LANDOWNERS AND DEVELOPERS - BEWARE THE RIGHT OF FIRST REFUSAL

Are you a landlord or developer of property which includes residential flats?  Are you going to dispose of your interest in that property?  If so, you may be obliged to offer your residential tenants a right of first refusal before selling to anyone else. If you don't, you could face serious consequences including criminal sanctions.

In this blog we go back to basics to explain when the statutory right of first refusal applies, what the consequences are when it does and how it is relevant in the context of mixed-use developments.

The Landlord and Tenant Act 1987 gives tenants this statutory right, however, the legislation was rushed through parliament in the run-up to the 1987 general election by a Conservative government who were under pressure to redress the balance of power between landlords and tenants in the residential sector. The result was a complex and defective piece of legislation which has been heavily criticised by the courts over the years.

1. When does the right of first refusal apply?

2. What are the consequences when the right of first refusal applies?

3. How is the right relevant to mixed-use developments?

1. When does the right of first refusal apply?

The statutory right applies when a landlord of premises which contain two or more residential flats proposes to make a relevant disposal of those premises. There are a few exceptions where certain tenants will not benefit from the statutory right (such as tenants under assured shorthold tenancies or business tenancies) but the legislation is widely drafted and will generally apply to most tenants occupying a flat under a tenancy agreement. Equally there are a few exceptions for specific types of landlord but these are generally intended to protect public bodies such as local authorities and housing associations.

As for what constitutes a "relevant disposal" by the landlord for the purposes of the legislation, again this is widely defined and it will capture any disposal whether by way of the creation or transfer of an estate or interest in any premises to which the 1987 Act applies. Certain disposals are excepted from the legislation (such as, perhaps obviously, the grant of a tenancy of a single flat), however, the right of first refusal will normally apply upon sales of a freehold or leasehold title or the grant of a new lease including a lease of the common parts.

2. What are the consequences when the right of first refusal applies?

Put simply, if a landlord intends to make a relevant disposal of premises to which the legislation applies then it must first offer to dispose of the premises to the tenants who satisfy the qualifying criteria under the 1987 Act. If those tenants do not accept the landlord's offer then the landlord is free to dispose of its interest to a third party during the following 12 months provided that the price is not less than that stated in the offer to the tenants and the other terms of the disposal correspond with such offer.

The procedures and time periods for making an offer to tenants and the rules regarding the percentage of tenants who must accept any offer are complex and go beyond the scope of this blog. However, if there is any possibility that the right of first refusal may apply to a proposed transaction then a landlord should always obtain detailed legal advice as a disposal of premises in breach of the 1987 Act is a criminal offence. Furthermore, a new landlord who acquires a property in breach of the statutory provisions can be required to dispose of its interest to the tenants on the same terms on which it acquired its interest.

3. How is the right relevant to mixed-use developments?

In the context of mixed-use developments the right of first refusal will apply if the aggregate internal floor area of all parts of the premises which are intended to be occupied for non-residential purposes is 50% or less of the internal floor area of the premises taken as a whole (ignoring any common parts for these purposes). In these circumstances it should be noted that tenants to whom the statutory right applies will be entitled to acquire the landlord's interest in both the residential and non-residential parts of the premises.

During the original development stage of a mixed-use property, there are certain steps that can be taken and lease structures that can be put in place by a landlord to facilitate future disposals without having to make a first refusal offer to tenants under the 1987 Act. The most common of these is the "blocker lease" which sits above occupational flat leases and below the freehold interest so as to allow the freehold to be sold without triggering the 1987 Act. Another option (which avoids the jurisdiction of the 1987 Act altogether) is to set up a corporate structure that allows the landlord to sell the property by means of a share sale. With sufficient planning it is possible to transfer the property to an associated company of the landlord (owned as such for the previous two years, in order to comply with the legislation), and to then to dispose of the associated company by means of a share sale. This approach means the purchaser does not have to worry about acquiring historic liabilities of the original landlord. For each of these structures it is essential that they are correctly implemented at an early stage and legal advice should be obtained in order to protect the value of the landlord's interest.

Once built and let, or for older properties, the position becomes more complex. In particular, there are potential traps where landlords are considering granting a developer a lease to build in the airspace above a building, or where a re-jigging of common parts is contemplated that might lead to some of these being incorporated into existing flats. Each of these scenarios could trigger the statutory right of first refusal and result in criminal liability for a landlord if the procedures under the 1987 Act are not followed.

Please contact us for more information if you require advice on any of the above issues.

Author: Michael Chivers, Senior Associate, Real Estate, London