Reform to leasehold Enfranchisement, The Law Commission’s final report
The Law Commission has today published its three final reports on leasehold reform and the future of home ownership. Their recommendations about leasehold enfranchisement and the right to manage are aimed at improving the existing system of leasehold ownership, whilst the third report about commonhold seeks to create a viable alternative to leasehold ownership, with a view to its widespread use in the future.
The enfranchisement report represents the last stage of the enfranchisement section of the project, which commenced in September 2018 when the Commission published its consultation paper on enfranchisement reforms, provoking more than 1000 responses from landlords (and their advisors) and over 1,500 responses by leaseholders.
In total the Report makes 102 recommendations, many of which are far reaching and, if enacted, would fundamentally change the enfranchisement sector as we know it.
The key recommendations are:
1. The New Regime
The Commission has proposed a simpler enfranchisement regime, with the purpose of broadening the availability of enfranchisement rights to leaseholders. The core elements are:
(a) The existing two-tier system (which requires properties to be categorised as “houses” or “flats”) is to be replaced by a new unified qualification scheme. A property will now qualify for enfranchisement rights if it is a “Residential Unit”. A Residential Unit must (i) be a separate, independent premises which either constitutes a building or part of a building and (ii) must be constructed or adapted for use for the purposes of a dwelling.
(b) A leaseholder will qualify if they have a (i) a long lease of over 21 years of (ii) a premises which includes at least one Residential Unit. If this initial test is satisfied, the tenant will be entitled to a lease extension (see paragraph 2 below) and may be entitled to acquire their freehold (see paragraph 3).
2. The right to a lease extension
The Law Commission has recommended a new uniform right to a lease extension for both leaseholders of houses and flats. The basic right is:
(a) The right to a lease extension of 990 years plus the remaining term of the existing lease at a peppercorn rent on payment of a premium.
(b) The landlord will be entitled to obtain possession of the property for the purposes of redevelopment during the last 12 months of the term of the original lease or in the last five years of each period of 90 years after the commencement of the extended term.
(c) The new lease should be on the same terms as the existing lease, subject to any necessary modifications. A necessary modification would include remedying defects in the existing lease or amending the new lease to reflect alterations which have occurred to the Residential Unit.
In addition to the above, in an attempt to tackle the issue of onerous ground rents, the Law Commission has recommended two new rights are created:
(a) First, if the Government does not follow the Commission’s recommendation, as set out in their report on enfranchisement valuation, to cap the level of ground rent that is taken into account when assessing the premium payable at 0.1% of the freehold value of the property, the Commission recommends that leaseholders with onerous ground rents should be entitled to extend the term of their lease without buying out their ground rent. This would mean that a leaseholder can obtain long-term security by extending their lease without needing to pay for the “term” element of the premium.
(b) Secondly, the Commission recommends that a leaseholder who already has a very long lease is entitled to buy out their ground rent obligations without extending the term. This is effectively the reverse of (a) above. A leaseholder could extinguish its ground rent payments without needing to extend its term and pay for the reversion element of the premium.
3. Freehold Acquisition
The Commission recommends that the new regime should include three acquisition rights:
(a) The right to acquire the freehold of the tenant’s building. This will replace the individual’s right to enfranchise their house under the Leasehold Reform Act 1967. A tenant will have the right to acquire the freehold of the building if the relevant building is in the ownership of a single long leaseholder.
(b) The right to collective freehold acquisition. This right will exist if there are (i) two or more Residential Units in the building (ii) two thirds of the Residential Units in the building are held on long leases and (iii) at least half of the Residential Units participate in the claim.
(c) The right to estate acquisition. This new right will permit long leaseholders of Residential Units on an estate comprising of multiple buildings to acquire freehold of whole estate.
The Law Commission have also recommended the removal of a number the existing restrictions on enfranchisement, notably:
(a) The percentage limit of permitted non-residential use is raised from 25% to 50%. This will vastly increase the number of buildings that are eligible for enfranchisement.
(b) The two-year ownership requirement (which is currently relevant to house claims and lease extension claims) will be abolished.
(c) The restriction that prevents tenants who own three or more flats in the same building from enfranchising will no longer apply.
(d) The financial tests under the Leasehold Reform Act 1967 will no longer be relevant.
The Commission recommends that a new, single procedure should be adopted for all enfranchisement claims.
(a) Regardless of which enfranchisement right the leaseholder is exercising, the claim will be commenced by serving a prescribed Claim Notice on the competent landlord (that is, the first superior landlord who holds sufficient interest in the premises to grant the interest claimed). The notice can be served by post, hand or email. Provided the notice is served at one of the landlord’s addresses (which are prescribed by the new regime), it will be deemed served. It will then be the competent landlord’s responsibility to serve the claim on any intermediate landlord.
(b) If the leaseholder considers that it has a missing landlord, it can apply to the Tribunal for permission to proceed with the claim without serving a Claim Notice.
(c) The competent landlord must respond to the Claim Notice using a single prescribed Response Notice within two months of the date of the Claim Notice. If this deadline is missed a landlord will be entitled to apply to the Tribunal for permission to join the claim and serve a Response Notice late. If no Response Notice is served, the Tribunal will determine the terms of the acquisition, but are not bound by the terms of the Claim Notice.
(d) The Commission also recommends that a leaseholder’s claim will not be treated as withdrawn because they have failed to apply to the Tribunal for a determination of the claim within six months of the Response Notice. However, if no such application has been made a landlord can apply to the Tribunal for the claim to be struck out.
(e) The service of the Claim Notice will no longer create a statutory contract.
(f) A claim notice will automatically transfer on the assignment of a lease unless it is disclaimed by the assignee.
(g) All disputes will be determined in the Tribunal. With certain valuation disputes being heard by a single valuer member of the Tribunal.
(h) The Tribunal will have the power to execute a transfer or the new lease where a party has failed to sign. Similarly, it will have the power to set-aside a determination or discharge a contract between parties because the premium has not been paid.
(i) If the Government adopts a valuation methodology based on market value, leaseholders should not generally be required to contribute to their landlord’s non-litigation costs.
(j) If the Government adopts a valuation methodology which is not based on market value, leaseholders should be required to make a fixed contribution to their landlord’s costs.
5. Voluntary transactions and contracting out
The Commission has recommended that the Government should regulate lease extensions and individual transfers which are not on statutory terms. This should be done by requiring that all such transactions are first approved by the Tribunal as objectively reasonable and priced. The Commission has also recommended that any attempt to contract out of the new regime will be void.
The Commission’s reforms will be welcomed by leaseholders. The Commission set out to undertake a “root-and-branch” review of enfranchisement rights with the purpose of making “our homes our own, rather than someone else’s asset”, and these reforms go a long way to achieving that aim. They will also make the process easier by removing some of the usual statutory time limits that regularly cause claims to fail.
However, in doing so, they will profoundly shift the market for all those who operate in the sphere of enfranchisement. Reforms such as the 990-year lease extension at a peppercorn rent and the removal of the 25% non-residential restriction will concern landlords who rely on ground rent and lease extension premiums for income.
Nonetheless, much will depend on how/ when the reforms will be enacted. The fastest that the Law Commission’s programme of reform has moved from consultation paper to legislation is just over five years. We also have the added complications of Brexit and economic ramifications of coronavirus. Nonetheless, it is evident that that landlord and tenant reform is high on the Government’s agenda. This was evident yesterday when the Government announced the Building Safety Bill to fire safety. It will be interesting to see whether Boris Johnson also has the appetite for an aggressive programme of leasehold reform.
James Carpenter is an Associate in our Property Litigation team.