The Leasehold Reform Act 1967 is on the face of it a statute about houses, not commercial buildings

The first line of the Supreme Court’s decision in the cases of Day v Hosebay Limited and Howard de Walden Estates Limited v Lexgorge Limited 3 sets the tone in a judgment which reinforced the original purpose of the 1967 Act. The majority of the 15 page judgment comprises an analysis of the history of the Act and a review of the existing precedents. Looking at the specific circumstances of the cases before them, their Lordships took just four paragraphs to explain why commercial tenants, such as the applicants in these two cases, should not enjoy the benefits of the statutory enfranchisement regime. Whilst welcomed as a “victory for common sense” (particularly by the owners of historic London estates), the Supreme Court’s decision dealt with two buildings in exclusively commercial use, meaning that other questions about the meaning of “house” for the purpose of the 1967 Act were not addressed, and some uncertainties remain.

The history and purpose of enfranchisement legislation

The LRA 1967 was brought into force to resolve a perceived inequality between the holders of long residential leases and their landlords. In a problem felt most acutely in London, freeholders of large estates had an unfettered ability to charge high premiums in return for the grant of residential leases which – by their very nature – were depreciating assets that would eventually expire, leaving the tenant with no option but to buy a new lease. The Act empowered tenants of houses to either acquire a lease extension or buy the freehold as of right, in return for a premium calculated under a statutory formula.

As originally enacted, the LRA 1967 required the tenant to have lived in the house for a requisite period of years before being able to exercise the right to enfranchise. Many of the qualifying criteria have since been relaxed or abandoned. There had been concern that the residence requirement was unfairly restricting the number of tenants of flats able to extend their leases under the Leasehold Reform, Housing and Urban Development Act 1993. The legislature’s response, by way of the Commonhold and Leasehold Reform Act 2002, was to remove altogether the residence requirement for both flats and (under the 1967 Act) houses. In the latter case, the intention was to bring tenants of houses in line with tenants of flats, and to ensure a right to enfranchise was available to leaseholders who own their house leases through companies (which, by their very nature, cannot “reside”).

That amendment to the 1967 Act led to what Lord Neuberger recognised in his Court of Appeal judgment in the present cases as an unintended and undesirable consequence: a rash of enfranchisement claims by corporate leaseholders who could satisfy the ownership criterion and – notwithstanding that their interest in the subject property was purely commercial – show that, on a literal interpretation of the definition of “house” under section 2, the subject property satisfied the last remaining criterion of being a “house”.

Section 2(1) defines a “house” as:

including any building designed or adapted for living in and reasonably so called, notwithstanding that the building ... was or is not solely designed or adapted for living in...”

The applications by both Hosebay and Lexgorge exemplified that unintended consequence, but Lord Neuberger, in the Court of Appeal, considered that on a strict reading of section 2 he was required to find that in both cases the buildings qualified as “houses”. 29, 31 and 39 Rosary Gardens in South Kensington (the subject of the Hosebay case) had been built as separate houses in the late Victorian era but, at the date of the application, had been converted for use as short-term accommodation in self-contained rooms, each of which had self-catering facilities (probably in an historic breach of the user covenant under the lease). In a literal sense, they had been adapted “for living in”. The Lexgorge property at 48 Queen Anne Street, Marylebone, was a single terraced house from the early 18th Century, whose four main floors above the basement were being used as offices at the date of the 1967 Act application.

Premises made suitable for commercial uses were not intended to fall within section 2

In overturning the Court of Appeal decision in both cases, the Supreme Court was led by what was, without doubt, the original purpose of the 1967 Act. The legislature in the 1960s was looking to empower residential tenants, rather than allow corporate leaseholders to seize valuable freeholds from their landlords. Business occupiers already had a statutory right to renew their leases, pursuant to the Landlord and Tenant Act 1954. The Supreme Court held that, “the court should avoid as far as possible an interpretation which has the effect of conferring rights going beyond those which Parliament intended”.

In relation to the properties at Rosary Gardens and Queen Anne Street, the Supreme Court was able to determine with relative ease that the commercial tenants should not be entitled to exercise rights under the 1967 Act on the following basis:

  1. The test under section 2 of the 1967 Act is twofold. If a building is not a house “reasonably so called” there is no need to enquire as to the original design or most recent adaptation of the building.
  2. Buildings which are wholly used as offices are not houses “reasonably so called” under the second part of the test. To reach an alternative conclusion would be contrary to the purpose of the original legislation.
  3. “Living in” means, for the purpose of the first part of the test, something more settled and permanent than simply “staying in”. Self-catering short-term accommodation or hotels are not houses within the meaning of section 2.

