Nailrile Ltd v Earl Cadogan and another and similar appeals

Leasehold enfranchisement – Leasehold Reform, Housing and Urban Development Act 1993 – Lease extension – Intermediate leasehold interests – Amount payable to holder of ILI on enfranchisement – Appropriate methods of valuing ILIThese were conjoined appeals from five decisions of leasehold valuation tribunals (LVTs) concerningclaims by qualifying tenants to acquire new 90-year leases of their flats at a peppercorn rent pursuant to the leasehold enfranchisement provisions of Chapter II of Part I of the Leasehold Reform, Housing and Urban Development Act 1993. In each case, the competent landlord for the purposes of granting the new lease was the freeholder, but an intermediate leasehold interest (ILI) held by one of the appellants sat between the interests of the tenant and the freeholder. An issue arose in determining the payment due to the appellants in respect of their ILIs under Part II of Schedule 13 to the Act. The question was how to value an ILI where the rent payable by the intermediate leaseholder to the freeholder would exceed that paid by the tenant, producing a negative income flow, following the abatement of the tenant’s rent to a peppercorn under section 56(1) of the Act.In the second, third and fifth appeals, the LVTs followed the Lands Tribunal’s approach in Visible Information Packaged Systems Ltd v Squarepoint (London) Ltd [2000] 2 EGLR 93, which was to capitalise the gross rent that the leaseholder would lose using a dual-rate years’ purchase (yp) (the Squarepoint approach). In the fourth appeal, the LVT calculated the amount that a purchaser of the ILI would require in order to establish a fund, including costs and the VAT on any reverse premium, that would be sufficient to meet the leaseholder’s continuing obligation to pay rent while simultaneously producing an adequate return for the purchaser (the reducing fund approach). In the first appeal, the LVT applied the formula laid down in para 8 of Schedule 13 for minor intermediate leasehold interests (MILIs), namely interests with an expectation of possession of “not more than one month” and a profit rent of “not more than £5 pa”, on the ground that the interest was a MILI after the grant of the new lease.Various matters were raised on the appeals, of which the main issue was the correct approach to negative income flow.Held: The third appeal was dismissed; in the other cases, the parties were invited to propose valuations based upon the conclusions of the court and the agreements already reached between themselves.(1) An assessment in respect of an ILI under Schedule 13 assumed an open market sale by a hypothetical willing vendor to a hypothetical willing purchaser. Although that language was in terms applicable only where the interest hypothetically sold had a positive value, it applied equally to situations with a negative value. Although a sale at the best price reasonably obtainable was to be assumed, that price had to reflect the options available to the willing seller in negotiations, one of which would be to refuse to sell and to retain the ongoing liability to pay the head rent. Further, if the leaseholder’s interest included other flats in the block, and it could be expected that it would be willing to sell its interest only in the block as a whole, rather than the ILI of the flat alone, that fact could be taken into account and the ILI should be valued as a component of a sale of the intermediate interest. A coherent approach to the valuation of ILIs had to encompass differences in the range of possible factual situations:(a) The Squarepoint approach was appropriate where the intermediate lease extended to other flats besides the one that the tenant was enfranchising. Although the grant of the new lease reduced the leaseholder’s profit for the block as a whole, the ground rent of the ILI did not become onerous as a result. In such circumstances, the proper measure of what the leaseholder had lost was the capitalised value of the gross rent of the flat, since, in practice, such a leaseholder would probably retain the leasehold interest and value its loss in that way.(b) Where the intermediate interest had a negative value after the grant of the new lease, the appropriate approach was to capitalise the leaseholder’s negative income flow using a single-rate yp, which should be the yield on 2.5% consolidated stock, adjusted downwards where necessary to reflect future uncertain liabilities. Although in such cases, the leaseholder might want to surrender its interest and the freeholder might agree to this in return for the payment of a lump sum, the Schedule 13 payment could not be measured by reference to what the leaseholder would pay for the surrender. The freeholder had to be excluded as a potential purchaser in a sale of an ILI; this followed from a modification of the provisions of para 3(2) of Schedule 13, pursuant to para 8(1) in order to “relate those provisions… to a sale of the interest in question”.(c) Other acceptable approaches to valuing an ILI were: (i) the capitalisation approach, which involved capitalising the negative profit rent of the ILI following the grant of the new lease, using a dual-rate yp; and (ii) the total profit rent approach, capitalising the profit rent of the whole of the intermediate lease, not merely the ILI element, both before and after the grant of a new lease to the tenant, using a dual-rate yp. The capitalisation approach was to be preferred in situations where reviews of the rent and the head rent took place at different times. Either the capitalisation approach or the total profit rent approach were appropriate where the reasonable assumption was that the ILI would be sold only as part of the leaseholder’s interest in the block of flats, such that it fell to be valued as a component of the intermediate interest and remained positive despite the grant of the new lease. On either of those approaches: (i) the remunerative rate used was a matter of market evidence but was likely to be the same as that used to capitalise the value of the leaseholder’s existing interest; (ii) the accumulative rate should be the risk-free rate of 2.25% taken in Earl Cadogan v Sportelli [2008] UKHL 71; [2009] 2 WLR 12; and (iii) any reversion to a higher fixed head rent should be valued as though it were an increased profit rent.(d) The reducing fund approach should not be followed since it failed to have proper regard to the positions of the hypothetical seller and purchaser, and accordingly produced unrealistic results. (e) The function of the MILI provisions was to provide a convenient formula to apply where the value of the interest was of very small value. An intermediate interest that qualified as a MILI in the “before” valuation, for the period prior to the grant of the new lease, did not have to be regarded as a MILI in respect of the “after” valuation. For a lease extension, the after valuation would not be on the MILI basis because the leaseholder would have no expectation of possession and a negative or nil profit rent and, accordingly, would not qualify as an ILI with an expectation of possession of “not more than one month” and a profit rent of “not more than £5”, within para 8(3)(a) and (b) respectively; that wording indicated that there had to be at least some expectation of possession and at least some profit rent in a positive amount, but below the indicated limits.(2) As to the other matters raised: (i) the Act did not provide for commuting the rent under the headlease; (ii) compensation might be payable to a freeholder, under para 5 of Schedule 13, in respect of a “two-stage” enfranchisement if, as a consequence of the lease extension, it might receive less on a subsequent collective enfranchisement and the market value of its interest was diminished for that reason; (iii) where there was a substantial reversion before the grant of the new lease, a deferment rate of 5.5% should be applied to the vacant possession value of the ILI of the flat, representing an addition of 0.5% to the generic deferment rate identified in Sportelli for freehold interests; and (iv) relativity fell to be determined by doing the best one could with such transaction evidence as might be available, although this evidence was of limited assistance and did not reveal consistent patterns, and graphs of relativity.Philip Rainey and James Fieldsend (instructed by Forsters LLP, in the first appeal; Wallace LLP, in the second, fourth and fifth appeals; and Goodman Derrick LLP, in the third appeal) appeared for the appellants; Nicholas Dowding QC and Mark Sefton (instructed by Pemberton Greenish) appeared for the respondents in the first and third appeals; Anthony Radevsky (instructed by Pemberton Greenish, in the second appeal; and Farrer & Co LLP, in the fifth appeal) appeared for the first respondent to the second appeal and the second respondent to the fifth appeal (freeholders); Timothy Harry (instructed by Portner & Jaskel LLP) appeared for the second respondents to the second appeal (tenants); the other parties did not appear and were not represented.Sally Dobson, barrister