Kutchukian v Keepers and Governors of John Lyon Free Grammar School
HH Judge Nicholas Hutchinson and Mr Norman J Rose FRICS
Collective enfranchisement – Purchaser price – Restrictive covenants – Leasehold Reform, Housing and Urban Development Act 1993 – Enfranchisement of property comprising four flats – Restrictive covenant limiting property to such use – Whether such covenant to be included in transfer under Schedule 7 – Value to be attributed to prospect of reconversion to single dwelling on expiry of original lease terms – Effect of uncertainties as to ability of freeholder to obtain possession of flats under section 61 and compensation payable under Schedule 14 – Appeals allowed in part
The appellant and his wife held a headlease of a detached property in London NW8 for a term expiring in September 2046. The respondent was the freeholder. The property had originally been built as a single dwelling but had been converted into flats in the 1950s; the headlease contained a covenant not to use the property other than as four self-contained private residential flats. The flats were let to tenants on leases that had been extended, on applications under the Leasehold Reform, Housing and Urban Development Act 1993, to run until 2136. On a subsequent collective enfranchisement under the Act, the appellant acted as the nominee purchaser for the tenants for the purpose of acquiring the freehold of the property from the respondent. The relevant valuation date was September 2008.
The leasehold valuation tribunal (LVT) determined that £51,800 was payable to acquire the freehold. It imposed a restrictive covenant under Schedule 7 in terms that permitted use of the property as four self-contained flats or a single private dwelling-house. However, it discounted by 90% the value attributable to the prospect of reconversion to a single dwelling in 2046. The discount took into account uncertainties as to: (i) the ability of the hypothetical purchaser to exercise the right of “the landlord”, under section 61 of the Act, to apply for possession of the flats in the last year of the original lease terms on the ground of an intention to redevelop the property; (ii) whether, if it could do so, it would effectively have to pay a ransom or marriage value to the tenants as compensation, by virtue of Schedule 14; (iii) the future planning position, market conditions and redevelopment costs; and (iv) whether an estate management scheme, to which the property would be subject after the transfer, might be amended before 2046 to prevent reconversion.
On appeal from that decision, the appellant contended that no restrictive covenant should be included in the transfer but that there should be no consequent increase in the price owing to the uncertainties to which the LVT had referred. The respondents also appealed, seeking an increase in the price. On the appeal, they contended for a restrictive covenant in similar terms to that in the existing headlease, and not permitting use as a single dwelling.
Decision: The appeals were allowed in part. The price payable for the freehold was revised to £143,497.
(1) The relevant provision of Schedule 7 in the instant case was para 5(1)(b)(i). The restriction sought by the respondents could properly be said to represent the restrictions in the headlease with only “suitable adaptations”, within the meaning of that provision. It was also “capable of benefiting other property” since it was a covenant restricting user, of a type frequently adopted for the purposes of benefiting retained land. However, the proposed restriction had not been shown materially to enhance the value of other property. Although the concept of a material enhancement in value of other property could include the concept of maintaining a value that would otherwise deteriorate, material enhancement had to be distinctly proved: Peck v Trustees of Hornsey Parochial Charities (1971) 22 P&CR 789, Le Mesurier v Pitt (1972) 23 P&CR 389, Moreau v Howard De Walden Estates Ltd LRA/2/2002 and Earl Cadogan v Erkman [2011] UKUT 90 (LC); [2011] PLSCS 163 applied. The respondents had advanced, by way of evidence, only theoretical situations that had no more than a possibility of occurring, and that, if they did occur, could be controlled satisfactorily under the estate management scheme. The covenants in the scheme were effectively as good as the restrictions in the headlease; although they were qualified whereas the covenants in the headlease were absolute, the headlease covenants might still have been discharged or modified under section 85 of the Law of Property Act 1925. There was no significant prospect of the scheme being amended adversely to the respondents, so as to allow through some objectionable use. Therefore, the restrictions in the headlease were not such as materially to enhance the value of other property, bearing in mind the existence of the estate management scheme and the lack of any evidence showing any real problems on the estate or any usefulness of the restrictive covenant over and above the terms of the scheme. No such restrictive covenant should be included in the transfer.
