Lawrence Caun discusses a rare reported case concerning a tenant’s right of first refusal
A right of first refusal is the shorthand term for the right available to tenants under Part 1 of the Landlord and Tenant Act 1987 (“the Act”). This “confers on tenants of flats, rights with respect to the acquisition by them of their landlord’s reversion”, essentially giving qualifying tenants rights of first refusal on disposals by their landlord. The facts of a recent case colourfully illustrate the workings of the Act.
Artist Court
In Artist Court Collective Ltd v Khan [2015] PLSCS 313, the tenants were five out of eight long leaseholders in a block with three shops beneath. On 9 August 2011, Khan, the landlord, contracted to transfer the freehold to SGR Properties (UK) Ltd (“SGR”), referred to as his “investment vehicle”. Khan became a majority shareholder and SGR the new landlord.
The contract stated that SGR “would acquire the freehold at a nominal sum of £225,000 but the sale price will not include the three shops” and that “the rental income from the shops would be given to [Khan] by [SGR]”. A year later, on discovering that the property had been transferred to SGR, the tenants served a request for information (eliciting a denial that there was a deed of trust) and then served a purchase notice on 15 December 2013.
SGR did not comply, and the tenants started proceedings against it which revealed that SGR had transferred the property back to Khan on 19 April 2013 for nil consideration. This was found to have been done in order to “stop” the proceedings. The tenants had to restart the statutory process, this time against Khan. For the first time, Khan then produced a deed of trust (pre-dating the first transfer from Khan to SGR) by which SGR declared it held the beneficial interest in the property for Khan.
After a trial, Khan was ordered to transfer the freehold to the tenants for nil consideration.
Disposals
A relevant disposal is a “disposal by the landlord of any estate or interest (whether legal or equitable)” (section 4(1)) but excludes: (a) the grant of a tenancy to a single flat; or (b) disposals defined in section 4(2) – for example, a disposal pursuant to a matrimonial adjustment order (section 4(2)(c)(i)). In Artist Court, Khan effected a “disposal” on transferring the freehold to SGR. Applying Lord Browne-Wilkinson’s dictum in Westdeutsche Landesbank Girozentrale v Islington LBC [1996] AC 669, this was analysed as a transfer of the whole legal and beneficial interest, which, by virtue of the declaration of trust, was then followed immediately by a further “disposal” of the equitable interest by SGR to Khan. When SGR later transferred the freehold back to Khan, there was a “disposal” of the legal title.
The judge rejected an argument that it was an exempt disposal under section
4(2)(g) (“disposal… made in connection with… the discharge of any trustee”) because the property had to be held on trust both before and after the transfer. Also this subsection only applied where a trustee was discharged from a continuing trust pursuant to the Trustee Act 1925 section 36 or section 39.
Landlord, tenants and premises
The landlord is usually “the immediate landlord of the qualifying tenants” or (less frequently) the superior landlord if the immediate landlord has a term of less than seven years or whose interest is terminable within seven years (sections 2(1) and (2)).
Part 1 of the Act applies to those premises which consist of the whole or part of a building, containing at least two flats held by qualifying tenants and where those tenants hold at least 50% of the flats in the building (section 1(2)) but not if more than 50% of the internal floor area excluding common parts is occupied for non-residential purposes (section 1(3)).
A qualifying tenant, subject to exceptions, is a tenant of a flat other than a protected shorthold, service, business and assured tenancies (section 3(2)). The requisite majority is 50% of these tenants, each flat having one vote (section 18A).
Offer and acceptance
The landlord’s obligation before making the disposal (section 5) is to serve an offer notice on qualifying tenants specifying the terms of the disposal, including the deposit and consideration required. The offer notice varies according to whether the disposal is by sale contract, by auction, by way of grant of an option or by conveyance not preceded by contract (sections 5A, 5B, 5C, and 5D). The landlord must give at least two months’ notice (“Period A”) to the qualifying tenants followed by at least an additional two months (“Period B”) to enable them to nominate a purchaser to complete the sale (section 5.)
Under section 6, tenants must accept within Period A and completion must take place within Period B, during which the landlord must not dispose of the property to anyone else. If tenants fail to accept within Period A (or do so but fail to nominate a purchaser before the end of Period B), the landlord can dispose of the property (but must not, for 12 months, dispose of it for a lower consideration or on terms which do not correspond with the terms offered to the tenants) (section 7).
