John E Moore and Graham Vivian
The Landlord and Tenant Act, which received the Royal Assent on May 15 1987, was rushed through its last stages so that it became law prior to the dissolution of Parliament before the General Election. The Government has made a commencement order for some parts of the Act which brings into effect on February 1 the whole of Parts I and VI, section 45 and some incidental provisions. The Government hopes to make a further commencement order in March.
This Act (which applies to England and Wales but not to Scotland) will have a profound effect on the residential investment market. It aims to strengthen the rights of tenants living in privately-owned flats, and implements the main findings of the Nugee Committee which investigated the problems of managing blocks of flats.
It seems, however, that the Act has gone almost unnoticed by the many landlords and tenants that it will affect once the orders bringing it into force have been made.
In this article we intend to concentrate on the new body of law giving tenants of residential accommodation the right of pre-emption when their landlord wishes to dispose of his interest. Also dealt with in the Act (but not covered in this article) is the right that tenants have to apply to the court for the appointment of a manager of the property in which they live and the right that qualifying tenants have to acquire compulsorily their landlord’s interest.
The tenants to whom Part 1 of the Act applies comprise both those given statutory, protection — for example, under the Rent Acts — and tenants who hold their properties by way of a long lease at a ground rent. The Act makes no distinction between furnished and unfurnished tenants, and equally there is no rateable value qualification.
Section 3 of the Act excludes protected shorthold tenants, business tenants and service tenancies from the definition of qualifying tenants, but does not exclude lettings of flats to companies for residential purposes.
Resident landlords and exempt landlords (which include local authorities and housing associations and the Crown) are excluded from the provisions of the Act.
Business premises are also excluded from the Act. However, section 1(3) requires that the internal area of the commercial part of the premises must exceed 50% of the internal area of the premises taken as a whole, excluding the common parts for the exclusion to apply. Under section 1(5) the Secretary of State may alter the above percentage.
Example
Perhaps the easiest way to look at how the pre-emption provisions of the Act work is by taking a straightforward example and then to draw attention to certain anomalies that arise.
Quicksale are the freehold owners of a London block of 20 flats let as follows: three protected tenancies; nine protected shorthold tenancies; eight long leases with terms between 15 years and 99 years left to run. (NB. The Act’s effects are not limited merely to blocks of flats.)
Quicksale now wish to put the property on the market and instruct an agent, A, who draws attention to the new legislation relating to the sale of property comprising residential flats and refers Quicksale to his solicitor. A meeting is arranged between the solicitor, A and Quicksale to enable the solicitor and A to advise on the procedures to be adopted prior to disposal of the property.
To Quicksale’s surprise they find that they may not be able to sell the property immediately to whomever they wish and that the qualifying tenants within the property have a right of pre-emption.
Quicksale are therefore advised that they must adopt the following procedure before negotiating the sale to a third party.
(1) Quicksale must serve a notice (“the offer notice”) on the qualifying tenants because two or more flats are held by qualifying tenants and their number exceeds 50% of the total number of flats in the premises (section 1(2)). The nine shorthold tenants do not qualify but the three protected and eight long-lease tenants do qualify. There being 11 of these out of 20 tenancies, the 50% rule is satisfied. The notice must contain particulars of the principal terms of the disposal Quicksale propose, including details of the property, the interest to be disposed of, and the price (section 5). It must be clear that the notice constitutes an offer by Quicksale to dispose of the property on those terms, which may be accepted by the requisite number of qualifying tenants. The notice must also specify a period of not less than two months within which the offer may be accepted. Finally it must specify any further period, not less than two months, within which a person may be nominated for the purpose of proceeding with the formal purchase of Quicksale’s interest.
If all the qualifying tenants are not served with a notice this is acceptable provided that not less than 90% have been served, or, if there are less than 10 tenants in total, notice has been served on all but one of them.
(2) If the offer is accepted by the requisite majority of qualifying tenants of the constituent flats (ie qualifying tenants with more than 50% of the available votes, with one vote allocated to each flat), then Quicksale may not dispose of their interest during the “relevant period” (which begins with the date of service of the acceptance notice and terminates with the end of the period specified in the offer notice for nominating a person to proceed with the purchase on behalf of the qualifying tenants) except to a person or persons nominated by the requisite majority of qualifying tenants (section 6).
