Legal Briefing

At cross porpoises? The lessons from Dolphin Square

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Real estate | 01 September 2014

The right to acquire the freehold or an extended leasehold interest conferred on the lessees of blocks of flats pursuant to the Leasehold Reform Housing and Urban Development Act 1993 continues to raise tricky issues for property investors. The recent long-awaited decision in Westbrook Dolphin Square v Friends Provident [2014] tackles a number of those issues. 


OVERVIEW OF COLLECTIVE ENFRANCHISEMENT PURSUANT TO THE 1993 ACT

Chapter I of Part I of the Leasehold Reform Housing and Urban Development Act 1993 (the 1993 Act) confers on the requisite majority of qualifying tenants of flats in a block of flats the right to acquire through a nominee purchaser the freehold of the block, which must be a self-contained building or part of a building containing two or more flats held by qualifying tenants. The total number of flats held by qualifying tenants must be not less than two thirds of the total number of flats in the building. Furthermore, if an area of the block is neither occupied nor intended to be occupied for residential purposes and does not form part of the common parts of the block and the internal floor area of that part or any such parts taken together exceeds 25% of the total floor area of the block, then the block will not qualify for enfranchisement under the Act.

A tenant is a qualifying tenant of a flat if they are the tenant of the flat under a long lease. There is no requirement that the tenant should have held the leasehold interest for a particular period before the claim is made. However, if a person satisfies the conditions for being a qualifying tenant of three or more flats in the block, then the 1993 Act provides that there should be taken to be no qualifying tenant of any of those flats. Furthermore, where the tenant is a company, any letting to an associated company (as defined by s736 of the Companies Act 1985) is treated as a letting to the company.

The mechanism by which the 1993 Act confers the right to acquire the freehold commences with the service of a notice of claim by the participating tenants pursuant to s13 of the 1993 Act. The notice must set out the tenants’ proposals in respect of the premium to be paid for the freehold and the other terms of acquisition. The landlord must then serve a counter-notice pursuant to s21 of the 1993 Act, which either admits or denies the tenants’ right to acquire the freehold of the block and, in the case of an admission, either accepts the tenants’ proposals contained in the initial notice or puts forward counter-proposals.

If agreement as to the premium payable or the terms of acquisition cannot be agreed between the parties within a certain period, the 1993 Act provides for the determination of outstanding issues by the first-tier tribunal.

THE DOLPHIN SQUARE LITIGATION

Dolphin Square in Pimlico is a block of 1,229 flats together with shops, offices, a fitness centre, a spa and a restaurant and bar. It is one of the largest blocks of flats in Europe. The claim to acquire the freehold of the block is comfortably the largest such claim there has been since the 1993 Act was brought into force. The sum proposed as a premium under the tenants’ initial notice was £111m and one of the issues for the Court to determine was whether that not inconsiderable sum was so low as not to be a bona fide offer for the block.

In 2006, the head leasehold interest in the block was acquired by Westbrook. In April 2007, they granted underleases of each of 1,223 of the flats to 612 newly created companies. None of the companies owned more than two flats in the block. Furthermore, care was taken to ensure that the companies were not ‘associated companies’ for the purposes of the Companies Act 1985.

The landlord resisted the tenants’ claim to exercise a right of collective enfranchisement on the following grounds:

  1. that the corporate structure of the companies holding the underleases was such that the companies were associated companies;
  2. that on the true construction of the 1993 Act, the companies were not ‘tenant[s] of a flat under a long lease’ because the companies were created solely to avoid the effect of ss5(5) and 5(6) of the Act preventing a qualifying tenant from being the tenant of more than two flats;
  3. whether, in the light of the previous issue, the landlord’s rights under the Human Rights Act were infringed;
  4. whether it was open to the landlord to contend that the building contained more than 25% of non-residential space given that the point had not been referred to as a reason for rejecting the claim in its s21 counter-notice;
  5. whether the block was not capable of being enfranchised on the grounds that more than 25% of the floor space was used for non-residential purposes;
  6. whether the tenants’ notice was invalid because it did not ‘specify the proposed purchase price’ for the block;
  7. Whether the landlord could contend that the scheme whereby the underleases of the flats were granted was a transaction at an undervalue for the purposes of s423 of the Insolvency Act 1986

The matter was heard before Mann J in the Chancery Division in February 2014 and judgment was handed down on 17 July 2014.

Space will not permit a full discussion of all of the issues canvassed in a lengthy 140-page judgment. Indeed, many of the issues are unlikely often to arise in practise and I will therefore concentrate on the two issues which are most likely to arise again in the future.

FAILING TO REFER TO A GROUND OF REJECTION IN THE COUNTER-NOTICE

Section 21(1) requires the landlord to serve a counter-notice on the nominee purchaser, which must either accept or deny the tenants’ right to acquire the freehold and must:

‘… state that, for such reasons as are specified in the counter-notice, the reversioner does not admit that the participating tenants were so entitled’.

The landlord in Dolphin Square had served a counter-notice which denied the right to enfranchise but which had not included the allegation that the block included more than 25% of floor space which would be a valid reason – if proved – for rejecting the claim. The lessees contended that it was not open to the landlord to take the point at trial having failed to refer to it as a ground for rejecting the claim in its counter-notice.

