Real Estate: Proposals for Enfranchisement Reform: Have they raised more questions than answers?
After being invited to attend the Law Commission Symposium on 5 November 2018 to hear the proposals for enfranchisement reform and discuss how they will work in practice, Louise Uphill examines the key points and asks whether the reforms will indeed work in the real world?
The Law Commission published an initial paper in July 2018 setting out a number of solutions for leaseholders of houses. In September 2018, this was followed by a detailed consultation setting out the Law Commission's proposals for reform of enfranchisement legislation for flats and houses. The task of reforming this complex and detailed area of law is going to be fraught with difficulty. Here we examine just a few of the main proposals currently on the table and raise questions about how they will affect all parties involved, not just leaseholders.
The Law Commission is proposing an individual right for a sole leaseholder to acquire the freehold of a block of flats. This removes the current requirement for at least 50% of the leaseholders to collect together to do this, thus opening up the process to individual leaseholders or investor leaseholders. However, the risk here is that if there is a rogue leaseholder who is in dispute with his landlord or fellow leaseholders, he could acquire the freehold on his own with no ability to successfully manage the block of flats.
This individual enfranchisement proposal will also open the door to investors who want to buy one leasehold flat and then purchase the freehold of the block with a view to redeveloping the roof space or the car parks, for example. Whilst the landlord may be compensated for loss of development value, what impact will this have on the remaining leaseholders? Under the current regime, if a leaseholder owns more than three leasehold flats in one block, then he is excluded from being a qualifying tenant for the purposes of the enfranchisement legislation. The reason for this "three strikes and you are out" rule was to stop investors acquiring leasehold flats in order to gain control of the freehold and redevelop the block.
A new 'estate enfranchisement' will be created, where leaseholders can collect together to purchase multiple buildings within the estate, regardless of whether they are flats or houses. Whilst this is intended to allow leaseholders to take ownership and control over multi-unit sites (which may be excluded from current legislation), this could result in a number of issues relating to management where house and flat owners are unable to agree on how the estate should be managed. Why should a house owner pay towards the maintenance of the lift in the block of flats on the other side of the development? Watertight agreements and estate rentcharges will need to be in place, thus costing the leaseholders more money in legal fees.
Estate enfranchisement may also lead to additional valuation issues relating to the common parts, car parks, community gardens etc. which will increase costs for both landlord and leaseholder, going against one of the primary aims of these reforms.
Ordinarily on an enfranchisement claim, the participating leaseholders are required to fund the non-participating shares. The reforms suggest that instead of this, 999 year leasebacks, with zero ground rents, will be granted back to the landlord by the nominee purchaser for those flats whose leaseholders do not participate in the freehold claim. It is unclear whether the Law Commission will provide a means for landlords to be compensated for the loss of these ground rents.
There is also the 'right to participate' where leaseholders who have not been invited to participate in a previous enfranchisement can be invited to join in at a later date. This may seem a good idea, but in practice it is generally the case that a particular leaseholder has been excluded for a reason (i.e. they are difficult or they have different ideas about how to manage the building that do not accord with the wider group).
The Law Commission has also sought views on whether implementing a ban on re-enfranchisement for 5 years after an enfranchisement completion would be a good idea. However, it may have the effect of devaluing the 999 year leases owned by the landlord, as the 999 year lease will no longer be valued on the open market and so it may better serve a leaseholder to wait until after the enfranchisement has completed to invoke his right to participate.
Treatment of flats and houses
Under the current regime and due to various piecemeal Acts of Parliament, the treatment of flats and houses is very different. As a result, the Law Commission is proposing that a new definition of "Residential Unit" is used to describe both a house and a flat.
This proposal is welcomed as it is not necessarily right that a flat owner has a different process to follow than a house owner. Although, given that the Supreme Court cannot agree on a definition of "house", the definition of "residential unit" would need a standardised definition which straddled both regimes and which had a rigorous test that could be applied. If the Leasehold Reform, Housing and Urban Development Act 1993 ("1993 Act") approach was used it would strike out most houses which overhang other properties. Numerous questions arise here: How would a derelict house be defined? Do we look at the current use or the intended use? Again, whilst this proposal is welcome, it will need a great deal of careful consideration to ensure it operates as intended.
