Planning ahead: the Landlord and Tenant Act 1987
When developing mixed use premises it is important to plan ahead especially where a developer intends to dispose of the freehold of the whole building or grant a long lease of the commercial parts as an investment.
Account must be taken of the Landlord and Tenant Act 1987 (1987 Act). Section 1 of the 1987 Act provides a right of first refusal on a disposal for ‘Qualifying Tenants’ of the residences contained in the development. Failure to comply with the 1987 Act is a criminal offence.
What is the effect of the 1987 Act?
Under Section 1 of the 1987 Act, where a landlord wishes to dispose of the freehold or leasehold of the building or part building or common parts to a third party which contains the requisite number of flats (see below) the Qualifying Tenants must be offered the right of first refusal by way of an offer notice under Section 5 of the 1987 Act in respect of the disposal (Section 5 Notice).
The Qualifying Tenants must be offered the interest being disposed of on the same terms as the landlord proposes to sell it to a third party.
What’s a Qualifying Tenant?
Each lease must be checked but in general terms a Qualifying Tenant is a tenant with a long lease of a flat which is not:
a) a protected shorthold tenancy;
b) a business tenancy;
c) a tenancy terminable on the ending of employment; or
d) an assured tenancy.
A leaseholder who owns three of more flats in the building cannot be a Qualifying Tenant.
When does the 1987 Act apply?
The right of first refusal applies where premises:
a) consist of the whole or part of a building;
b) contain two or more flats held by Qualifying Tenants; and
c) the number of flats held by Qualifying Tenants exceeds 50% of the total number of flats contained in the premises.
There are exceptions relating to mixed-use premises. The premises will not qualify if part or parts of the premises is or are occupied, or intended to be occupied, for non-residential purposes and the internal floor area of those non-residential part(s) taken together exceeds 50% of the total internal floor area in the premises (disregarding the internal floor area of any common parts).
If the qualifying conditions are met, the landlord must serve a Section 5 Notice (the nature and timing of which will depend on the type of disposal being proposed) and follow the procedure set out in the 1987 Act. The Section 5 Notice must specify a period of not less than two months from the date of service of the notice within which a requisite majority of the Qualifying Tenants may accept the offer plus a further two month period in which to nominate a purchaser. This can cause delays and additional costs to the disposal.
Although it may have been unlikely that the 1987 Act was passed to capture disposals of commercial premises, the case of Dartmouth Court Blackheath Ltd v Berisworth Ltd  EWHC 350 established that Section 5 Notices have to be served when disposing of something over which tenants have rights. This means the 1987 Act could be triggered on the disposal of commercial premises or airspace.
If landlords fail to comply with the 1987 Act, they run the risk of criminal prosecution and/or civil proceedings from Qualifying Tenants.
Avoiding the 1987 Act
There are practical ways to avoid the 1987 Act but these require forward planning:
- Timing of sale of flats – a disposal prior to the exchange of contracts for the flat which would take the number of Qualifying Tenants over the 50% threshold.
- Pre-existing contractual obligation – a disposal pursuant to a contract entered into prior to 50% of the flats being held by Qualifying Tenants is an exempt disposal under the 1987 Act.
- Disposal to an associated company – a disposal to a company which has been associate of the seller for at least two years is also an exempt disposal. If set up well in advance or it a suitable company already exists, a landlord can transfer its interest to an associated company and then sell the shares of the associated company.
- Creation of a headlease – the grant of a lease superior to the Qualifying Tenants’ leases may allow disposal of the commercial premises without triggering the 1987 Act.
- Mixed use development – a developer could plan a mixed use development to ensure greater than 50% of each building on the development is non-residential.
- In new developments – an agreement for sale before any flats are subject to leases or agreements for lease; or using an SPV (special purpose vehicle) to hold the premises (before the development takes place).
- Plan the tenant profile to reduce the number of Qualifying Tenants in the premises.
- Another way of avoiding a disposal being caught by the Act is if the disposal is the grant of a tenancy of a single flat.
- A disposal by one charity to another might not be caught by the Act.
If legal advice is taken early arrangements can be put in place so the requirement to serve a Section 5 Notice on investment disposals is not triggered.