The Landlord and Tenant Act 1987 – Ignore it at your peril (extended version)

The Landlord and Tenant Act 1987 (the Act) was rushed through Parliament just before the 1987 general election in an effort to placate tenants of Central London mansion blocks.

It was not unusual for the freehold of these blocks to change hands more than once without the tenants’ knowledge, from one offshore company to another, and the tenants, keen to put in place some consistency of management, sought some means of gaining control themselves. Not yet willing to allow a right of collective enfranchisement, the Government concluded that giving the tenants a right of first refusal would suffice. In the hurry to bring the Act into force, many of its provisions were not properly thought through and it has been heavily criticised by the courts; Lord
Browne-Wilkinson famously describing it as “ill drafted, complicated and confused”. Set against this background, the Act has only been litigated a surprisingly few times. However, the consequences of breaching this Act are serious, as is all too clearly demonstrated by the recent case of Artist Court Collective Ltd v Khan [2015] PLSCS 313, which came before the County Court in October last year.

The Act

Part 1 of the Act gives certain residential tenants of certain premises a statutory right of first refusal. It does so in a negative way, by prohibiting the tenants’ immediate landlord from making a wide range of disposals without first offering that disposal to the qualifying tenants, on the same terms as have been agreed with a prospective purchaser.

The qualifying criteria to be satisfied for the Act to apply are detailed and should be carefully considered against each set of circumstances. In summary, the premises in question must consist of the whole or part of a building, containing two or more flats held by qualifying tenants, with the number of flats held by qualifying tenants exceeding 50 percent of the total number of flats. Where the premises in question are in mixed-use, they will still qualify under the Act if more than 50 percent of the internal floor area (disregarding common parts) is occupied, or intended to be occupied for residential use.

The Act can have wider application than expected, for a number of reasons. For example, the definition of a qualifying tenant in the Act includes not only tenants with long leases but also short term common law tenancies and tenants protected by the Rent Act 1977 and Housing Act 1988. Similarly, the definition of a relevant disposal includes all disposals by the immediate landlord apart from a few limited exceptions, meaning that a disposal of internal or external common parts may be caught.

Where the Act applies, a landlord is required to serve formal notices on its qualifying tenants as soon as possible after the terms of the disposal have been agreed upon. It is then required to wait at least two months for a response and if the majority of the tenants accept, the landlord must 52 (2016) 20 L. & T. Rev., Issue 2 © 2016 Thomson Reuters (Professional) UK Limited and Contributors dispose to the tenants’ nominee company. If either no response is received, or too few accept the offer, then the landlord is free to dispose to a third party within the next 12 months, at a price no less than that contained in the notices.

The facts

The case of Artist Court Collective Ltd v Khan [2015] PLSCS 313 concerned a mixed-use building in East London, which consisted of eight residential flats let on long leases with three commercial units on the ground floor. The freeholder, Mr. Khan, was based abroad and he had, therefore, appointed a relative, Mr. Mehmood, to act as his agent in connection with the property. In 2011, Mr. Khan instructed Mr. Mehmood to incorporate a company called SGR Properties (UK) Limited (SGR), in which Mr. Khan held a controlling interest. The property was transferred by Mr. Khan to SGR for the sum of £225,000 on 9 August 2011. The disposal occurred without an offer first being made to the residential tenants, in contravention of the Act; Mr. Mehmood claimed in evidence that he and Mr. Khan had believed the disposal to be exempt, as the beneficial ownership remained with Mr. Khan. No attempt was made to inform the tenants of the change of landlord and the tenants only became aware of the transfer in the middle of 2012, when the opening of a fish and chip shop in one of the commercial units prompted them to look into their rights.

