The Leasehold Reform (Ground Rent) Bill: opportunities and challenges

Or, how to prevent this important reform from being nobbled by monetisers in the sector …

Liam Spender is a Trustee of the Leasehold Knowledge Partnership. Personally affected by the cladding scandal, Liam is a Solicitor-Advocate and Senior Associate at Velitor Law practising commercial litigation and arbitration in the City of London. Views in this article are personal and do not constitute legal advice.

By Liam Spender

As LKP reported late last week, the government has laid the Leasehold Reform (Ground Rent) Bill before Parliament. The bill has been introduced in the House of Lords and will complete all of its stages in the Lords before moving to the House of Commons.

The bill is incredibly important. It abolishes ground rents and therefore cuts off the income stream that underpins the current leasehold system. If investors are not incentivised to buy up leaseholds for their ground rents, then this removes the risk they will appoint managing agents who see leaseholders as little more than cash cows. Once that happens there is a prospect that buildings may start to be run in the interests of people living in them, as opposed to the interests of investors who see them as little more than accounting entries.

As expected, there are already grumblings from some landlord interests that the bill is too vague to be of use.

The Lords is due to start considering the Bill in detail at a Second Reading on 24 May 2021. If all goes well, we can expect the bill to reach the statute book before this time next year. There is more information on the stages a bill passes through on its way to becoming law here: https://www.parliament.uk/about/how/laws/

The bill is likely to be amended as it makes its way through Parliament before becoming law.

This article takes the form of Frequently Asked Questions on the current text of the bill. We hope to update it as the bill goes through Parliament.

What does the new bill do?

The bill bans any landlord under most types of residential lease from demanding or receiving any monetary payment in the form of rent. The only payment a landlord will be allowed to demand or to receive is a peppercorn.

How will the new bill be enforced?

The bill gives powers to local weights and measures authorities (i.e. Trading Standards Departments) to oversee the new law. Local authorities also have powers to levy fines of up to £5,000 in addition to requiring the repayment of any prohibited ground rent. This is the same approach as adopted under the Tenant Fees Act 2019.

Enforcement by local authorities is likely to be a weak point of the law. Trading Standards Departments are chronically underfunded. It is likely most local authorities will decline to get involved, as they do in most private sector housing disputes now, on the grounds that leaseholders have civil claims they can use to recover any prohibited ground rent.

Speaking of civil claims, clause 15 of the bill give leaseholders the right to bring a claim in the First-Tier Tribunal for a declaration as to whether the lease contains any term relating to a prohibited ground rent. The provision does not make clear that the landlord would have to refund any prohibited payment. The drafting should be improved to require an order for repayment plus interest.

At least in relation to new leases, conveyancing solicitors are likely to owe a professional duty to check whether the lease terms meet thew new law, when it comes into force. The easiest way to avoid a prohibited ground rent sneaking through will be to strike it from the lease wording before it is signed.

If a developer and its recommended solicitor somehow squirrelled through a ground rent on the first sale once ground rents were banned, it would impact the second sale. The solicitor for the buyer would be under a duty to note the clause which, in turn, would inevitably reduce the price the second purchaser would offer, and then give rise to a potential action against the solicitor in the first sale.

Why a peppercorn and not £1?

This was an issue of controversy when the government first announced it would look at banning ground rents. The industry advocated for a ground rent cap of £10 per year but this was rejected by the government, which has opted for a non-monetary cap of one peppercorn.

Setting a monetary value would affect the valuation of the leasehold if the leaseholder wished to extend the term. The leaseholder has to pay the landlord for the loss of the ground rent income stream. A ground rent of £1 a year for 999 years does have a value and would have an impact on that calculation, albeit not a significant impact. A ground rent of one peppercorn is worthless in monetary terms and would not have any impact on the valuation of the leasehold.

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Philip Rainey QC defines a peppercorn ground rent:
https://www.leaseholdknowledge.com/wp-content/uploads/2019/01/PhilipRaineyWhatispeppercorn.pdf

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What about shared ownership leases?

Clause 5 of the bill caps the ground rent a shared ownership leaseholder has to pay in respect of the shared owner’s portion of the lease to a peppercorn. The landlord will still be able to charge any monetary amount as ground rent on the landlord’s share.

The explanatory notes to the bill say that these ground rents are already capped under the rules of shared ownership scheme (see: https://bills.parliament.uk/Publications/41517/Documents/262/5802001en.pdf)

Are there any leases which will be exempt from the ban on ground rents?

Business leases, statutory lease extensions, community housing leases and home finance plan leases are exempt.

Statutory lease extensions are exempt because they already provide for any lease extension to replace a monetary rent with a peppercorn rent.

