Leasehold enfranchisement – House – Leasehold Reform Act 1967 – Respondent underlessees seeking to acquire freehold of house – Long head leasehold interest interposed between respondents’ lease and freehold – Unusual terms of headlease requiring annual payment to freeholders of increasing proportion of premiums and fines received by head lessee for grant of underleases after first 42 years of headlease – Approach to calculating core value of head leasehold and freehold interests – Appropriate capitalisation and deferment rates – Appeal allowed
The respondents exercised their right, under the Leasehold Reform Act 1967, to acquire the freehold of the property of which they held an underlease. The leasehold valuation tribunal (LVT) was asked to determine the price payable for the freehold. At the relevant valuation date, the unexpired term of the underlease was 35.39 years and it was due to expire in December 2040. The central issue concerned the correct apportionment of the enfranchisement price between the freeholders and the appellant headlessee in the light of the unusual terms of the headlease.
The headlease was of the entirety of the Grosvenor Belgravia Estate for a 200-year term expiring in 2184. It had been granted, without premium, by the freeholders in 1984, in their capacity as the trustees of the will of the second Duke of Westminster, in order to mitigate inheritance tax. It contained an absolute covenant against assigning part of the estate, although an assignment of the whole, or underletting of the whole or part, was permissible with the freeholders’ consent, which was not to be unreasonably withheld. A rent of £1,000 pa was payable for the first 42 years of the term. Thereafter, an escalator clause provided for the rent to be calculated as an annually increasing proportion of the fines or premiums received by the appellant for the grant of underleases in each year; the proportion was 5% for the 43rd year of the term from March 2026, increasing by 5% annually until it reached 90% for the 60th and all subsequent years of the term.
The issue was how to identify the investment or core values of the freeholders’ and the appellant’s respective interests in the property, which they were entitled to retain as part of the purchase price, as opposed to marriage value, of which, under the legislation, they were entitled to retain only 50% between them. The parties approaches to valuation differed and an issue also arose as to the appropriate capitalisation and deferment rates.
The LVT determined a total enfranchisement price of £1,269,249, of which £100,799 was payable to the freeholders and £1,168,450 to the appellant. The appellant appealed.
Held: The appeal was allowed.
(1) Separate valuations of the freehold and of the head leasehold interest were required under section 9(1A) of, and Schedule 1 to, the 1967 Act in order to establish the core value of those interests. Those values, along with the core value of the underlease, had to be deducted from the freehold vacant possession value of the property in order to find the marriage value and to calculate the enfranchisement price.
(2) In valuing the head leasehold interest, it was to be assumed, notwithstanding the absolute covenant in the headlease against an assignment of part of the estate, that the freeholders would grant a one-off permission to enable the hypothetical sale of the head leasehold interest in the open market that was contemplated by section 9(1A) of the 1967 Act. Any bid from the occupying tenant was to be disregarded on such a sale, reflecting, as it would, the overbid that that tenant would make as special purchaser in the light of the additional value to it of the coalescence of all interests in the property, whereby it would obtain the freehold with vacant possession. Accordingly, the relevant bid was that of the underbidder (X).
The prospect of escaping from the escalator clause would be important to X in deciding how much to bid. The options for achieving this were: (i) reaching agreement with the occupying tenant for the grant of a new long underlease at a premium prior to December 2026; (ii) purchasing the occupying tenant’s interest and granting a new underlease to another tenant at a premium prior to that date; (iii) granting to a purchaser, for a premium, a reversionary underlease to 2184, commencing on the expiry of the existing underlease in December 2040; (iv) a buy-out by the freeholder of the head leasehold interest; and (v) the option of a sale of the severed head leasehold interest in the property to a special-purchase vehicle, for occupation by its shareholders. Options (i) and (ii) had to be disregarded since they involved marriage value at the stage of assessing core value; both relied on a coalescence of the head leasehold interest with the underlease. Option (iv) had likewise to be rejected, even though it did not rely on a transaction with the occupying tenant, since the extra value instead arose directly from a coalescence of the freehold and head leasehold interest: see section 9(1D) of the 1967 Act and Jones v Wentworth Securities [1980] AC 74. Option (iii) could be taken into account. It was not prohibited by any implied term of the headlease and would not create an interest superior to that of the occupying tenant so as to fall foul of the Leasehold Reform Act 1979. It was to be assumed that the highest bidder would receive legal advice to the effect that the freeholders could not reasonably withhold consent to such a transaction. However, its bid would include a 40% reduction from the value that would apply were the escalator clause to be avoided without risk. Option (v) could also be taken into account, assuming a one-off consent from the freeholders; it was not necessary to assume a sale of the entirety of the headlease extending to the estate as a whole: Nailrile Ltd v Earl Cadogan [2009] 2 EGLR 151 considered. Taking into account the risks associated with that option, the bidder would make a 30% reduction in the value of the head leasehold interest from that which could be obtained were the escalator clause to be avoided without risk. Overall, hypothetical purchasers under option (v) would offer the highest bid.
(3) With regard to the freehold value, the hypothetical purchaser would consider it a virtual certainty that head leaseholder would escape the escalator clause by entering into a transaction with the occupying tenant prior to December 2040. The only party that might pay a substantial sum for the freehold would be the head leaseholder, but since the value to that party flowed from the coalescence of the freehold and head leasehold interests, it had to be disregarded at the stage of calculating the core value of the freehold. The value was therefore £1,130, being the present value of the freeholders’ distant reversion.
(4) An increase above the agreed freehold capitalisation rate could not be justified for the years before the escalator clause became operative. Thereafter, between 2026 and 2040, a rise in the capitalisation rate by 0.75% to 5.5% was justified to reflect the obligations and risks associated with the operation of the that clause. As to the deferment rate, an increase over the Sportelli rate of 4.75% was appropriate when valuing the basic value that X was certain to enjoy, namely the rents to December 2026 and 22.5% of a premium for the grant of a new 143.25-year underlease; the higher rate reflected the risk to the reversion from the escalator clause, which placed the head leaseholder in the position of having to sell in December 2040 to avoid the operation of that clause. However, as to the remainder of the value of the head leasehold interest, a purchaser under options (iii) or (v) would be content to adopt the Sportelli generic deferment rate of 4.75%.
(5) Assuming that option (v) was adopted, the enfranchisement price was £1,292,245, of which £1,290,291 was payable to the appellant and £1,954 to the freeholders.
Jonathan Gaunt QC and Anthony Radevsky (instructed by Boodle Hatfield) appeared for the appellant; Philip Rainey QC (instructed by Bircham Dyson Bell LLP) appeared for the respondents.
Sally Dobson, barrister
