Investment schemes offering guaranteed high rates of return may be too good to be true and should always be approached with extreme caution. A High Court case on point concerned a scheme in which retail investors ploughed millions into acquiring rooms in care homes with a view to letting them out at a profit.
After the Financial Conduct Authority (FCA) took action with a view to achieving restitution of funds lost by investors, the Court noted that the scheme involved the sale of long leases of care home rooms to private investors. Its operator did not conceal the fact that the rooms were being sold at a substantial overvalue. The apparent sales pitch was that surplus funds would be spent on renewing or refurbishing properties concerned, thereby improving their rental yield.
The offerings, which were presented as buy-to-let investments, typically indicated that investors would receive a guaranteed annual return of 10 per cent during the first 25 years. Investors were further attracted by an indication that, at various points during that period, the operator would be prepared to repurchase their rooms from them for at least 115 per cent of their initial investment. That was whether or not their rooms were actually let and regardless of the commercial performance of underlying care home businesses.
Part of the attraction of the scheme’s model to investors was that it appeared to offer enhanced security. Evidence that long leases of specific rooms had been registered in investors’ names at HM Land Registry gave the appearance of securing at least part of their money.
Ruling on certain preliminary issues in the case, the Court noted that a view was taken that the operator was not required to recognise its obligations to investors under the guarantees as liabilities on its balance sheet. That approach seemed to have been adopted on the basis that those obligations were mere contingencies that might not arise.
Despite having no capital resources, the operator was thus able to raise funds from investors at promised high rates of return without recognising on its balance sheet the liabilities to which the promises made to them gave rise. Had such recognition been given, it would have been transparently clear that, far from being based on a viable financial structure, it was hopelessly balance sheet insolvent.
An important feature of the scheme’s structure was that it required no investment at all from its originator. Because the sales were at an overvalue, each of them created an accounting profit that appeared to constitute capital of the company. Although the operator appeared well capitalised and solvent, in reality it was the investors who were taking all the risk involved in the commercial operation of the properties concerned.