Landlords and developers need to consider The Landlord and Tenant Act 1987 (LTA 1987) carefully when disposing of existing residential and mixed use properties. However, considering the LTA 1987 from the outset when purchasing new properties or development land may avoid potential problems on future sale.

The LTA 1987 is a complicated statute, fraught with difficulties and unanswered questions and it has been heavily criticised by the Court. Landlords need to be aware of the provisions of the LTA 1987 as there are serious repercussions if it is not complied with.

Brief summary of the LTA 1987

In certain circumstances, where the landlord wishes to dispose of the freehold, under the LTA 1987, it must first offer it to the qualifying tenants in the building. If this offer is not made, there are serious consequences, including, since 1996, criminal sanctions.

Under Part I of the LTA 1987 certain residential tenants have a statutory right of first refusal in relation to various disposals by their immediate landlord of whole or part of their building. The landlord cannot make a relevant disposal of the freehold without first offering it to qualifying tenants on the same terms as have been agreed with a prospective purchaser.

To fall within the LTA 1987, the premises must consist of the whole or part of a building containing two or more flats held by qualifying tenants. The number of flats held by qualifying tenants must exceed 50% of the total number of flats. "Qualifying tenants" includes tenants with long leases, but also short term common law tenancies and tenants protected under the Rent Act. A "relevant disposal" includes all disposals by the immediate landlord; although there are some limited exceptions. The qualifying criteria are detailed and need to be carefully considered in each case.

Procedure

The LTA 1987 covers a wide range of disposals by the tenants' immediate landlord, even disposals of the common parts alone, but this note will concentrate on disposals of the landlord's reversionary interest.

If the LTA 1987 applies, the landlord must serve formal notices on the qualifying tenants as soon as possible after the terms of disposal are agreed. The landlord must offer on the same terms as have been agreed with the prospective purchaser. It is advisable to agree Heads of Terms first to avoid having to re-serve the notice at a later date, although if the price is reduced during the course of a transaction then notices will need to be served again. The landlord must then wait at least two months before proceeding to exchange, even if all the tenants immediately respond in the negative. If the majority of the tenants accept, the landlord must dispose of the freehold to the tenants' nominee company. If no response is received or not enough tenants accept the offer, the landlord can dispose of the freehold to a third party within the next 12 months at a price no less than that contained in the notices.

This situation causes inevitable difficulties for any prospective third party purchaser; they risk wasting time and costs, if the tenants accept the offer. There is also the delay of two months; a prospective purchaser may not be willing to wait for that time. If the tenants do not accept the offer, the landlord could then be in a position where it has no buyer and has to go back to the market but cannot sell for less than the price stipulated in the notices.

Consequences of breach

As well as criminal sanctions for the disposing landlord, there are serious consequences for a purchaser; the majority of the tenants are entitled to undo a transaction carried out in breach and require the transfer of the property to themselves at the same price. This was evidenced in the case of Artist Court Collective Limited v Khan [2016] EWHC 2453 (Ch) where the landlord of a mixed use premises transferred the freehold to a limited company (of which he had a controlling interest) for £225,000. He did not carry out the formal offer procedure under the LTA 1987. The tenants served a purchase notice under the LTA 1987 requiring the freehold to be transferred to them at the same price. In an attempt to satisfy the tenants and end the litigation the landlord then transferred the freehold back into his name for no consideration. Unfortunately for him, the tenants then served a further purchase notice requesting he transfer the freehold to them for no consideration. At first instance it was held that the tenants were entitled to have the freehold transferred to them for no consideration, which would have resulted in them gaining the benefit of the income from the commercial units. This decision has subsequently been overturned on appeal; the High Court, rather unexpectedly, construed the initial transfer as having been between trustees and therefore falling within one of the exemptions. However, the case still provides a neat demonstration of the potentially serious consequences of not complying with the LTA 1987 in a case where no exemption is available.

