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Law Commission backs commonhold? It’s not that simple for leaseholders

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The long-awaited report by the UK Law Commission, which was supposed to deal with the iniquities of Britain’s leasehold property system, is out. Badly put-upon leaseholders, particularly in a post-Grenfell Tower environment, were placing much hope in the commission recommending a system that removes freeholders and lets leaseholders administer their own blocks – commonhold.

But has the Law Commission really backed commonhold (where a block is owned by the people leasing the  flats in it rather than a possibly distant entity known as a freeholder) as a replacement for leasehold? It has set out the issues, proposed ways of making commonhold “work”, and is full of words that give the impression of a strong statement, but the reality is that it in effect concedes the matter will be a political decision. The Commission knew the Government wanted something on commonhold – but also knew it didn’t want to go all the way. The biggest omission is to do with whether commonhold should be the sole form of tenure for owning flats henceforth. The Law Commission hedges around the question.

The problem with leasehold (owning a flat on a lease for a period, often initially set at 99 years though some can be as much as 999 years) from the point of view of leaseholders is basically that the flat is a wasting asset. This means the lease has to be regularly extended ie extra years bought to keep it above the 80 years when costs of extension rise rapidly and it risks becoming unsaleable and unmortgageable (see this on marriage value). There is also ground rent and an unsatisfactory system of deciding on maintenance for the common parts and updating the fabric. The post-Grenfell situation is only the most egregious example of where this can go horribly wrong, with leaseholders vastly out of pocket. It’s a legal minefield and a lawyers’ field of gold.

This diagram in the Law Commission report: Purpose of leasehold offers a rather cosy view of the leasehold system with leaseholders’ and freeholders’ interests in the same building apparently nicely balanced. Leaseholders get safety, shelter, privacy and a capital asset (as long as they keep extending the lease); the freeholder gets a capital asset, income from permission fees (for works the leaseholders do on their own flats), ground rent payments, lease extention payments and administrative fees. So you can see the problem, particularly when, for the most part, the freeholder can charge legal expenses to the leaseholder for garnering these juicy financial benefits.

This, the Commission says, has given rise to “concerns that the tenure has too readily facilitated the extraction of excessive monetary payments from those leaseholders”. It adds that “the landlord and leaseholder have opposing financial interests – generally speaking, any financial gain for the landlord will be at the expense of the leaseholder, and vice versa”.

Commonhold takes the freeholder out of this unequal equation. In theory a developer would simply build the block and sell each unit (freehold) to include a stake in the common parts of the building (through a “commonhold association”) – and all the duties of mainenance and management that go with it. A democratically elected management group then runs the place or gets professional managers in.

This system has been available since 2004, but it has not taken off (it is thought there are fewer than 20 schemes), not least because it is not something freeholders would want – they lose those profits down the line based on ground rents but mostly all the other, often opaque, payments leaseholders have to make.

Commonhold – the Law Commission stance
The Law Commission was given the brief to, as the report’s title suggests, “reinvigorate” commonhold. It sets out the objections to leasehold (as perceived by leaseholders) while also explaining there is “a good legal reason” why flats are mainly held leasehold – to do with passing on maintenance obligations down the years. It adds:

“The concerns set out above lie against a background, generally speaking, of leasehold purchasers not understanding what leasehold ownership involves.”

This smacks a little of victim-blaming, though it is, of course, true that you would have to have some quite profound level of expertise in property law to really understand the implications of buying leasehold. That’s the essence of the problem, along with the fact, acknowledged in the report, that there is usually no choice for those buying a small home in a big city.

The advantages of commonhold are set out in the report:

(1) it allows a person to own a flat forever, with a freehold title – unlike a leasehold interest, which will expire at some point in the future;
(2) no ground rent is payable;
(3) it gives the homeowner greater control of their property than leasehold; and
(4) it is designed to regulate the relationship between a group of people whose interests are broadly aligned. That is in stark contrast to the leasehold regime, which has to attempt to balance and regulate the competing interests of landlord and leaseholder.

There is a strong passage (1.37 et seq) on the need for a cultural change to bring about acceptance of commonhold (the commission’s suggestions why this hasn’t happened so far are set out below). But the report balks at suggesting leasehold be done away with for modern developments, saying instead: “our recommendations about commonhold are aimed at creating a workable alternative to leasehold ownership, with a view to its widespread use in the future”. [Emphasis added]

One has to ask, why? Why not go further and abolish new-build leasehold, unless there are really good reasons for it in individual cases? And dismantle the current leasehold system (over a reasonable period with reasonable compensation for freeholders) so that quite speedily the assets are transferred to leaseholders? The reason why is that the Government wouldn’t wear it. It wants “choice” and a situation where two competing tenures do the same job.

Comment
The Law Commission’s terms of reference extended to promoting “transparency and fairness” in the leasehold sector and providing “a better deal for leaseholders as consumers”. Its terms of reference did not extend to a radical overhaul of the system. They “indicate a policy conclusion reached by Government that the leasehold system in its current form is not a satisfactory way of owning homes” [emphasis added] – so leasehold shall have a different form rather than be swept away. The report says:

“We would go as far as to say that it [commonhold] should be used in preference to leasehold, because it overcomes the inherent limitations of leasehold ownership set out above. But commonhold can only replace leasehold if it is workable in practice.” [Emphasis in the original].

