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In this week's round up we consider a recent case concerning the recovery of legal costs under the service charge in a residential lease and enfranchisement as an investment opportunity. We have also included a refresher summarising the steps currently available and the latest restrictions applicable to the recovery of commercial rent arrears. As always, we conclude with some much needed positive news together with insight from around the firm.

Legal costs recoverable under residential service charge?

The Upper Tribunal has confirmed, in the case of Eshraghi & Ors v 7/9 Avenue Road (London House) Ltd v Ltd [2020] UKUT 208 (LC), that legal costs incurred by the landlord of a block of flats were recoverable from the leaseholders under the particular service charge mechanism in the residential lease.

The case was brought under section 27A of the Landlord and Tenant Act 1985 by the current and former leaseholders of three flats in a block in St John's Wood, London and concerned service charges payable in 2016 and 2017 in connection with three areas:

  1. The costs of litigation between the landlord and individual leaseholders which had been paid from funds held in the service charge reserve account;
  2. The costs of professional services provided to the landlord by accountants and managing agents; and
  3. Consultation in relation to proposed works to the common parts and lift.

An application was made to the First-tier Tribunal (Property Chamber) by the leaseholders for the issues to be determined. On the first issue, the First-tier Tribunal found that it had no jurisdiction to consider an allegation of breach of trust. In relation to the other two issues, it held that "the recovery of these legal fees would in our view fall within what a reasonable person would have understood the parties to mean" when interpreting the lease wording. It held that the landlord was therefore entitled to recover these costs by way of the service charge.

The leaseholders appealed to the Upper Tribunal (Lands Chamber) who considered the first two issues and allowed the appeal in part. The Upper Tribunal was clear that it had jurisdiction on the first issue and allowed the recovery of costs in connection with a dispute over the appointment of directors to the management company until a specified date by which the identity of those in charge was agreed. Until this point, the Upper Tribunal noted that the resolution of the matter had been in the interests of good estate management. The Upper Tribunal further held that the landlord's legal costs of defending litigation relating to breaches of its disrepair covenant and, separately, claiming payment of unpaid service charges were recoverable costs associated with the proper management of the building. On the second issue, the disputed costs were allowed subject to some minor adjustments. The third issue was not considered.

A service charge dispute will turn, in part, on the wording of the service charge provisions in the relevant lease and these should be closely reviewed by landlords and tenants when considering whether a charge can be properly recovered. In this case, the landlord successfully relied on the "sweeper" provision to recover costs found to have been incurred in the interests of good estate management.

Landlord & Tenant FAQs – Refresher

At the beginning of the Coronavirus lockdown, we discussed some frequently asked commercial landlord and tenant questions surrounding options to recover rent arrears. Much has changed since then and here is a refresher of steps currently available to commercial landlords, along with the key restrictions and their relevant deadlines (these may be extended further or altered by the government in the coming months):

Steps currently available

  1.  Rent concessions / constructive dialogue – there are many cases of landlords and tenants working together to find a way through the financial difficulties caused by the pandemic and, in some cases, agreeing concessions in return for the extension of the lease term or the removal of a tenant break right so that the immediate pain is shared and there is an upside for the landlord. The government's voluntary code provides a structure for such discussions.
  2. Letters before action – landlords can chase for the payment of arrears and seek to open a dialogue through a letter to the tenant noting the current arrears and seeking payment, failing which further action may be taken.
  3. Court proceedings – landlords remain able to issue Court proceedings to claim the payment of arrears or pursue other breaches of tenant covenants.

Current restrictions

  1. Moratorium on forfeiture – the Coronavirus Act 2020 prevents landlords from exercising a right to forfeit a lease on the basis of a tenant's non-payment of rent during the period from 26 March 2020 to 31 December 2020. A landlord is still entitled to take steps to forfeit based on other breaches which give rise to a forfeiture right under the lease, subject to service of a section 146 notice and arguments as to waiver;
  2. Statutory demands - there is nothing preventing the service of a statutory demand but these are currently rendered "toothless" as no corresponding winding up petition can be presented for an unpaid demand served from 1 March 2020 until 31 December 2020;
  3. Winding up petitions – a "financial effect" test has been introduced meaning that petitions can still be brought in respect of a statutory demand served prior to 1 March 2020 or on the basis the company is otherwise "unable to pay its debts" but only if the creditor has reasonable grounds for believing that coronavirus has not had a financial effect on the tenant company or that the tenant company would have been unable to pay its debts regardless of the financial effect of coronavirus. A statement made by a creditor on this basis will be considered by the Court when deciding whether to allow a petition to be issued;
  4. CRAR – Commercial Rent Arrears Recovery i.e. the new form of distress using bailiffs to recover rent arrears – changes have been introduced to safeguard against aggressive rent collection tactics. As at 29 September 2020, CRAR cannot be used unless an amount equal to 276 days' rent is overdue and this is set to increase to 366 days' rent from 25 December 2020. Essentially, this means that action can only be taken if the arrears include sums that fell due pre-lockdown and, even then, if the tenant were to pay off the older arrears the overall amount due may be reduced to a level where the threshold restrictions "bite" preventing any further recovery;

Enfranchisement as an investment opportunity

Collective enfranchisement is the right of leaseholders to force the sale of the freehold of their block of flats. It is a right that has become increasingly prominent and utilised.

Enfranchisement claims are often in need of additional investment, usually due to a number of leaseholders not participating in the claim or there being a particularly valuable area of the building such as a basement or roof space which has not been demised under the leases. These elements of a building need to be acquired by leaseholders participating in the claim as part of the freehold. In some cases outside investment will be required to fund the acquisition of these areas. This can be an attractive opportunity for a developer or investor, who would take a lease or headlease over the area or non-participant's share in the claim, in exchange for funding the relevant element of the premium payable to the landlord.

Some cases will see the leaseholders fund the additional shares, or investors owning multiple flats in a block with an appetite for further investment in the building. Such investment can be complicated by the enfranchisement qualification criteria, which excludes leaseholders who own more than two flats, this exclusion including ownership by group companies.

The Law Commission proposals for reform of enfranchisement include the removal of the multi-ownership restriction, which will be welcome news for those looking to obtain the freehold of a building through the ownership of a number of leases. This may bring an expanded element to enfranchisement claims for investment purposes.

If you would like more information or have any questions about enfranchisement in general please contact our enfranchisement specialist, William Bethune.

Insights from around the firm:

 Positive news:

  • Kenya is experiencing a boom in the number of baby elephants being born and now has double the amount of elephants it had 30 years ago. The increase is thought to be due to increased rainfall in 2018, as elephant pregnancies last up to 22 months!
  •  A dog named Dou Dou accidentally left at a petrol station in China has been reunited with its family a month later, after it found its own way back home, 37 miles away. Although skinny, Dou Dou is said to be very well.
  • Scientists have found a coral reef taller than the Empire State Building (500m high) this week. The new reef is the first of its kind to be discovered in over 100 years.