Informal lease extensions which occur outside statutory provisions are also not subject to the new Act. Clause 6 permits informal lease extensions to continue to charge ground rent for the duration of the original term of the lease. This is another reason to be careful before agreeing to extend a lease rather than completing the full statutory lease extension process, as LKP has previously warned here: https://www.leaseholdknowledge.com/informal-lease-extensions-are-pure-poison/.

When will the new law come into force?

There is no certainty as to when the new law will come into effect. Clause 25 allows the government to name a day for the new law to be effective. The government may also name different days for different types of leases.

A different day (or different days) may also be named by the Welsh government, which will control when the changes take effect in Wales.

The only certain part is that ground rents for retirement properties will not be banned any earlier than 1 April 2023 (clause 25(4)).

Note that it will still be possible to sell new build flats with ground rents up to and including the day the new law comes into effect. Clause 1 permits leases to continue to contain ground rent provisions if the lease in question is granted as a result of a contract entered into on or before the day the new law comes into effect. New build flats are typically sold on the basis of an agreement for lease followed by a grant of lease just before the buyer moves in.

LKP has previously reported that some large developers have already removed ground rents from their leases in advance of the Help To Buy ban on ground rents coming into effect (https://www.leaseholdknowledge.com/do-not-buy-a-new-property-with-ground-rents/).

If anyone is considering buying a newbuild flat with a ground rent, they should ask for the ground rent provision to be deleted in light of the ban in ground rents coming in the near future. As above, buyers should also ask their solicitors to check the lease terms carefully to ensure there are no other ground rent-like payments hidden in the terms.

Why can’t the government abolish current and future ground rents?

If the government were to abolish current ground rents it is likely landlords would seek to challenge that under the Human Rights Act. More specifically, landlords would argue that Article 1, Protocol 1 of the European Convention on Human Rights applies because the government would be taking landlord’s property away from them. Landlords would argue that required the government to pay fair compensation to landlords for the loss of their future ground rent income. If landlords were successful in that argument, it could require the taxpayer to pay them many billions of pounds in compensation.

Won’t this create a two-tier market?

In the future, there is a risk that the millions of properties which currently carry ground rents will be valued less than new properties which do not carry a ground rent. Unless, of course, the sector succeeds in reintroducing ground rents by the back door for new properties.

That scenario is likely years away from becoming reality. It will take decades before there are millions of properties which benefit from the ban on ground rents. Until that happens it is likely there will be only a negligible effect on property values of flats which are subject to ground rents because most flats for sale will remain subject to ground rents for many decades to come.

The reforms the government has promised in relation to fixing leasehold extension prices may further reduce the risk of any two-tier market. The government has promised to implement the Law Commission’s recommendations on simplifying leasehold extensions.

Any statutory leasehold extension automatically reduces the ground rent payable to a peppercorn. If leaseholders in flats with ground rents choose to exercise the new extension rights that would put them in the same position as a flat benefitting from a ban, albeit that there may still be a substantial payment involved to exercise the right to an extension.

There is also doubt about how many properties will actually be affected by the ban. If the government succeeds in reinvigorating commonhold and synchronises the introduction of the new ground rents ban with new commonhold rules, there may be no – or very few – residential leaseholds to which the new ban would apply because most flats will be sold commonhold. We are, however, likely to see the ground rents ban introduced before any reinvigorated form of commonhold takes root.

What rents does the new bill capture?

The bill as drafted removes the lifeblood of the ground rents investment sector. There can no longer be any monetary rent in exchange for the grant of a lease. That is a problem for the sector because it runs using borrowed money. Freehold investors borrow large amounts of money (sometimes hundreds of millions of pounds at a time) to buy up the freeholds of tens of thousands of leasehold flats. Very little of the borrower’s own money is put down to secure this lending. They are able to secure lending because the ground rents are contractual terms of the leases. If leaseholders do not pay, then the flat can come back to the freeholder via the forfeiture process.

No bank will lend on new leaseholds without ground rents unless there is an equivalent contractual provision that gives a certain income stream for the freeholder. As LKP speculated last week, that could take the form of a fixed payment for arranging the buildings insurance or for appointing and supervising the managing agent.

There is some uncertainty in the bill as currently drafted as to whether such payments would be caught by the new law’s definition of “rent”. The bill does not define what “rent” means. The bill provides that no rent under a lease other than a peppercorn is permitted unless the lease is one of the types of lease excepted from the bill.

There are statutory definitions of rent in, for example, section 205(1)(xxiii) of the Law of Property Act 1925, but the bill does not cross-refer to that, or any other, statutory definition. The explanatory notes, which are not part of the bill, say that the Act is intended to capture any payment under a lease which does not impose an obligation on the landlord to provide a service.

In modern leases, and modern case law, “rent” often has a broader meaning. Many modern leases will define “rent” as including both ground rent and service charges. Some modern leases also specify separate “insurance rents” to cover the costs of buildings insurance arranged by the landlord.

