What is the smallest enfranchiseable part of a building ? – Craftrule Considered – Craftrule Limited v 41-60 Albert Palace Mansions (Freehold) Limited [2010] EWHC 1230 (Ch)

The Leasehold Reform Housing and Urban Development Act 1993 (as amended) (‘the 1993 Act’) gives long leasehold flat owners the right to purchase the freehold to their building, provided that they act collectively and in accordance with the procedures set down in the 1993 Act.

In order to exercise the right 50% or more of the qualifying tenants in that part of a property to which the claim is made must act collectively. A question therefore arises on the investigation (or instigation) of a claim as to how many of the flat owners in a particular part of the property are taking part in the claim and whether their number is sufficient.

Section 3 of the 1993 Act provides that the right to claim the freehold applies to any premises that are a ‘self-contained part of a building’ and contain at least two flats held by qualifying tenants. ((A qualifying tenant is a flat owner who owns a lease that was originally granted for a term of at least 21 years.)) Of the flats in that part of the building at least 2/3 must be qualifying tenants.

In assessing whether premises form a ‘self-contained part of a building’ the test is that this part must be a vertical division of the building and structure such that the relevant part could be developed independently of the remainder of the building and the ‘relevant services’ ((services provided by means of pipes cables or other fixed installations)) required for that part of the building are provided independently or could be provided without significant interruption in the provision of such services to occupiers of the remainder of the building.

Whilst there have been previous decisions on what constitutes a self-contained part of a building ((See in particular the case of Oakdwood Court (Holland Park) Limited v Daejan Properties Limited [2007] 1 EGLR 121.)) the point arising in Craftrule has not been considered before. Craftrule is an important decision as it shows that a wider interpretation will apply when assessing the ‘part of a building’ and counting the number of qualifying tenants within it.

In Craftrule the participating tenants chose to serve a notice in respect of a building divided in two halves, both of which it was accepted on the facts were capable of independent redevelopment. The distribution of qualifying tenants between both halves was uneven, such that one half of the building would not have qualified in its own right if the tenants there had served a notice in respect of that part. However a combined claim was made counting the total number of participating flats in each of the two halves of the whole building to reach the qualifying number.

The tenants’ initial notice was challenged by the landlords at first instance and the tenants then appealed to the High Court.

The High Court found in favour of the tenants, accepting an argument advanced by their counsel that the provisions of section 3(1) relating to the building does not require those seeking to exercise their rights under Chapter I of the 1993 Act to select the smallest ‘enfranchiseable unit’ when formulating their claim. Rather, where there are various sections in a building it is open to those initiating the claim to select the division of the property that they are seeking to enfranchise and to then establish a qualifying number in that part.

Comment

The decision in Craftrule is important as it means when assessing how many flats are in a particular part of a block to count in a qualifying number for the purposes of a claim to the freehold the flat owners no longer have to serve a notice in respect of each of the smallest ‘enfranchiseable’ units in the building. Rather, if the structure of the building is similar to that in Craftrule two adjacent units may be counted together provided that this united structure is a self-contained building.

Another intriguing possibility (as mentioned by James Driscoll in his recent article in the Estates Gazette) is the possibility that if a building is enfranchised in a condition where there are separate sub-units which are enfranchiseable in their own right, is that there is nothing to stop the flat owners in these smaller units bringing a further claim to the freehold in respect of their ‘part’ of the building at a later date. Although in practice whether such subdivision would be practical or desireable remains to be seen.

There is also the possibility of a further appeal by the landlords in this case. So as ever, it is a case of ‘watch this space’.

Mark Chick

5th October 2010

This note (being very general in its nature) is not a complete statement of the law in this area.  It is therefore not a substitute for legal advice from a suitably qualified professional and should not be relied upon as such. No liability can therefore be accepted for any actions based on reliance upon it.

If you require legal advice please visit www.bishopandsewell.co.uk

For those of us that attended the Reigate valuers’ forum on Thursday 17th June there was an interesting dialogue concerning the impact of the service charge legislation on valuation for leasehold reform purposes in the post Kelton Court environment.

Whilst it appears that the principle of an enhanced ‘management risk’ associated with flats could give rise to an increase in the appropiate risk premium and hence the deferment rate, those circumstances where this would not be appropriate were also discussed.

The presence of headlease clearly negates some of the ‘management headache’ assciated with this asset class, but what about the situation where the Right to Manage (RTM) has been exercised ?

In this situation the landlord (arguably) has a reduced management burden – although this of course assumes a well-run RTM company. If the landlord has to exercise his powers to compel the company to comply with its obligations this will not be the case.

Similarly, if the RTM company has the right to place the insurance then arguably one of the motivating factors associated with owning a ground rent is also diminished. So the question then arises as to whether the one cancels the other out.

I expect that in practice the particular property will need to be examined to see which of the following factors are present and are likely to be of significance in arguing for a departure from the Sportelli deferment rate of 5% for flats. Briefly, these seem to be:-

1. Whether there is a headlesse in place (with management responsibility).

2. Whether there is a ‘third party’ management company (a party to the leases and with all the flat owners as members) and with the power to set the service charge.