Criminal sanctions
If the landlord, without reasonable excuse, makes a relevant disposal without complying with section 5 or any of the restrictions in sections 6 to 10, he commits a criminal offence (section 10A). The original act was amended by the Housing Act 1996, after the court in Belvedere Court Management Ltd v Frogmore Developments Ltd [1997] QB 858 remarked on the absence of any sanction for breaching mandatory provisions. Local authorities are given authority to prosecute but have not yet done so.
Rights against a disponee
Under section 11, if the landlord fails to give notice of a disposal or contravenes provisions of sections 6 to 10, the tenants have the following rights (after serving notice) against the disponee, or purchaser:
- To receive particulars of the terms of the “original disposal” (as distinct from the disposal due to be effected to the tenants) (section 11A); (in Artist Court, the transfer from Khan to SGR was an “original disposal” and so was the transfer from SGR to Khan); the information must contain full particulars because that information can be relied on by the tenants as the basis of their purchase notice (Michaels v Harley House (Marylebone) Ltd [2000] Ch 104);
- To take the benefit of a contract (ie if not completed) (section 12A);
- To compel the purchaser to transfer the property to them on the same terms as any sale to the purchaser (section 12B); the purchase notice must be adequate for such purpose (Kay Green v Twinsectra Ltd [1996] EWCA Civ 1355; [1996] 2 EGLR 43 and Belvedere);
- Or to compel the grant of a new tenancy (where premises were disposed of by surrender of a landlord’s superior tenancy (section 12C).
A first-tier tribunal has jurisdiction to determine any issue relating to matters specified in purchase notices (section 13). A purchaser can face enforcement many years after the disposal; sections 12A(2), 12B(3) and 12C(3) provide that the six month period for serving purchase notices only begins to run after the majority of qualifying tenants receive from the purchaser: either the section 11A particulars; or information alerting them to the existence of their purchase rights which informs them of the time within which such rights must be exercised.
Other provisions
Section 14 provides for tenants withdrawing a claim against a purchaser. Section 16 addresses the position where tenants have served notices on a purchaser but that purchaser has, afterwards, transferred the estate or interest to a “subsequent purchaser”, in which case the obligations to comply with notices are imposed on the subsequent purchaser. Section 17 allows the purchaser landlord to terminate the tenants’ rights if premises cease to be premises to which the Act applies or if the tenants do not either complete the purchase or apply to a tribunal or court within three months. Section 18 enables prospective purchasers to serve pre-emptive notices to ensure rights of first refusal do not arise.
Under section 19, if a landlord fails to comply with his obligations, the court has a discretionary power (including granting an injunction) to require him to “make good the default”, providing the tenants first serve a default notice, and then allow 14 days for the landlord to comply.
Why this matters
Rights of first refusal have existed since 1988, but few cases have been reported, and, perhaps, the uptake has been small. One reason may be that tenants have to cooperate to get their act together within a limited timescale which can be as little as two months.
Tenants, of course, have a similar right to collective enfranchisement under the Leasehold Reform, Housing and Urban Development Act 1993, but the 1987 Act can allow a simpler process in so far as there are usually no valuation issues.
For a landlord (assuming he does not ignore the provisions of the Act), the procedure can involve a delay while the tenants are given time to nominate a purchaser, or notification of an auction must be given at least four months beforehand.
Despite doubts expressed by some commentators, the reversion will include any commercial part if it was included in the landlord’s proposed disposal.
Ironically, original landlords are probably less at risk than their disponee/purchaser because, once the property is transferred, the only sanction against them is criminal prosecution, which has so far proved to be a largely toothless threat as no prosecutions have been made.
The greater danger is for purchasers of the reversionary interest of premises in which tenants have the right of first refusal. This is because the time limit is open-ended and begins to run against the tenants only after they have been informed that a disposal has occurred; that they have rights under the Act; but also of the time within which their rights may be exercised. In one case known to the author, the tenants found out about the disposal almost 10 years after it had taken place, but were still able to acquire the freehold at the same price as had been paid by the purchaser 10 years earlier. The conveyancing solicitors found themselves liable to their client, the unfortunate purchaser, for very substantial damages as a consequence.
Lawrence Caun is a barrister at Lamb Chambers