It is uncertain if the bill intends to force future leases to be redrafted so that these provisions are no longer described as part of the “rent”, or if the bill is not intended to capture these provisions because they are payments for tangible services.

If the bill does intend future residential leases to be redrafted so that only the peppercorn ground rent is described as “rent” than that would be welcome. Nowadays, where the right of forfeiture is severely curtailed, there is no good reason why the service charge and payments toward insurance need to be described as “rent”. Landlords’ continued preference for describing these items as rent in the lease is two-fold. First, to ensure that they can avail themselves of the right of forfeiture if the “rent” as defined in the lease is not paid. Secondly, defining the service charge as “rent” means it must be paid to avoid forfeiture before a leaseholder may contest the amount charged.

Forfeiture is a draconian remedy that gives a landlord a windfall gain. Forfeiture extinguishes the lease. The landlord then gets all value in the lease, without having to give back any value above the amount the leaseholder owes. In no other branch of the law, including the law of property applied to secured lending, does a creditor get to keep the surplus value above a debt owed. Any surplus above the debt is always returned to the owner, although there may be arguments about whether the secured lender achieved the best price possible on any sale (generally the secured lender owes no duty to achieve a price that maximises the surplus available).

Landlords argue that forfeiture is essential because otherwise they would have to put up with a leaseholder not paying rent (however defined) but continuing to occupy the landlord’s property. The right to forfeiture is now so severely curtailed it rarely results in the landlord obtaining possession of the property. Nowadays tenants pay up long before any forfeiture occurs.

There are better ways of ensuring leaseholder compliance with covenants to pay than forfeiture. For example, the system could be reformed so it operated in the same way as repossession rights under mortgages. That would balance the need of landlords to ensure compliance with payment obligations without generating windfall gains. Indeed, during the passage of the Fire Safety Act, ministers did promise that forfeiture would be examined as part of the package of leasehold reforms.

If the bill does intend to continue to permit service charges to be described as “rent” but not subject to the provisions of the new law, then there may need to be some simple drafting changes to make that clear.

That clarity could be achieved by either amending the bill so it cross-refers to a definition like section 205(1)(xxiii) of the Law of Property Act 1925, or else that it includes a definition of prohibited rent as any payment in money or for money’s worth which does not oblige the landlord to provide any tangible service in return.

There is a danger that landlord interests will suggest amendments to the bill that give statutory blessing to certain types of charges, such as those that allow charges for arranging buildings insurance or for appointing and supervising the managing agent. This is what happened in the Tenant Fees Act, which contains a schedule permitting certain types of charges to tenants, such as for replacement keys. Anything that has the certainty of law behind it is likely to result in perpetuation of the current ground rent investment market.

There may also be a need to amend the bill to ensure that landlords do not create future leases with fixed service charges. Fixed service charges, as the law currently stands, includes charges which are fixed at the outset but which rise in line with a measure of inflation.

The issue with fixed service charges is that they cannot be challenged by leaseholders. For example, it would be possible to include in a future lease a payment of £200 per year rising in line with CPI inflation as a payment for the landlord’s expenses in arranging buildings insurance. It seems that such a definition, if it was not reserved as rent, would be a fixed service charge rather than a prohibited ground rent caught by the new law. It would not be possible for leaseholders to challenge that payment as the law currently stands. Such fixed charges may still be used to form the basis for secured lending against freeholds, thereby perpetuating the ground rent investment industry.

Will the new bill do anything about permission fees?

The bill as currently drafted appears not to do anything about permission fees. These are fees payable for the cost of obtaining the landlord’s permission, for example for a new pet. They may also include fees for registration of new mortgages or for subletting. They can often be excessive, with reports that a new pet permission can be £200 or more per pet. There is typically very little work involved in considering and granting an application for permission. Usually, it involves merely changing a standard form so it includes the leaseholder’s name and address.

Depending on how the lease is drafted, these permission fees may be subject to regulation as administration fees. Leaseholders may be able to apply to the First-Tier Tribunal for determinations as to the amounts payable. This is an imperfect solution. For instance, the First-Tier Tribunal recently found that a landlord could charge an administration fee of £30 per ground rent demand, despite the fact that the letters were in standard form and appeared to be generated from a database (see LKP report here: https://www.leaseholdknowledge.com/now-israel-moskovitz-wins-right-to-charge-30-for-his-ground-rent-demands/).

The good news is that permission fees alone, even if they remain unaltered in the future, are unlikely to be viewed by lenders as a suitable basis on which to lend large amounts of money.

The bottom line?

The bill is a welcome and long overdue development. We should remain vigilant against attempts by freeholder interests to try and vary the drafting so as to permit ground rents by another name.