Preparing for Collective Enfranchisement

Published on 18 Nov 2008 under category: article

Introduction

These notes are designed to answer the typical questions that are asked, or should be asked, by lessees of flats who are considering buying the freehold to their block – or pursuing “collective enfranchisement” as it is also known – under the Leasehold Reform, Housing and Urban Development Act 1993 (“the Act”).

These notes only deal with the rules governing blocks owned by private sector landlords and where there are no public tenancies; the Act can sometimes apply in those situations nonetheless and specific advice should always be taken.

These notes do not cover situations where the reversion to leases of flats is voluntarily offered for sale by the landlord, which are governed by the Landlord and Tenant Act 1987.

These notes are written by James Brenan of Cubism Law as general guidance. They are not a substitute for proper advice on the specific facts of any situation and no responsibility is accepted for action taken without first obtaining specific advice from retained solicitors.

1. Qualifying rules

There are a number of rules that define which premises qualify for the right of collective enfranchisement. It is essential to check that your group and block satisfy these rules, or you could waste significant funds in pursuing a non-existent right. If there is an arguable issue of fact or law that stands to be determined before you know with certainty whether you are within the qualifying rules your solicitor will need to address with you and possibly the opposing party or parties the most appropriate method for resolving this argument – or else you would put unnecessary sums of money at risk by proceeding on only an arguable case.

There are preliminary notice procedures that can be followed in order to gather necessary information before exercising the right.

In broad summary only, the qualifying rules are as follows:-

a. Self-contained buildings or vertically-severable divisions only

A building has to be self-contained and structurally detached from any neighbouring buildings.

The right also applies to a vertically divided part of a building, provided that it either has its own independent services or it is capable of having those without carrying out any works that would cause significant interruption in the services for the remainder of the building. This issue of “significant interruption of services” may need to be explored in pre-action correspondence between the parties before you can be offered the best advice on your rights.

Accordingly, estates laid out over several buildings do not qualify unless it can be shown that individual block on the estate are self-contained and then those blocks may be enfranchised individually.

b. No commercial element over 25%

No building or part of a building qualifies if is contains a commercial element of greater than 25% of the total building. The areas of internal common parts are taken together with the area of residential parts for the purpose of arriving at the necessary 75%.

c. Number of flats

The premises must contain two or more flats held by “qualifying tenants” and these must be at least two-thirds of the total flats in the premises.

d. “Qualifying tenants”

These are any owners of long leases – i.e. an original term of 21 years or more – where the permitted use is not for business purposes (or primarily for business purposes), the flat is not let by a charitable housing trust in pursuit of its charitable purposes, and it has not been created in breach of terms of a superior lease (unless the breach has been waived by the landlord), and the owner or an associated company does not own three or more flats in the premises.

e. At least 50% of qualifying tenants must participate

This is self-explanatory. The participating tenants are so designated in the notice of claim and they must all sign it. Until the Right to Enfranchise Company rules as put forward in the Commonhold and Leasehold Reform Act 2002 are ever brought into force individual tenants cannot force their way into the group of participating tenants against that group’s wishes.

f. No “resident landlord” (small blocks only)

A block of 4 flats or less that was not purpose-built as flats, is excluded if the same person has owned the freehold since before the conversion and that person or a member of his/her family has lived in one of the flats as his/her principal home for 12 months leading up to the notice of claim.

2. Property to be acquired

This will be the premises concerned, i.e. the block, and any appurtenant property which is either demised to a qualifying tenant or is bound by common rights, such as a garage, outhouse, garden, or yard.

3. The optimal number of participating tenants

If the leases’ terms have more than 80 years unexpired at the date of the notice of claim the optimal number of participating tenants is 100%.

