Conveyancing

Law Commission: reforming RTM, commonhold and enfranchisement: Part 1

The Law Commission’s proposals for leasehold property reform are discussed and assessed, as is what the plans could mean for conveyancers and their clients.

About the author: David Bowden is a SolicitorAdvocate of David Bowden Law®

The problems caused by leaseholders who find that their ground rent doubles automatically every year, leaving these sorts of flats virtually unsaleable, has been headline news over the past few months; added to this, some buyers of new houses are having to accept leasehold tenure. The reform of this situation has become a political priority for government.

The Law Commission has also had the drains up in this area, with consultations and recommendations for law reform that apply to leasehold property more generally.¹ Separately, on 19 March 2019, the House of Commons Housing, Communities and Local Government (HCLG) Select Committee published a report with recommendations for the urgent reform of leasehold property.²

CILEx’s policy position

Very sensibly for both its members and the clients they serve, CILEx has welcomed the commission’s proposals for commonhold reform, but stressed that leasehold changes must come first.³ CILEx members have cautioned against having a mix of commonhold and leasehold tenure within a single block as this is likely to create practical diÿculties and risks a two-tiered system.

Concerns about leasehold

The Law Commission says that the concerns about leasehold fall into five groups:

High and escalating ground rents especially those ground rents which double every 10 years.
Leasehold homes being unmortgageable and/or unsaleable due to escalating ground rents.
Houses being sold on a leasehold rather than on a freehold basis for no good reason.
The levying, by landlords, of unreasonable permission fees to carry out alterations to a property.
Close relationships between property developers and conveyancers which may undermine a conveyancer’s independence where they are advising clients to buy leasehold properties.

In addition, the HCLG Committee’s other concerns include the following:

Developers’ sales teams deliberately misleading leaseholders with partial sales information or false promises of purchasing their freeholds at an agreed price.
Flat buyers being coerced into using developer recommended conveyancing solicitors.
Ground rent becoming onerous where it becomes disproportionate to the value of a home.
Whether or not onerous leasehold terms are ‘unfair terms’ and, if so, are unenforceable.

Commonhold

Commonhold was first introduced, in 2004, by the Commonhold and Leasehold Reform Act (CLRA) 2002 as a form of ownership of land which is designed to enable the freehold ownership of flats. Although commonhold is now 15 years old, the commission has been forced to admit that this alternative to leasehold has not taken off. There are only around 150 commonhold units in England and Wales as compared with 4.2m leasehold units.

Lenders have put some obstacles in the way as, while they are familiar with leasehold properties, several have created artificial diÿculties for those seeking to borrow to buy commonhold property.

Nearly all new builds are leaseholds, with no major housebuilder offering commonhold on their new developments. The HCLG Committee wants commonhold to become the ‘primary model of ownership of flats’ in England and Wales (HCLG report ‘Leasehold reform’, p3).

Conversion of leasehold tenure to commonhold

To try and get around this, the commission’s proposals seek to make it easier for leaseholders to convert their tenure into commonhold.› However, the case for conversion to commonhold does not seem to be made out despite the lengthy attempts to justify it in the consultation paper. It does not seem that a commonhold property increases in value when compared with a leasehold property. The issue remains as to the ownership and management of the common parts of a block.

Although there have been abuses in relation to leasehold properties, the commission’s proposals for commonhold do not look very different. Indeed, commonhold has one big disadvantage absent in leasehold properties, which is that the common parts are owned by a commonhold association creating the issue of flying freeholds, which causes lenders alarm. In its response to the commission consultation paper, CILEx points out that the ‘unwillingness’ of mortgage lenders to lend on commonhold was identified by its members as the biggest barrier (para 3.4).

Consents needed to convert

Where leaseholders do want to convert to commonhold then, at present, they need the consent of everyone affected, including the freeholder (or assignee), all leaseholders and all mortgagees. For this reason, there have been few, if any, conversions. The commission wants to make this easier and proposes two options. The first would enable conversion to commonhold where only 50% of leaseholders agree to do so, but those who are against conversion would keep their leasehold title. The second proposal is that where 80% or more leaseholders want to convert to commonhold, that would be a suÿcient quorum to enable everyone to convert to commonhold.

The Law Commission proposes that a commonhold conversion process would mirror that of a collective enfranchisement process. Some of the issues that have been identified early in the consultation include the following:

Properties on a shared ownership basis where the flat owner has not staircased to full 100% ownership;
absent landlords; and
where units have been sublet.

Mixed-use commercial and residential developments

The issues around commonhold conversion are compounded where there is a mixed-use development such as the common scenario where residential flats are built above units on a ground floor used for shops, oÿces or other commercial uses. The CLRA means that everyone would be regulated by the same commonhold statement. So, for example, where a shop owner wanted to install a CCTV camera to protect the premises, at present, under the commonhold statement, the flat owners would have to contribute to the cost of installation even though they would not benefit from the camera’s presence.