Having discovered the transfer, the majority of the residential tenants formed a company and served an information notice (under s.11A of the Act) on SGR. SGR’s solicitors responded to the effect that Mr. Khan continued to be the beneficial owner of the property, but they were not able to produce any further evidence of any underlying trust. The tenants then served a purchase notice on SGR, under s.12B of the Act, requiring the freehold to be transferred to them at the same price. On receipt of this notice, Mr. Khan, apparently in a bid to “satisfy the tenants” and close off the litigation, transferred the freehold from SGR back into his sole name, for no consideration. However, his actions, of course, achieved the opposite to what he intended. Seeing a second transfer in breach of the Act, the tenants served a further purchase notice, this time requiring the freehold to be transferred to them for no consideration.

The judgment

During the County Court proceedings, Mr. Khan’s representatives produced a trust deed, dated 5 August 2011, declaring that, when SGR acquired the property, it would do so on the basis that it held on bare trust. This document had not been produced previously during the communications with the tenants, even when they requested details of any underlying trust. By producing this trust deed, Mr. Khan’s counsel sought to rely on s.4(2)(g) of the Act, which gives an exemption for disposals in connection with the appointment or discharge of a trustee in relation to existing and continuing trusts. However, the judge held that there was no trust in place before the first disposal, or after the second, and therefore, neither of these transfers fell within this exemption.

Mr. Khan’s representatives also tried to argue that the second transfer had not, in fact, been for no consideration, as Mr. Khan had written off the debt due from SGR (£225,000 plus costs) simultaneously with the transfer. Unsurprisingly, the County Court judge was not persuaded by this argument. He held fully in favour of the tenants; confirming that both the first and second transfers were “relevant disposals” for the purposes of the Act and had been carried out in contravention thereof. As a result, the tenants were entitled effectively to “undo” the transactions and to have freehold of the property (worth, presumably, in excess of £225,000) transferred to their nominee company for no consideration, together, of course, with the benefit of the income from the commercial units.

The right result

Given the particular circumstances of this case, it is difficult to see how the judge could have come to a different conclusion. The building qualified for the purposes of the Act, with more than half the flats let to qualifying tenants. The tenants’ immediate landlord transferred his reversion from his sole beneficial ownership to that of a company (possibly on trust for himself) and back again, without carrying out the formal offer procedure prescribed by the Act on either occasion. On these facts, the application of the Act was unusually clear; as long as they acted in the majority, the qualifying tenants were entitled to compel the eventual purchaser to transfer the freehold to them, at the same price as he paid.

The result may seem harsh on Mr. Khan as freeholder, as he lost a fairly valuable asset (as well as the right to income from the commercial units) without any compensation and having, no doubt, incurred considerable costs in defending the proceedings. Whatever the commercial rationale for the first transfer, the intention had clearly been to retain the property within Mr. Khan’s ultimate control—at least for the time being—rather than to sell to a third party.

However, to quote the County Court judge in this case, Mr. Khan “brought this situation upon himself”. He entered into transactions for which his own counsel could identify no commercial rationale, he was apparently aware of the provisions of the Act when he did so (although, perhaps, labouring under the misapprehension that they did not apply) and he sought to rely during the proceedings on documents which had never previously been disclosed. Furthermore, he made no secret of the fact that the intention behind the second transfer was to close off the proceedings the tenants were about to make.

Could the consequences of the Act have been avoided?

On the assumption that he was the sole legal and beneficial owner of the property prior to the first transfer (as appears to be the case), it seems unlikely that Mr. Khan could have legitimately made use of any of the exemptions within s.4(2) of the Act. Had he instead held the freehold in a company name, he could have transferred it to an associated company without triggering the right of first refusal (as long as that company had been associated with the freeholder for at least two years). If no such company yet existed but time was not an issue, he could have created an associated company and waited two years before making the disposal. Similarly, if either the original freehold company or an associated transferee had been a special purpose vehicle then he could have sold the shares in that company to a purchaser rather than transferring the property itself, thereby avoiding the Act altogether (a route which has the added benefit of a stamp duty saving). Where the freeholder is an individual, however, it is often difficult to avoid going through the formal notice procedure, unless the disposal is either a gift to members of the landlord’s family or a transfer within members of the same family.

