. This is a tax imposed by the government on certain transactions involving immovable property, including sales/purchases and leases (but not usually mortgages).

The government revises the stamp duty bands every April. The current rates are as follows:

If the price paid is less than the value of the property as assessed by the government, extra duty may be charged on the difference.

The time at which stamp duty must be paid depends on whether the property is residential or commercial. In the case of commercial property, stamp duty is payable when the assignment of the property is completed.

If the seller of the property is a company whose sole asset is the property, it may be more cost-efficient to acquire the shares in that company instead of the property. This is because the rate of stamp duty applicable to a transfer of shares in a Hong Kong company is much lower than that for a transfer of land. The parties are then required to execute contract notes with respect to the transfer of shares. The share transfer rate is 0.125% of the amount of the consideration, or of its value, at the date on which the contract note is to be executed. No stamp duty is payable for the transfer of shares in overseas companies. However, special considerations will apply (eg, whether the buyer is able to obtain finance for the purchase of shares and whether the company has any undisclosed liabilities).

Legal fees
A solicitor acting on behalf of a party to a property transaction will charge a professional fee. A scale of charges set by the Law Society determines the fee payable based on the value of the property, but this has ceased to be applied mandatorily. Nowadays, a fixed fee is usually agreed at the beginning of the transaction. In certain unusual cases, the fee is calculated according to the time spent on the matter by the solicitor.

Mortgages

Introduction
The mortgage market in Hong Kong is very competitive and it is usually possible to mortgage a commercial property for up to 60% of the value of the property. However, the amount will be affected by the status of the borrower, the age and type of property, and whether the property is tenanted or for owner occupation. If it is tenanted, the rental yield and the status of the tenant will be relevant factors.

Since the introduction of the Conveyancing and Property Ordinance (CPO) in 1984, the only way a legal mortgage may be created in Hong Kong is by a legal charge which is an encumbrance over the land. Legal charges must be created by deed. Under a legal charge, the mortgagor and the mortgagee have the same protection, powers and remedies as if the mortgage had been effected by assignment of the legal estate. The remedies available to a mortgagee by assignment (eg, the power to foreclose, to take possession and to sell) are all preserved.

The creation of equitable mortgages has not been affected by the CPO. A mortgage of an equitable estate can only be equitable itself. Therefore, where land is held under conditions of sale that have not yet been complied with (ie, under an agreement for lease), the grantee does not yet hold the legal estate in the land and can only create an equitable mortgage over the land. When the conditions of sale have been complied with, the grantee's interest in the land will be converted into a legal estate under the CPO. Upon such conversion, the equitable mortgage will become a legal mortgage.

Types of mortgages
All-monies mortgage
This is the most common type of mortgage. It secures all monies owed by the borrower to the lender, irrespective of the value of the property. If a sale of the property produces less than the amount owed to the lender, the borrower will be personally liable for the difference.

An all-monies mortgage saves the borrower the legal costs of obtaining a further mortgage if more funds are required after the initial drawdown. However, one disadvantage is that it will be difficult to obtain a second charge from a different lender.

Fixed loan
In a fixed loan, the security is limited to a fixed amount that is stated in the mortgage. This will usually be less than the value of the property, unless property values fall dramatically. However, as with all-monies mortgages, if a sale of the property produces less than the amount owed to the lender, the borrower will be personally liable for the difference.

A further charge is needed to secure any further advances beyond the amount stated in the mortgage.

Tripartite mortgage
This type of mortgage is used where the mortgagor and borrower are different parties. The mortgagor mortgages the property to secure the obligations of the borrower. In most cases the mortgagor also gives personal covenants for the repayment of all sums due by the borrower to the lender.

Limited recourse mortgage
Occasionally (although rarely), a lender will agree to limit its security to the value of the property. In such cases, the borrower will not be liable for any shortfall on the sale of the property.

Repayment
Most mortgages provide for the monies due to the lender to be repayable on demand. Although the lender will usually have agreed that the loan is repayable by instalments over a specified term, the lender will require that this arrangement is subject to the lender's overriding right to demand repayment of the loan at any time.

Occasionally, a lender will make a term loan without reserving the right to demand repayment before the end of the term.