(2) When determining the price payable under Schedule 6 of the 1993 Act, it was not necessary to reach a definitive decision on whether the hypothetical purchaser would, in 2046, succeed in overcoming the identified legal problems under section 61 and Schedule 14. If the freehold had been offered for sale at the valuation date, the hypothetical purchaser have taken advice as to the likely strengths and weaknesses of his position in 2046, so far as potential legal difficulties and other uncertainties were concerned, and would have framed a bid on that basis. Para 3 of Schedule 6 did not require the tribunal to take any different approach. It assumed that the premises were being offered for sale with the rights subject to which the conveyance was to be made. It did not require the prospective 2046 litigation to be decided definitively as at the valuation date, since, at that date, no rights yet existed under section 61 and Schedule 14; the respondents merely enjoyed the prospective right in 38 years’ time to seek to operate section 61 and Schedule 14 against the then occupying underlessees. The potential rights that would arise under section 61 and Schedule 14 in due course, absent a change in the law, should be valued for what they were worth at the valuation date, with all their respective strengths and weaknesses, rather than the prospective 2046 litigation being effectively decided now by the tribunal in a decision that would not bind the tenants holding the underleases in 2046.
(3) However, it was appropriate for the tribunal to express a view on the legal issues, since the strength or otherwise of the parties’ arguments would be relevant to the well-advised hypothetical purchaser in deciding how much discount to make for the hazard of the prospective future litigation: Earl Cadogan v 2 Herbert Crescent Freehold Ltd LRA/91/2007; [2009] PLSCS 168 and Office of Telecommunications v Floe Telecom Ltd [2009] EWCA Civ 47 considered. Section 61 conferred rights on “the landlord”. At all material times in 2046, the freeholder would be the landlord, as defined in section 40. In a case where there was a headlease with a short reversion beyond the original expiry date of the underleases, which had subsequently been extended by renewal, the landlord who was entitled to exercise the section 61 rights was the “competent landlord” as defined by section 40(1), here the freeholder. An interpretation of section 61 that confined the expression “the landlord” to the immediate landlord would render the section useless in such circumstances, since the immediate landlord, with a short reversion, would not have the necessary intention for section 61 purposes.
On the hypothetical sale of each tenant’s underlease assumed for the purposes of Schedule 14, neither the freeholder nor anyone else would be prepared to bid anything extra to reflect development value since, under para 5(1)(b)(ii) of that schedule, the vendor was assumed to be selling subject to a restriction that limited the use of each flat to use as a flat and precluded the erection of any new dwelling or other building not ancillary to the flat as a dwelling. The purchaser would bid nothing extra to reflect any value in redeveloping the flat (together with the other flats) back into a single house because that covenant would prevent any such redevelopment. Consequently, assuming the freeholder could prove a sufficient intention to redevelop in 2046, then it would succeed against the underlessees under section 61 and the compensation that it would be required to pay under Schedule 14 would not include any uplift to reflect an element of the value of a development back to a single house.
(4) The legal advice that the successful hypothetical purchaser was likely to receive on the section 61 and Schedule 14 points was that it was likely to succeed ultimately on both points but that there was a substantial prospect of litigation. In light of that, the hypothetical purchaser was likely to make a 30% discount from the value attributable to the potential conversion to a house. On the expert evidence, the risk of adverse changes in planning policies justified a further reduction of 5%. A deduction of 35% should be made to reflect the combined risks that the prevailing market phenomenon of houses appreciating in value faster than flats would go into reverse during the next 38 years and that there would a change in the economics of conversion. The prospects of success of an application to vary the estate management scheme so as to make conversion to a house more difficult were so slight that they would not materially affect the price paid for the freehold. The price payable for the freehold was adjusted accordingly.
Edwin Johnson (instructed by David Conway & Co Ltd) appeared for the appellant; Jonathan Gaunt QC and Mark Loveday (instructed by Pemberton Greenish) appeared for the respondents.