The reforms proposed in the report include perfectly good ideas such as making enfranchisement easier (ie purchasing the freehold of a block by leaseholders) with reduced premiums; similarly with lease extensions; better regulation of property agents; “consideration” of the reform of the regulation of service charges, permission fees, and legal costs; reviewing the possibility of abolishing forfeiture (when the leaseholder loses the flat because of a breach in the lease) [1.96].

On commonhold it says only 50% of leaseholders (rather than unanimity) should be required for conversion of blocks to commonhold – though this leads by a complicated route to a charge being put on the flats of the non-consenting leaseholders to pay their share of the  compensation to the freeholder. This suggests that untangling the leasehold system is a complex and messy matter. The report acknowledges that:

“Based on the evidence that we have gathered during our projects, we have concluded that commonhold will not be used unless (a) it is made compulsory, or (b) adequate incentives are put in place to make it more attractive to developers than leasehold (or conversely that leasehold is disincentivised sufficiently to makes it less attractive than commonhold). Commonhold will not take root on its own.”

And that is the point. More is needed than “shoulds” and “alternatives” and “preferables” and “workables” and “choices” – particularly given, as the report accepts, potential leaseholders lack the knowledge to really understand what they are buying in to. Offering simply alternatives in a “workable” system (which amount to a choice of leasehold for cheaper upfront costs but we’ll fleece you later; or commonhold where we’ll sell you a freehold – but it won’t come cheap) still leaves all the cards in the hands of developers and the continuing freehold regime.

Leaseholds need to be squeezed out of the system to give purchasers a truly “better deal”. The Law Commission believes its reforms will lay the groundwork “so banning the use of leasehold for flats becomes a realistic possibility”. But it goes no further because it knows the Government will go no further. It lays out the options [see below], suggests the possibility of making commonhold compulsory, but puts the matter in the Government’s court. And there the ball is likely to lie, unplayed. 

Twitter: alrich0660

More property law material can be found on this blog here, including various pieces on the ramifications of the Grenfell Tower disaster for leaseholders.
Note: The government has now responded to the Law Commission report with a promise of legislation. This would:
• offer statutory lease extensions of 990 years with no ground rent (as opposed to 90 years now);
• abolish marriage value and replace it with a formulaic valuation system on which to base payments to freeholders for lease extensions;
• set up a Commonhold Council with landlord, leaseholder and government representation to prepare the ground for greater use of commonhold, ie to “reinvigorate” a largely moribund option (see reasons below).

The marriage value issue will be a knotty one. This is the additional market value of the lease if it has a 99-year lease extension as opposed to (say) a lease that has fallen to 75 years. The press release says this:

“The government is abolishing prohibitive costs like ‘marriage value’ and set the calculation rates to ensure this is fairer, cheaper and more transparent.”

This suggests a misunderstanding of marriage value. It is not just an arbitrary cost, but arises naturally from the added value of the property with the added years of the lease. Under the statutory scheme marriage value it discounted down to 80 years (ie you don’t have to pay it when extending a lease by 99 years). Clearly extending a lease by 990 years would theoretically attract a large marriage value – but applying no marriage value, or merely a notional value, would be tantamount to denying the freeholder a significant element of their property rights.

Indeed, keeping a freeholder from their property for another 990 years is itself tantamount to to dispossession, albeit accompanied by a payment (which normally would be the current value of future rights foregone ie the right of the freeholder to take back the property or to benefit from payments for further lease extensions). There is likely to be some wrangling about what would be fair compensation, so the promise of a fairer and cheaper system for leaseholders may be some way off yet (the government is prioritising the reform of “new leaseholds” on houses, which have caused particular problems).

See the government press release here.
Nearly Legal sees the proposasl as “the most impressive and serious proposals for leasehold reform that have been seen for a very, very long time”.

Alan Lodge offers a moderatly sceptical view of the Law Commission proposals for commonhold here.

A note on mortgagees
There are, sadly, three people in the unhappy marriage between leaseholders and freeholders. The banks that lend money to flat purchasers also have a significant interest in the properties – and consequently
are a significant barrier to reform. They have certainly resisted lending on commonhold properties, one of the reasons the system hasn’t taken off. They, of course, have an interest in the maintenance and management of blocks where they are lending money for flat purchase. Commonhold campaigners should look closely at an open letter to lenders on taking commonhold as security  attached to the report, which offers a perhaps rather draconian solution.

One problem mortgagees see in commonhold is when a minority of commonholders fail to stump up the money for shared costs of the block, damaging the interests of other flat (or “unit”) owners – and their lenders. Originally the Commission suggested the other unit owners would have a first charge on the defaulting owner’s flat – but lenders pointed out the damage to their interests if they are bumped down the queue of creditors if the flat owner also defaulted on the mortgage. So the Commission came up with this:   

“Instead of a charge, we recommend a new power for the commonhold association, subject to a number of safeguards, to apply to court for the sale of a defaulting owner’s unit in order to recover arrears.”