If the leases’ terms have less than 80 years unexpired then, from the perspective of minimising the compensation payable, only the minimum necessary - see para 2(e) above – is the optimal number, due to the Act’s the particular valuation rules. (“Marriage value”, which is payable at 50% when the lease terms have less than 80 years to run, is only payable in respect of the leases owned by participating tenants; in respect of the remainder it is acquired for nothing.) To avoid committing a dishonest manipulation of the law there must be no prior arrangement with the non-participating tenants to sell them stakes in the freehold after it has been acquired.

However, it creates a conflict of interests within a block for some lessees to participate in owning the freehold while others (or even one other) do not. The excluded flat owner can then in effect hold the rest to ransom by taking legalistic points in order to avoid paying service charges, knowing that these lost amounts will have to be made up somehow by the majority in order to avoid their company becoming insolvent and thereby being forced to sell the freehold. So you should think long and hard before opting to save money in the short term by having less than 100% participation. Of course, some owners may not want to or be able to participate anyway, and then there is not much you can do – except decide not to buy the freehold.

If the leases comprise a mixture of which some are and some are not for over 80 years, then the optional number of participating tenants is too detailed a question for summary here.

A further potential reason for maximising the number of participating tenants is that the Act’s compensation rules provide for improvements to flats of participating tenants to be disregarded - whereas the flats of non-participating tenants are valued as they stand.

4. Participation agreement or head of terms?

A model precedent for a Participation Agreement appears on the Leasehold Advisory Service website – www.lease-advice.org. The preparation and completion of one of these agreements can be costly and groups of tenants in smaller blocks may consider it to be better to rely on short heads of terms instead. These should be made legally enforceable before any notice is given.

The typical issues to be covered in heads of terms are as follows:-

a. In cases where there are four or fewer participating tenants, the first question is whether to own the freehold in those four individuals’ names jointly, with a deed of trust, or whether to use a company (which would be “limited by guarantee”) as your “nominee purchaser”. There are advantages and disadvantages for each method to be considered, which we can explain.

b. The voting rights in all further decisions should be laid down now. These can be either one vote per flat or weighted in accordance with the service charge percentages. (You should review the fairness of the service charge percentages – which a Court has power to alter if any changes are made to flats’ sizes).

c. If there are to be weighted voting rights in a company, the question arises whether these weightings should also attach to directors’ voting in board meeting; otherwise there would be a different balancing of power between the general meeting and the board meeting – and the directors typically decide all management matters on a show of hands.

d. Consider how much money to require all participating tenants to contribute for their respective shares of the capital costs of this exercise, both before the initial notice is served and at later stages and how such money is then to be held securely - say by your solicitors or bankers. This will of course protect you against individuals later being unwilling or unable to make their contributions when you are already committed as a group, and it will especially protect the initial promoters of the scheme.

e. Lay down a set of rules dealing with admitting the remaining owners to the group in case they choose to apply.

f. Decide on your stance as a group on interim management and service charges issues, and how these are to be negotiated or even litigated with the present landlord.

g. Possibly now is a good time to discuss your intended policies for the future management of the building, particularly regarding any developable space within it (e.g. pavement vaults, air space at rear or above) – taking into account what the leases already provide on these aspects.

h. Agree to grant new leases, say for 999 years and at peppercorn ground rent, or even to convert to commonhold, once the freehold purchase is completed.

i. Agree whom to appoint as the company’s valuer, solicitors, bankers, accountants, and – most importantly – any new managing agents.

j. Decide on who to use as the next building insurers and what reinstatement value to insure. (If a new claim against the current insurance is imminent you should consider staying with the present insurers and taking an assignment of rights under the current policy.)

k. Nominate one of your number to give instructions to solicitors and funds from time to time on behalf of all, which will save costs.

l. Consider and agree whether to bind individual participating tenants not to sell their flats while the claim goes through its stages, unless the assignee gives a deed of covenant binding him/her to participate on the same terms.

m. Take a confidentiality undertaking from each participating tenant, in order to prevent sensitive information as to legal and valuation matters passing to the wrong persons.

n. Assuming that a leasehold structure is to be retained it should be a term that all participating owners must later transfer their stake in the freehold when transferring their flat. (This is achieved by including a particular restrictive clause in the lease held by each participating owner and then registering that at the Land Registry.)