Sally Dobson, barrister
Collective enfranchisement – Purchaser price – Restrictive covenants – Leasehold Reform, Housing and Urban Development Act 1993 – Enfranchisement of property comprising four flats – Restrictive covenant limiting property to such use – Whether such covenant to be included in transfer under Schedule 7 – Value to be attributed to prospect of reconversion to single dwelling on expiry of original lease terms – Effect of uncertainties as to ability of freeholder to obtain possession of flats under section 61 and compensation payable under Schedule 14 – Appeals allowed in partThe appellant and his wife held a headlease of a detached property in London NW8 for a term expiring in September 2046. The respondent was the freeholder. The property had originally been built as a single dwelling but had been converted into flats in the 1950s; the headlease contained a covenant not to use the property other than as four self-contained private residential flats. The flats were let to tenants on leases that had been extended, on applications under the Leasehold Reform, Housing and Urban Development Act 1993, to run until 2136. On a subsequent collective enfranchisement under the Act, the appellant acted as the nominee purchaser for the tenants for the purpose of acquiring the freehold of the property from the respondent. The relevant valuation date was September 2008.The leasehold valuation tribunal (LVT) determined that £51,800 was payable to acquire the freehold. It imposed a restrictive covenant under Schedule 7 in terms that permitted use of the property as four self-contained flats or a single private dwelling-house. However, it discounted by 90% the value attributable to the prospect of reconversion to a single dwelling in 2046. The discount took into account uncertainties as to: (i) the ability of the hypothetical purchaser to exercise the right of “the landlord”, under section 61 of the Act, to apply for possession of the flats in the last year of the original lease terms on the ground of an intention to redevelop the property; (ii) whether, if it could do so, it would effectively have to pay a ransom or marriage value to the tenants as compensation, by virtue of Schedule 14; (iii) the future planning position, market conditions and redevelopment costs; and (iv) whether an estate management scheme, to which the property would be subject after the transfer, might be amended before 2046 to prevent reconversion.On appeal from that decision, the appellant contended that no restrictive covenant should be included in the transfer but that there should be no consequent increase in the price owing to the uncertainties to which the LVT had referred. The respondents also appealed, seeking an increase in the price. On the appeal, they contended for a restrictive covenant in similar terms to that in the existing headlease, and not permitting use as a single dwelling.Decision: The appeals were allowed in part. The price payable for the freehold was revised to £143,497.(1) The relevant provision of Schedule 7 in the instant case was para 5(1)(b)(i). The restriction sought by the respondents could properly be said to represent the restrictions in the headlease with only “suitable adaptations”, within the meaning of that provision. It was also “capable of benefiting other property” since it was a covenant restricting user, of a type frequently adopted for the purposes of benefiting retained land. However, the proposed restriction had not been shown materially to enhance the value of other property. Although the concept of a material enhancement in value of other property could include the concept of maintaining a value that would otherwise deteriorate, material enhancement had to be distinctly proved: Peck v Trustees of Hornsey Parochial Charities (1971) 22 P&CR 789, Le Mesurier v Pitt (1972) 23 P&CR 389, Moreau v Howard De Walden Estates Ltd LRA/2/2002 and Earl Cadogan v Erkman [2011] UKUT 90 (LC); [2011] PLSCS 163 applied. The respondents had advanced, by way of evidence, only theoretical situations that had no more than a possibility of occurring, and that, if they did occur, could be controlled satisfactorily under the estate management scheme. The covenants in the scheme were effectively as good as the restrictions in the headlease; although they were qualified whereas the covenants in the headlease were absolute, the headlease covenants might still have been discharged or modified under section 85 of the Law of Property Act 1925. There was no significant prospect of the scheme being amended adversely to the respondents, so as to allow through some objectionable use. Therefore, the restrictions in the headlease were not such as materially to enhance the value of other property, bearing in mind the existence of the estate management scheme and the lack of any evidence showing any real problems on the estate or any usefulness of the restrictive covenant over and above the terms of the scheme. No such restrictive covenant should be included in the transfer.