If no such person is nominated during the relevant period then Quicksale may during the 12 months beginning with the end of the relevant period dispose of their interest to such persons as they think fit, provided that the consideration accepted is not less than that stated in the original offer notice to the qualifying tenants, and also that the other terms (so far as they relate to any matters covered by the terms specified in the offer notice) must correspond.
For the purposes of a disposal by a landlord within the 12-month period, the Act is unclear as to whether the landlord must actually complete the disposal, or whether an exchange of contracts would be sufficient. If the consent of any person is required to the transfer of the landlord’s interest, then the landlord must use his best endeavours to secure that the consent is given and must institute proceedings if the landlord feels that the consent is being unreasonably withheld.
If any person is nominated within the relevant period Quicksale cannot dispose of their interest, except in accordance with the right of pre-emption for a further period of three months beginning with the end of the relevant period.
(3) The tenants have the right to make a counter-offer which can either be accepted or rejected by Quicksale (section 7(2)). If the offer is rejected by Quicksale, then Quicksale’s notice can state that the notice of rejection constitutes a fresh offer to dispose of its interest. The qualifying tenants in turn may also make a further counter-offer. Quicksale do not have to make a fresh offer and can simply reject the counter-offer made by the qualifying tenants. If Quicksale do this, they are then free to dispose of their interest to any party they think fit, but subject to the 12-month rule.
(4) The tenants can withdraw, in which event Quicksale can dispose of their interest, during the period of 12 months beginning with the service of the tenants’ notice of withdrawal, to such person as they think fit, but the consideration accepted must not be less than the amount originally agreed with the tenants, and the other terms (if appropriate) must also correspond. Quicksale can also withdraw but do not have the right in these circumstances to dispose of their interest to any party they think fit (section 9).
The right to withdraw does not apply to a binding contract which has been entered into but only applies to “subject to contract” negotiations.
(5) If Quicksale fail to comply with the procedures set out in the Act, section 11 contains an anti-avoidance provision. This essentially provides that the requisite majority of qualifying tenants may serve notice on the purchaser from Quicksale requiring him to furnish the person nominated by the qualifying tenants with particulars of the terms of the disposal and the date when the disposal took place. This notice must be served within two months of the qualifying tenants being notified of the transfer and the new landlord must then comply with this notice within one month of service.
The qualifying tenants can require the new landlord to sell the property to them, but if the property has increased in monetary value since the original disposal owing to any change in circumstances such as improvements carried out by the new landlord, then the amount payable shall be the amount that might reasonably have been obtained on a corresponding disposal made in the open market at the time of the original disposal if the change in circumstances had already taken place. Increases in general property values over that period of time would therefore not be taken into account.
(6) In the present example Quicksale will have to adopt the procedure under the Act thereby offering to dispose of the property to the tenants before the company is free to sell elsewhere.
Points to note
Several points should be noted which relate either to the current example or arise in other situations.
(1) The Act lays down strict requirements as to the contents of the notice to be served on the tenants. In addition a landlord must carefully consider if he wishes to make an unconditional offer at the outset, which, if unconditionally accepted by the tenants, will create a binding contract. A landlord may not wish to do this. In these circumstances he should ensure that the offer to the qualifying tenants, the acceptance of such an offer, or submission of a counter-offer, remains subject to contract until there is an intention to be bound.
Bearing in mind the drafting of the Act, it would appear that if landlords wish to go through the mechanism of offering a property to their qualifying tenants as quickly as possible, they may prefer to make the offer unconditional rather than subject to contract. Clearly, strict time-limits should be laid down in respect of the acceptance of the offer.
(2) The pre-emption rights apply where there is a relevant disposal affecting any premises to which Part 1 of the Act applies (section 4). This is a reference to the disposal by the landlord of any estate or interest (whether legal or equitable). A disposal means a disposal whether by the creation or the transfer of an estate or interest in land. It therefore includes, for example, the grant of an option and the surrender of a tenancy, but there is specifically excluded a disposal under the terms of a will or under the law relating to intestacy (section 4(3)).
