QUESTION
I have the following questions relating to the Freehold Purchase where I live, as collective enfranchisement has been proposed.
The building:
The building is made up of 150+ apartments. The building is a converted hospital (building).
The building, all flats, have a 990 year Lease. The buildings are Grade 11 Listed.
Does this mean the freehold cannot be purchased? .
Qualifying Leaseholders
At least 50% of the Enfranchisement cooperative must be qualifying tenants.
Are "Buy to rent" landlords classified as qualifying tenants? These landlords rent the flats as a commercial investment business.
Approximately 60% of the flats are owned and rented out by "buy to rent" landlords. Consequently having commercial interests as opposed to those of an owner/resident.
The Enfranchisement
The agreement being put forward is that each flat pays 20 x the annual Ground Rent. This gives one (1) share of the Freehold.
Those that are unable to pay this proportion for a Freehold Share, are being offered £1 membership of the cooperative, they have NO SHARE OF THE FREEHOLD and have NO VOTING RIGHTS.
Are these £1 members classified as part of the 50% qualifying tenants? as they have no financial share or vote in the management of the Freehold.
Finances
If ONLY 20% of the 50% of qualifying tenants have the money to purchase the Freehold, with the remaining funds to purchase the freehold on a loan; if the loan is defaulted on, who is responsible for the debt?
Would those who declined to participate in the freehold purchase have any financial responsibility for the debt?
Would any financial default have any impact on the Lease of those that did not participate in the Freehold purchase?
Shares are being offered to qualifying tenants who want to invest in the Freehold, and being offered 3 - 4 % annual interest return on their investment. Is this legal?
Should those offering this be registered by the Financial Services Authority?
A company has been set up for the purpose of purchasing the Freehold. Those paying £1 to join the company and not actually buying the freehold, will not have a Freehold Share and will have NO voting rights.
With only 20% actually putting up the money (20 x Ground Rent) and also investing for a 3-4 % return; leaving 80% of tenants having no say or ownership in the freehold, not voting rights, no control of shares and not owning part of the freehold.
Can the Freehold purchase be legal?
Will non participants in this process have any financial responsibility i.e. legal costs, stamp duty, surveyor, freeholders costs etc?
ANSWER
It is worth remembering that in nearly all cases, it is the freeholder of a block of flats who owns the land and the ‘bricks and mortar’ that make up the building. All that each lessee (flat owner) owns is a lease which is a contract between the lessee and the freeholder giving the lessee the right to occupy the flat for a period of time. Both sides will have rights and obligations under the lease. The freeholder will have obligations to repair and maintain the fabric of the block and the services. The lessee will have the obligation to pay the service charge or a share of the freeholder’s costs and probably a ground rent as well.
Assuming there are no intermediate landlords or headlessees, there are 3 ways in which the lessees of a block of flats can but their freehold:
- They can exercise the right of compulsory purchase given to them by the 1993 Act
- They can exercise the right of first refusal when their landlord wants to sell given to them by the landlord & Tenant Act 1987
- They can simply agree terms with their landlord if he is willing to sell.
However they proceed, the lessees of the flats have to act together as a single body. Under the 1993 Act that body is known as the Nominee Purchaser. It is worth remembering that all that happens when the freehold changes hands is that the lessees find themselves with a new landlord. All the flat leases (and other leases, if there are any) stay in place unaltered, unless and until the Nominee Purchaser and the lessee concerned agree to enter into a new lease or to revise the terms for example by reducing the ground rent. It may be hard to credit, but those behind the Nominee Purchaser could actually go to another investor they prefer and get him to buy the freehold as the Nominee Purchaser.
However, assuming that the Nominee Purchaser is to represent the lessees, there is nothing in any acts of Parliament telling them how to organise themselves - that is entirely their choice.
There are several options:
- Up to 4 people can own an interest in land, so if there are 4 flats or less in the block, the lessees themselves can own the freehold. The problem is that whenever one of them sells, they have to transfer not only the lease of the flat but also the freehold.
- 2 - 4 people can be found to act as trustees for all the lessees. This saves transferring the freehold whenever a flat is sold but leaves the lessees in the hands of individuals.
- A ‘body corporate’ can be formed. This is generally a company which can be limited by shares or limited by guarantee. Ideally the company that owns the freehold of a block has no intrinsic value (see below) but that is not always the case.
3a. If the company is limited by shares, the owners of the company are known as ‘shareholders’. Shares with a nominal value are issued to lessees and a register of shareholders is kept. Problems can arise if the ownership of the shares become detached from the ownership of the flats. Sometimes people sell their lease but forget to sell or transfer the share. Sometimes there is value in the freehold company and the flat owner decides to keep the share to extract the value from it.
