by Jonathan Denman
Rumour has it that commonhold legislation will be introduced in the next session of Parliament. Not before time, it might be said. In May 1986 the Lord Chancellor set up a working group under the chairmanship of Trevor Aldridge which produced a detailed, very readable report in July 1987 entitled Commonhold — Freehold flats and freehold ownership of other interdependent buildings (Cm179, 1987). This was followed by the publication by the Lord Chancellor’s Department in November 1990 of a paper entitled Commonhold — a consultation paper (Cm1345), which included a draft Bill. With relatively few exceptions, the proposals in the consultation paper follow the Aldridge recommendations.
The latest development was a brief statement by the Lord Chancellor in the House of Lords in July confirming the Government’s intention to introduce commonhold. It seems, at the same time, that there will be legislation giving long leaseholders of residential flats the right collectively and compulsorily to acquire the freehold interest in their building and yet further legislation to produce arrangements for the enforceability of positive and negative covenants relating to freehold land. This article is concerned primarily with commonhold, although some reference will be made to the compulsory acquisition of the freeholds of buildings used for residential flats. It is based on the assumption that the commonhold scheme will be in the form envisaged by the Aldridge Report, as varied by the consultation paper.
The basic scheme
The intention is primarily to provide a mechanism whereby residential flats can be owned freehold but in theory, at any rate, there is no restriction on the introduction of commonhold to commercial or mixed developments. In this article reference will, therefore, be made to units rather than flats. A commonhold scheme can be set up for the whole of a building or for a series of buildings. A commonhold cannot be formed for part of a building. It will not be possible to introduce a scheme unless the building in question is registered at the Land Registry with freehold absolute title; there will be provision for voluntary registration where the title is unregistered.
The preparation of a commonhold declaration is a first step towards the creation of a commonhold scheme. The commonhold declaration defines the number and extent of each commonhold unit. It also sets out the easements and covenants applicable to each unit including the service charge provisions; essentially the equivalent of the easements granted to and the covenants to be observed by the tenant of a long leasehold. Standard easements and covenants for all commonholds are to be enshrined in statutory instrument and, therefore, commonhold declarations will merely vary or supplement the statutory provisions. Once a commonhold declaration has been prepared, it will be necessary to change the promoter’s (current freeholder) title to the building at the Land Registry by a series of notes in the property register (including a note of the commonhold declaration) and restrictions in the proprietorship register.
Every commonhold scheme will be run by a commonhold association, whose members will comprise the owners of the units. Simultaneously with the transfer of the first unit by the promoter, the freehold interest in the common parts of the building will vest in the commonhold association which will thereafter be responsible for maintaining the common parts, managing the building and collecting service charges. A commonhold association will be similar to a limited company but easier to run because certain of the formalities relating to limited companies will not apply, such as the requirement to make annual returns. Commonhold associations will have the right to enforce provisions of the commonhold declaration against individual unitholders.
The equivalent of a freehold will be vested in the holder of each unit, who will also be given the right to enforce the provisions of the commonhold declaration directly against other unitholders. In certain circumstances, it will be possible to terminate a commonhold scheme and this will normally require the consent of at least 80% of the members. On completion of a winding up, each individual unitholder will have an interest in the whole property equivalent to the service charge proportion specified in the commonhold declaration.
Separate provisions, which in practice may be contained in another part of the same Bill, will be introduced giving long leaseholders of residential flats the right compulsorily and collectively to acquire the freehold interest in the block in which they reside. At least two-thirds of all householders ordinarily residing in the block must vote in favour. The right will not apply if more than 10% of the internal floorspace of the block (excluding common parts) is used for non-residential purposes. It is important to note that it will not be necessary to set up a commonhold scheme in order to take advantage of the right to buy the freehold; the leaseholders will be free to acquire the freehold by using a traditional vehicle such as a limited company.
Main problems solved
At first glance it seems that commonhold will solve all the main criticisms which have been levied at the present long-leasehold system for holding flats.
(1) Flat owners will have freeholds and, therefore, no longer be concerned about the wasting nature of a leasehold and the difficulty of mortgaging towards the end of the term.
(2) The documentation will largely be prescribed in statutory instrument and, therefore, flat owners should not find themselves troubled by the problems of enforceability of covenants and the like which, in the past, have arisen from badly drawn leases.