The effect of compliance

Although not administratively taxing, the notice procedure necessarily involves delay and uncertainty for both parties. The offer notices must give the tenants full details of the proposed transaction, so it is advisable to have first agreed heads of terms with a purchaser, to avoid having to re-serve the notices later. However, as the Act treats the disposal as taking place on exchange, a seller cannot bind a third party to purchase the property until at least two months have elapsed following service of the notices (assuming the tenants do not accept). Even if all the tenants give a negative response within a month of the offer notices, the seller must wait the full two months before proceeding in case they change their mind. This will add significant delay to the transaction.

The two month required delay is also beset with uncertainty. For a seller, there can be no guarantee that a purchaser will wait in the wings for two months, given the wasted time and costs incurred if the tenants accept the offer. Even if the tenants initially accept the offer, they may later withdraw from the transaction, by which time the purchaser is unlikely to re-enter negotiations. Finally, if the tenants do not accept the offer but the purchaser withdraws, the seller cannot sell the property for any price lower than that in the offer notices without serving further notices on the tenants. For a purchaser, as well as the risk that the tenants accept, there is the possibility that the seller could change its mind at some point during the two-month waiting period and decide not to proceed at all.

That said, in the particular circumstances of Artist Court, it is difficult to see how the service of offer notices could have had any materially adverse effect. Mr. Khan’s solicitors would have had to prepare and serve notices on the eight residential tenants on his behalf, setting out the terms of the proposed disposal to SGR. However, given that there did not appear to be any particular commercial pressure surrounding this transfer, a two-month delay would not be especially problematic and, if the tenants had accepted the offer, Mr. Khan would have had the choice either to sell the property to the tenants for £225,000 or to withdraw from the proposed disposal altogether; retaining the property in his own name. With no third party purchaser waiting in the wings, compliance with the Act would seem no more than an inconvenience.

The effects of non-compliance

As excellently illustrated by Artist Court, the consequences for both parties of a breach of the Act are serious. First, since 1996 there have been criminal penalties for failure to comply with the Act. Secondly, in practical terms, the tenants have the right to compel the purchaser to resell the property to their nominated entity for the same price as it paid; unfortunately for Mr. Khan, this enabled the tenants to obtain the freehold for nothing. Furthermore, the time period for serving a purchase notice only starts to run from the date on which the tenants are either told or otherwise find out, that a disposal has been made in breach of the Act. For this reason, in the case of Green v Westleigh Properties Ltd [2008] EWHC 1474 (QB); [2008] N.P.C. 77, in 2005 the tenants were able to undo a transaction dating from 1992, paying a price of just £500 for the freehold of a two-flat building.

Conclusion

The case of Artist Court has attracted an unusual amount of attention for a County Court judgment, for two reasons. Despite the lack of clarity within the Act, it is relatively rare for a case on this subject to reach the courts and, as a result, any such cases tend to be pounced upon by commentators as a live example of this confusing, complex legislation. The case also provides a clear and effective illustration of the potentially disastrous consequences of ignoring the requirements of this Act. It is often said that it is wrong to dwell on the misfortunes of others, but the example of poor Mr. Khan has provided a salutary lesson to landlords of residential and mixed-use buildings that the requirements of the Act are not to be taken lightly and has highlighted that tenants and their advisers are alive to the fact that their rights under this Act exist and can be utilised to their advantage.

As well as treading with caution when dealing with existing properties, landlords would do well to consider the Act when structuring new developments or acquiring new properties; selecting a purchasing entity on the basis of an easier exit strategy may seem somewhat premature, but it could make all the difference to the speed and process of the eventual sale.

The law is stated as of 11 February 2016.

This material was first published by Thomson Reuters (Professional) UK Limited in Landlord and Tenant Review, The Landlord and Tenant Act 1987 – Ignore it at your peril, (2016) 20 L. & T. Rev., Issue 2 and is reproduced by agreement with the Publishers.