The Right of First Refusal of the Freehold to Leaseholders
The Right of First Refusal (RFR) is provided by s5 of the Landlord and Tenant Act 1987 (Part 1). It is not a means of forcing a landlord to sell the freehold because leaseholders who want to do that can do so through the collective enfranchisement provisions of the Leasehold Reform, Housing and Urban Development Act 1993. RFR simply enables leaseholders to purchase the interest before it is offered on the open market or by auction.
When a freeholder transfers or sells the land, it is termed as a disposal which can take the following forms:
- A simple sale of the interest (which is the lease);
- The sale of the freehold;
- The creation and sale of an intermediate lease (a new interest) by the superior landlord to someone else known as a head-lease. This head lessee will also be able to make a profit from ground rent if the ground rent collected from all the other leaseholders in the block exceeds the ground rent payable by him to the freeholder. A head lessee can also hold a reversionary interest (the right to get the lease back once the term expires) if he is granted a longer lease term than the other leaseholders, for example 125 years against 99 years. So with a 26 year longer lease than the others, the head lessee has the right to all those flats before they would have to be returned to the freeholder.
Where the disposal is a relevant disposal and the conditions relating to the building, the landlord and the leaseholders are met then the right of first refusal exists and the disposal must first be offered to the leaseholders.
A selling landlord has a statutory obligation to serve notice on at least 90% of the qualifying leaseholders. If there are less than 10, a formal notice of the intent to sell has to be served on all but one of them. The Notice required comes under s5 of the Landord and Tenant Act 1987. If it is being sold on the open market then s5a of the Act is applicable and if it is to be sold at auction then s5b applies.
The Notice will show:
- The interest to be disposed;
- The price and other principal terms (such as the terms of any proposed contract) set by either the freeholder or the auction house. There is no right for that price to be determined by the FTT or anyone else.
- That the notice constitutes an offer to sell under the Act.
- That leaseholders have 2 months to nominate a purchaser if they want to take up the offer.
When the first refusal offer has been served on the qualifying tenants the owner cannot sell his interest until the period given to them to reply has lapsed. If the period specified for acceptance in the notices are different then effectively the date for responding will be the latest of those dates, providing that this is within the specified period of reply. During these two months, the qualifying tenants have 3 options:
- Accept the offer which requires more than 50% of the qualifying tenants to accept in which case they must nominate a person (individual, company etc) to purchase the interest and this person must buy the interest within the set time frame, usually of two months;
- If the qualifying tenants want to purchase but on different terms, a counter offer must be made which will require further negotiations between the parties who will accept or reject the new offer;
- Confirm they do not wish to proceed. It is important to be aware that silence through the offer period is take as a refusal of the offer.
The landlord cannot sell to another party during that time and neither can he offer the interest to anyone else at a price less than that proposed to the tenants.Nor can he offer it to anyone else on different terms. If, on the other hand the first refusal offer is not accepted then the owner can then sell to any third party within the next 12 months provided that he offers the interest on the same terms and at no lower price than the offer rejected by the qualifying tenants. On the other hand if he wants to sell at a lower price or on different terms he must first offer the property again to the tenants
If these requirements are breached and leaseholders suddenly find themselves with a new freeholder then they can serve a s11a Notice under the 1987 Act on the new freeholder demanding details of the sale, including the price that was paid. Action can then be taken to compel the new freeholder to sell it to the leaseholders at the price originally paid.
Note: s91 of the Housing Act 1996 strengthened the right of first refusal introduced by the Landlord and Tenant Act 1987 by making it a criminal offence to sell the freehold to a third party without offering it to the flat owners first. If the landlord fails to comply with the first refusal procedure or if he sells on better or different terms after the qualifying tenants have rejected the offer, he again commits a criminal offence, both of which are punishable by a Level 5 fine (maximum £5,000).
EXEMPTIONS OR LOOPHOLES?
Whilst the majority of such disposals will trigger the right of first refusal, there are some exemptions where it is not triggered. For example, on new-builds where developers want to maximise their profits they often sell ground rents (pre-packaged in bulk) to ground rent investors before construction starts. These investors pay a large deposit up front which will be used to fund building costs and as long as the sale of ground rents occurs before half of the flats are sold, there is no need to issue a Section V notice. It’s not actually illegal because legislation requires there to be a majority of leaseholders willing to accept the right so if less than half of the leases have been granted then such a majority simply does not exist!
Another area when the right of first refusal is exempt is where a developer may keep the freehold and register it in a limited (associated) company. On completion of the development, the sale of all the leases, and after a period of 2 years, the developer then sells all of the shares in the company (the freehold) to another party such as a ground rent investor. There is no change of ownership, because in effect the freehold has simply changed hands and it is the company that has new owners. So under this arrangement, they are not obliged to offer leaseholders the Right of First Refusal.
Transfers within a family or trust are also exempt as are the following:
- Grant Of Single Tenancies: The disposal (sale) must apply to the whole building. The landlord is free to grant tenancies of individual flats;
- Grant Of A Mortgage: This is where the landlord obtains a mortgage or a loan on the security of his interest;
- Disposal Is In The Hands Of A Receiver Or Trustee In Bankruptcy: This means that if the disposal was transferred to the receiver, liquidator or trustee first it makes it an exempt disposal. However, any subsequent disposal by the receiver,liquidator or trustee will not be exempt and the leaseholders will need to receive notice of their rights;
- The Disposal To An Associated Company: This is where the interest is transferred as an asset to another company, which has been associated with the parent company for at least two years. Therefore a landlord which is a company may transfer its freehold of a block of flats to an associated company. Leaseholders are not able to exercise the RFR in this case, but should investigate, (through the Registrar of Companies), that the associated company has been associated for the requisite two years before the transfer as per the Landlord and Tenant Act 1987.
Note: Some of the above information has been provided by and sourced from the following: Katie Cohen, Partner at Child & Child, Leasehold Life guest contributor, Brett Williams of CP Bigwood from ‘Exceptions to the Rule for Freehold Sales’ and by ALEP (Association of Leasehold Enfranchisement Practitioners) from ‘Why Werent’ We Offered Right of First Refusal’ who kindly allowed Leasehold Life to reproduce it.