Some mortgages contain penalties if the borrower repays all or part of the loan before a specified date.

Covenants by the borrower
All mortgages contain covenants by the borrower. The following are some of the most common:

• to repay the loan, the interest on it and the lender's costs;
  
  
• to keep the property in a good state of repair;
  
  
• to insure the property and either to assign the benefit of the policy to the lender, or to note the interest of the lender on the policy;
  
  
• not to let or part with possession of the property without the lender's consent;
  
  
• to pay the government rent, rates and all other outgoings;
  
  
• to comply with all regulations affecting the property;
  
  
• not to create further charges over the property;
  
  
• not to alter the property without the lender's consent; and
  
  
• not to use the property for any purpose other than its permitted use.

Events of default
Certain acts or failures by the borrower will be deemed to be events of default, entitling the lender to pursue its remedies. The following are common events of default:

• failure to pay any sum due to the lender on the due date or on demand;
  
  
• breach of any of the borrower's covenants;
  
  
• death or bankruptcy of an individual borrower;
  
  
• insolvency, winding-up or liquidation of a corporate borrower;
  
  
• destruction of, or substantial damage to, the property; and
  
  
• re-entry of the property by the government.

Lender's remedies
Most mortgages will give the following remedies to the lender on the occurrence of an event of default:

• to sue the borrower for breach of covenant;
  
  
• to take possession of the property;
  
  
• to sell the property;
  
  
• to appoint a receiver; or
  
  
• to foreclose (although rarely used).

Leases

The usual landlord and tenant relationship in Hong Kong is between the person who holds a government lease of premises and the person who leases those premises.

Term
Most leases in Hong Kong are short relative to those in other jurisdictions. The usual period is two or three years, although commercial leases for longer periods (eg, six or nine years) are becoming more common.

Tenants of commercial premises have no security of tenure (ie, a right to remain in the premises at the end of the term). A tenant who wishes to have the right to remain should negotiate an option to renew the term. Any option should be registered at the Land Registry so that the landlord's successors are bound by it.

Rent
If the term is two or three years, the rent is usually the same throughout the term. For longer leases, the rent will normally be reviewed every three years, in line with the market rent at that time. The rent review clause should set out the machinery for the review, and specify the assumptions that will be applied. There are usually adequate numbers of similar premises that can be compared to the property.

Initial rent-free periods for fitting-out are common.

Other charges
Rates and management fees are normally payable by the tenant. The landlord should pay the government rent unless the tenant has agreed to do so.

Deposit
Most landlords require the tenant to pay a deposit equal to two or three months' rent. The landlord is usually entitled to keep the interest on the deposit.

The tenant has no security for the return of the deposit and is only an unsecured creditor. If the landlord sells the premises, the purchaser will not (unless it specifically contracts otherwise) be obliged to repay the deposit to the tenant. If the amount involved is significant, the lease term is long, or the landlord is unknown or a shelf company, the tenant may wish to negotiate a replacement of the deposit (or part of it) by a bank or third-party guarantee. This should be negotiated at an early stage.

The tenant may also wish to ensure that, if the landlord sells the premises, it must transfer the deposit to the new owner who must enter into a direct covenant to repay the deposit to the tenant. This would give the tenant a right of action against its known landlord, the previous landlord possibly being untraceable or no longer having any assets.

Sub-letting and assignment
Hong Kong landlords have traditionally resisted granting tenants the right to sub-let or assign. However, a tenant taking a term longer than three years should be able to negotiate some alienation rights.

Repair
If the premises form part of a building, the tenant is usually responsible for the repair of the interior of the premises, and the landlord or manager of the building will maintain the exterior and the structure.

The tenant should pay attention to the scope of its obligations at the end of the term, as the costs of reinstatement can be significant.

Alterations
There are no implied obligations on the landlord to grant consent to alterations. The tenant should try to negotiate a clause stating that in the case of internal, non-structural works, the landlord cannot unreasonably withhold or delay its consent.

For further information on this topic please contact Sally Durant at Baker & McKenzie by telephone (+852 2846 1888) by fax (+852 2845 0476) or by email ([email protected]).