Dealing with Restrictive Covenants

Published on 18 Nov 2008 under category: article

1. Introduction

A land owner who decides to transfer some land, either by disposing of the freehold or granting a lease, can by stipulation impose restrictions against the land’s future use or development - which will usually mean accepting a lower price at the time, of course.

These notes cover typical questions and their answers arising in connection with restrictive covenants only, i.e. those that in substance impose a negative duty on the new and successive owners of the land. Thus they do not cover positive covenants, such as for the payment of money or the doing of works.

These notes are written by James Brenan, a solicitor with many years experience in conveyancing and property litigation, as general guidance only and do not pretend to be any kind of substitute for proper advice on the specific facts of any situation. No responsibility is accepted for any decision taken in reliance on what is said here. You should only rely on advice from your retained solicitors.

2. Basic Matters: Examples, Terminology, Registration and Legality

Restrictive covenants are in effect prohibitions. Here are typical matters that they can prohibit:-

- to add to or enlarge a building;
- to alter a building’s architectural appearance;
- to subdivide a parcel of land;
- to excavate the ground;
- to carry out any mining;
- to build at all on the land;
- to erect any satellite dish, aerial or mast;
- to use the property in any specified (prohibited) way;
- to trade outside certain hours.

The person who imposes a covenant and in due course his/her successor in title is known as the covenant owner or covenantee. Establishing who has the benefit of a particular covenant is one of the first tasks of any adviser. In some situations a multitude of local residents can be entitled to enforce the covenant. Establishing who has the benefit of a particular covenant is one of the first tasks of any adviser. In some situations a multitude of local residents can be entitled to enforce the covenant.

The party who has given the covenant is the covenantor, and his successors also stand to be treated as being the covenantor.

Restrictive covenants created since the beginning of 1926 must be registered at the Land Registry for registered land or at the Land Charges Department for unregistered land in order to bind future owners of the burdened land.

If a restriction is against competition between traders, such as a tie to restrict products being sold except ones from an approved supplier, the covenant owner will be subject to possible challenge and penalties under competition laws. This is common of course in the case of public houses and petrol garages.

Any covenant that attempts to impose discrimination contrary to laws such in areas of sex, race, age or disability discrimination laws is illegal.

3. The Interpretation of Vague or Uncertain Wording

Anyone affected by a covenant should first consider its exact words and establish what it means, and particularly with regard to any proposed development.

Vague or uncertain meanings are always for a Court to decide ultimately, and not for a Lands Tribunal (see below). There is jurisdiction for the Court to grant such declarations while Land Tribunal proceedings are pending under subsection 84(2) of the Law of Property Act 1925.

To ascertain meaning a Court will consider the document containing the covenant as a whole and its factual context from the time of its creation, which is known as the factual matrix. Any party’s contention about what they actually intended by using the words they did is not admissible as an aid to interpretation. Subsequent dealings between the parties are not admissible in evidence regarding the meaning of the covenant.

Where an outdated term is used, such as “a victualler”, it is necessary to consider its dictionary definition from the time when the covenant was granted.

4. Absolute and Qualified Prohibitions

If a total ban on some activity or type of change is imposed the covenant is known as “absolute” and the covenant owner usually has no implied duty even to consider any proposal for relaxation or discharge. There are very limited exceptions to this rule in the case of covenants against alterations to business premises - which are explained in James Brenan’s notes on “Improvements and Additions to Business Premises”.

If the covenant controls an activity by making it subject to prior approval from the covenant owner then the covenant is known as “qualified” and the question arises as to the limits of the covenant owner’s discretion in exercising that control.

The owner of a qualified covenant has a wide leeway for decision but must not act in a way that is beyond all bounds of reasonableness. That owner can only refuse permission to such a change for the protection of its own neighbouring property or business interests. That owner cannot simply refuse in order to extract money. Accordingly, a refusal will need to be supported by a statement of reasons if it is challenged.

There is no liability in damages for an unreasonable withholding of consent in one of these situations. The covenantor’s remedy is simply to sue for a declaration that consent has unreasonably been denied - or to wait to be sued for breach and then counterclaim for such a declaration (which would be more risky).

5. Remedies for Breach: Injunction Orders

A covenant owner should voice objection by a letter upon learning of any breach or that owner risks being found to have waived its right to claim an injunction. Many years of acquiescence to an obvious breach can also give rise to a waiver of the covenant entirely. In the context of leases the Courts have drawn this line in various cases between 15 and 20 years.

An injunction claim is stronger if it is accompanied by a claim for an interim injunction to preserve the status quo pending the eventual trial, but this can be a difficult issue and Counsel’s opinion will be necessary.

An injunction is a discretionary remedy from the Court which means that the claimant party must “come with clean hands”: that party must not have done anything to mislead the defendant or otherwise acted unreasonably. Thus, any injunction claim should be pursued within a suitably reasonable time of the damage complained of, or the defendant can rely on the equitable defence of “laches” (which means unconscionable delay). In high value situations, that time limit can be measured in weeks or even days.