3. Whether the Right to Manage has been exercised.

4. In the case of a small block (usually two flats) whether the leases impose a full repairing obligation on the flat owners (i.e. Where there is no service charge).

I would be interested to know what other practitioners think.

Mark Chick

22.06.2010

There is an interesting interplay between the limited power of the LVT to vary the terms of lease during the renewal of a lease under the 1993 Act and the wider discretion of the LVT to deal with a situation where the service charge provisions in a lease are ‘defective’ in an application made under the Landlord and Tenant Act 1987 (‘the 1987 Act’).

Often the flat owner seeking a lease extension may want (not unreasonably) to tackle any perceived (or indeed actual) injustices in his current lease. What is not always realised by those unfamiliar with this area is that the power of the tribunal to amend or vary lease provisions in a lease renewal is in fact fairly limited.

1993 Act

Section 57 of the 1993 Act permits variations of the lease terms but only where these are ‘necessary’ to remedy a defect. In particular, in a case where there are significant problems – e.g. where the landlord might not be able to recover any service charge, or sums payable for insurance for instance, the tribunal will have discretion to order a change.

In a situation like this can the LVT assist using its jurisdiction under the 1993 Act?

The first thing to note is that the LVT has a very limited discretion to make any substantive changes to the terms of the existing lease. See in particular the Lands Tribunal’s decision in the case of Gordon (Gordon v Church Commissioners LRA/110/2006).

Secondly, in a lease renewal under the 1993 Act the tribunal is only concerned with the terms of one lease – the lease in question – and as such it does not have a power to vary the terms of other leases in the building.

In particular section 57 (2) provides that:-

Where during the continuance of the new lease the landlord will be under any obligation for the provision of services, or for repairs, maintenance or insurance—

(a) the new lease may require payments to be made by the tenant (whether as rent or otherwise) in consideration of those matters or in respect of the cost thereof to the landlord; and

(b) (if the terms of the existing lease do not include any provision for the making of any such payments by the tenant or include provision only for the payment of a fixed amount) the terms of the new lease shall make, as from the term date of the existing lease, such provision as may be just—

(i) for the making by the tenant of payments related to the cost from time to time to the landlord, and

(ii) for the tenant’s liability to make those payments to be enforceable by distress, re-entry or otherwise in like manner as if it were a liability for payment of rent.

So unless the service charge adjustment that is sought can be made by an amendment to the individual lease alone and the applicable test(s) in Section 57 can be met, not much can be done simply by pursuing a lease extension.

1987 Act

Consider the case of a situation in a block where the service charge percentages do not add up to 100%. This may of course be a situation of real injustice and statute provides a remedy in Section 35 of the 1987 Act. This permits the tribunal to make an order varying the lease terms in a building to resolve such a situation.

Section 35(4) of the 1987 Act sets out a test for a situation where a lease fails to make satisfactory provision for the calculation of service charges however, this is limited to a situation where the overall proportions paid by the flat owners either exceeds or is less than the landlord’s total expenditure.

In practice, there are sometimes situations where the service charge proportions are allocated in a way that is perceived to be ‘unfair,’ – for instance the owner of a large flats may pay the same as (or perhaps less) than the owner of a smaller unit. If the overall percentages add up to 100% as the case of Morgan shows, the 1987 Act does not provide a remedy.

Morgan v Fletcher [2009] UKUT 186 (LC)

In this case, 6 out of 8 flat owners made an application to the LVT asking for a variation of their leases on the basis that the service charge percentages under all the leases added up to 116%. Of the two remaining leases one was owned by the landlord. As a result of the application the landlord varied the service charge proportion in the other two leases to bring the total recoverable percentage down to 100%.

The flat owners applied to the LVT on the basis that they considered that the allocation of the percentages between the flats was of itself ‘unfair.’ The LVT adjusted the percentages and the landlord appealed.

The Lands Tribunal considered the provisions of Section 35(4) of the Landlord and Tenant Act 1987 and gave a narrow construction to the circumstances in which an order varying lease provisions can be made. The interpretation of Section 35(4) provided by this case is that only the circumstances set out in that section can give rise to a situation where lease terms can be varied.

In other words, a situation where the service charge proportions seem to be allocated between the flats in a way that was perceived to be ‘unfair’ was not enough in itself to warrant a variation in the lease terms. Particularly if the service charge proportions added up to 100% of the landlord’s total expenditure.

Comment

On policy grounds the decision in Morgan may be a sensible decision – it would of course be impossible to devise a test of what constituted an ‘unfair’ allocation of service charges in a building where the total percentages added up to 100% – although perhaps greater flexibility could have been given.

There are good policy reasons for not wanting to ‘open the floodgates’ to claims based on ‘unfair’ service charge proportions, but in practice this case does nothing to assist those whose fundamental problem is with the size of the service charge percentage allocated to their flat.

There is a reluctance to interfere with the freedom of contract of the original parties to the lease.

The only other way of resolving this sort of issue would therefore seem to be where either lease variations can be agreed between all interested parties or, possibly if the problem arises because of a ‘mistake’ by the parties to the original lease by rectification of this.

