Mark Chick, Director of The Association of Leasehold Enfranchisement Practitioners (ALEP) explains what Section 5 Notices are and outlines how leaseholders and freeholders should approach the Right of First Refusal.
Under the Landlord and Tenant Act 1987 (‘the Act’), a landlord (‘freeholder) who wishes to sell their freehold interest in a block of flats must first serve a Section 5 Notice on the leaseholders, giving them the opportunity to buy the freehold of their building, before it is offered on the open market. This right is provided by Part 1 of the Act, as amended by the Housing Act 1996, and is known as ‘the Right of First Refusal.’
If a majority (more than half) of the leaseholders wish to acquire the freehold on those terms, then they must formally notify the freeholder within the time limits set out in the Notice. The Notice must give them at least two months to accept. If a majority of the leaseholders fail to respond within the time frame, then they will lose their legal right to buy the freehold under the offer and the freeholder will be free to sell to whoever they wish for a period of a year afterwards.
Section 5 Notices must be served by any freeholder looking to sell their freehold (or other qualifying interest) to a third party. There are some limited exemptions for transfers to family members and related companies, but the general position is that if a freeholder wants to sell, Notices must be served.
If the freeholder fails to do this, then they will commit a criminal offence. As well as this, there are rights for the leaseholders to take the freehold on the same terms as originally transferred by the freeholder. In a situation where the price has been kept deliberately low, or is zero for instance, this would be a disaster for the freeholder and significant gain for the leaseholders.
Leaseholders served with a Section 5 notice will need to act quickly if they want to accept the landlord’s offer. In a larger building this may prove a challenge. ALEP recommends that advice is obtained from a leasehold professional as soon as possible because of the deadlines involved.
If the freehold is sold without providing the Right of First Refusal, the leaseholders can serve a notice on the new freeholder demanding details of the transaction, including the price paid; they may also be able to take action to force the new owner to sell to them.
If you own a freehold and want to sell, then it is very likely that you will need to serve a Section 5 Notice. The Act’s provisions also apply to other interests (such as a head lease) and basically any situation in which you are the immediate landlord of qualifying flat owners. Other areas forming part of the ‘common parts’ may also be covered.
To qualify, a building needs to be at least 50% let out on long leases (that is to say leases that were for more than 21 years originally when granted). Some other types of lease also qualify to be notified (such as regulated tenancies). Mixed use property is also covered by the Act provided that the non-residential part does not exceed 50%. Specialist advice should therefore be sought if there is any question about whether the building qualifies.
Failure to serve notice in qualifying situation is a criminal offence punishable by a fine. It therefore pays for freeholders to get this right, particularly given that if the leaseholders exercise their rights to take over the transaction where the Act has been breached as there may also be court or other costs involved. This is best avoided!
Another potential pitfall for freeholders, is that any disposal or transfer of the ‘common parts’ is likely to be ‘caught' within the Act. So, a disposal of a common area (such as a roof space, or a store area for instance) where the leaseholders have rights will almost certainly need to be notified using a Section 5 Notice. There are some exemptions such as transfers between immediate family or changing a trustee or transfers between associated companies (again, there are strict definitions).
ALEP therefore strongly recommends that specialist advice is taken before proceeding with any sale or transfer either of all of or part of a qualifying freehold.
There are two main ways of dealing with this process:
This involves serving a Notice under Section 5A which stipulates a price which you would be prepared to accept for the sale of the freehold interest and gives the leaseholders a fixed time frame (which must be at least two months) in which to respond. If a majority accept and follow through the further steps in the process, they can purchase the freehold interest.
If the leaseholders fail to accept the offer within the specified timeframe, then as freeholder you are able to sell the freehold to the property at any time during the following 12 months, provided that you do not sell the freehold for less than the price quoted in the original offer Notice.
The second way of dealing with this situation is by serving a Notice under Section 5B of the Landlord and Tenant Act 1987.
This is the process if you want to sell the freehold (or other relevant interest) at auction. Similar criteria as mentioned above apply. By following this process, Notice is given to the leaseholders of the intended sale of the freehold at auction. If a majority of the leaseholders take all of the relevant steps (serving several relevant notices) then they will end up with a ‘right of first refusal’ against the successful auction bidder.
They then have the right to take over the purchase contract and have the same time frame to complete as the bidder would have (normally 28 days).
When looking at new roof space and airspace leases, the creation of the lease itself will normally trigger the provisions of the Landlord and Tenant Act 1987. This means that the right of first refusal will apply, and the transaction needs to be notified to the leaseholders by serving a Section 5 Notice.
If the freeholder plans to sell an area of the common parts (for instance a store cupboard) to one of the leaseholders, then this may well need to be notified to all. This is often overlooked in practice. It may be possible to structure the transaction in such a way as to not only allow notification to take place, but also so that only the intended purchaser will be likely to accept.
There is also a ‘clearance’ process that can be used if there has been a disposal that may have been made in breach of the Act. Specialist advice should always be obtained if any of these points are likely to affect you.
This is only a brief summary of the position and is not a substitute for legal advice. ALEP members can provide further advice and details on how leaseholders and/or freeholders should approach the Right of First Refusal.
Membership of ALEP acts as a badge of assurance so that leaseholder and freeholder clients can be confident that they are employing professionals with the right level of expertise in handling potentially complex transactions.
You can use our website to find a qualified enfranchisement practitioner who will be able to assist you: ALEP.
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