(3) Problems of lack of maintenance and insurance plus poor services and management associated with absentee, disinterested or “money grabbing” landlords should not arise. Buildings will be controlled by commonhold associations run by the flat owners themselves.
(4) Many of the problems associated with running management companies (such as the failure to make annual returns) will not arise because commonhold associations will be free of certain of the more tedious requirements imposed on limited companies.
(5) The procedure relating to the winding up of commonholds will remove the concern of what happens when leases expire.
Is this the end of the problem? Are we all now to live in a world of satisfied freehold flat owners? Life is seldom this simple and a number of factors can be found which are likely to undermine this utopia. Understandably the Government is not proposing to make commonhold compulsory for residential flats, as has been strongly advocated by certain commentators, and, therefore, the way will be open to continue to opt for a leasehold regime.
The present system re-examined
By using well-drafted documentation and a well-thought-out scheme, many of the problems briefly mentioned above can be eliminated or, at least, considerably mitigated without recourse to any new legislation, commonhold or otherwise. Take, for example, the following scheme for a typical block of, say, 30 flats:
(a) Each lease is granted for a term of 999 years so that the wasting asset problem does not arise and no one is seriously worried by what will happen after 999 years.
(b) The freehold is, in any case, vested in a management company owned by the long leaseholders with provision for shares in the company to pass on assignment of the leases so that, in effect, each leaseholder owns a share in the freehold.
(c) The leases are drawn in such a way as to contain the essentials (such as mutual enforceability of covenants) but to eliminate the unnecessary provisions found in many such documents.
(d) The block will be large enough to justify the employment of outside managing agents or accountants whose job will be to see that the block is properly managed and the formalities associated with the management company are observed.
Will developers choose commonhold?
Let us take, first, the typical developer who is just completing the construction or refurbishment of a block of flats or a mixed development. Will he opt for commonhold or a more traditional leasehold scheme of the type summarised above? It will be a brave developer who decides to set up the first commonhold scheme. Moreover, a number of reasons can be identified against choosing commonhold and in some cases commonhold will not be available even if the developer would otherwise have chosen it.
1. Before a developer can complete the sale of any unit, he will first have to draw up the commonhold declaration and then register the same at the Land Registry, effecting at the same time the conversion of his title. How long in practice will the Land Registry take to perform these tasks? Facing the choice, on the one hand, of using a well-tried set of leasehold documents available without first involving the Land Registry and, on the other, of possible Land Registry delays, a developer will be tempted to take the former course. The answer, you may say, is for developers to plan ahead and ensure that Land Registry formalities are undertaken well before it is necessary to complete the sale of the first unit. In practice, however, it is unlikely that developers will think ahead in this way.
2. Although, in theory, commonhold will be available where as few as two units are involved, it is unlikely to be suitable for typical “one-up one-down maisonettes” or even conversions of large houses to form two or three units. The formation of a commonhold association will always be a prerequisite to a commonhold scheme. Although commonhold associations will be considerably simpler to cope with than limited companies, they will still involve a certain amount of managing and, therefore, be impracticable for a development of only a few units. Further, commonholds will have to conform to detailed statutory requirements such as the establishment of reserve funds. Such funds are unnecessary for a very small development and, particularly with their inherent tax problems, will be unattractive. Small developments are likely to continue to be dealt with as in the past; the freehold of the building will be taken by one of the flat owners, the others having long leases.
3. Every commonhold scheme will be subject to certain statutory regulations (the equivalent of the easements and covenants normally found in leases). However, one development is never exactly the same as another and it will always be necessary for the developer’s lawyer to introduce into the commonhold declaration amendments to the statutory provisions. This in itself is not altogether satisfactory as it is often easier and quicker (and therefore cheaper) to draft a document as a whole rather than prepare a series of amendments that have to be read in conjunction with another document. Further, certain regulations cannot be amended; for example, it will not be possible to place any restriction whatsoever on the right of a unitholder to transfer his unit. Faced with having to make amendments in the way mentioned above and the statutory restrictions, a developer’s lawyer is quite likely to turn to his well-tried, flexible leasehold scheme rather than launch into the untried, inflexible waters of commonhold.
4. The service charge payable to the commonhold association will rank as a first fixed charge on each unit and, at the termination of a commonhold, the mortgagee of each unit will be left with a charge over the mortgagor’s equitable share in the whole building. Although the Building Societies Association is said to be in favour of commonhold, a developer may understandably be nervous that it will prove unacceptable to certain mortgagees, particularly in the present economic climate.