A defendant’s undertaking to the Court given in a particular form and under appropriate warning is binding as much as an injunction. Both an injunction order and an undertaking to the Court are ultimately enforceable by a fine and/or by imprisonment for contempt of Court.

Injunction Orders are enforced through the same Court using the criminal law burden of proof, of “beyond a reasonable doubt”, due to the threat of imprisonment of a fine. This procedure is known as “committal”.

6. Remedies for Breach: Damages and Costs

As well as or instead of claiming an injunction, the covenant owner can claim damages.

Damages are usually awarded for the breach until it is remedied.

If the claimant party’s position is not as strong as it might be, for example due to certain delay or the loss being only slight, the Court may also award damages instead of an injunction. This works in effect as a private compulsory purchase.

Damages for such infringement of property rights can be claimed and calculated on the equitable basis, i.e. with regard to the profits made. These are known as “disgorgement damages”. Accordingly, the defendant party will have to disclose all relevant financial information to show the net profit from the breach, and expert evidence may be called in order to assist the Court to find this and to analyse it.

Alternatively, “restitutionary damages” can be claimed in the amount for which the covenant owner would have sold the release or variation needed to the wrongdoer. This is also known as “the negotiated share approach”. This will give rise to legal argument over the issue of what is a due proportion of the profits attributable to the breach. This proportion has to be reasonable in all of the circumstances. The Court has a broad discretion to find and award a percentage share of profits from the development that seems just or, as the cases put it, that “feels right”.

7. Purchase of Insurance Cover

If there has been an existing development in apparent breach of covenant for many years then insurers can often be willing to extend cover against the costs and risk of having to face enforcement action in the future. If you are contemplating taking out insurance cover then you should do nothing to disturb the situation or to alert the covenant owner in the meantime - for that is a common cause for such insurance cover to be refused or an increased premium to be charged.

You would need to study carefully the proposed insurance terms, with regard to issues such as:-

- development you are insured to carry out;

- the limit of cover and any excess;

- who will have the conduct of any dispute;

- calculation of the insured amount of your loss in case you are later required by an injunction order to comply with the restrictive covenant.

Any insurance policy is only as good as the financial standing of the insurer.

8. Conversion of a Single Dwelling-House into Flats

Section 610 of the Housing Act 1985 enables any interested party to seek a variance of a prohibition - on either freehold or leasehold property - against converting one dwelling-house into two or more where either there have been changes in the character of a neighbourhood that favour letting of several flats instead of one house or planning permission has been granted for such a conversion. The Court has to give a right of hearing to any interested party and can then make whatever award appears most fitting, which can include making a variance order accompanied by the payment of compensation.

9. Discharge or Modification by the Lands Tribunal

Any interested person can apply to the Lands Tribunal for the discharge or modification of a restrictive covenant in respect of freehold land. This right therefore extends to: mortgagees, purchasers under uncompleted contract and option holders over freehold land.

A leaseholder of premises under a lease originally granted for 40 years or more of which 25 years have expired can also apply to the Tribunal. Thus many restrictive covenants leases are potentially challengeable by this route.

Interested parties can object but their interest must be as a covenant owner or beneficiary rather than as a mere neighbour or busy-body.

Careful advice will be necessary on the choice of remedy, between discharge or modification and the new terms to be offered if modification is to be sought.

If any question as to the meaning of a covenant arises this should be decided first by a Court - not by the Lands Tribunal - before any application for discharge or modification is pursued.

There are four available grounds for applying - explained below.

- Ground One: Obsolete Restriction

The Lands Tribunal’s first available ground for discharge or modifying is: “by reason of changes in the character of the property or the neighbourhood or other material circumstances of the case.... the restriction ought to be deemed obsolete.”

This ground is very difficult to satisfy. First the restriction’s purpose must be identified and then it must be shown to be no longer capable of fulfilment. The changes of circumstances that can support such a finding will be either environmental, economic, or social.

The Tribunal has to consider whether the purpose for which the covenant was created is still capable of fulfilment and if it is then the covenant ought not to be deemed obsolete.

- Ground Two: Reasonable User Impeded

This second ground invites the Tribunal to counter-balance the developer’s proposed reasonable user against the remaining practical benefit of the restriction to the covenant owner or the public interest, and to consider what monetary compensation would be adequate to cover any loss or disadvantage to be suffered by the covenant owner from a discharge or modification.

This is the most common basis for such applications to the Lands Tribunal. The evidential demands can be great, due to the wide-ranging cost-benefit analysis that it envisages. Expert evidence is likely to be called, possibly from experts in several disciplines. Prior planning permission makes this ground easier to show but is no guarantee of success.

The “public interest” alternative within this ground is especially difficult to prove. If the local council objects to an application in its capacity as guardian of the public interest the application is probably doomed.

On the other hand, local authorities sometimes apply to the Tribunal on this ground for release from covenants and in such instances local residents can object as guardians of the public interest. Compensation is unlikely to be deemed to be an adequate recompense for loss of the covenant’s restriction in cases where a larger number of people object.

- Ground Three: Express or Implied Agreement

Seeking a declaration from the Lands Tribunal that there has been a binding agreement from all covenant owners is useful in case any owner is being evasive as to giving their consent or there is an argument for waiver from long acquiescence to the breach.