6. Leasebacks of units to landlords

In situations where there is no qualifying tenant of a distinct unit of occupation in the block, the landlord who owns that unit is able to call for a 999-year leaseback. This is one of the things which must be stated in the landlord’s counter notice. However, since the right to a leaseback can also arise if that qualifying condition is satisfied at any time up to the completion of the transfer of freehold to a nominee purchaser, the relevant notice can in those situations be given later.

This right will not apply where the landlord already holds a long lease of that unit.

If this election is made it will have a significant effect on the amount of compensation payable. The participating tenants, however, have to offer initially to pay a price on the basis that there will be no leaseback.

Also, in situations where a freeholder is both a resident landlord and a qualifying tenant the freeholder can elect to exchange his existing lease for a 999-year leaseback.

The Act prescribes in outline the terms of such leases back and any dispute over these is dealt with by the LVT. Their easements are something to watch out for in case the acquiring tenant or tenants have any plans in mind to carry out development affecting amenities of the relevant flat.

7. Stages of the collective enfranchisement process

From the solicitor’s position these are typically as follows:-

a. Preliminary advice on heads of terms and their documentation – including a deed of trust or formation of a company.

b. Preparing the initial notice and its attached plan which then has to be signed by all participants and then effectively served at the landlords’ addresses and also on any management company that was a party to your leases. At this stage solicitors’ advice may be needed on the correct valuation basis.

c. The notice must immediately then be protected by notice at the Land Registry (or the Land Charges Registry, in cases of unregistered titles) in order to make your claim binding against successors in title.

d. Deducing title on your behalf and paying over your deposit of 10% of the offered price.

e. Considering the landlord’s counter-notice and taking appropriate legal and valuation advice.

f. Giving notice of your nominee purchaser, if this has not been done in the initial notice.

g. Making the necessary application to the Leasehold Valuation Tribunal, assuming that the validity of your notice is admitted. Alternatively advising you and representing you in a County Court claim regarding any dispute over the validity of the claim or respond to the landlord’s default under the required procedure.

h. Liasing with your valuer and preparing for the Tribunal hearing and instructing Counsel as may be necessary.

i. Correspondence and negotiations regarding the terms of the transfer, covering such matters as easements or restrictions proposed by the landlords.

j. Minimising your liability for the landlords’ valuers’ fees and their legal costs (in investigating the validity of your notice and the conveyancing only).

k. Once the terms of transfer and any leaseback have been agreed or decided, effecting the necessary conveyancing.

l. Surrenders and re-grants of leases, or conversion of the block to a commonhold title scheme, and disposing of any vacant part.

8. The need for a valuer’s advice

Your notice of claim should offer precise sums for the reversion of the building being enfranchised, for any appurtenant premises, and for any intermediate landlord’s interest to be acquired.

Those sums should be advised to you by a valuer who specialises in working under this Act. Due to the volatility of the valuation rules - and particularly as to the deferment rate to be applied for converting the landlord’s present right to a future stream of income and capital into a current capital figure - you should request any valuer advising you to provide a “best case” and “worst case” valuation, and you probably should not go ahead unless you and your group of participating tenants are reasonably certain that you can, if necessary, afford to pay the worst case figure. Otherwise you could become liable for a great deal of abortive costs at a later date.

The above volatility of valuation has been highlighted in a recent decision of the Leasehold Valuation Tribunal - Arbib v. Cadogan - in which a low deferment rate of only 4.25% was accepted, thereby causing the value of the Cadogan Estate’s (i.e. landlord’s) interest to be much higher than the tenant had contested. The Tribunal has indicated the need for expert evidence on investment values to be put forward in such disputes. In the latest case of Cadogan v. Sportelli the Lands Tribunal, which hears appeals from LVTs, arrived at deferment rates of 5% for flats and 4.75% for houses. This has been upheld in the Court of Appeal. Particular circumstances will be needed to persuade any tribunal to depart from these rates.