5. The scheme for commonhold service charges lacks flexibility. In a large development, it is often sensible to have different heads of service-charge expenditure applying to different parts of the development; for example, some tenants will have the right to use and will be expected to contribute towards the cost of a communal garden, whereas others will not be permitted to use the garden but will have the use of and be expected to contribute towards the cost of maintaining the lift. With commonholds such flexibility will not be permitted. The owner of each commonhold unit will be expected to pay his due proportion of a single universal list of communal expenditure.
6. One of the basic concepts behind commonhold has always been that it should not be possible for a developer to complete the sale of any unit until the whole development has been practically completed. This was thought to be unworkable as it would lead to serious cashflow problems and, therefore, subject to certain restrictions, a developer will be permitted to complete a commonhold development in up to four phases. Even with this tolerance, a developer may wish to opt for the present scheme, where there is no statutory restriction on completing sales before the development is finished and “what he can get away with” is dictated by the market.
7. If the development is mixed use (for example, shops on the ground floor with flats above), a commonhold scheme could still be introduced, although the commonhold declaration would have to contain substantial amendments to the statutory provisions to cater for the varying requirements of the residential and commercial users. The developer would sell the freehold units in the shops in the same way as the freehold flats, the shop owners becoming members of the commonhold association. It is, however, likely that the developer will wish to retain the option of letting all or some of the commercial units on rack-rents. In theory, he could himself take commonhold units in the shops in the name of a nominee who would grant the rack-rent leases. It all sounds novel and cumbersome and the temptation would surely be particularly strong to opt for a traditional scheme where a mixed user is involved.
8. Even with exclusively residential developments, many developers, particularly in the present depressed market, will wish to reserve the right to let some of the flats on short rack-rent leases. Again a development of mixed residential units, some sold at premiums and others let on short rent tenancies, does not fit readily into a commonhold scheme.
9. Finally, it is worth noting that it will never be possible to introduce a commonhold unless the developer owns a freehold interest in the whole building. If, for example, the developer has a long lease of, say, the upper part of a mixed-use block, the choice of commonhold will not be open to him.
Will existing leaseholders choose commonhold?
Commonhold will be available not only where a building has been recently constructed or refurbished but also where existing leaseholders are joining together to acquire the freehold either by negotiation or using the new statutory powers mentioned above. Leaseholders will have the choice either of taking the freehold in the name of a limited company or similar vehicle and granting “themselves” long leases (say, 999 years) or of forming a commonhold.
Many of the disincentives to forming commonhold identified above will apply. In addition, other serious logistical problems are apparent. According to the Aldridge Report, before a commonhold scheme can be established it will be necessary first to obtain the consent of:
(a) all the long leaseholders;
(b) all their mortgagees;
(c) all the subtenants (although if 80% agree a court order can be sought to dispense with the consent of the minority);
(d) all the mortgagees of the subtenants (although again there is provision for dispensing with the consent of the minority); and
(e) any other third parties likely to be affected by the scheme (such as those entitled to easements).
Once the consents have been obtained and before the scheme can be set up, it will be necessary to deposit at the Land Registry all the land and charge certificates relating to the property. The logistical problems associated with such a campaign are mind boggling and likely to lead to considerable expense, especially where certain leaseholders and others are unco-operative or initially show enthusiasm and then prove to be elusive. It is understood that the Government is considering introducing an element of compulsion to force a minority of long leaseholders (if it is sufficiently small) to accept commonhold, which may ease the difficulties mentioned above but would be likely to give rise to other complications.
The beauty of acquiring a freehold using a limited company and long leases is that not all the leaseholders need be involved.
It is possible, for example, for half the residents to join together to negotiate the purchase of the freehold, borrowing such additional funds as they may require.
Having done so, they can then grant “themselves” long leases, leaving the remainder of the residents to join in at a later date when they have raised sufficient funds to do so.
Conclusion
Will commonhold ever get off the ground or will it remain a white elephant? Only time will tell. The idea of a freehold flat is readily understandable by members of the public and the Government is surely right to persevere with proposals to make this idea a reality. When commonhold is introduced it should be made as flexible and simple to operate as possible. Only then will it stand a chance of surviving.
