In the last of the series on rights for residential tenants, Peta Dollar explains how landlords can structure a transaction so as to avoid falling foul of the legislation
The first five articles in this series considered the various rights enjoyed by qualifying residential tenants under various legislation, namely the right of first refusal, the right to enfranchise a house, the right to collectively enfranchise a multi-let building, the collective right to manage and rights in relation to service charges.
It will have become apparent from these articles that the legislation is often complex, confusing, time-consuming and costly for a landlord to comply with, and a landlord may well wish to avoid having to comply with any or all of this legislation.
This article, the final one in the series, will consider how a landlord can avoid having to comply with each of the legislative provisions.
Right of first refusal under the 1987 Act
Avoiding having to comply with the Landlord and Tenant Act 1987 (as amended – the “1987 Act”) is relatively easy – it is simply necessary to take the appropriate steps at the appropriate time. If the landlord has not put the appropriate measures in place in advance, however, avoiding the need to comply with this legislation becomes much harder.
The landlord can:
• Take the premises outside the legislation. There is no need to comply with the legislation unless the disposal relates to a building that contains two or more flats.
Although there is no case law on the subject, it is possible that a disposal made early in the development process, before anything that could be reasonably described as a building has been created, or before that building contains two or more flats, will not need to comply with the legislation. The definition of “flat” requires that the premises be constructed or adapted for use for the purposes of a dwelling; where no kitchen or bathroom facilities have yet been installed, arguably the building does not contain any “flats”.
Obviously a building that only contains a single flat will never fall within the legislation and, similarly, a building that contains just over 50% non-residential use will always be outside the legislation.
• Use the resident landlord exemption (in the case of a non-purpose built building) to avoid having to comply with the legislation.
• Ensure that a disposal can always be made without having to comply with the legislation by granting a head lease of the whole building (or of the residential parts of it) for at least seven years (without any landlord’s option to break in the first seven years of the term) that intervenes between the freeholder and the qualifying residential tenants. The freeholder will not be the immediate landlord of the qualifying tenants, and hence will not need to comply with the legislation.
Note, however, that the creation of such a lease in relation to a building that already falls within the legislation will itself be a disposal that is caught by the legislation; the lease needs to be created before the building falls within the legislation.
Alternatively, an individual intervening lease can be created in respect of each flat within the building (thus taking advantage of the single flat lease exemption); a subsequent disposal of the whole building by the landlord need not then comply with the 1987 Act, because the landlord is not the immediate landlord of the qualifying tenants. Remember that in this case, although the freeholder need not comply with the legislation, the legislation will still apply to the building, and to any disposal made by the immediate landlord of the qualifying tenants.
• Limit the number of qualifying residential tenants by granting a sufficient number of assured or assured shorthold tenancies. Provided that the building contains less than two flats let to qualifying tenants, or the number of flats held by qualifying tenants is not more than half of the total number of flats in the building, the building will not fall within the legislation.
• Ensure that the disposal will not be a relevant disposal by exchanging contracts (or granting an option or right of pre-emption) at a time when the premises do not fall within the legislation. Completion of the sale pursuant to the contract, option or right of pre-emption will then be a disposal outwith the legislation even though, at the time of completion, the building falls within the legislation.
• Find an associated company (with which the landlord has been associated for at least two years) and transfer the premises to that company (this is not a relevant disposal and so compliance with the 1987 Act is not required). The disposal of the premises to a third party can then proceed by way of a sale of the shares in the associated company (this will not be caught by the 1987 Act, as it is a disposal of shares, not a disposal of an estate or interest in land).
Clearly, if the landlord does not happen to have a convenient associated company, then two years must elapse after the formation of such a company before this loophole can be used. In view of the comments of the Court of Appeal in the case of Michaels v Harley House (Marylebone) Ltd [1998] PLSCS 289, the landlord would be well advised to complete the transfer to the associated company, including registration at the Land Registry (if required), before commencing the marketing of the premises to a third party by way of share sale.
• Own the building through the medium of a company (or similar body, such as a unit trust or limited liability partnership). The shares in that company (or the units or other medium through which the body is owned) can then be transferred to a third party without the disposal being caught by the legislation. However, the initial acquisition of the building by the company (or similar body) would need to be done at a time when the building falls outwith the legislation, otherwise the disposal of the building to the company would itself be caught by the legislation.
