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Landlords and Developers Beware - The Tenants' Right of First Refusal

The Landlord and Tenant Act 1987 ('1987 Act') provides "qualifying tenants" with a statutory right of first refusal by prohibiting certain landlords from making certain disposals of certain premises without first offering the disposal to the "qualifying tenants" of the building.

There are criminal penalties for non-compliance and so the right of first refusal should be at the forefront of any landlord's or developer's mind when dealing with multi-let residential, or mixed-use, premises. Purchasers must also be wary given that the court can order a purchaser to transfer its interest in the land to the tenants if the 1987 Act was not complied with.

When does the 1987 Act actually apply?

The 1987 Act only applies in certain circumstances which are outlined below.

Premises:

The 1987 Act applies to premises which are the whole, or part, of a building which contains two or more flats held by qualifying tenants and more than half of the flats in the premises are held by qualifying tenants. As a basic example, the 1987 Act would apply to the whole or a part of a building containing ten flats where at least six of those flats are owned by qualifying tenants.

The 1987 Act does not apply to buildings in which greater than 50% of the internal floor area is occupied for non-residential purposes. This can be a useful exemption for landlords.

Qualifying Tenants:

The 1987 Act provides a wide definition of "qualifying tenants" which includes any tenant of a flat under a tenancy, save for some specific exceptions including business tenancies and ASTs. A tenant who owns a tenancy of three or more flats in the building is also excluded from being a "qualifying tenant".

Landlords:

Generally, the 1987 Act only applies to the immediate landlord of the qualifying tenants. Therefore, in situations where the residential parts are held under a head lease, a disposal of the freehold would not be caught by the 1987 Act. This structure is often useful in enabling freehold owners of mixed-use premises to freely dispose of the commercial parts.

Relevant Disposals:

The 1987 Act is wide-ranging as it applies to "relevant disposals" which are disposals by the landlord of any estate or interest in the premises (including any estate or interest in the common parts). This obviously includes the sale of the freehold, but also includes the grant of a head lease and entering into a contract to sell, or otherwise dispose of, the premises. The landlord cannot even enter into a contract conditional on the tenants not exercising the right of first refusal.

There are some limited exemptions which include the grant of a tenancy of a single flat; the grant of security for a loan and a disposal to an associated company (provided that it has been associated for at least two years).

Roof/Air Space

Land shortages have led to an increased demand for rooftop development and so it has become common for a landlord to grant a lease of the roof and air space to a developer.

The 1987 Act provides that common parts include the structure and exterior of the building. Therefore, it is accepted that the 1987 Act will apply to the disposal of a building's roof.

However, what may be surprising is the decision in Dartmouth Court Blackheath Ltd v Berisworth Ltd, a 2008 case, in which the Court held that a disposal of air space would also fall within the provisions of the 1987 Act.

Commercial Premises

Given that the 1987 Act relates to the disposal of any estate or interest in the premises,  disposing of any commercial parts of the premises would, strictly speaking, be caught by the 1987 Act. In mixed-use premises where the above criteria is met, the landlord cannot, for example, grant a lease of a commercial unit without first making an offer to the qualifying residential tenants.

What to do if the 1987 Act applies?

Assuming that the qualifying criteria are met, it is essential that the requirements of the 1987 Act are strictly followed. This can lead to delays in transactions as the landlord is required to serve an offer notice on the qualifying tenants giving them two months to accept the terms of the disposal. The landlord cannot proceed with the transaction until the expiry of the two month offer period. To minimise delays, the 1987 Act should be considered at the outset of any transaction.

If the requisite majority of qualifying tenants accept the offer, the landlord can only make the disposal to a purchaser nominated by the qualifying tenants. The landlord may withdraw from the transaction but is then prohibited from making the disposal for a 12 month period. Even after the 12 month period has expired, the landlord cannot make the disposal without again fulfilling the requirements of the 1987 Act.  

Practical Advice

Once the qualifying criteria are met it is very difficult to avoid the 1987 Act although it is possible to try and rely on one of the above exemptions e.g. by making a disposal to an associated company (subject to the two year rule).

Legal advice should be sought at the outset of a development so that avoidance mechanisms can be put in place before the 1987 Act applies (note, there will be no qualifying tenants until tenancies are granted). For example, it would be prudent for a developer to grant a headlease of the residential parts at the outset of the development. Secondly, the 1987 Act does not apply to a disposal made pursuant to a contract entered into before the qualifying criteria are met. Therefore, a developer should consider finding and contracting with a purchaser long before the development is completed.

If you are a landlord intending to dispose of potentially affected premises and would like advice on the tenants' right of first refusal please contact Alison Oates on a.oates@ashfords.co.uk.

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