In the case of Green v Westleigh Properties Limited [2008] EWHC 1474 (QB) in 2005 the tenants were able to undo a transaction dating from 1992 and paid just £500 for the freehold of a two flat building. This was because the tenants' time period for serving a purchase notice starts to run from the date on which the tenants are either told or find out that a disposal has been made in breach of the LTA 1987, which can be many years later. When acting for the purchaser of a qualifying building therefore, it is important to check for compliance with the LTA 1987 on previous sales.

Avoiding the consequences of the LTA 1987

Where the transaction falls within the LTA 1987, there are limited ways to avoid its consequences. The exemptions are set out in section 4(2) of the LTA 1987 and include, among others:

  • Transfers to the landlord's family or a charity or gift to the landlord's family.
  • The appointment of a new trustee or in connection with the discharge of any trustee.
  • Transfers from a body corporate to an associated company of that body (which must have been associated for at least 2 years).
  • Where contracts are exchanged for the disposal before sufficient flats are sold, the subsequent completion will be exempt.

Where the Landlord is an individual or individuals, it is difficult to avoid having to go through the formal notice procedure unless the individual landlord is gifting it or transferring it to members of his family.

One way of circumventing the LTA 1987 is for the company landlord to purchase the land and at the same time to set up an associated company. Then if it wishes to dispose of its interest (at least two years) in the future, it would be able to transfer the freehold to the associated company (an exempt disposal) and then sell the shares in that company to the purchaser.

Landlords can also consider at the outset holding the building in a special purpose vehicle (SPV). It can then sell the shares in that SPV to a purchaser rather than transfer the property itself. This avoids the LTA 1987 altogether and has the additional benefit of a stamp duty saving.

There is also the option of granting a headlease for a term over seven years, to a residents management company for example. This would preferably be put in place (or at least the agreement for lease entered into) before a sufficient number of flats are sold, meaning that the formal notice procedure can be avoided Once this lease is in place, the landlord would then be able to sell or transfer its interest without having to offer it to the tenants, as it is no longer the immediate landlord of the qualifying tenants.

Other ways to avoid the application of the LTA 1987 include the following:

  • Ensuring there are sufficient flats let to individuals on assured shorthold tenancies, although it can be difficult to ascertain whether tenancies are truly ASTs, i.e. the tenants use the flat as their only or principal home.
  • Ensuring that more than 50% of the internal floor area of the building is in commercial use (excluding common parts), to ensure that the building does not qualify under the LTA 1987.

Developments

The implications of the LTA 1987 can be more difficult to interpret where a development is in its very early stages. For example, where some of the flats are sold off plan and the landlord then considers a disposal of the freehold before there is an actual physical building, it is arguable that the LTA 1987 does not apply given that there is no "building" at that point. Pursuant to clause 1 (2) of the LTA 1987….."this part applies to premises if (a) they consist of the whole or part of a building…. (emphasis added). Unhelpfully, the LTA 1987 does not define "building" and there have been several cases on this definition; although none of these cases considered a development site or partially built property.

Where the building has been wholly or partially constructed, it should still be possible to dispose of the building where less than 50% of the flats have been sold, although it is unclear whether the calculation should be done on the basis of the building so far constructed or on the basis of the intended finished product. Furthermore, the definition of qualifying tenant includes a tenant who has exchanged an agreement for lease, even if the lease has not yet been granted.

Where interpretation of the LTA 1987 is necessary, it is likely to be advisable to seek Counsel's opinion, although it is notoriously difficult to predict how this LTA 1987 will be interpreted by the courts. Where possible, it is obviously best to avoid the uncertainty by considering the LTA 1987 at the very beginning and structuring the purchase accordingly with future disposal in mind, for example by putting a headlease in place or by holding the property in an SPV.

Where there is a mixed use development, it is particularly important to consider at the outset how the commercial and residential elements are held to avoid potential problems disposing of the commercial parts of the property in the future.

Conclusion

There are potentially disastrous consequences for landlords if they do not comply with the LTA 1987. Therefore, where there is to be a disposal of existing property, it should be carefully considered as to whether the LTA 1987 applies before the property is marketed. Where new land or property is purchased, the LTA 1987 should be considered at the very start as careful structuring can greatly assist future disposals. It is imperative that landlords seek expert legal advice in this regard from the outset to avoid potential pitfalls in the future.