I am just about to complete an office to residential conversion. Should I be concerned about my tenants' pre-emption rights, and how can I protect my position?
If the intention is to sell the flats on long leases then yes, you should be concerned about your residential tenants' pre-emption rights and yes you can mitigate against these risks, provided that sufficient planning is put in place before the flats are sold. The further in advance you plan, the more options you will have. If you ignore this issue now, it will most likely lead to delays and increased costs further down the line.
The issue here is that, in certain circumstances, if a residential landlord wishes to make a disposal, they are obliged to serve a notice offering the disposal to all of the residential tenants in the building. A "disposal" here includes selling a freehold interest in the property, granting a headlease and theoretically even granting a lease of any commercial elements of a mixed use building (such as a shop on the ground floor).
The notice must contain all of the agreed terms of the disposal. The notice must be served on all tenants and they then have two months to respond. If a sufficient number of tenants respond positively, then they have two months in which to proceed with the transaction.
This is all very unpalatable if you are looking to make a disposal. Firstly, most buyers and tenants would not want to disclose the details of a contract or lease to a third party, as these may well contain confidential information. Secondly, the time delays arising from having to serve the notices are significant, being at least two months. If you are trying to exit the scheme or grant a lease of commercial elements of the building, you may lose prospective buyers or tenants because of the delays involved. Finally, if you serve the notices and your buyer or tenant then withdraws, you cannot sell the property at a price higher than that set out in your notices for twelve months without having to serve the notices again. This lack of flexibility can cause significant delays.
You may be thinking that this all sounds a bit too complicated, and the best way to proceed is to ignore the legislation and deal with any penalties that may arise. However, failure to comply with the tenant's right of pre-emption is a criminal offence. Whilst you may not end up spending the night in Wormwood Scrubs for failing to comply, no developer wants a criminal record and a fine. So you either need to comply, or find a way to mitigate the risk of the relevant legislation applying.
Mitigate the risk
It is possible to mitigate the risks of this legislation, but it is imperative that you look at how to do this from the outset, preferably when you commence the development, but at the very latest before you start selling the flats on long leases.
There are ways to protect your position, by way of structuring the title or, in some circumstances, setting up a group company. The best approach will depend upon the relevant circumstances for your development, depending upon the set up of your building (for example whether there are just flats or mixed use), the current title structure and your tax position. You should seek legal advice as soon as possible to determine the best approach for your development.
This article was written by Robert Marchbank and originally appeared in the Professional Housebuilder & Developer magazine in November 2014.