Implications of the recent High Court judgment where a freehold is sold or transferred without serving an offer notice on leaseholders in circumstances where a trust arrangement is in place.

The county court decision in Artist Court Collective Ltd v Khan last year attracted a great deal of publicity, as it provided a clear example of the potentially disastrous consequences of ignoring Part 1 of the Landlord and Tenant Act 1987 (1987 Act) when disposing of a residential or mixed use property. On appeal, the High Court overturned the county court decision, finding that this particular transfer fell within one of the exemptions in the Act. However, the 1987 Act remains a minefield for landlords and it is always worth leaseholders taking a careful look at any sales or transfers by their landlord, particularly where no prior notice has been given.

Part 1 of the Landlord and Tenant Act 1987 (1987 Act) gives “qualifying tenants” of flats in certain buildings a right of first refusal when their landlord proposes to make a disposal of its interest. Long leaseholders are qualifying tenants, but other tenants (such as Rent Act protected tenants or short term company tenants) also qualify. A landlord intending to make a disposal to a third party is required it to offer it first to the qualifying tenants, on the same terms as have been agreed and before exchange of contracts.

There are serious consequences for both parties for failing to comply with the 1987 Act. A landlord making a disposal in breach, without reasonable excuse, will be committing a criminal offence. Furthermore, once a disposal has been made in breach, the qualifying tenants have the right to undo the disposal and have the property transferred to them at the same price, meaning that the purchaser will lose its property and, depending on when this right is invoked, the price could be lower than the market value.

This case concerned a mixed use property in East London; commercial units on the ground floor with eight residential flats above, the latter let on long leases. In 2011, the landlord, Mr Khan, entered into what the judge described as a “strange sequence of transactions”. He had a company incorporated, SGR, which he controlled and shortly afterwards he transferred his freehold interest in the property to SGR for a consideration of £225,000. . It was later discovered that, four days prior to this transfer and unbeknown to the solicitors who drafted the sale contract, Mr Khan had entered into a trust deed with SGR declaring that when the freehold interest in the property was transferred to SGR, SGR would hold the property on trust for Mr Khan.

In contravention of the 1987 Act, Mr Khan failed to offer the freehold interest to the leaseholders and they only found out about the transfer when they sought legal advice about the use of one of the commercial units as a fish and chip shop. Having discovered the transfer, the majority of the leaseholders formed a company and served a purchase notice on SGR seeking the transfer of the freehold to their own company at the same price.

In an attempt to resolve the position, Mr Khan then arranged for SGR to transfer the freehold back to himself, this time for nothing. The leaseholders reacted by serving a further purchase notice on Mr Khan, again claiming the freehold but this time for nothing.

The leaseholders’ claim succeeded at county court level; the judge finding that both transfers were “relevant disposals” and therefore in breach of the 1987 Act. The judge in the County Court therefore ruled that the leaseholders’ company was entitled to undo the second transfer and acquire the freehold for nothing.

The judge in the High Court took a rather different view. With regards to the first disposal, the leaseholders had argued that the trust deed and the contract for the transfer of the freehold were two separate transactions, given that the contract had been drafted without knowledge of the trust. The judge, however, found that they were nevertheless part of a single composite transaction; jointly comprising a “relevant disposal” for the purposes of the 1987 Act. Although this was not specifically addressed in the judgment, the implication is that despite the first transfer technically being in breach, the leaseholders would have no interest in stepping into the shoes of SGR if they would be forced to hold the property on trust for Mr Khan.

The second part of the judgment created more of a blow for the leaseholders. It had been argued on behalf of Mr Khan that the second transfer, from SGR back to his sole name, fell within the exemption in the 1987 Act allowing disposals of an interest held on trust in connection with the appointment or discharge of any trustee to take place without being offered to the leaseholders. Despite the fact that the second transfer was to the beneficiary and therefore terminated the trust, the High Court judge was of the view that this exemption applied. The High Court therefore held that the leaseholders were not entitled to undo the second transfer and take the property (and the accrued rents) for nothing.

This judgment is somewhat unusual amongst cases on this subject. The 1987 Act is well known as being (in the words of one law lord) “ill-drafted, complicated and confused” and this has led to some surprising results in the past, but as a general rule any confusion has historically been decided in favour of the tenants. That said, this decision effectively turned on a technicality and, unless they find themselves in very similar circumstances to Mr Khan, it is unlikely that many landlords will be capable of relying on this decision to their advantage. Leaseholders should therefore remain aware of their rights under the 1987 Act. If a disposal occurs without offer notices having been served, the 1987 Act gives leaseholders the ability to serve an information notice on the landlord and if the disposal was exempt for any reason, the landlord should be able to provide details making that clear.

Take aways from the judgment:

  1. For landlords, the tenant’s right of first refusal should be carefully considered on any sale or transfer of a building containing two or more flats.
  2. It may be possible for a sale/transfer to fall within one of the exemptions in the Act, although the scope of these is generally quite narrow.
  3. 3.Leaseholders should remain alert to any sign of their landlord’s interest changing hands without offer notices being served.

This article originally appeared on the LEASE website, which can be accessed on the following link: https://www.lease-advice.org/article/a-landlord-reprieved/.