Where a landlord making a relevant disposal under the Act is a leaseholder, the Act does not require that the freehold of a property is sold to the qualifying tenant. This will come as some relief to estate owners. It would not appear that where, for example, freeholders have granted long leases of individual properties on their estate, and the head leaseholders have in turn granted tenancies or long leases of the various flats, that the qualifying tenants would have a right to purchase if the freehold were to be sold subject to the headlease.
(3) Because “transfer” includes the creation of an estate or interest in land it may include the creation of a mortgage. It is believed that section 4(2)(a)(ii) is intended to avoid the situation arising where before a mortgage is entered into the landlord must put to the tenants the terms on which he wishes to raise finance and give them the opportunity of providing that finance in the same way as under a right of pre-emption. However, the wording is unclear and might be construed as only excluding, for example, assignments by the lender of existing mortgages.
If in doubt the provisions may be circumvented on an acquisition, for example, by the lender giving the borrower an option to borrow funds secured by a charge on agreed terms, at a time when the borrower is not the landlord. The exercise of the option would not constitute a disposal.
(4) Although it appears that a mortgage may be a disposal for the purpose of the Act a mortgagee exercising his power of sale under the mortgage would not appear to be bound by the Act. However, a receiver who acts as agent for the borrower (and indeed a liquidator) would in all probability be bound by the terms of the Act.
Notwithstanding this, valuers will in the future have to take into account the fact that pre-emption rights attached to property may delay repayment of loans where the lender does not wish to exercise his power of sale.
(5) The pre-emption rights apply to property if (a) it consists of the whole or part of a building and (b) it contains two or more flats held by qualifying tenants and (c) the number of flats held by such tenants exceeds 50% of the total number of flats contained in the premises (d) the internal floor area of the residential units exceeds 50% of the whole building.
The Act would appear to affect both purpose-built blocks of flats and houses converted into flats. In cases of large mixed-use residential and commercial premises surveyors may have to make detailed measurements of entire buildings in marginal cases to determine whether or not a sale falls above or below the 50% area figure. This could well cause the institutions problems in valuing mixed-use buildings.
The Act will not apply to the many two-storey suburban properties converted or constructed as two units if, for example, the landlord were to sell only one of the units. However, the Act would apply if the whole property were to be sold.
(6) Landlords should exhaust the procedure under the Act before they put their blocks of flats into the auction room, although individual sales of flats are excluded from the pre-emption rights. If the purchaser at the auction acquires a property at a figure lower than that offered to the qualifying tenants then he could be forced to sell to the tenants at the price he has paid.
(7) The Act does not apply to the sale of shares in a company. It may therefore be prudent for the purchaser of a block of flats to buy the block in a newly created company which, following the purchase, does nothing other than hold the property as a single asset. If necessary a separate company can be incorporated to deal with the management of the building. In these circumstances, when the landlord wishes to sell he may decide to dispose of the shares in his company free of the rights of pre-emption. However, the purchase of companies as opposed to the underlying property asset is not always acceptable to the market, and selling companies with property assets as opposed to the properties themselves will undoubtedly limit the number of purchasers.
(8) It should be noted that the Act applies where the whole or part of an interest is sold and is, therefore, not avoidable by splitting up a property into its component parts unless such component parts are excluded by virtue of their being of a non-residential nature.
(9) Because landlords wishing to sell estates or portfolios of properties which are affected by the Act will be obliged to offer the individual blocks or parts of each property to the qualifying tenants therein this will greatly complicate and delay the sale of a large portfolio. As the purchase of residential investments by tenants is likely to be the exception rather than the rule, vendors wishing to sell properties quickly without notifying tenants will have to indemnify and compensate purchasers if the tenants subsequently exercise their right to buy.
(10) A rent assessment committee will have jurisdiction to consider any question arising out of purchase notices. One point that vendor landlords may wish to consider is whether in their purchase notice they include a requirement that the purchaser must be a “good covenant” in order to indemnify the landlord in respect of any obligations that he has undertaken to the tenant, for example in relation to service charges.
