Reliance issues in mezzanine finance

Reliance issues in mezzanine finance

Critical to claims by lenders against property valuers is the question of reliance. In many cases, it will be quite clear why a valuation was commissioned and how it informed the lending decision. In others, such as Skykomish Ltd v Gerald Eve LLP [2025] EWHC 1031 (Ch), a case concerning mezzanine finance for the development of student accommodation, the position is much less clear cut. We consider the decision, which examines questions of reliance, along with a number of other issues of interest to valuers, including limitations on liability.

Background

Back in 2013 Aberdeen was considered as a “prime regional” city in development terms. Student accommodation, particularly purpose built student accommodation (‘PBSA’), was in very short supply.  The PBSA market was vibrant at that point and the claimant wanted a share of it. The borrower SPV Visage Ltd (‘Visage’) began to consider a development opportunity for some 170 studio flats in the city.  It sought the defendant’s valuation opinion as to the proposed leasehold interest it intended to acquire, which the defendant duly valued £16.57 million, in a report prepared strictly for Visage’s internal use only.

Armed with that initial valuation, the borrower’s Mr Taylor approached the claimant, Skyomish, to seek mezzanine funding for the development. The claimant’s sole director, Mr Tellwright, was most impressed by Mr Taylor and his development proposition, with the claimant’s own lending expert going on to opine that the relationship which developed between the two was “more akin to an equity joint venture, the highest risk highest return form of investment, than any true form of lending.” The claimant nevertheless required its own valuation of the leasehold interest before proceeding, although the borrower made all the arrangements to obtain the same on its behalf. The defendant duly reworked their earlier report for the claimant, confirming also that a limitation of liability of £5 million applied.

The parties went on to execute a venture profit share agreement in February 2015, with the claimant providing a total facility to Visage of £2.5 million. That provision of mezzanine finance was, as the claimant put it in evidence, the “priming of the pump” which would then attract other funders, typically institutional lenders, to advance the larger sums required for the scheme. The claimant then went about introducing Visage to its banking contacts, securing further funding from Titlestone Property Finance Ltd (which obtained a supportive valuation from one of its own panel valuers). Visage itself advanced further funds of its own, although with its position then becoming subordinated to that of Titlestone.

As completion of the development approached, Visage began to investigate the realisation of the leasehold to repay the claimant and Titlestone. By that time Aberdeen’s fortunes had declined sharply due to the fall in the price of oil, deterring investment in the local property market. Investors were also concerned about the onerous, upwards only ground rent provisions in the lease which were considered to favour the landlord unduly. Ultimately, the sale achieved just £4.2 million in October 2024, resulting in a sizeable shortfall to Titlestone, a total loss to the claimant and a significant claim against the defendant valuer.

The issues

• Reliance

Highly relevant to the issue of reliance upon the valuation was the status of the claimant as mezzanine lender. The Judge found there to have been quite limited reliance by the claimant on the valuation; it was not the valuation which had sold Mr Tellwright on the venture but rather the persuasions of the impressive Mr Taylor, by Mr Tellwright’s own wish to invest in the PBSA sector in Aberdeen and by the excellent rate of return which he expected to earn from the profit sharing agreement. In the Judge’s view, obtaining a Red Book valuation was something of a tick box exercise in terms of the lending decision; its real importance was in enabling the claimant to attract primary bank funding.

Whilst the Judge therefore concluded that the claimant would not have proceeded without a supportive valuation, he found that the claimant would only have pulled out if the figure in the valuation was significantly below that reported in the previous valuation produced for Visage’s use only (which had been initially shared with the claimant but could not be relied upon), or if it reported that there was no realistic market for the leasehold interest, but as the Judge went on to find the sort of warnings which ought to have been included in the Valuation would not have deterred the claimant.

• Duty of Care

In terms of the valuation, the parties’ experts were in agreement that the defendant valuer’s approach was insufficiently supported by comparable transaction evidence, and the valuer was not fully able to explain the methodology and so breached the duty of skill and care. However, determining the true market value to have been £15.1 million and applying a 12.5% bracket to that figure meant that the defendant’s valuation fell within the Judge’s view of the acceptable range.

The Judge went on to consider the duty to comply with the RICS Standards in terms of warning of material valuation uncertainty, concluding that there was a further obligation to warn about the following matters which the report did not address:

• that the uncapped, upwards only ground rent review provisions were onerous;
• that the residual method valuation adopted was sensitive to key inputs and that there was a lack of comparable evidence to support the leasehold valuation;
• that leaseholds were inherently less saleable than freeholds/heritables.

However, he held that the required warnings would have to have been framed in the context of the valuation as a whole. The valuation (found to have been non-negligent) was for £16.58 million. Such warnings as were required would not have altered the valuation conclusion and, “would have been properly in the context of a conclusion that said a willing buyer could be found for the Leasehold, with proper marketing, at a price of £16,580,000.”

As to the impact the inclusion of such limited warnings might have had, the Judge found that the claimant had no regard to the “should be this, but may be this” sort of caveat often found in valuation reports, and that all they were truly interested in was the valuation figure itself. That advice had not been negligent.

• Exclusions and limitations of liability

The issue of any limitation on liability was academic in view of the above findings. Nonetheless, the Judge went on to find that the relevant clauses were properly incorporated into the defendant’s retainer. Here the relevant provision was seeking to exclude liability for indirect and consequential loss, which the Judge found was common in business contracts and so neither onerous nor surprising, particularly taking account the modest valuation fee charged. The Judge also found that the exclusion clause was sufficiently brought to the claimant’s attention in that it appeared on the first page of a two-page appendix to the engagement letter, which the claimant’s solicitors had seen but had not commented on at the time. Those were also amongst the various factors which also satisfied the Judge as to the reasonableness of the clauses when considering the issue of enforceability under the Unfair Contract Terms Act 1977 (UCTA).

Comment

The case highlights – on this occasion in the context of mezzanine finance – the importance of understanding fully the circumstances in which a valuation is obtained and the precise purposes for which it is sought, so as to determine the nature of the lender’s reliance placed upon it. It also serves as a further reminder for valuers of how fundamental it is to the subsequent defence of claims that the rationale behind the methodology adopted is logical, compelling and carefully documented on the file. In this case it had not been clearly recorded, and it was therefore unsurprising that at trial a decade later the valuer struggled to explain their earlier thought processes.