The commission has looked at what is done in Australia and in New Zealand where they have a workable solution. The possible solutions in the consultation paper include the following:

creating two commonholds: a residential commonhold for flats and a separate commercial commonhold for business units;
creating an umbrella commonhold association with two layers, keeping residential units in one layer and the business units in the other;
sectional commonhold where owners of residential units have different voting rights to the owners of business units (similar to voting rights in private companies which have issued class A and class B shares, with different voting rights). This is the approach that has been adopted in British Colombia in Canada.

Corporate governance

For larger developments, the commission proposes that there would be a single commonhold board of directors, but then there would be sub-committees which would deal with issues relating to either residential flats or commercial units.

Insurance and catastrophic events

Where there is a catastrophic event, such as a fire, flood or lightning strike, the commonhold association will have to bear the rebuilding costs (unless it has adequate insurance). For this reason, insolvency of commonholds is not unusual, and this has been the experience in the USA, Hong Kong and Australia. Consequently, some lenders remain unwilling to lend on the security of a commonhold property. The commission is consulting on a requirement that commonhold associations take out public liability insurance of a substantial amount, the level of which would be set by statutory instrument.

Reserve or sinking funds

The commission also proposes requiring commonhold associations to set up reserve funds, with a requirement that the amount of such a fund be reviewed at least once every 10 years.

Unpaid service charges

Leaseholders who do not pay their ground rent or service charges risk having their leases forfeit, which is the ultimate lever freeholders have to obtain payment. However, there is no forfeiture at present with commonhold.

When the bill which led to the CLRA was being considered in parliament, it had been proposed to give a commonhold association a first legal charge over unpaid commonhold contributions; nevertheless, this proposal did not make it into the Act.

The commission proposes that legislation reverses this omission. This would align commonhold with leasehold and provide an effective lever for those who do not pay their service charges. However, the commission suggests safeguards for flat owners who are in financial diÿculty. It wants to adapt the measures in Administration of Justice Act 1970 s36 (a court cannot make a repossession order where a defaulting borrower can show that they can repay the arrears within a reasonable time).

Insolvency

Finally, the Law Commission looks at other issues arising where a commonhold association becomes insolvent. The association is required to be a company limited by guarantee, and it could enter into a company voluntary arrangement. CLRA s51 provides for a successor association to take over, but the commission wonders if the Companies Court should have power to grant conditions in these circumstances.

In the end, the commission’s provisional proposals are that where a commonhold association becomes insolvent, a court should appoint a successor association and impose whatever conditions are necessary; nevertheless, a liquidator of the insolvent predecessor body would not be able to demand further payments unless a court orders it.

Enfranchisement

Leasehold enfranchisement

The commission says that current enfranchisement regime is the product of over 50 Acts of parliament, with numerous anomalies and unintended consequences resulting from piecemeal changes having been made over time.› The commission observes that many aspects of the regime are incredibly complex, and it can be diÿcult to work out whether or not a leaseholder qualifies for enfranchisement. In addition, the complexity of the process gives rise to both legal costs and valuation costs, each of which can be significant or disproportionate to the property value.

Currently, the provisions of the Leasehold Reform, Housing and Urban Development Act 1993 only allow a group of leaseholders collectively to buy a freehold interest in their properties if they are leaseholders within a single block of flats. The rules do not allow leaseholders of a wider estate (where there is a mixture of flats and houses) to acquire the freehold of the whole estate. Leaseholders of flats are entitled, on payment of a premium, to be granted a 90-year lease extension without an obligation to pay any ground rent.

There is no limit to the number of lease extensions that can be obtained. Yet, while leaseholders of houses are also entitled to a lease extension, these are granted on very different terms:

they are entitled to a single 50-year lease extension;
no premium or purchase price is paid for the lease; and
the price of a lease extension can be very high.

Provisionally, the commission proposes the following:

a universal right to a lease extension which is available to all leaseholders whether they own a house or a flat;
a right for leaseholders to acquire either the freehold of a building or of a building and estate collectively; and
a new right for leaseholders who did not participate in a previous collective freehold acquisition to do so at a later date.

The HCLG committee goes further, recommending that ground rents on all new leasehold properties be set at a peppercorn with a ‘zero financial value’ (para 129). For existing flats, the HCLG committee suggests that existing ground rents should be ‘limited to 0.1% of the present value’ of the property with a cap on this of £250 per year (para 117).

Lease extensions

The commission proposes that all leaseholders who qualify for a lease extension would have a uniform right to an extension, as often as they wish, for a nominal ground rent; its consultation was on the length of that extension.