If the flat owners buy their freehold with 100% participation (and have all agreed in advance to vary the lease terms once this is done) then this might be another means of addressing the problem.

Mark Chick
25 May 2010

James White from Fanshawe White comments on the recent decision in Kelton Court….

A recent decision in the Lands Tribunal has reopened the debate on deferment rates and given the initiative back to leaseholders and their valuers to argue for higher deferment rates to reduce the premium payable for a lease extension or the freehold interest.

The generic rate of 5% for flats set by Sportelli no longer applies automatically and each case should be judged on its individual merits.

In areas outside Prime Central London (PCL) there is scope to argue a higher deferment rate to reflect the greater risk of deterioration and obsolescence (+0.25%) and the prospect of lower capital growth (+0.5%) compared to PCL.

In all areas, including PCL, there is scope to argue a higher deferment rate to reflect the increasingly onerous management burden and liability associated with flats compared to houses (+0.25%).

Background

The Sportelli case was an aggregated number of appeals to the Lands Tribunal concerning Prime Central London (PCL) Leasehold Valuation Tribunal decisions where the deferment rate was an issue.

For the first time evidence from financial experts, in addition to valuers, was relied upon in determining the deferment rate. Their decision was based on the following formula:

Risk free rate 2.25% – based on a 5 year rolling average for index linked gilts

Less

Real growth 2.00% – based on growth of property above inflation

0.25%

Plus

Risk premium 4.50% – based on risk of property as an asset class distinct from gilts

Extra risk for flats 0.25% – based on additional management compared to houses

Deferment rate 5.00%

Although all the properties were in PCL the Tribunal stated that they saw no reason, based on the evidence before them why this decision should not apply outside of PCL. The financial evidence was of the opinion that over a long period (say 50 years) property growth was the same across all regions, both prime and secondary, and as such there should be no distinction for location. Accordingly a precedent was set which has been applied by LVT’s throughout England and Wales with little exception.

This decision was appealed to the Court of Appeal who upheld the Lands Tribunal’s decision but left the door ajar by suggesting that further evidence could be presented, in particular regarding the risk premium, for different areas.

The Kelton Court decision

This was an appeal to the Lands Tribunal of an LVT decision which had applied the Sportelli precedent of 5% to multiple lease extension claims in a 1930’s purpose built block in Edgbaston, Birmingham.

The basis of the risk free rate (2.25%) less real growth (2%) remains the same but the leaseholders’ valuer successfully argued the additional risk premium (4.5%) and allowance for flats (0.25%) applied in Sportelli did not fully reflect the circumstances of this case;

Deterioration and Obsolescence – it was held that the comparatively low value of property in Birmingham compared to PCL, coupled with not dissimilar costs of repair, made it less economically viable to keep property in good repair leading to a greater risk of deterioration not reflected in vacant possession values. Accordingly an extra 0.25% was added to the risk premium.

Prospect of future growth – it was held that the real growth rate of 2% determined in Sportelli for PCL might not be achievable in Birmingham based on a comparison of the statistical date presented. The evidence presented was the Nationwide Regional Index for the West Midlands and the corresponding Halifax Regional Index compared to the Knight Frank Index for Kensington & Chelsea (part of PCL where the Sportelli cases were situated) which showed a considerable difference in growth between the areas. Accordingly an extra 0.5% was added to the risk premium.

Allowance for flats – Sportelli established the principle that the management of flats compared to houses was more complex and warranted a 0.25% addition to the deferment rate. Sportelli did not consider it justified to differentiate between flats that are subject to head leases, nor between small and large blocks of flats. In Kelton Court the leaseholder’s valuer successfully argued that the introduction of The Service Charges (Consultation Requirements) (England) Regulations 2003 made the management and risk associated with flats much greater. Accordingly an extra 0.25% was added to the 0.25% adjusted made by Sportelli. The point was made that had there been a head lease, thereby placing the management risk and burden on the head lessee rather than the freeholder, an extra 0.25% on the deferment rate would not have been appropriate.

The overall result of these additions was to increase the deferment rate in the Kelton Court case from 5% to 6%.

Our Conclusions

This decision has proved that it is possible to achieve a higher deferment rate but only subject to producing new evidence.  We do not consider it reasonable to simply rely on this decision as a precedent, unlike Sportelli, and so the onus must be on the leaseholder to produce and successfully argue new evidence.

It does raise the possibility of the RICS being asked to commission research into regional variations in growth to see how they compare to PCL.

Where there is a head lease the freeholder’s deferment rate should not be affected on the grounds of complex management.

We further believe that in small buildings such as converted houses with only 2 or 3 flats the extra 0.25% should not apply irrespective of whether there is a head lease or not. We consider the lack of communal areas and lack of shared services results in either no annual service charges or very often a simple apportionment of the buildings insurance premium.  In such cases we consider the additional 0.25% is not appropriate.

The possibility of a future Right to Manage (RTM) company could be used as an argument to mitigate the freeholder’s management risk as a counter to the threat of an extra 0.25% being added to the deferment rate.

James White

31/03/2010