Give us a break! Just who IS the landlord when it comes to redevelopment rights?

10 March, 2013

The widely reported recent case of Kutchukian v Free Grammar School of John Lyon (2013) concerned a collective claim to acquire the freehold interest of a house divided into flats at 87 Hamilton Terrace in St John’s Wood. The Court of Appeal was faced with answering two vexed and important questions;

  • Who is entitled to exercise the right under section 61 of the Leasehold Reform, Housing and Urban Development Act 1993 (“the Act”) to bring an extended lease to an end for the purposes of redevelopment, and
  • In the event that this right is exercised, how is compensation under paragraph 5 of Schedule 14 of the Act to be assessed?

The premises were let as a whole under a head lease. Each of the flats was demised on a long under lease. As is commonly the case, the head lessee’s reversion was nominal; a mere 3 days. The under leases were extended under the provisions of Chapter II of the Act. Accordingly each extended lease was subject to a break clause. It was accepted that the premises would be worth substantially more if converted back into a house.

The right to break under section 61 is exercised by the landlord giving notice either within 12 months of the date on which the original lease was due to expire or  within 5 years of the term date of the new lease. On the earlier of these two occasions there will be two landlords; the freeholder who is also the competent landlord and the headlessee being the leaseholders’ immediate landlord. Which of them will be entitled to exercise the section 61 break?

The issue arose because section 57(7) provides that the extended lease shall reserve a right to obtain possession in accordance with section 61 in favour of the “immediate landlord”. (It is not necessary for the right to be included expressly in the lease as it is a statutory right). However section 61 itself refers only to “the landlord”.

The Court of Appeal agreed with the freeholder and held that the competent landlord can break the lease under section 61. In reaching this conclusion it had regard to the definition of “the landlord” under section 40 which is not the immediate landlord unless he has a reversion of over 90 years. Further, section 61 reserves the right to break in respect of a lease which has been granted under section 56. The obligation to grant the new extended lease under section 56 is upon the landlord. This can only mean the landlord as defined under section 40 as no other landlord will have a reversion of sufficient length.

In practice, an immediate landlord with a nominal reversion of only 3 days is not going to be able to implement a redevelopment so the right to break will be worthless as far as he is concerned. The Court was persuaded that the purpose of section 61 is to preserve the development value that the property may have had at the expiration of the original lease for the benefit of a freeholder or a leaseholder with a very long reversion.

This reasoning is consistent with the Court of Appeal’s judgment in respect of the other issue it had to consider, namely, whether the compensation payable to a leaseholder when the right to break is exercised should include a share of the increased value arising as a result of the proposed development.

Central to the argument was paragraph 5(1)(b)(ii) of Schedule 14. It provides that on a sale of the new lease it is to be assumed the vendor is selling “subject to any restriction that would be required (in addition to any imposed by the terms of the lease) to limit the uses of the flat to those to which it has been put since the commencement of the lease and to preclude the erection of any new dwelling or any other building not ancillary to the flat as a dwelling”.

The freeholder contended that this provision excludes any element of value attributable to the possibility that the building, of which the flat forms part, could be converted to a use other than the permitted use (in this particular case as 4 flats and 2 garages). The nominee purchaser disagreed and argued that as the landlord can be assumed to be among the potential purchasers on the hypothetical sale of the new lease it will have an incentive to pay more than others and the leaseholder should, therefore, be entitled to a share of the increased bid.

The Court found the nominee purchaser’s argument to be fallacious and that the deemed restriction in paragraph 5(1)(b)(ii) was imposed for the very purpose of precluding the hypothetical sale from reflecting any potential redevelopment profit. It said that the leaseholder’s compensation is for the loss of the rest of the term of the new lease and not for the loss of any redevelopment value of which he never had any prospect and which is therefore not something of which he has been deprived by the exercise of the section 61 right to break.

A decision on these points is long overdue given that the Upper Tribunal in two previous appeals had declined to address them. Indeed, even in this case the Tribunal was not persuaded that the legal issues needed to be decided (although they did express their conclusions in the event that this primary determination was found to be wrong). The Court of Appeal held that the Tribunal should have decided the legal issues rather than making an allowance in the valuation for uncertainty and applying a discount of 30%.

However, this is not the end of the story; permission to appeal to the Supreme Court was granted in March 2013. Keep your eye out for future editions and our updates on this topical case.