(2) When determining the price payable under Schedule 6 of the 1993 Act, it was not necessary to reach a definitive decision on whether the hypothetical purchaser would, in 2046, succeed in overcoming the identified legal problems under section 61 and Schedule 14. If the freehold had been offered for sale at the valuation date, the hypothetical purchaser have taken advice as to the likely strengths and weaknesses of his position in 2046, so far as potential legal difficulties and other uncertainties were concerned, and would have framed a bid on that basis. Para 3 of Schedule 6 did not require the tribunal to take any different approach. It assumed that the premises were being offered for sale with the rights subject to which the conveyance was to be made. It did not require the prospective 2046 litigation to be decided definitively as at the valuation date, since, at that date, no rights yet existed under section 61 and Schedule 14; the respondents merely enjoyed the prospective right in 38 years’ time to seek to operate section 61 and Schedule 14 against the then occupying underlessees. The potential rights that would arise under section 61 and Schedule 14 in due course, absent a change in the law, should be valued for what they were worth at the valuation date, with all their respective strengths and weaknesses, rather than the prospective 2046 litigation being effectively decided now by the tribunal in a decision that would not bind the tenants holding the underleases in 2046.(3) However, it was appropriate for the tribunal to express a view on the legal issues, since the strength or otherwise of the parties’ arguments would be relevant to the well-advised hypothetical purchaser in deciding how much discount to make for the hazard of the prospective future litigation: Earl Cadogan v 2 Herbert Crescent Freehold Ltd LRA/91/2007; [2009] PLSCS 168 and Office of Telecommunications v Floe Telecom Ltd [2009] EWCA Civ 47 considered. Section 61 conferred rights on “the landlord”. At all material times in 2046, the freeholder would be the landlord, as defined in section 40. In a case where there was a headlease with a short reversion beyond the original expiry date of the underleases, which had subsequently been extended by renewal, the landlord who was entitled to exercise the section 61 rights was the “competent landlord” as defined by section 40(1), here the freeholder. An interpretation of section 61 that confined the expression “the landlord” to the immediate landlord would render the section useless in such circumstances, since the immediate landlord, with a short reversion, would not have the necessary intention for section 61 purposes.On the hypothetical sale of each tenant’s underlease assumed for the purposes of Schedule 14, neither the freeholder nor anyone else would be prepared to bid anything extra to reflect development value since, under para 5(1)(b)(ii) of that schedule, the vendor was assumed to be selling subject to a restriction that limited the use of each flat to use as a flat and precluded the erection of any new dwelling or other building not ancillary to the flat as a dwelling. The purchaser would bid nothing extra to reflect any value in redeveloping the flat (together with the other flats) back into a single house because that covenant would prevent any such redevelopment. Consequently, assuming the freeholder could prove a sufficient intention to redevelop in 2046, then it would succeed against the underlessees under section 61 and the compensation that it would be required to pay under Schedule 14 would not include any uplift to reflect an element of the value of a development back to a single house.(4) The legal advice that the successful hypothetical purchaser was likely to receive on the section 61 and Schedule 14 points was that it was likely to succeed ultimately on both points but that there was a substantial prospect of litigation. In light of that, the hypothetical purchaser was likely to make a 30% discount from the value attributable to the potential conversion to a house. On the expert evidence, the risk of adverse changes in planning policies justified a further reduction of 5%. A deduction of 35% should be made to reflect the combined risks that the prevailing market phenomenon of houses appreciating in value faster than flats would go into reverse during the next 38 years and that there would a change in the economics of conversion. The prospects of success of an application to vary the estate management scheme so as to make conversion to a house more difficult were so slight that they would not materially affect the price paid for the freehold. The price payable for the freehold was adjusted accordingly.Edwin Johnson (instructed by David Conway & Co Ltd) appeared for the appellant; Jonathan Gaunt QC and Mark Loveday (instructed by Pemberton Greenish) appeared for the respondents.
Sally Dobson, barrister
