Landlord and Tenant Act 1987: consequences of breaching the Act

You should have asked me first

27 September 2016

Olivia Tassell considers the potentially drastic consequences of breaching the Landlord and Tenant Act 1987

It is always tempting to consider residential and commercial property as entirely separate commodities. Indeed, they do often present very different, sometimes competing, issues. Perhaps for this reason, many property professionals choose to limit the scope of their expertise to one kind or the other.

However, in every town or city there will always be a large number of buildings in mixed use, from the typical high-street shopping parade of ground-floor shops with flats above to large new developments incorporating restaurants, hotels, apartments, gyms and convenience stores in one site.

Mixed-use buildings such as these often mean that residential and commercial property issues need consideration side by side – sometimes with unexpected consequences. It is important to remember that mixed-use properties may be governed by legislation designed to protect the interests of residential tenants and occupiers that would not affect a property solely in commercial use.

Landlord legislation

One such piece of legislation is the Landlord and Tenant Act 1987 (the act), which confers a pre-emption right on residential tenants in certain residential and mixed-use buildings. This right of pre-emption operates in a negative way, prohibiting a landlord from making a disposal to a third party without first offering it to its residential tenants.

A disposal in this context is very widely defined: the most obvious and common example is the sale of a landlord’s reversionary interest, but even the grant of a lease of some of the common parts of a qualifying building can be covered.

This right of pre-emption can seriously hamper a landlord’s ability to deal with their investment interest.

The qualifying criteria under the act are very detailed and must be considered on a case-by-case basis. In broad terms, they will apply where more than 50% of the relevant building is in residential use and that building contains 2 or more flats held by residential 'qualifying tenants'.

If the legislation does apply, a landlord must, by way of formal written notice, offer the interest being disposed of to the qualifying residential tenants in the building – on the same terms as those agreed with a third-party purchaser – before contracting with that purchaser. The tenants then have 2 months in which to accept; if they do, the acceptance must be by more than 50% of the tenants.

Where a valid acceptance notice is served, the landlord must withdraw terms from the third-party purchaser and sell to the tenants instead. A landlord may only proceed with a sale to a third party if the 2-month notice period has elapsed without a valid acceptance notice being served. Even if all the tenants respond negatively within the first week of the offer notice, the landlord cannot proceed until the full 2 months have elapsed.

While the delay is unpalatable, involving uncertainty and potentially wasted costs for both parties, there are serious sanctions if the legislative requirements are not met, both for the landlord’s selling entity and a purchaser acquiring the landlord’s interest.

If a landlord makes a disposal in breach of the legislation without serving notices or waiting the requisite 2 months, they – or, if a company, the directors – will have committed a criminal offence. The risk for a purchaser is that the residential tenants have the ability to undo the transaction carried out in breach and acquire the landlord’s interest at the price paid by the purchaser.

Case sets costly lesson

The recent case of Artist Court Collective Limited v Khan [2015] PLSCS 313 offers a relatively unusual example of litigation involving the act. It has received a high level of publicity for a county court decision as it illustrates the potentially drastic consequences of breaching the act.

This case involved a mixed-use building in east London consisting of 3 commercial units on the ground floor with eight residential flats above, sold off on long leases. In 2011, the freeholder landlord transferred his interest to a newly incorporated company under his control for a price of £225,000.

The Landlord and Tenant Act 1987 confers a pre-emption right on residential tenants in certain residential and mixed-use buildings

Khan made this disposal without first offering it to the residential tenants, in contravention of the act. In fact, no attempt was made to inform the tenants of the change of landlord; they only became aware of the transfer in mid-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 breach, the majority of the flats’ owners formed a company and served a notice on the new owner, seeking to invoke their right under the act to have the freehold transferred to them for the same price. On receipt of this notice, Khan sought to rectify the position by reinstating the original situation, transferring the freehold from the name of the company back into his own name, this time for no consideration.

However, he again failed to offer the interest to the residential tenants, breaching the act for a second time. As a result, the court held that the residential tenants were entitled to acquire the freehold interest on the same terms as the second transfer for no consideration. In practical terms, the tenants acquired, and Khan lost, a valuable freehold interest for nothing.

The example of Khan provides a salutary reminder to landlords of residential and mixed-use buildings that the requirements of the act are not to be taken lightly. Furthermore, residential tenants and their advisors are clearly becoming more aware of how they may use the legislation to their advantage.

The owners of the flats, provoked into action in protest against an undesirable use of one of the retail units below, ended up acquiring control of the whole building. This included the right to income from the commercial units, without having to reach into their own pockets.

Ascertaining compliance

Where a group of residential tenants are considering a claim for collective enfranchisement, for example, or otherwise want to get their hands on the management of their building, it is worth checking first whether any transfers of the landlord’s interest are revealed at the Land Registry; if so, did these comply with the act?

A few simple questions to the landlord, or more formally, the service of an information notice under the act can ascertain compliance. Indeed, the tenants themselves would know whether notices were served, as they should have received them.

There is no time limit for serving purchase notices following a disposal carried out in breach, so it may be possible to undo a transfer carried out several years ago at a price much less than current market value. However, this will only ever be achieved if a sufficient majority of the tenants work together; with large blocks of flats it may prove extremely difficult to ensure that a majority of participants are willing, and even more difficult to coordinate them.

On the other side of the coin, landlords of qualifying buildings will often seek a way round the unpalatable delay associated with the service of offer notices. This may sometimes be possible by making use of exemptions in the act; for example, by transferring properties between associated companies and/or selling the shares in a landlord company, rather than disposing of the property interest itself.

However, the exemptions are limited and it will frequently not be possible to find an alternative to following the notice procedure and waiting the requisite 2 months. No matter how frustrating this is, those who are advising landlords should have no trouble convincing their clients of its importance – now they have the story of Khan to relate.

Olivia Tassell is a partner in the property team at law firm Boodle Hatfield

Further information

This feature is taken from the RICS Property journal (July/August 2016)