A call for reform in the Landlord and Tenant Act

The Law Commission recently concluded a consultation on its 14th Programme of Law Reform covering a wide range of topics, including commercial leaseholds. In its response to the consultation, the Property Litigation Association – drawing on the views of its 1,400 members – has urged the Law Commission to incorporate into its programme much‑needed reform to the Landlord and Tenant (Covenants) Act 1995 and the Landlord and Tenant Act 1987. Many of the issues with the 1995 Act will be well known to the industry, not least the challenges around intra‑group assignments and parent company guarantees. The challenges presented by the 1987 Act are less well known but, in our view, no less frustrating and are only likely to become more of an issue as the industry moves further toward mixed-use buildings and residential-focused asset classes. What is the 1987 Act? Provided that certain qualifying conditions are met, the 1987 Act gives long leaseholders of residential flats a right of first refusal if their landlord wishes to dispose of its interest. At its simplest, where the landlord of a block of flats wishes to sell its interest, it must first offer to sell to the residents on the same terms (usually through a management company) before selling to a third party. So, what is the problem? This may sound straightforward and uncontroversial. However, the 1987 Act is widely agreed to be poorly drafted (it was described by one leading judge as “ill drafted, complicated and confused”), with the result that understanding and applying the Act is leaden with pitfalls. For example: Even the simple question of which buildings the Act applies to is potentially fraught with difficulty. The position may be straightforward enough in the context of a single, self-contained block of flats. However, as soon as one factors in terraces of buildings or estates of multiple buildings with shared facilities, matters become much less clear cut. Complexities also arise in the context of mixed-use buildings where the relative floor areas of the residential and commercial parts (excluding common areas) must be measured to determine whether the Act applies. The definition of a “disposal” under the Act is exceptionally wide. Subject to some limited exceptions, it catches almost any dealing by the landlord save for a lease of a single flat. Most troubling of all, the Act does not exclude the grant of a commercial lease from the definition of disposal. As such, in a scenario of a mixed-use block with commercial units on the ground floor and flats above, the landlord may be prevented from granting a rack rented lease of a commercial unit unless it has first offered the residential leaseholders the opportunity to take the lease. This is almost certainly not what the Act intended but is a consequence of its poor drafting. The process of complying with the Act can be onerous, time-consuming and costly. Where the Act applies, the landlord must serve notice on all the residential tenants before making any disposal to a third party and can only proceed with the disposal when at least two months have passed without the tenants having sought to exercise their rights of first refusal. In large blocks with hundreds of leaseholders, this inevitably causes delays to transactions (including commercial lettings as set out above). The landlord may also find it has to start the whole process again should the terms of the underlying intended disposal change during negotiations, meaning that new terms then need to be offered to the leaseholders and another two-month delay ensues. These challenges are all exacerbated by the fact that failure to comply with the Act constitutes a criminal offence. This is not therefore a case in which a well-advised landlord could “take a view” on the risks of non-compliance. While we are not aware of any criminal prosecutions for non-compliance, if a landlord did pursue a disposal in breach of the Act, the proceeds could technically be regarded as proceeds of crime under money laundering regulations. A further issue around non-compliance is that, in some circumstances, the leaseholders have an ongoing right to acquire the landlord’s interest from the third party to whom it was wrongfully disposed and its successors in title. This can create difficulties with future disposals where it may not be known whether the Act was complied with previously. Even if the prospective purchaser ensures that the Act is complied with on the acquisition, it faces an unknown risk of leaseholders later asserting their rights in respect of previous disposals. One silver lining might be that, for sophisticated landlords who are well advised at the outset, it can be relatively straightforward to set up leasehold structures in a way that largely avoids the application of the Act. For example, residential flats can be held under a separate headlease set up prior to letting the residential flats, which then insulates the remainder of the landlord’s interest (including any commercial parts) from the Act. An exemption for intra-group disposals can also be used to good effect provided that the group companies have been associated for at least two years. While this may be positive news for landlords, in our view it further emphasises the failings of the Act: legislation that can largely be avoided by sophisticated landlords with sound legal advice but which continues to apply to smaller, less well-advised landlords (who may not even know about it) cannot be considered to be good legislation. What do PLA members think? Earlier this year, the PLA surveyed its members on their thoughts on the 1987 Act and the options for reform. The results were clear. More than 70% of respondents had experience of the 1987 Act delaying or complicating transactions and 92% believed that it resulted in increased costs. Only 17% felt that the benefits conferred on tenants by the Act outweighed the disadvantages to landlords. Indeed, only 34% of respondents felt that the Act had any valuable benefit to tenants. Respondents’ views were, however, more evenly balanced on whether the benefits conferred by the Act have been superseded by other tenant-friendly legislation, such as the right to enfranchise or the right to manage. While only 35% of respondents would support the abolition of the Act in its entirety, almost 60% felt that the criminal sanctions for non-compliance should be abolished and almost 85% felt that the Act should be amended so that it would no longer apply on the grant of a commercial lease. The PLA Law Reform Committee is clear in its view that the Landlord and Tenant Act 1987 is in need of long overdue reform. Although many of our members regard abolition of the Act as a step too far, a number of changes would clarify and simplify the application of the Act, the most pressing being the removal of commercial leases from its ambit. With an increased focus on mixed-use development and diversification of the high street, mixed commercial and residential blocks will almost certainly become more common. The inevitable result is that the difficulties associated with the Act will start to affect more and more commercial leasing transactions, with the attendant cost and delays identified by our members. The government has committed to a review of commercial landlord and tenant law and, while the 1987 Act may not loom large in that review, its reform would be a small but significant step in the right direction. Paul Tonkin is a member of the Property Litigation Association Law Reform Committee and a partner at Hogan Lovells International LLP Image © Susannah Ireland Photography Ltd/Shutterstock