news | 1 month ago | Charmaine McQueen-Prince, in-house counsel at Homeground Management

The unintended consequence of the Leasehold and Freehold Reform Bill: the risk of landlord insolvency

The Leasehold and Freehold Reform Bill was introduced to the House of Commons on 27th November 2023, with the aim of improving homeownership for leaseholders living in England and Wales.

The bill contains several high-profile provisions, including a ban on the sale of new leasehold houses; restrictions on leaseholders paying landlords' legal costs; replacement of insurance commissions with administration fees; and many more. However, this article focuses specifically on the bill’s more complex enfranchisement (lease extension and freehold acquisition) and ground rent buy-out provisions.

The government has decided to reform the enfranchisement and the valuation process to make it easier and cheaper for leaseholders to extend their lease to 990 years or acquire their freehold, while also enabling certain leaseholders to ‘buy out’ of their ground rent without entering into a lease extension. These provisions will result in leaseholders paying a reduced premium and benefitting from extended leases, as well as a massive transfer of wealth.

When we consider the reform of enfranchisement and ground rent, there are three important stakeholders: landlords, leaseholders, and lenders — and each will have their own view on the proposed reforms. 

Landlords are seriously concerned by the proposed reforms, firstly by the significant loss of income and the reduction in ground rent value. According to The Residential Freehold Association (RFA), £15bn could be wiped off pension funds, landlord property portfolios will take a significant hit and companies may be forced into insolvency. The government admits in its own impact assessment the loss is likely to be in the region of £27.3bn. Based on this, we predict that landlords will likely take legal action against the government for what they consider to be unprecedented interference and abuse of their property rights.

Initially, many leaseholders are likely to view the proposed reforms as well overdue, granting the opportunity to own their home and have full management control over their block. They’ll also relish the potential demise of ground rent, which works out at an average of £298 per annum, according to government figures.

We have seen lenders recently raise concerns about levels of ground rent, complexity and frequency of rent review clauses, as well as the potential risk to their security. However, it’s highly unlikely that those lenders would support the insolvency risk to landlords and are likely to support a more temperate approach to reform.

What would be the impact of an insolvent landlord?  

For a block subject to two-party leases, the landlord and tenant relationship would grind to a halt, and the former would be unable to carry out its obligations. Contracts governing everyday functions, such as buildings insurance, lift maintenance, fire alarm maintenance, cleaning etc. would likely be terminated, and repair and major works/remediation projects would likely stop. Managing agents would step down if insolvency is a termination event in their contract — even if it isn’t, there’d be no client to provide instructions.  This would negatively impact levying service charge demands and issuing year end accounts.

Leaseholders would be trapped, unable to sell or remortgage their property.  All lending transactions are likely to go on hold and anyone with a mortgage is likely to be in breach of their mortgage agreement — through no fault of their own — if building insurance is terminated. The processing of transactional and administrative documents, such as notices, deeds of covenant, landlord certificates, and leaseholder deeds of certificate, will stop. 

Leaseholders will essentially be on their own, without the services they rely on and with very limited options.  When considering options, leaseholders might choose to:

  1. Spontaneously manage their building — this is a problematic option especially if it’s a higher-risk building. There would be no obvious principle accountable person (PAP) and even if the building wasn’t higher-risk, leaseholders may not want to take on the management responsibility. A government report confirmed not all leaseholders want to manage their blocks — let alone manage in a landlord insolvency situation. 
  2. Make an appointment of manager application (AOM) to the First-tier Tribunal (FTT) together with their former managing agent. This could take anywhere between three to six months depending on the FTT, while liquidators make decisions about the insolvent landlord’s title and other assets which could also take six to twelve months. If a higher risk building had a building safety defect, perhaps leaseholders could ask the Building Safety Regulator to make an application to the FTT for a special measures manager (SMM), but again, this will take time.  Higher-risk buildings without a defect may be in limbo because an FTT appointed manager can’t be a PAP.
  3. Purchase their insolvent landlord’s title which will depend on the leaseholders’ finances and legal advice. It may be that leaseholders do not want to purchase the title because of the potential problems and liabilities — company operating costs, legal costs, building safety costs — not covered by the service charge or the income stream which will be depleted by the bill.   

To avoid landlord insolvency, the government should collaborate with landlords, lenders and other industry professionals to help achieve the reform required and avoid sending landlords to the wall, legal titles vesting in the Crown and crippling the leasehold property market. The government must prioritise sensible reform, which respects legitimate property rights, regulates managing agents and increases service charge transparency to ensure the Leasehold and Freehold Bill improves homeownership for leaseholders.

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