Right of enfranchisement (houses) under the 1967 Act
The landlord can avoid the tenant having the right to enfranchise (or apply for a new lease) under the Leasehold Reform Act 1967 (as amended – the “1967 Act”) by:
• Ensuring that the building is not a “house”, by ensuring that other premises not comprised in the lease lie under or over the leasehold premises. For example, where a townhouse has a garage on the ground floor, the house itself can be let on one lease and the garage on a separate lease for less than 21 years. The house will not then be capable of enfranchisement.
• Ensuring that the house is not let on a long lease. If the lease is for less than 21 years and does not contain a right of renewal, then the legislation will not apply.
Right of collective enfranchisement under the 1993 Act
The Leasehold Reform, Housing and Urban Development Act 1993 (as amended – the “1993 Act”) cannot, for most practical purposes, be excluded in part or whole. So, for example, a lease within the 1993 Act cannot require a tenant to refrain from exercising its rights (if any) under the 1993 Act. Similarly, it cannot require the tenant to offer to surrender its lease, nor impose any kind of penalty on a tenant, in the event that it seeks to exercise such rights. The 1993 Act also prohibits the increase in the value of the freehold by, for example, the creation of an overriding lease.
However, the landlord can avoid its tenants having the right to collectively enfranchise by ensuring that the building does not meet the qualifying criteria. This could be achieved by:
• arranging for services, such as heating, to be shared with a separate building;
• having only a single flat in the building;
• having more than 25% of the internal floor area used for non-residential purposes; or
• letting fewer than two-thirds of the flats to qualifying leaseholders (a tenant who is not a long leaseholder will not qualify).
In the case of a non-purpose built building containing four or fewer flats, the resident landlord exemption can be used.
The most practical way for the landlord to avoid the residential tenants having the right to an extension lease will be to ensure that they are not long leaseholders as defined in the legislation.
The right to manage under the 2002 Act
Section 106 of the Commonhold and Leasehold Reform Act 2002 (the “2002 Act”) is a widely worded anti-avoidance section, which makes void any agreement relating to a lease (whether contained in the lease or not and whether made before the creation of the lease or not) in so far as it:
• purports to exclude or modify the right of any person to be, or do any thing as, a member of a right to manage company (an “RTM company”);
• provides for the termination or surrender of the lease if the tenant becomes, or does anything as, a member of an RTM company or if an RTM company does anything;
• provides for the imposition of any penalty or disability if the tenant becomes, or does anything as a member of an RTM company or if an RTM company does anything.
Any provisions in the lease relating to management, such as obligations to pay service charges, will automatically pass from the landlord to the RTM company if the right to manage is transferred, so there is no point in including specific provisions relating to what will happen if the RTM company takes over.
The only way to avoid the right to manage arising is to design the building in such a way that the building does not qualify, or ensure that there are insufficient qualifying tenants.
Rights in relation to service charges under the 1985 Act
The landlord has only a very limited ability to avoid the rights granted to residential tenants in relation to service charges under the Landlord and Tenant Act 1985 (as amended – the “1985 Act”). The landlord can:
• Grant leases that do not contain a variable service charge – a fixed service charge, or rent that is inclusive of service charge, will avoid the provisions of the 1985 Act. But there are obviously serious drawbacks to this course of action in the case of a long-term lease.
• Enter into a long-term arrangement with a third party for maintenance and provision of services before the building has been constructed or let. This will avoid the need to consult with the residential tenants, but will not prevent those tenants from challenging future costs on the grounds of cost or quality, and the landlord may find himself having to pay sums to the third party that cannot be recovered from the tenants.
• Impose service charge-type obligations on the tenants in their capacity as shareholders (say, in a management company) rather than in their capacity as tenants under their leases. Case law confirms that the protection of the 1985 Act will not apply in this case.
Peta Dollar is a freelance lecturer, trainer and writer, with particular expertise in relation to mixed use and residential tenants’ rights and is co-author of Mixed Use and Residential Tenants’ Rights: The Landlord and Tenant Act 1987 and Enfranchisement