As part of the Law Commission's consultation, they are asking the industry whether leases should be granted for 125, 250 or 999 years. It may be that any variation to the standard term granted could however have an impact on the premium paid by the leaseholder, as it would increase the value of their leasehold interest by converting it to a virtual freehold. Opinions are also being sought on whether the leaseholder should have the choice to extend their lease term only or buy out the ground rent only. This may be a better option for some leaseholders who cannot afford to pay for both.
There is a growing problem with long leases because the buildings in which they are situated are not likely to be in any fit state for habitation in 99, 125 or 999 years' time. This may not be of primary concern for our generation, but it will be a problem for future generations as their leases will invariably outlive their buildings.
Under the current regime for statutory lease extensions, section 61 of the 1993 Act allows the landlord certain break rights for redevelopment, which can be activated within 12 months of the expiry of the existing lease and within 5 years of the expiry of the new lease.
If the Law Commission makes it so much easier for leaseholders to extend their leases to 999 years and buy their freeholds, it will also need to consider development break rights. Otherwise, how will these buildings be redeveloped in the future? Furthermore, who will pay for the hefty cost of redeveloping and refurbishing these blocks in years to come? If non-trading residents' associations take control of their freeholds, how will the cost of redevelopment be funded? They will not have the ability to temporarily re-house the residents whilst their block is refurbished. Perhaps a new breed of developer will be born, but only if redevelopment break rights are factored into all extended leases, regardless of whether they are statutory or voluntary extensions.
The Law Commission has suggested different claims tracks for either lower or higher value claims, which may help ease some of the burden for the Tribunal. There is also the suggestion that all disputes will be overseen by the Tribunal only, which is positive news because under the current regime it can be difficult for leaseholders to know whether the parties should refer their disputes to the Tribunal or the County Court.
The Law Commission has proposed that all questions regarding qualification with its new criteria are referred to the First-tier Tribunal to determine. Under the current regimes, the various pieces of legislation set out the qualifying criteria and, whilst it differs from houses to flats, there is at least a point of reference. The result may therefore be an increase in costs for both parties who may become forced to litigate these questions instead of taking the advice of specialists.
One concern is that if the overriding principal of these reforms is to keep costs to a minimum, then the Law Commission will have to think carefully about directing parties to litigate instead of seeking advice on qualifications prior to making a claim.
Premiums for enfranchisement
Under the present regime, there is a separate method for calculating the premiums payable for flats and for houses. The Law Commission has suggested one method for both flats and houses, which would make understanding the process much easier. It has considered whether an online calculator might work, or whether a formula of 10 x the annual ground rent might be the solution.
If capitalisation, deferment and relativity rates are pre-set within an online calculator, then the Law Commission may need to decide how the rates will be maintained and kept up to date in line with the market and case law.
If the key is to reduce the premiums payable by leaseholders, the Law Commission will also have to have regard to the landlord's right to peaceful enjoyment of property contained in Article 1 of the First Protocol to the European Convention of Human Rights. How this can be reflected in a type of compulsory purchase by private individuals will remain to be seen, as the arguments for both sides are compelling. The Law Commission has invited views on in its proposals and it will be interesting to see what comes to light with these issues of valuation. It may however boil down to political judgement in the end.
Costs of enfranchisement
There has been some suggestion that landlords will have to pay their own costs of dealing with leaseholder's claims of enfranchisement, which does not sit well with the theme of compulsory purchase legislation. Other proposals include a sliding scale of fixed costs, thus capping costs at a maximum limit. Whether this will cover the actual cost of undertaking the whole job doesn’t seem to be a concern, as long as the overall costs to the leaseholder are reduced. Balancing the views of landlords and leaseholders will be difficult, and consultees are invited to provide practical examples of how this will affect the parties.
As can be seen, the proposals are numerous and far reaching. Some of the proposed changes will be beneficial and will streamline the enfranchisement process, making navigation through the system more straightforward. However, other proposals have simply raised more questions and will require much more thought and consultation. It is imperative therefore that stakeholders provide practical examples and comments for the Law Commission to take on board by responding to some, if not all, of the 135 questions.
The deadline for responses to the consultation has been extended to 7 January 2019 and details of the online form can be found by accessing this link.
If you have any questions or would like to discuss the Law Commission's proposed reforms, please contact Louise Uphill, our enfranchisement expert in our Southampton Real Estate team.