Enfranchisement: a collective effort

The Leasehold Reform, Housing and Urban Development Act 1993 (the 1993 Act) governs the process by which tenants can either extend the leases of their leasehold flats or join together with the other flat owners in their building to buy its freehold, in a process called collective enfranchisement. The laws surrounding both of the enfranchisement processes under the 1993 Act are currently being reviewed by the government, which is proposing reforms to make the processes involved fairer, less costly and more transparent. Despite there currently being no certainty on what reforms will look like or when they will be brought in, this has caused some individual tenants of leasehold flats to decide to wait until these reforms come in before carrying out their lease extensions. However, collectively tenants still seem keen to use the collective enfranchisement process to buy the freehold of their building.  What do tenants need to do to buy the freehold of their building? The first hurdle is that the building itself has to qualify under the 1993 Act. Specialist legal advice should be sought in order to establish whether or not the building qualifies before any collective enfranchisement process is embarked upon. The building has to fulfil certain criteria. For example, first, the building must contain two or more flats, and two-thirds of those flats have to be owned by qualifying tenants. A qualifying tenant for this purpose is a tenant who owns a lease of a flat that was originally granted for a term of more than 21 years. Secondly, the building has to be self-contained as defined under the 1993 Act (see box). This can sometimes be problematic to satisfy. A terraced building can still be self-contained for the purposes of the 1993 Act but if, for example, a building is somehow connected to another building by a doorway, or a flat has been laterally converted with a neighbouring building, or there is a basement car park that runs under the neighbouring building as well, then the building by itself will not be self-contained. Any commercial element of the building must not take up more than 25% of the total floor area of the building (excluding common parts). In a mixed-use building, a surveyor should be employed to calculate the requisite floor areas. If the building qualifies, then at least 50% of the tenants have to join together to make the application to the landlord to purchase the freehold of the building. It can often take several years in very large blocks to arrange for at least 50% of the tenants to agree to join together to go through this process. How much will the freehold cost the tenants? In order to establish how much the freehold is likely to cost, a specialist enfranchisement valuer will usually be employed to advise on the likely price that will be payable for the freehold, and also to negotiate the purchase price with the landlord’s valuer. The price can vary depending on the number of participating tenants, so it is best to have an idea of the likely number of participants before instructing a surveyor so that they can calculate the purchase price as accurately as possible. It is sensible to appoint one or two representatives in the building in order to organise and run the process, and to liaise with the professional advisers. It would also be advisable to set up an initial costs fund whereby tenants who are interested in proceeding all pay a sum of money to cover the costs of the initial valuation and any legal advice required at the beginning of the process. If tenants want to join in the process, they are usually asked to sign a participation agreement and pay a deposit on account of the professional fees to be incurred. The participation agreement is the document by which all the participating tenants agree to proceed and pay their respective share of the purchase price for the freehold. This is then the contract by which they all agree with each other to proceed. A company will be created which will be the nominee purchaser of the freehold. The participating tenants will either be shareholders or members of that company. The nominee purchaser will buy the legal title to the freehold and hold it on trust for each of the participants. The participating tenants will also be asked to sign the notice of claim which has to be served on the landlord, requesting them to sell the freehold to the nominee purchaser company. The landlord must then serve a counternotice either accepting or rejecting the claim. They have two months to serve such counternotice. If they accept the claim, they will include in their notice a counter-offer price. The price is then negotiated by the respective parties’ valuers. This process is governed by a timetable set out in the 1993 Act, which includes strict time limits to adhere to. It is therefore important that tenants obtain expert legal advice to guide them through the process. An application to the First-tier Tribunal is usually made by the tenants to protect the claim. Failure to make one at all within six months of the service of the counternotice makes the claim invalid if the terms have not been agreed by then. This does not mean that a full tribunal hearing will always