Rights of First Refusal
25th October 2020
25th October 2020
In certain circumstances, before a landlord can dispose of his interest (whether that be the freehold of the block, or some other interest or part of the premises), that disposal must first be offered to the leaseholders. This is known as the ‘rights of first refusal’ set out in Part 1 of the Landlord and Tenant Act 1987 (“the Act”). It is a criminal offence for a landlord to dispose of an interest which is caught by the Act, without first offering the disposal to the leaseholders, so this is not an obligation that should be taken lightly.
This Legal Update sets out a very basic outline of when the Act applies and the process the landlord must follow. It does not intend to provide a comprehensive account of the rules, which are complex (and often confusing), and specialist legal advice should be taken on the facts of any particular case to ensure that the landlord is fully aware of their obligations before proceeding with any given transaction.
When does the Act apply?
The Act applies to premises which consist of “the whole or part of a building”, which contain two or more flats where more than 50% of the flats are held by qualifying tenants (e.g. long leaseholders). Where more than 50% of the premises is for non-residential use (disregarding any common areas), the Act will not apply. There are exclusions where a qualifying tenant owns three or more flats in the block.
The Act applies where the immediate landlord of the flat owners is making a relevant disposal, so a superior landlord may make a disposal which would otherwise be caught by the Act without offering the disposal to the leaseholders, given that the disposal is not being made by the immediate landlord. Certain landlords are excluded from the Act (including Local Authorities, charitable housing trusts and, in some cases, where the immediate landlord is resident at the block).
What is a relevant disposal?
The simplest example is the sale of the entirety of the landlord’s interest, be that the freehold of the block or its intermediate leasehold interest. However, there are other, more complicated instances where the Act may apply and advice should be taken in relation to the specifics of any proposed transaction. Some disposals are exempt, including the grant of a lease of an individual flat, as well as in some circumstances where the disposal is to an associated company, and in some cases where a disposal is between family members.
What is the process?
The process depends on how the disposal is going to occur and the Act sets out the different requirements of the landlord’s offer notice, depending on whether the disposal is :-
a simple sale by contract - Section 5A
by public auction - Section 5B
by grant of an option or right of pre-emption - Section 5C
sale not pursuant to a contract - Section 5D
sale for a non-monetary consideration - Section 5E
A sale by contract and by public auction are the two most common methods of disposal and the basic process is covered below. Failure to comply with these steps can amount to a deemed withdrawal and can be fatal for either side (including giving rise to costs liabilities).
The process is commenced by the service of an initial ‘offer notice’, and the content of the notice is prescribed by the relevant sub-sections of Section 5 of the Act as above. The offer notice must be served on the qualifying tenants, although the landlord will be deemed to have complied if he serves 90% of the leaseholders (or, where there are less than ten qualifying tenants, he serves all but one of them).
Whilst the disposal is offered to the leaseholders, in order for the offer to be accepted, the ‘requisite majority’ of leaseholders must accept. That majority is over 50% of the qualifying tenants. A purchaser is then nominated to proceed with the disposal on behalf of the requisite majority of qualifying tenants accepting the offer, e.g. the leaseholders do not acquire the interest in their own right. This is usually a company set up on behalf of those leaseholders accepting the offer.
Sale by contact - Section 5A
The requisite majority of qualifying tenants have two months to accept the offer, and a further two months to nominate a purchaser. If the offer is not accepted or no such nomination is made within that period, the landlord is free to dispose of that interest within the next 12 months, but not on different terms or at a lower price than that offered to the leaseholders. Where the offer is accepted and a nomination is made in time, the landlord must issue the contract to the nominated purchaser within one month and the nominated purchaser has two months to sign the contract and pay the deposit (which is to be no more than 10% of the purchase price as set out in the notice), with exchange occurring 7 days later. There is no set period for completion.
Sale by public auction - Section 5B
The offer notice must be served no more than six, and no less than four, months before the date of the proposed auction. The requisite majority of qualifying tenants again have two months to accept the offer, and a further period of 28 days to nominate a purchaser (ending at least 28 days before the auction date). A further notice is to be served by the nominated purchaser at least 28 days before the auction, electing to continue with the process.
Where no such notice is served (or in any case where the offer is not accepted or no nomination is made), the landlord is free to sell to the highest bidder at that auction. Note the process has to start afresh if the interest does not sell at the auction specified and the landlord wants to list the disposal in another auction or sale by private contact. Otherwise, where the offer is accepted, bids are then made at the auction subject to the rights of first refusal. If a successful bid is made at the auction, the landlord must send the contract to the nominated purchaser within 7 days, and the nominated purchaser has 28 days to accept and pay the deposit. This has the effect of replacing the successful bidder at the auction.
What are the sanctions for non-compliance?
Sanctions for non-compliance are severe. The landlord commits a criminal offence and is liable to an unlimited fine. The qualifying tenants can also force the landlord to sell to them on the same terms on which he sold to the purchaser (and this can be enforced against subsequent purchasers). This is known as an acquisition order and strict time limits apply. Note the new landlord must notify all qualifying tenants that the disposal was one to which Part 1 of the Act applied (in addition to the obligation under Section 3 of the Landlord and Tenant Act 1985 for new landlords to provide leaseholders their name and address).
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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