Lawyers have had their say on the potential impact that Clause 34 of the Leasehold and Freehold Reform Bill will have on landlords reclaiming litigation costs from tenants, if the bill is passed.
The bill aims to amend the rights of tenants under long residential leases to acquire the freeholds of their houses, to extend the leases of their houses or flats, and to collectively enfranchise or manage the buildings containing their flats.
Despite plans to allow residents a simpler way to acquire their leaseholds and freeholds, lawyers have questioned the potential, yet unintentional, effect the bill — and, in particular Clause 34 — could have on landlords.
Merle Wray, real estate partner at Fieldfisher, detailed the potential litigation costs that landlords face in an article she wrote titled, ‘Unintended consequences of the Leasehold and Freehold Reform Bill.’
Taking a closer look at the bill’s Clause 34, Merle explained that landlord litigation costs were not regarded as relevant when determining the amount of variable service charge.
She also noted that all contractual rights a landlord may have in respect of litigation costs would be removed, meaning litigation costs could only be recovered through an application to court or tribunal and, ultimately, a judge.
According to Merle, among those who may be affected by Clause 34 are likely to be enfranchised leaseholders and leaseholder RMT companies with limited property management companies that may rely on external legal advice that may not be recuperated.
Merle wrote: “This impact of Clause 34 brings to light how parts of the bill — designed to protect and support leaseholders — may in fact lead to significant issues for many in the residential property sector, undermining the leasehold model to a point where entire housing schemes are unsustainable to maintain.”
In cases where landlords want to pursue litigation against a leaseholder, such as for defaulting on payment of the service charge or being in breach of their covenants under the lease, typical legal fees would need to be footed upfront by the freeholder.
Speaking to BTL, Merle noted how Clause 34 may impact all landlords, rather than just institutional investors, which she said the bill was aimed at: “It would include all those leaseholders who have bought a share in their building and [have] become landlords.”
Additionally, Clause 34 may not be confined to landlords and leaseholders with a stake in the property, added Merle, but could have a trickledown effect on the general standards of the building itself.
“Landlords, particularly those who are also leaseholders, may be faced with difficult decisions about going to court for the recovery of service charges.
“Those with limited resources may be forced to scale back on the quality of repairs and maintenance and cleaning etc if they can’t effectively recover service charges and litigate to recover their costs.”
BTL spoke to other legal professionals within the BTL sector to give their take on the issue.
Juliet Baboolal, partner at Gunnercooke, highlighted that while the bill — and Clause 34 — may create a more transparent and fairer system, it could still have a negative financial impact on landlords.
“On the one hand, the clause is aimed at bringing some financial relief to leaseholders; by excluding litigation costs, leaseholders don’t have to directly bear the burden of the landlord’s legal expenses,” Juliet explained.
“It also promotes transparency and fairness. By excluding litigation costs, the determination of variable service charges and administration charges becomes more transparent and fairer; leaseholders won't have to pay for costs that have nothing to do with the services provided to them.
“On the other hand, the consequence of the clause financially impacts landlords as they have to cover the litigation costs themselves, which may put a strain on their finances.
“They may need to carefully consider their legal strategy and explore alternative dispute resolution methods to keep costs in check.
“In my view, the government needs to provide clear guidelines on what constitutes reasonable litigation costs that can be excluded from the charges — this could help landlords and leaseholders have a better understanding of what to expect.”
Juliet suggested that both leaseholders and landlords should explore other means of resolution, such as mediation or arbitration through negotiating legal fees or seeking solutions to keep costs down and encourage cooperation.
“From a practical perspective, there seems to be an issue with the courts’ capacity to deal with these claims, so landlords are being discouraged from bringing them as the costs may not be recoverable. Alternative dispute resolution is the ultimate and most cost-effective solution here and corroborates with the courts’ overriding objective.”
Abtin Yeganeh, senior associate at Lawrence Stephens, agreed the bill presented a “huge obstacle” for landlords looking to recover costs they incur defending claims.
“At present, the majority of leases contain a contractual provision that allows a landlord to recover any legal costs incurred, even where a leaseholder has been the successful party,” claimed Abtin.
“As a result, the leaseholders must apply to the court or tribunal to limit their liability and the landlord’s ability to recover costs — this often leads to one-way costs shifting and a generally unfair outcome where lessees are left to foot the bill regardless of the outcome.
“Instead, the onus is shifted and, in order to recover any sums expended in litigating matters by way of administration charges under the lease, landlords will need to make an application to the court or tribunal permitting them to do so.
“When met with an application, the court or tribunal will need to consider whether it is ‘just and equitable’ to grant an order in the landlord’s favour.
“Clause 34 of the bill should strike a balance between the rights of landlords to recover costs and the rights of leaseholders to challenge unfair and poor practices.”
Jonathan Newman, senior partner at Brightstone Law, gave his take on the bill and what it may mean for lenders and their lending appetites on such properties:
“Lending on leasehold properties carries additional complication and risk, as most bridging lenders will be aware.
“This particular proposed reform may raise concerns for some lenders.
“In practice, however, when exercising power of sale, lenders — or receivers appointed by lenders — typically seek to avoid becoming embroiled with service charge and administration disputes, if they can, and for good reason.
“So, the recovery, or non-recovery, of legal costs in such disputes is unlikely to have much bearing on the decision to lend or not; if the occurrence is low, so will be the additional risk.
“Generally, leasehold reforms tangentially feed into how leasehold properties are valued — the market will dictate the extent.”