The lessees contended that the use of the word ‘must’ in s21(2) demonstrated that the requirement to state reasons was mandatory. There would be no point in requiring reasons to be specified in the notice if they could then be supplemented at a later stage. They relied on a County Court decision, Bishopsgate Foundation v Curtis [2004] in which His Honour Judge Cooke took a narrow view of the section, holding that:

‘… the whole purpose… is to define the basic issues… before proceedings start and the landlord should not be entitled then to depart from that position…”

For their part, the landlord contended that the requirements of the 1993 Act were more flexible. They pointed to the judgment of Auld LJ in 9 Cornwall Crescent London Ltd v Kensington & Chelsea [2006] where he said that:

‘It does not serve, as the judge appears to have considered at para 25 of his judgment, as a means of securing a final definition of, or constraint on, the issue or issues for determination by the court or a leasehold valuation tribunal, if the matter goes that far. Rather, it serves as a useful negotiating stage during which any issues may be resolved.’

Mann J favoured the more flexible construction of s21(2). In particular, he was persuaded by two arguments. The first was that pursuant to s25(3) of the 1993 Act, if the landlord fails to serve any counter-notice at all, the lessees are entitled to an order of the County Court requiring the freehold to be transferred to the nominee purchaser, but only if the court is satisfied that:

‘… the participating tenants were on the relevant date entitled to exercise the right to collective enfranchisement in relation to the specified premises’.

The court would therefore be required to deal with any argument which, if successful, might lead to the conclusion that the lessees were not entitled to exercise the right to acquire the freehold. As Mann J noted, that would therefore put a landlord who served no counter-notice at all in a better position to resist enfranchisement than one who had served such a notice but inadvertently failed to specify a good ground for resisting the claim to enfranchise.

The learned judge was also persuaded by a comparison between the wording of s21 and other property statutes such as s30(1) of the Landlord and Tenant Act 1954, which states specifically that only grounds of opposition relied on in the landlord’s counter-notice may be subsequently relied upon. No such wording appears in s21 of the 1993 Act.

It seems clear that unless there is an appeal on this or another case, the law is likely to take a flexible approach to this requirement of s21(2). Landlords will be given a second bite at the cherry even if they fail to specify a ground for rejecting the claim on which they wish to rely. How that would impact on a claim if the counter-notice admitted the right to enfranchise and the landlord sought to take a point subsequently which, if proved, would exclude the claim remains to be determined.

VALIDITY OF THE TENANT’S NOTICE

Section 13 of the 1993 Act requires the tenant’s notice to specify ‘the proposed purchase price’ for the freehold interest in the block and any other property to be acquired. The issue in the case was whether the lessees’ s13 notice was invalid if it specified a proposed purchase price that was unreasonably low.

This involved the Court in a consideration of two questions; whether there was any valuation test for a valid s13 notice and, if so, whether it is an objective test or whether it is a subjective one based on bona fides.

The Court considered two Court of Appeal authorities on the issue. In Cadogan v Morris [1999], the Court of Appeal considered that the figure proposed had to be a ‘realistic figure’ but declined to consider further how such a figure might be recognised. In 9 Cornwall Crescent, the issue concerned the validity of the landlord’s counter-notice to which different criteria applied, but Mann J considered that all three judges had considered that there were some restrictive criteria when proposing a premium to be paid in a s13 notice.

Mann J considered that it would be wrong for him to depart from these authorities. He considered, therefore, that there was a valuation test for a valid s13 notice.

The learned judge then undertook a detailed consideration of the judgments of the Court of Appeal in the Morris and 9 Cornwall Crescent cases. He concluded that neither case supported an objective test based on valuation evidence. If such a test was imposed, the courts might well be required to embark on a time consuming and expensive valuation exercise at a preliminary stage of the proceedings to identify whether the proposal in the s13 notice was within a reasonably accepted range of premiums for the property before a similarly complex and expensive valuation exercise would take place before the first-tier tribunal to determine the actual premium to be paid. This cannot have been what Parliament intended by the use of the word ‘proposed’.

The landlord submitted that the correct test was whether the figure proposed was one which the lessees genuinely believed could be a purchase price calculated pursuant to Schedule 6 to the 1993 Act. Mann J felt that this was overburdening the word ‘proposes’ as it would require the lessees to at least attempt to carry out a valuation exercise under the Act before serving their notice.

The lessees contended that the proper test was whether the proposal in the s13 notice was a genuine opening offer as opposed to a nominal figure. It must be genuine in the sense of being advanced as a bona fide offer which would be seen by a reasonable landlord as a real offer. The lessees do not have to believe that it will or even might be accepted. The learned judge preferred this test considering that it was more consistent both with the wording of the 1993 Act and also with the previous authorities.

It does leave one anomaly, however. It is well established by the decision of the Court of Appeal in Willingale v Globalgrange [2000] that if a landlord fails to serve a valid s21 counter-notice to the lessees’ s13 notice, the lessees are entitled to have the freehold transferred to the nominee purchaser on the terms contained in the s13 notice including the proposed purchase price. Clearly, if the purchase price in the initial s13 notice need be no more than a price which is inserted in good faith and not nominal, the consequences for a landlord’s failure is significantly higher than if, for instance, the figure had to be justified by valuation evidence. Mann J reflected that while this was a concern, the test reflected the proper balance between the interests of the landlord and the lessees; the landlord would not be forced into selling for a ‘stupid price’ and the lessees could commence negotiations at what was seen by them to be an appropriate figure.

The Dolphin Square claim was held to be a valid claim. At present, it is unclear whether an appeal will be launched.