Lease Extensions and Property Management
The Right of First Refusal
A Tenant’s Right of First Refusal under Landlord and Tenant Act 1987 (as amended)
When a private, non-exempt landlord is proposing to sell his interest in a building which contains two or more flats, he must first offer the interest to at least 90 per cent of the qualifying tenants before sold to a third party. A premium for the interest – whilst likely to be professionally valued – remains at the landlord’s discretion and could therefore be lower or higher than the market value.
A landlord’s interest is most commonly disposed on the open market (under Section 5A of the Landlord and Tenant Act 1987) or by auction (under Section 5B of the Landlord and Tenant Act 1987).
Disposal on the open market
The following is a brief outline of the steps which follow after a landlord serves an offer notice:
- More than 50 per cent of the qualifying tenants must accept the landlord’s offer should they wish to purchase it themselves. If the building only contains two qualifying flats then both tenants would be required to participate.
- An initial period of two months is given to the tenants to accept the offer; the tenants then have a further two months to nominate a purchaser.
- The landlord must provide a contract for the sale of the freehold within one month of receiving the nomination notice from the purchaser.
- The landlord and the nominated purchaser have two months from the date of receipt of the contract to exchange contracts and pay the deposit (unless the parties agree to extend the exchange deadline).
- The completion date is agreed on exchange of contracts.
Disposal by auction
Qualifying criteria is the same for this route as selling the freehold on the open market. However a particularly careful consideration must be given by which the landlord’s offer is accepted. In addition, as one would guess, the disposal of the interest is via auction.
The following is a brief outline of the steps which follow after a landlord serves an initial offer notice:
- The requisite majority of the qualifying tenants must accept the notice within the proposed deadline (at least two months).
- The tenants have further 28 days to nominate a purchaser for the process.
- If the date of the auction is not included in the initial notice the landlord must serve a further notice to requisite majority specifying date, time and location of the auction.
- In addition to accepting the initial notice to purchase the interest the nominated purchaser must confirm with the landlord that the tenants will be going ahead with a purchase as specified by the landlord. Failure to send a formal notice to the landlord 28 days before the auction will result deemed withdrawal from the process.
- On the auction, as expected, the value of the interest will be determined. However, rather than a successful bidder being able to purchase the interest, the first bite to the cherry will be given the participating tenants.
- The tenants have 28 days in which to accept the contract and pay the deposit. Only then if they fail to enter into a contract after auction a successful bidder, who determined the value of the interest at first place, would be free to purchase the interest from the landlord.
Selling the freehold without first offering to qualifying tenants is a criminal offence. If the landlord sells the freehold without following the legal framework the tenants can take action to force the new owner to sell the interest to them at the price the new owner paid for it.
To acquire a freehold under the Right of First Refusal is an opportunity to take control of the upkeep of your building with your neighbours. Tenants are also able to extend their leases and reduce their ground rent to zero after the purchase is complete. Inevitably though, as the tenants are stepping into the landlord’s shoes, the purchase will also bring with it certain responsibilities. The tenants will take charge of all decision-making in relation to budgets and insurance, enforcing leasehold covenants, standards of management and service provision, repairs, major works and the overall functioning of the building.
What to do if you are served with a Section 5 Notice under the Landlord and Tenant Act 1987 i.e. the landlord’s offer of sale?
Whilst the timeframes for acquiring a freehold are relatively generous, managing the purchase process without professional assistance is difficult. We would always recommend taking immediate legal advice if you are served with a Section 5 Notice. A specialist solicitor will liaise with all the flat owners and the landlord’s representatives, to “project manage” the freehold acquisition. Whilst a solicitor will investigate the freehold title and advise the tenants before exchange of contracts about the implications of acquiring the interest. The process is not a means of forcing a landlord to sell his interest but a means of purchasing the freehold if it is on offer (forcing the landlord to sell the freehold interest could be achieved by serving a collective enfranchisement Notice of Claim under Leasehold Reform, Housing and Urban Development Act 1993).
If there are more than four flats, it is advisable for the tenants to set up a company which will act as a purchasing vehicle. It is also common to enter into a participation agreement. Such an agreement will set out how the purchase price will be paid by the tenants, what happens if one of the participating tenants decides to pull out of the process and how purchase expenses can be shared amongst the tenants.