It is some relief to note at least that the valuation date will be the date of your notice of claim and the costs incurred before the Leasehold Valuation Tribunal are not recoverable by a successful party.

If you only guess the appropriate prices to offer formally then you risk either paying too much or else giving an invalid notice of claim by offering substantially too little. The rule in Cadogan v. Morris requires prices stated in tenants’ notices of claim to be reasonably accurate, on penalty of the notice otherwise being invalid.

As explained already, the valuation will have to take account of any space within the block or its appurtenant premises that the landlord owns the right to develop. However, the landlord can call for 999-year lease-back in its counter-notice in respect of any non-residential unit or other developable unit of space – and so your valuation and offer for this commercial or development unit may prove to be hypothetical. This puts you in a position of great uncertainty in such cases until the landlord’s reply is known – which is a good reason to attempt to tie up a transfer of freehold or reversion outside the Act; see below.

9. Missing landlord situations

These are more complicated due to the need to issue Court proceedings and to file evidence as to the facts of the landlord’s disappearance. A private investigator’s report can be useful in this situation. This gives rise to greater initial expenses.

On the other hand, there is a possibility of saving costs in two ways. First, you may succeed in paying a lower compensation figure that would normally apply (due to lack of argument over valuation issues) and, second, you can obtain an award of costs in your Court claim and then off-set these costs against the compensation payable. The residual sum is then paid into Court.

10. Duration of the process

The preparatory stage alone can take a while, as the participating lessees have to resolve scheme design issues. Then the notice of claim has to be prepared (together with a plan), signed by every participating tenant, and served at the correct address or addresses.

Once the notice of claim is served there are at least two months before a counter-notice is due. Then two more months must pass before you can apply to the Leasehold Valuation Tribunal. This should then be done as soon as it becomes available. Then it takes between 3 and 6 months for the Tribunal application to be disposed of by a hearing or a compromise, or longer in case of adjournment. Then it can take up to 3 months for the conveyancing to proceed to completion.

One year from start to finish is good going.

There are penalties in the form of “deemed withdrawal” if you take too long at any stage, having started. So you must be continually proactive throughout the process. Time is of the essence!

11. Legal Costs

In view of the variety of possible facts involved in this process and the several stages in the process when a variety of responses - each with different consequences - may be encountered from the landlord party or parties (and any management company needing to be joined) James Brenan does not quote fixed prices for this work but can advise potential fee levels for the various stages once familiar with any matter. It is one of the purposes of these notes to save our time when giving advice and therefore to save you - as the potential client - in fees.

You stand liable to pay the following categories of professional costs incurred by the landlord or landlords: their initial inspection and valuation, any investigation reasonably undertaken, showing their title, and the eventual conveyancing work. Those conveyancing fees are able to be charged to you on a percentage scale rather than just as hourly charges, particularly for high value work.

12. Proceeding outside the Act

Due to the additional costs and complications of proceeding under the Act, it will be cheaper if you can persuade your landlord to sell the freehold to your group (or its nominee) without going through the Act’s process. If you find that voluntary negotiations leave you a relatively small amount apart from over the price it is often worth paying a few thousand pounds more so as to avoid the need for formal procedures.

However, if your landlord is evasive as to entering into any commitment, which is often the case when lease terms reduce towards the 80-year point, you are best advised to serve a notice of claim as soon as possible.

Any such deal struck outside the Act will have to be implemented in compliance with lessees (and Rent Act tenants) rights of pre-emption under the Landlord and Tenant Act 1987, thereby adding some additional complexity and costs to the process.

13. Your choice of legal representative

This type of matter calls for the combined forensic skills and know-how of both a conveyancer and of a litigator, which are of no use at all unless your legal representative has fully mastered and keeps up-to-date with the relevant enfranchisement legislation and case law.