John Stephenson examines participation agreements for collective enfranchisement claims under the 1993 Act
A participation agreement (PA) for a collective enfranchisement claim under the Leasehold Reform, Housing and Urban Development Act 1993 (the 1993 Act) governs the making of the freehold application, the payment of the funds required when they are needed, the issue of the shares in the new freehold company and the grant of the 999-year leases, with any agreement on future management objectives.
Meetings and communication
In many cases, the participant tenants will not know each other well, if at all. It is remarkable how many neighbours actually meet each other in person for the first time when discussing a freehold bid. The greater the rapport between the participants the better, and if they don’t know each other they are unlikely to trust each other in what may be a substantial financial transaction. A meeting of participants also tends to flush out difficult issues and challenging personalities.
Channels of communication should be agreed. To minimise costs it is best to agree that two participants only can contact the professionals and it will then be up to them to relay information to and from their fellow lessees.
The lessees should have a valuation done before they incur legal costs, unless there are preliminary issues of whether the building qualifies or the proposed group is sufficient to pursue a claim. The need to raise a fighting fund to pay for the valuation is a useful sign of commitment on any lessee’s part.
Non-participating premises
If only some of the lessees are participating, they must decide how the share of the freehold price attributable to the non-participating flats is to be found, either from within the participating body themselves or through an external investor, known as a “white knight”. The white knight is usually a property professional who can see future profit when the non-participating flat extends its lease, because marriage value is not paid under schedule 6 of the 1993 Act on non-participating flats. White knights are often the difference between a claim being able to go ahead and not, so such an investor needs to be identified early.
Caretaker flats can be a complicating factor depending on whether the participants want to maintain a resident caretaker function (and this must be spelt out in the PA if applicable). There may also be non-residential premises which are potentially the subject of a leaseback to the freeholder under Schedule 9, but the freeholder is not obliged to seek a leaseback, and the agreement will need to say how that is to be funded if none is sought.
Nominee purchaser company
Before making the claim, participating tenants should form the company which will be the nominee purchaser. There are standard management company constitutions available from formation agents, but it is worth flagging a few points.
Membership: the participants should all have a share or be members (according to whether it is a company limited by shares or guarantee), but what about the white knight? It could have a share for every non-participating flat, but if the participant numbers are only just enough to found the claim, the white knight may finish up with a nearly 50% interest in the freehold company and that is often unacceptable to the participating tenants. So the white knight shareholding is something that needs to be recorded in the PA. The owner of the share, whether participant or investor, should always be the same person as the 999-year leaseholder, as the leases should contain a provision that the freehold share will be assigned with the shareholder’s flat.
Directors: some standard articles say that only members can be directors, which is unnecessarily restrictive and causes especial difficulties for corporate lessees. In my view, this should be amended so that any member can appoint a nominee director, and for small buildings (say up to 10 flats) every member should be allowed (or even required) to appoint a director. It is often hard to find enough people willing to be a director and material obstacles should not be placed in their way.
Directors’ responsibilities should be explained to them, but any concerns are usually allayed on the basis that the day-to-day running of the building, and indeed of the company if they offer a company secretarial service, will be left to the managing agents, and further that directors’ liability insurance can be obtained for very modest premiums, which the company should pay.
The PA is binding
The PA is not a non-binding statement of intent – it is a legally binding contract. For that reason, advisers should be aware that they are advising the collective group, and not any individual lessee. Once signed, the participation agreement effectively becomes the client, since it reflects the collective will. Individual lessees should be advised that they are free to take their own independent advice on the PA insofar as it affects them.
Note also section 18 of the 1993 Act, which requires that if at any time from the service of the claim notice to the exchange of contracts for the freehold purchase, there is a binding agreement between the nominee purchaser and anyone other than a participating tenant whereby that person will obtain any interest in the building, which of course would include a
999-year lease of a non-participating flat, that agreement has to be notified to the landlord, and the general view is that such an agreement would require marriage value to be paid on the relevant non-participating flats.
So the white knight should not be a party to the PA. The PA may express intent to find a white knight and identify who it should be, so long as they are not party to it.
Who pays what?
Use the same proportions for the freehold price and the stamp duty land tax (remembering collective enfranchisement reliefs), as the two are related. Either agree the proportions at the outset, based on the valuer’s assessment of the likely price payable by each unit, or agree to abide by the valuer’s apportionment of the actual price. Most groups seem to prefer the certainty of the first option.
Other costs, primarily the group’s own legal and valuation costs and those of the landlord under section 33 of the Act, are usually divided either in the same proportions or equally.
Particular elements of the price may have special treatment; I have already mentioned some examples (non-residential premises if no leaseback is taken, any caretaker flat), and others (such as development value) will apply to different buildings.
The PA should contain a rescission clause if the price exceeds by an agreed margin that which the lessees are expecting to pay on the basis of the pre-claim valuation.
999-year leases
The PA should cover the terms of the 999-year leases to be granted to the participants after completion. They will often be in short form, just extending the term, reducing the ground rent to a peppercorn and incorporating by reference all the other relevant terms of the current lease, adding in the obligation to transfer the share in the freehold company with the lease, and also adding to the costs recoverable under the service charges the company’s running costs such as directors’ insurance.
If the current lease is one extended under the Act, remember to exclude the section 61 provisions in the 999-year lease. There is a tax planning opportunity here in granting the new lease to children subject to the parents’ shortening lease. Don’t delay their grant following completion, to avoid potential tax issues for the freehold company. The shares should also be issued, both to the participants and to the white knight for however many it is to receive.
Why this matters
One key to the success of a collective enfranchisement claim under the Leasehold Reform, Housing and Urban Development Act 1993 is a properly drawn agreement between the participants covering the process and the early stages of their ownership of the block.
A well-drawn participation agreement (PA), so that the participants are fully aware of their obligations and entitlements, can mean the difference between a successful claim and one that ends in failure and acrimony.
The key points that the agreement should include are:
- The first-stage meeting and channels of communication with the professional advisers and between the participants;
- Funding of non-participating flats and non-residential premises including “white knight” investors;
- The nominee purchaser company: membership and directors;
- Financial contributions to freehold price and costs; and
- The terms of new 999-year leases to be granted to the participants after completion; ν Key initial management objectives (which are as often the motivation for a claim as declining lease lengths, which can be more simply resolved by a lease extension claim).
Who would benefit?
- Tenants seeking to enfranchise
- Solicitors acting for the participating group
- Valuers
Useful resources
- Hague on Leasehold Enfranchisement Radevsky, A and Greenish, D, (6th ed, Sweet & Maxwell, 2015)
- Association of Leasehold Enfranchisement Professionals (ALEP): www.alep.org.uk
John Stephenson is senior partner and head of enfranchisement at Bircham Dyson Bell LLP. This article is based on a talk given to the Association of Leasehold Enfranchisement Professionals earlier this year