An extended lease would be on the same terms as the existing lease except where either party elects to adopt noncontentious, modernised terms drawn from a prescribed list. This is meant to remove scope for unfavourable terms to be added to a lease during the enfranchisement process. The HCLG committee wants a process that will make enfranchisement ‘substantially cheaper’ and wants the government to introduce low-interest loans to help leaseholders who want to enfranchise or extend their lease (para 212).

Collective and estate enfranchisement

As to collective freehold acquisition, the commission proposes that all acquisitions would be carried out by a nominee purchaser being a company limited by guarantee. The right to collective enfranchisement would not be limited to leaseholders in a single block of flats but would extend to leaseholders on an estate comprising multiple buildings, whether those buildings are houses or blocks of flats or a combination of the two, to buy the entire estate collectively.

Participating leaseholders would be able to require a landlord to take a leaseback of any parts of the property being acquired (other than common parts) which are not let to the participating leaseholders. This is meant to reduce the cost of the enfranchisement. Nonetheless, this right would be available only where the building or estate in question has not been the subject of a prior collective freehold acquisition within the last five years.

Houses, flats and residential units

The commission observes that there is no clear definition of the word ‘house’ and that disputes regularly arise as to what ‘self-contained building’ means. To solve this, it proposes that there be a single set of criteria which will apply whether the residential unit is a flat or a house. The commission says that there should be only two ‘logical stages’ in enfranchisement (page 38):

to establish whether a lease extension is available; and, if so,
to establish whether the leaseholder has the ability to acquire the freehold.

The commission proposes the abolition of existing qualifying criteria based on financial limits or historic rateable values. It wants to extend the 25% limit on non-residential use (which applies to collective freehold acquisition claims) to all freehold acquisition claims and to remove the requirement that a leaseholder must have owned the lease for the past two years.

Where there are only two flats in a building, at present, the owners of both flats must participate for enfranchisement to succeed; however, the commission wants to change this, so that a single flat owner could acquire the freehold leaving the other flat owner entitled to exercise the new right to participate. In addition, the commission wants to abolish the present provision which prevents a leaseholder who holds a long lease of three or more flats in a building from mounting a collective enfranchisement claim.

Reform of enfranchisement process

At the moment, both the county court and the First-tier tribunal (FTT) (property chamber) have jurisdiction over differing parts of the process. The commission proposes that the FTT has exclusive jurisdiction and that the procedure be simplified by a single set of prescribed forms for enfranchisement claims. Controversially for property owners, it has consulted on whether leaseholders should no longer have to pay a landlord’s legal costs on an enfranchisement claim in the FTT given that usually the tribunal does not award costs.

Valuation in enfranchisement cases

At present, a surveyor needs to be instructed to give an opinion on the ‘marriage value’ being the price a leaseholder needs to pay the landlord for the freehold (pages xiv and 392). The commission rightly says that valuation is ‘complicated and expensive’, with the valuation methodology being ‘not readily understandable to the lay person’, which is ‘diÿcult to apply without specialist advice’ (page 44).

It proposes two solutions neither of which are likely to be palatable to freeholders:

A simple broad-brush formula which moves away from attempting to identify a market value. This would be a ground rent multiplier and a percentage of the capital value of the property.
Reform of the current valuation methodology so that all components which go into the mix are reduced.

• 'Law Commission: reforming RTM, commonhold and enfranchisement: Part 2' will appear in (2019) Summer CILEx Journal, which will also publish an article on recent developments in conveyancing law and practice by the CILEx policy team.

‘Reinvigorating commonhold: the alternative to leasehold ownership’, Consultation Paper 241, December 2018, available at: https://tinyurl.com/ ybqh8h2z The consultation closed on 10 March 2019; ‘Leasehold home ownership: buying your freehold or extending your lease’, Consultation Paper 238, September 2018, available at: https://tinyurl.com/y7emmrhu The consultation closed on 7 January 2019; and ‘Leasehold home ownership: exercising the right to manage’, Consultation Paper 243, January 2019, is available at: https://tinyurl.com/y3a2mq3f The consultation closed on 30 April 2019
‘Leasehold Reform: Twelfth Report of Session 2017–19, HC 1468, 19 March 2019, available at: https://tinyurl.com/yxb3hlhc
Law Commission Consultation - ‘Reinvigorating Commonhold: the alternative to leasehold ownership: a response by the Chartered Institute of Legal Executives (CILEx)', March 2019, available at: https://tinyurl.com/ y6r5wf7l
See ‘Reinvigorating commonhold: the alternative to leasehold ownership’, Consultation Paper 241, December 2018, available at: https://tinyurl.com/ ybqh8h2z
See ‘Leasehold home ownership: buying your freehold or extending your lease’, Consultation Paper 238, September 2018, available at: https://tinyurl.com/y7emmrhu

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