3b The solution to the separation of shares and flats issue if to make the company limited by guarantee. Then the owners of the company are known as ‘members’. The Memorandum and Articles of Association for the company will state that the members of the company are the owners for the time being of the 999 year leases of the flats in the block. In that way there can be no separation of the ownership of the flats and the company.
In the same way as there are no rules as to how the Nominee Purchaser is organised, there are no rules as to how it raises the money necessary to make the purchase. The obvious choice is to ask all the lessees to make the appropriate contribution for their flat (this is known as participating), but not all may wish to do so and not all lessees may ‘fit into’ the purchasing group.
For example the freeholder may also own some flat leases. There is certainly no obligation to invite all the lessees to participate.
Any lessee who agrees to participate and make a contribution should hand over his money to the Nominee Purchaser as a loan and in return he should expect to get a 999 year lease of his flat at a peppercorn rent, soon after the freehold purchase completes. This is a step that lessees often forget to undertake and it can have tax consequences (see below).
In a small block it is possible that all lessees will participate but in medium sized or larger blocks that is almost impossible. So the question then arises as to how to cover the cost of buying the freehold interest in the non-participants’ flats. Those interests are pure investments. There is no question of re-granting the flat leases because if there were, the lessee would be a participant.
So the answer is that an investor will have to be found to put up the costs. In return the investor should get the 999 year lease of the non-participant’s flat subject of course to the non-participant’s lease. The investor will become the landlord of the non-participant receiving the ground rent and a premium as and wants a longer lease. Sometimes the Nominee Purchaser acts alos acts as the investor.
Where the non-participant’s lease has less than 80 years unexpired and marriage value is payable, these are attractive investments and investors are not hard to find. For that very reason, the participants as a whole or individually or a group of them may want to act as the investor. In that case, if only for tax reasons, any groups should set up another company to buy the investments. There are many blocks where there is both a Name-of-block Freehold Company Ltd owning the freehold and a Name-of-block Investors Company Ltd owning some long leases.
The tax angle is this:
- The ground rents payable will be income to the Nominee Purchaser company and that company will have to pay corporation tax, so it makes no sense for more rent to be payable than is necessary. Hence the granting of leases at peppercorn rents (for the appropriate contributions to the purchase price) makes good commercial sense.
- Once a non-participant wants to extend his lease he will have to pay more for it than was paid in the purchase from the original freeholder. The investor will pay corporation or capital gains tax when the profit is realised but may also have to pay corporation tax on the increasing value of the investments as and when they are revalued. It is preferable to leave the freehold owning company with a valueless freehold.
With all the above in mind, the answers to the reader’s questions are:
• I am not sure what the reader sees as the potential pitfall, but the freehold of a Listed block of 150+ flats (being a converted hospital) held on 990 year leases can be claimed under s13 of the 1993 Act.
• What constitutes a qualifying tenant depends on the existing leases and the number of those leases that each lessee holds. The leases must have been for more than 21 years, so the 999 year leases qualify and I guess they all have modest ground rents. If any lessee has more than 2 leases, he is not a qualifying tenant of any flats. So ‘buy to rent’ landlords can be ‘qualifying tenants’ provided each owns no more than 2 of them.
• I do not know if 20x the ground rent is a fair price. To judge its value, I would need to know the level of the current rent and how often and on what basis it increases.
• As a reminder, the freehold is not divided into shares, even if the new freeholder is to be a company with a shareholding. So no-one will be getting a ‘share of the freehold’. The description of a flat as being held with a ‘share of the freehold’ is jargon and shorthand for saying that it is held on a lease with a share in (or membership of) the freeholder company. In this case, with leases already over 990 years, what the participants should get for their contributions to the purchase price is a deed of variation to the lease, reducing the ground rent to a peppercorn.
• I do not understand the distinction between being a £1 member of the co-operative and having voting rights. The Nominee Purchaser company can have have more than one class of shares and they can have different voting rights.
• the membership or shareholding of the Nominee Purchaser company has no direct linkage to the qualifying tenants. The direct linkage might be to participation/contributions, but as explained above, shareholders could also be outside investors.
• If the Nominee Purchaser company takes out a loan to cover the cost of buying the freehold, the company, its shareholders or members are responsible for the debt. It is one reason why such companies rarely finance themselves by formal loans.
• non-participants have no more responsibility for the Nominee Purchaser’s debts than they do for the current freeholder’s debts.
• non-participants will have no liability for any of the costs of buying the freehold.
• the leases would not be affected by a bankruptcy of the Nominee Purchaser company. If that happens, the Treasury Solicitor will step in and should have no problem finding a buyer for the freehold at the ‘right price’.
• I do not understand how a return on the investment in the Nominee Purchaser can be mooted at an annual figure when the ground rent income will be (or should be reducing as more lessees participate) and those organising the enfranchisement can have no idea when non-participant lessees might come forward wanting to participate ie buy down their ground rents.
Jennifer Ellis, Partner at Langley Taylor