The decisions in Hosebay and Lexgorge have brought welcome clarification as to how the 1967 Act should operate and, in particular, how the definition of “house” under section 2 should be read. Many freeholders, especially the owners of the large, historic London estates, will have breathed a sigh of relief.

Across the country, huge numbers of leasehold properties which were historically designed as houses have subsequently been adapted and used as commercial premises. Had the Supreme Court upheld the Court of Appeal’s interpretation of section 2, it would have opened the door to a huge number of similar claims and to freeholders being dispossessed by commercial tenants. Leases which pre-date the 2002 changes are unlikely to have contained specific safeguards against enfranchisement by corporate tenants because the possibility had previously seemed remote. More recently, freeholders have had to be cautious about granting commercial leases of 21 years or more. For example by limiting the extent of the demise or the duration of the term and imposing complete prohibitions on residential user. Even then, they have been unsure as to whether their tenants might still have the right to enfranchise. The issue has now been settled, at least in part.

Remaining uncertainty and room for debate

One should not assume, however, that the Supreme Court had the chance in Hosebay and Lexgorge to dispose of all uncertainties surrounding the definition of a “house” within the meaning of section 2 of the 1967 Act.

The Lexgorge property was used in its entirety (save for the basement) as offices, whilst the Hosebay property was used exclusively for the commercial business of short-term accommodation. The Supreme Court was lauded for reaching a common-sense conclusion: that a building used wholly for commercial purposes, notwithstanding that it might in another context be described as a house, cannot be a house “reasonably so called”. But what of a building which contains an office on the ground floor, but accommodation above? The Supreme Court did not have to consider those facts, but the law as it stands recognises that as a matter of principle a building of mixed use might reasonably be called a house.

The first part of the section 2 test is then brought into play, and one must consider the original design and subsequent adaptation of the building for “living in”. Whilst the Supreme Court had an opportunity to express a view as to how that test should be applied, the judgment of the House of Lords in Tandon v Trustees of Spurgeons Homes 4 (which Lord Carnwath said in the present cases was “not without difficulty”) remains the leading authority in that respect, and one must still consider the outcome of another House of Lords case, Boss Holdings Ltd v Grosvenor West End Properties Limited 5, which was concerned exclusively with the first part of the section 2 test.

Although in the Lexgorge case the Supreme Court decided that (not being a house “reasonably so called”) there was no need to look at the narrow factual issues of the building’s design or adaptation, they were nevertheless able to shed light on how the first part of the test should be read, and we can draw the following from the judgment:

  1. External and internal physical characteristics and appearance are not to be given determinative weight when deciding whether a building has been designed or adapted for living in, within the meaning of the 1967 Act.
  2. “Adapted” means little more than “made suitable”. An adaptation for living in does not have to be evidenced by structural alterations. When a building has been used for a particular purpose for a settled period of time, it will usually follow that the building has been “made suitable for” that purpose.
  3. As opined by Lord Neuberger in the Court of Appeal: where a building has been designed for living in, but has subsequently been adapted for a different purpose, it will only be a building “designed or adapted for living in” within the meaning of section 2 if its most recent adaptation was for the purpose of living in.

In Tandon, one of the key factors in determining whether the tenant should be able to exercise the right to enfranchise was that a substantial part of the building (in that case just 25%) was in residential, rather than commercial, use. That was held to be sufficient to make the building a house within the meaning of section 2. Will that be true in every case? A more appropriate conclusion is that the percentage of the space devoted to residential use, together with other factors including appearance and physical characteristics and (to a lesser extent) the user covenants in the lease, will together form a nexus of fact from which the courts must form their own view as to whether the property comes within the intended scope of the enfranchisement legislation. In the present cases, the Supreme Court has, at the very least, clarified that neither appearance, nor the terms of the lease, will be an overriding, determinative factor in deciding whether a building has been designed or adapted for living in. However, that also means there is no such thing as a one-size-fits-all answer to that part of the test.

The Supreme Court has closed the door to opportunistic enfranchisement by commercial tenants, which would have been contrary to the spirit of the Act. In so doing, they have reaffirmed the original purpose of the legislation and, to the extent permitted by the facts of the two cases before them, explained how the definition of “a house” should be read to give effect to that original purpose. However, there are plenty of leasehold properties in England and Wales which do not easily fall within the same categories as 29, 31 and 39 Rosary Gardens and 48 Queen Anne Street, and defining a property “designed or adapted for living in” remains problematic in the real world. Hosebay and Lexgorge will not be the last word on interpretation of section 2. In the meantime, freeholders who wish to protect their interests against enfranchisement should continue to take all safeguards they can (such as limiting the demise, or the duration of the term and the permitted user) in order to avoid having to wrestle with the uncertainties which remain.

An earlier version of this article was published in Estates Gazette on 3 November 2012.