Understanding the right of first refusal

Ellie Crofts, legal director in the Property Dispute Resolution team at Lodders explains the right of first refusal process, which premises qualify, and the consequences of breaching the provisions of the right.

The long leasehold sector is heavily regulated by statute, and it can be easy for the unwary to fall foul of the rules.

Right of first refusal

Where the landlord of a block of flats intends to dispose of their interest in the building, they must first, by law, offer it to the tenants. This involves the service of formal notices under the Landlord and Tenant Act 1987, which provides specific information to be included, such as the purchase price and what is included in the sale. The tenants must be given at least two months to respond, and the landlord cannot sell the property in that time. Breach of the statutory provisions is a criminal offence, so it is very important landlords are aware of their obligations.

Qualifying criteria

Not all buildings are subject to the right of first refusal. To qualify, a block must meet certain criteria:

• It must contain at least two flats, and
• no more than 50% of the block can be for non-residential use, and
• at least 50% of the flats must be owned by qualifying tenants.

A qualifying tenant is a leaseholder under either a long lease, fixed or periodic tenancy. The tenants of shorthold tenancies, business, or agricultural tenancies or those tied to employment do not qualify. Someone who owns three or more flats in the same building is also excluded from the right of first refusal.

The right of first refusal does not apply to registered social landlords, housing authorities including local councils, and most charitable housing trusts. The obligation also only applies to the immediate landlord of the tenants; this may be the freeholder, or it could be a superior leaseholder.

The next thing to consider is whether the landlord’s proposed disposal is caught by the legislation. Most disposals, such as sales of freeholds or the grant of a superior lease over the flats, will be caught by the Act. However, landlords are not required to serve notice where they are obtaining a mortgage, granting a lease of a single flat, or if they transfer the freehold to an associated company, for example to a parent company with which it has been associated for at least two years.

Property sale

Next, the landlord must decide how they intend to sell the property. The two most common methods are by private sale or by auction. In both cases, the landlord must serve notice on the tenants, but the form of notice is a little different.

Private sale

In the first case of a private sale, the notice must include the price and any other terms of the sale. The tenants must have a period of at least two months to respond to the notice and, in order to force the sale to the tenants, at least 50% of the qualifying tenants must accept the offer.

If an insufficient number of tenants accept the offer, then the landlord is free to sell to whomever they please, providing that they don’t sell for a lower amount than stated in the notice. What sometimes happens is a landlord will offer a freehold to the tenants for £50,000, for example, but fails to find a buyer. The landlord may receive a lower offer of, say, £40,000, but the landlord cannot accept this without first offering the freehold to the tenants again, at the lower price. Therefore, practically, a landlord selling by private sale will market the property and get an offer first, before then serving notice on the tenants.

If the tenants accept the landlord’s offer, then they have a further two months to nominate the purchaser, which is usually either one of the individuals or, more commonly, a specially incorporated management company.

Auction

In the second case, where the property is sold by auction, the landlord cannot include the sale price as this will be set when the hammer goes down. Therefore, the tenants must accept the offer without knowing the purchase price. If the tenants do not wish to purchase for the price achieved at auction, then they don’t have to accept the contract, but they will be liable for the landlord’s reasonable legal costs of the right of first refusal procedure.

Breach of the Act

It is a criminal offence for a landlord to not follow the statutory procedure without reasonable excuse. Even though the relevant legislation has been in force since 1987, there is still very little case law about what is a reasonable excuse for failing to comply with the Act. The safest thing to do is to follow it carefully.

Breaching the Act doesn’t mean that a landlord will end up serving time. In fact, the penalty for a breach of the Act is a fine. For offences committed before 13 March 2015, the maximum fine was £5,000. However, the Legal Aid, Sentencing and Punishment of Offenders Act 2012 made this fine unlimited for offences committed after 13 March 2015.

Even if a landlord is found guilty of breaching the right of first refusal by selling to a third party without first offering the freehold to the leaseholders, the sale to that third party remains valid.

Information notices

Section 11 of the 1987 Act allows tenants to serve an information notice on the purchaser of the property, seeking information on the price paid and the extent of the interest sold. The information notice must be served within four months of the purchase and must be served by the “requisite majority for the tenants of the constituent flats” which equates to 50% of the qualifying tenants.

The purchaser must reply within one month with the information requested. If they fail to do so, Section 19 of the Act allows the tenants to bring court proceedings to enforce the purchaser’s obligations.

Purchase notices

The tenants can also require the purchaser to sell the freehold (or any other interest transferred) to the tenants by serving a purchase notice. If an information notice has already been served, the tenants have six months to serve a purchase notice; otherwise, there is no deadline for a purchase notice.

Where a purchase notice is served, the purchaser must sell the property to the tenants for the same amount that they paid. If the transfer was made for no consideration, then the tenants get the property for free. Again, if the purchaser fails to complete the transfer, the tenants are able to issue court proceedings to enforce the sale.

Ultimately, anyone purchasing the freehold of a block of flats should always check that the landlord has already offered it to the tenants; otherwise, the ownership could be quite short-lived.

Key takeaways

In summary, right of first refusal is not a means of forcing a landlord to sell its freehold interest; it is simply an opportunity for tenants to purchase that interest before it is sold on the open market. The landlord can withdraw from the sale at any point prior to the exchange of contracts, even if notices have been served and the offer accepted.

The right of first refusal does not provide an opportunity for tenants to negotiate the sale price or terms. The landlord sets the price, and it cannot be determined by a court or the First-tier Tribunal. However, if the tenants do not accept the offer, the landlord cannot sell its interest to another party on different terms or at a lower price than that originally offered unless he again offers the right to the existing tenants on the new terms and/or at the lower figure.

If a landlord fails to comply with the statutory requirements, it is not only a criminal offence punishable by an unlimited fine, but the tenants can force a purchaser of the landlord’s interest to sell the interest to them for the same price.

Advice regarding right of first refusal

Ellie Crofts specialises in all property-related disputes and long leasehold issues, including service charges, the right of first refusal, Section 20 consultation, lease extensions and enfranchisement.  Ellie’s expertise extends to commercial landlord and tenant work, including a particular specialism in lease renewals under the Landlord and Tenant Act 1954.

For advice regarding the right of first refusal, please get in touch.

This article is part of a three-part blog series, exploring some of the key issues affecting the long leasehold sector. Read about navigating the service charge here.