It remains to be seen whether the landlord can be compelled to sell to a £100 company set up as a vehicle by the tenants for the purchase of a block of flats, or whether he will be entitled to call for guarantors to ensure that he is adequately protected. After all, in selling on the open market one of the landlord’s considerations will be whether the purchaser is a sufficiently good covenant, to be relied upon in the event of their being a claim against him following a breach of covenant by the new purchaser in circumstances where there is privity of contract.
(11) The administration required to comply with the notices necessary under the Act will be a considerable burden on the landlord or his managing agents. A landlord selling to a purchaser other than qualifying tenants will need to satisfy the purchaser that the necessary procedures have been fully carried out and the rights of the tenants have been exhausted.
(12) Vendors wishing to sell residential investment property on the open market where there is interest from the qualifying tenants will have to pitch their prices very carefully. They will not be able to sell at less than the price that they have offered the property to the qualifying tenants, which means that the premiums over market value sometimes paid by tenants’ associations to acquire the properties in which they live will be more difficult to obtain. Solicitors acting for purchasers will wish to know that the tenant notice procedure under the Act has been followed and the price quoted to the tenants. This could raise difficulties if a vendor is seeking a higher figure from third parties as will be the case where landlord and tenant have failed to agree.
(13) It is probably true to say that dealers in residential investments will come to know of properties where tenants are not interested in acquiring, and such purchasers may be prepared to buy and sell this type of investment without going through the formal procedure required by the Act.
(14) Developers constructing residential and commercial property would be well advised where possible to separate the residential from the commercial by building the residential in a separate block.
(15) The tenants will need careful advice as to how, if their offer is accepted, they should proceed with the purchase of the premises.
Should this be by way of a company to purchase the landlord’s interest, coupled with the incorporation, if appropriate, of a separate management company? As the Act applies not only to large blocks of flats but also to small houses converted into flats, it may not be appropriate in every case to worry about a separate management company.
(16) Advice needs to be given to ensure that money put up by the tenants to enable the purchase of the property is tax allowable. Generally, in return for their contribution, tenants will wish to extend the term of years under their leases. Valuation advice will need to be given as to the contributions to be made by the different tenants according to the value of their current interest and the value of the interest which they will seek to acquire following the purchase of the block.
(17) Most important of all, for the tenant looking to the future, is the setting-up of a suitable management structure which often turns on a few individuals taking an active role to ensure the smooth running of the premises in the future.
(18) In practical terms, many qualifying tenants will not be able to organise themselves to buy the properties in which they live. A large number of the residential investments offered today contain elderly tenants who have been approached to buy long leases of their flats but have not bought, either through lack of funds or because they would rather rent. On the other hand, ground-rented properties are often sold to the long-leaseholders at higher figures than could be obtained in the open market from an investor. The Landlord and Tenant Act will give such tenants the chance to negotiate the purchase of the property at a figure closer to that which an investor would pay, provided the landlord wishes to sell.
(19) Bearing in mind that so often tenants are unable to organise themselves or raise sufficient funds to acquire their property when it comes up for sale, the nominated purchaser mechanism laid down in the Act will help them. Equally there would appear to be no bar against tenants using the nominated purchaser mechanism to bring in a property company or purchaser of their choice to assist them in the purchase, provided there are sufficient qualifying tenants to comply with the requirements of the Act and who are prepared to support the purchase.
General
As time passes it is certain that many anomalies will arise as a result of the precipitous passage of this Act through Parliament. It is, however, clear that the sale of residential investments containing qualifying tenants has been considerably complicated by the Act and that some purchasers — particularly at auction — will need to exercise very much greater care in the purchase of residential investments and ground rents than they may have done in the past. From the tenant’s point of view, the Act is a great step forward and has put into law a debate which has gone on ever since the Leasehold Reform Act 1967, which gave tenants of houses the right to buy their freehold or obtain an extension of their lease.
The Landlord and Tenant Act does not go as far as the 1967 Act in giving qualifying tenants the right to enfranchisement, but it does give them the right to buy when a landlord wishes to sell his interest or part of his interest. One side effect of the Act may be that more landlords may create companies for each property they own and endeavour to sell the company with its sole asset being the property investment. Alternatively, landlords may sell to investors long leases of individual units in the block that they own rather than selling the blocks themselves. One word of comfort — the Act will not apply if contracts have been exchanged to a third party before the order to bring the Act into effect is made.