If no objectors file denials after appropriate notification of the claim the Lands Tribunal can be invited to find such an agreement.

- Ground Four: No Injury

This last ground is a sweep-up provision to prevent vexatious or frivolous objections: that there is no loss to any one from discharging or modifying the covenant.

In all situations the Lands Tribunal is obliged to consider the development plan, any declared or ascertainable pattern of development as well as the period and context in which the restriction was created. The fact that planning permission has been obtained for the proposed development is usually not relevant to the exercise of the Tribunal’s above role.

10. Statutory Compensation Awards

The Lands Tribunal has discretion to award compensation when making an order for discharge or modification, which is confined to two different ways for arriving at an amount.

The first way is to look at the covenant owner’s loss, from the impact of the development, which can be calculated by reference to any resulting fall in value of their property or by reference to the cost of works needed to counteract that adverse impact. The covenant owner’s loss of ability to hold the developer to ransom for a share of the scheme’s profits is not a recognised basis for assessing the amount of compensation.

The second method is to enquire into the effect that imposing that restriction had on the price originally received for the burdened land. A successor in title to the original covenant owner (except perhaps an heir) might have difficulty in showing this second basis of compensation claim but this is essentially a question of fact.

11. Processing a Claim for Discharge or Modification

First you will need to formulate the discharge or modification you will seek and identify the potential objections.

Although it can be expensive to obtain planning permission - which will now only be valid for 3 years - this can be a wise step. Specific advice should be taken.

Next, a case needs to be developed on issues of advantage and disadvantage to the opposing parties, identifying any objectors’ losses. Enquiries should be made to identify the valuation components to the price originally paid for the land if there is a risk of the second basis of statutory compensation being applied, as noted above.

Pre-action correspondence should be opened up with the covenant owner that addresses all points in a logical order and the parties’ respective evidence should be offered for agreement in order to try and narrow the issues. This causes a heavy commitment to professional costs at the early stages - often referred to as front-end loading - as is typical now in all civil claims.

Alternative dispute resolution methods - such as mediation and expert certification of specific technical points - should be considered, particularly at an early stage, when they can be most cost-effective.

12. Costs in Lands Tribunal cases

The Lands Tribunal has a power to award costs in these cases. The general rule is that, unless the conduct of an objector in opposing the application has been unreasonable, a successful objector will be awarded costs but an unsuccessful objector will not have to pay the applicant’s costs. These costs rules are set out in the Lands Tribunal’s practice direction of 11 May 2006.

This costs regime means that it lies in the parties’ interests to make formal offers as to the anticipated outcome of the proceedings and also to keep under review at all times the use of alternative dispute resolution methods such as mediation.

13. Persuading Councils to use Compulsory Purchase powers

Developers are sometime able to persuade the local planning authority to intervene by use of compulsory purchase powers and thereby help them to assemble the lands that they need. Compensation is of course payable through the council for the value of the land involved, but on its value without reference to the developer’s scheme – and therefore not on a ransom value basis.

This intervention by a planning authority can have the effect of washing land titles of their private encumbrances. Section 237 of the Town and Country Planning Act 1990 provides that once land is acquired or appropriated by a local authority for planning purposes no private right affecting that land, such as any restrictive covenant or easement (other than in favour of statutory undertakers or under the telecommunications code), is effective to restrict the erection, construction or carrying out of maintenance of any building or work on the land by the authority or its successor in title if this is done in accordance with planning permission. However, our understanding of the effect of Section 237 has been thrown into doubt by a controversial decision at first instance in Thames Water Utilities Limited v. Oxford County Council [1999] 1 EGLR 167 - where it was held that the section does not affect the application of such private rights against the subsequent use of the land. The government are presently consulting over bringing in new legislation specifically to counteract that controversial ruling.

14. Local Authorities as Covenant Owners

Local authorities are all creatures of statute and therefore can only act in so far as they are permitted by their constituting legislation. One example of this principle at work is that a local authority is not allowed to impose a restrictive covenant against future development over a house that is transfers under the “right to buy” legislation. The duty to sell under that legislation means to sell free of any such encumbrance.

Aside from any such specific restriction or duty a local authority can freely act as a private property owner in the normal self-interested way. The fact a local council may grant a planning consent for certain development does not mean that it should volunteer release of covenant rights that it owns that impede such development.

As a general rule a local authority has a duty to extract full value on the disposal of any property interest, which will include releasing a restriction.

A local council can however appropriate a property right that it owns in order to hold it for planning purposes under Section 232 of the Town and Country Planning Act 1990 and then it may dispose of that right in consideration for a planning benefit and without requiring any monetary payment. Such a transaction may form part of an agreement under Section 106 of the Town and County Planning Act, for example.

A restriction imposed by a Section 106 agreement can in principle be challenged later by an application to the Lands Tribunal. This would be one of the situations in which the Tribunal might consider the public interest. A very recently imposed restriction from a Section 106 agreement is unlikely to be discharged or modified in this way, unless perhaps there has been some significant and previously unforeseen change in the locality.