That might raise all sorts of worries for minority unit-holdrs who don’t get on with other holders. It’s not quite forfeiture, but it is quite a significant power in the hands of majority unit-holders.

Mortgagees would also get the right to apply to property tribunals to appoint professional directors to management committees in cases where there is a “failure to keep the building in repair, to insure it properly, or to keep sound finances”. This the Commission calls “a significant new tool for lenders to protect the value of their security”.

Commonhold associations will be required to take out public liability insurance, have reserve funds, and it would be made easier for the association to recover unpaid contributions from unit owners – all in the name of lenders’ interests. In the main report there is a whole, somewhat inconclusive, discussion on enforcemnt of financial and non-financial breaches (chap 18) including regarding noise, antisocial behaviour and getting in “nuisance tenants”. The idea is raised of “local rules” in individual blocks, fines and other procedures, suggesting commonhold blocks could become sites of quasi-legal social control. Some consultees for the report were all in favour of providing the association with a power to sell someone’s flat as a way of addressing non-financial breaches [18.16]. The Commission rejects this but the fact it was proposed suggests all is not necessarily peace and love in the world of commonhold.

• On this antisocial behaviour issue and how the right to expel owners has played out in Canada, see this interesting research by Douglas C. Harris:

The problem with leasehold
In brief the problem is this: many flats and maisonettes are “bought” by leasehoders while the underlying property interest is retained by a freeholder. The leasehoder buys the right to live in the property for a period of time, often starting at 99 years but other figures are possible. Although the leaseholder has property rights such as the ability to sub-lease or sell to another individual, the flat itself is a wasting asset. It’s as well to buy extra years when the term reaches 80 years since the cost of extending the lease rises rapidly from then on (ie a “marriage value” is applied) and the flat becomes unmortgageable and unsaleable.

These extra payments (based on the, generally, rising value of the property) are a handy income for the freeholder as are charges for permissions to make internal changes to the flats (even modernisations such as putting in a shower). They are also handy income for the freeholders’ lawyers – whom the leaseholders have to pay. There is also the issue of forfeiture, when there are breaches in the lease. A classic esample is use of the building for immoral purposes, but it can also be unauthorised changes. In such cases forfeiture is rarely accepted by the courts, but payments have to be made and lawyers must receive their remuneration – all from the leaseholder. 

The other big issue, and where Grenfell comes in, is that leaseholders are (usually) on the hook for work on the fabric of the building and general maintenance. It’s in the lease, the contract with the freeholder, and it’s not surprising. Why should freeholders have this responsibility for property they have in effect sold to the people living in the flats and which they never truly expect to receive back? As like as not they have turned the flow of potential cash from their leaseholds into investment instruments and they are not in any real sense property owners at all.

Why has commonhold failed to take off?
The law Commission notes:
1.38 Various suggestions have been made as to why commonhold has not taken off.

  1. (1)  Some have suggested that shortcomings in the law governing commonhold can make it unworkable in practice and have led to a lack of confidence in commonhold as a form of ownership.
  2. (2)  Some ascribe commonhold’s low uptake to an unwillingness of mortgage lenders to lend on commonhold units.
  3. (3)  Some think that there may be a lack of consumer and sector-wide awareness of what is a relatively unfamiliar form of ownership.
  4. (4)  Others point out that commonhold remains less attractive to developers than leasehold because of the opportunities that leasehold offers to secure ongoing income-streams on top of the initial purchase price paid by the leaseholders.
  5. (5)  Others point out that Government provided no incentives for developers to use commonhold – and no disincentives to them continuing to use leasehold (for example, by removing the financial advantages for developers of selling leasehold flats).
  6. (6)  Others suggest that the low uptake is more the result of inertia among professionals and developers. Moreover, we have been told that there is insufficient incentive (financial or otherwise) for developers of homes and commercial property to change their practices and adopt a whole new system while the existing one (from their perspective at least) does the job.

Commission tells the Government its options
Government must therefore decide:

    1. (1)  whether there should be an equivalent of the leasehold house ban for flats, so that flats cannot be sold on a leasehold basis in the future but must instead be sold on a commonhold basis. Put another way, commonhold could be made compulsory; or
    2. (2)  whether developers and other property-owners should (as is currently the case) be left to choose between using leasehold or commonhold for the sale of flats, and if so:
      1. (a)  whether – and how – the sale of flats on a commonhold basis should be incentivised; and/or
      2. (b)  whether – and how – the sale of flats on a leasehold basis should be disincentivised; and
    3. (3)  what measures it will adopt in order to overcome the other practical barriers to commonhold, in particular a lack of awareness, and caution and inertia amongst developers, lenders and professionals.

             

 

About alrich

Journalist and blogger on legal and financial/economics issues

One response »

  1. Goos post. We’re seeing similar issues in the United States.

    Reply

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