be required, but the directions that will be issued by the tribunal encourage parties to come to an agreement within a reasonable time frame, and if they are unable to do so the tribunal will decide the terms. From the service of the notice of claim it takes around 18 months, on average, to complete the freehold purchase, depending on how protracted negotiations become and whether any recourse is needed to the First-tier Tribunal or the courts to decide points in dispute. Why purchase the freehold? While this form of enfranchisement does tend to be a fairly lengthy and often costly process, it allows tenants to obtain control of the management of their building. Being their own freeholder provides the ability to control the level of service charges, so that they are not subject to any unreasonably high service charge costs. Furthermore, tenants can grant themselves long 999-year leases of their flats, reduce the ground rent payable in their leases to a peppercorn (effectively nil) and amend any terms of their leases to bring them up to modern-day standards. A long 999-year lease with a peppercorn ground rent and a share of the company that owns the freehold makes the flat lease as marketable as possible – given that we do not generally have freehold flats in England and Wales (save for a few exceptions). In particular, it is more likely to appeal to oversees purchasers who may not understand the freehold and leasehold structure used in England and Wales. There has been much recent coverage of the problem of escalating ground rents in leases, with onerous rent review provisions included within them so that tenants have trouble selling their flat or obtaining a mortgage on it. This is for two reasons. First, the rents can become so high that they simply become unaffordable, which will deter buyers on the open market. The second reason is that where a lease has a ground rent – either initially or as a result of a rent review – of more than £1,000 per annum in London or £250 per annum outside London, it may fall within the provisions of the Housing Act 1988 (the 1988 Act) and become an assured shorthold tenancy (AST) agreement. This is problematic because the landlord is able to terminate tenancy agreements for non-payment of rent by the tenant with greater ease than would otherwise be the case. If a long lease does not fall within the provisions of the 1988 Act, the landlord can terminate under the forfeiture process, governed by the Law of Property Act 1925. The court has discretion as to whether the landlord is able to terminate the lease, and the courts tend only to grant possession in cases of severe breaches. The tenant also has the ability to claim relief from forfeiture and has time to remedy the breach. In addition, lenders with an interest in the property are also required to be notified by the landlord of any proposal to issue forfeiture proceedings before they do so. Lenders therefore customarily accept this position and readily lend on long leases. If the lease is an AST, however, and the tenant fails to pay the rent due, the landlord can apply to the court for an order for possession of the property. If there are arrears, the court does not have any discretion in issuing a possession order; it is required to do so. Unless the lease expressly requires the landlord to notify any lenders with an interest in the property of their intention to seek possession of the property before taking such action, lenders will also be unaware that their security is about to be withdrawn. For this reason, banks are unlikely to lend on a lease where the 1988 Act applies. Collective enfranchisement gives tenants the opportunity to remove these problems by buying the freehold and granting themselves leases on new terms with a peppercorn ground rent so that the leases will never fall within the provisions of the 1988 Act; nor will the ground rents become unaffordable. Part of the calculation for the purchase price, however, is capitalising the ground rent payable to compensate the landlord for the loss of this income, but this cost should be balanced against the long-term benefits that can be gained. What is included in a collective enfranchisement claim? As part of the collective enfranchisement claim, tenants can also claim appurtenant land, such as a communal garden that is demised under their leases or property that the tenants have a right to use under their leases. The Court of Appeal in 4-6 Trinity Church Square Freehold Ltd v The Corporation of Trinity House of Deptford Strond [2018] EWCA Civ 764; [2018] PLCS 71 confirmed that even if tenants only have a revocable licence to use a communal garden or other communal property, they will be able to seek to acquire the freehold of the property or be granted a permanent right over it. What constitutes ‘self-contained’? Section 3 of the 1993 Act states that “a building is self-contained if it is structurally detached”, and a part of a building can also be self-contained if it “constitutes a vertical division of the building and the structure of the building is such that part could be redeveloped independently of the remainder of the building”. Lucy Barber is a partner and head of residential property at Forsters LLP