Legal and practical considerations where directors are not enforcing the terms of the lease
8th December 2022
8th December 2022
Whether you are a managing agent or leaseholder, from time to time you may come across a situation where the directors of the landlord, RTM company or RMC are not (or give the impression they are not) taking sufficient action in respect of a breach by another leaseholder in the block or development. The question we have been asked is, what can be done in such a situation?
Under company law, the affairs of a company are run by the directors and decisions of the directors must be taken in line with the processes agreed and set out in the company’s constitution (the articles of association). In general terms, the company (or, specifically, the directors), are not under a standalone obligation to enforce a breach of the terms of the lease, but there might be legal consequences if they elect not to. We aim to summarise these below.
Company directors are under a fiduciary duty to act in the best interests of the company and are subject to an array of duties to the company under the Companies Act 2006 (summarised here). Key duties include promoting the success of the company, and taking reasonable care, skill and diligence. A breach of directors’ duties may be enforced by the company, and any financial losses pursued against the individual director personally. Depending on the company’s articles of association, action might be taken to remove the director from office if the shareholders are unhappy with the action (or inaction) taken by the directors. Additionally, shareholders might be able to propose resolutions requiring the directors to take certain action. The specific processes and circumstances in which this action might be available are outside the scope of this Legal Update, and specific advice would be needed from a company law specialist.
Whether the company directors could be held in breach of their fiduciary and statutory duties by electing not to enforce a breach will be entirely fact specific. However, a breach is likely to be found where the directors fail to take action to recover service charge arrears, particularly where that puts the company in a position where it is technically insolvent (e.g. it is unable to pay its debts as they fall due). This is aside from any other claims the directors may be open to in the event of an insolvency situation. By contrast, it is generally accepted that the landlord, RTM company or RMC is not responsible for the nuisance caused by a leaseholder and as such is not under a general obligation to enforce such a breach (see here). In such circumstances, it may be difficult to establish a breach of directors’ duties, where the directors elect not to enforce such a breach of the lease. However, each case will be fact and circumstance specific.
Mutual enforceability covenants
Notwithstanding the above, it may be that leaseholders can compel the landlord, RTM company or RMC to take action, where the lease contains a mutual enforceability covenant, e.g. a covenant given by the landlord or RMC (and, by extension, the RTM company) to enforce the terms of the lease at the request of another leaseholder. Such a covenant is usually subject to an indemnity being given by the complaining leaseholder, that they will cover the landlord's, RTM company's or RMC’s costs for taking that action.
Where no action is taken to enforce the breach following such a request under the mutual enforceability covenant, the landlord, RTM company or RMC is likely to find itself in breach of covenant and liable to legal action by the leaseholder(s) making the request. This was the position in the now well-known case of Duval -v- 11-13 Randolph Crescent Limited  UKSC 18, where the landlord granted consent for alterations which were subject to an absolute prohibition in the lease, and as such could not enforce the breach when requested to do so by another leaseholder under a mutual enforceability covenant (see here) with the ultimate effect being that the landlord faced a liability in damages to the complaining leaseholder.
Specific duties of RTM companies
RTM companies are subject to specific, additional duties under Part 2 of the Commonhold and Leasehold Reform Act 2002 (“the Act”), in view of the landlord’s ongoing interest in the building and the reversionary title.
Under Section 101(2) of the Act, the RTM company must :
Keep under review whether the tenant covenants of leases are being complied with, and
Report to the landlord any failure to comply with any of the tenant covenants, within 3 months of such breach coming to the RTM company’s attention.
The reporting requirements will not apply where the breach has been remedied, or where reasonable compensation has been paid for the breach, or where the landlord has confirmed to the RTM company that it need not comply with its reporting requirements in respect of a particular breach.
Where the RTM company does not comply with its reporting requirements, the landlord may serve the RTM company with a default notice requiring compliance within 14 days. Where the default notice is not complied with, the RTM company’s reporting obligation may be enforced by the landlord in the County Court.
So, whilst this is not an obligation to enforce any breaches per se, the Act does impose obligations on the RTM company to keep breaches under review and report such breaches to the landlord and, in deciding whether or not to take action in light of those breaches, the RTM directors must keep in mind their directors’ duties as outlined above.
Practical and other considerations
In addition to the legal consequences outlined above, directors should be aware and take into account the practical considerations where the company decides not to take action to enforce a breach of the lease.
When faced with an arrears situation, the company could face the very real prospect of having insufficient funds to discharge its liabilities to contractors (thereby placing the company in an insolvent position) and/or to comply with its repairing obligations under the lease (thereby placing the company in breach of covenant to the other leaseholders). The company simply cannot comply with its various duties (including to remain solvent) without having sufficient funds and so,where there are arrears thelkely position is that the company has little choice but to enforce even though tecnically it is not directly obliged to do so.
Directors should also be mindful that a practice of non-enforcement is likely to lead to non-compliance more generally and could cause disharmony within the block or estate (‘why should I pay if they don’t?’). Indeed, we have seen blocks dramatically improve rates of compliance (specifically with payment of service charges) where the directors take a pro-active approach to enforcing breaches. Therefore, to see widespread and ongoing compliance, the directors should be willing to promptly enforce the terms of the lease where appropriate, to avoid leaseholders failing into a practice of non-compliance. In extreme cases, it could make enforcement more difficult (or impossible) at a later date, if the directors are seen to have waived compliance with the particular covenant in question.
Where you are a managing agent, you might consider whether you are willing and able to continue your appointment in circumstances in which the directors are not taking active steps (include legal action if necessary) to resolve a breach. Whilst a managing agent acts as agent on behalf of the landlord, RTM company or RMC and, as such, is unlikely to find themselves responsible for the actions (or inactions) of their client, from a management perspective if that action (or inaction) makes the manage agent’s job more difficult or indeed impossible, resignation (or a genuine threat of the same) may be the best incentive or only option available.
Directors of a landlord company or RMC should be mindful that leaseholders might exercise the right to manage (see here) or apply to the FTT to appoint a manager under the Landlord and Tenant Act 1987 (see here - which can also apply if there is already a RTM company), if they are unhappy with the action (or inaction) taken by the directors. Therefore, they could lose their management rights entirely.
The circumstances in which a landlord, RTM company or RMC should take action to enforce the terms of the lease will vary depending on the specific facts of the case and breach concerned. However, in any given case, the directors should be mindful of their obligations to the company (and the obligations of the company), as well as the potential consequences in the event of an election to not take action. This is a particular risk in the event of an election not to pursue a leaseholder for outstanding service charges. Competent legal advice should be sought where there is any doubt about what the company can and should do in any given case.
If you would like to discuss this week’s Legal Update with a member of the team, please feel free to get in touch on 01435 897297 or email@example.com.
This legal update is provided free of charge for information purposes only; it does not constitute legal advice and should not be relied on as such. No responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by any member of KDL Law or by KDL Law as a whole.
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