So you’ve bought your freehold, getting it right

Much has been said about the Government’s current policy of encouraging the building of more homes in order to turn a “generation of renters” into a “generation of buyers”.  While the current emphasis is on shared ownership properties, successive changes in legislation over the decades, have enabled tenants of long residential leases to take ownership through collective enfranchisement. 

Practicalities of ownership

In the rush to take advantage of this, little attention is often given to the practicalities of owning the freehold; the relationship between lessee and freeholder; and what happens when it goes wrong.  This is surprising given that purchasing a home is one of the biggest financial commitments we make and such failures often result in hefty legal fees and a breakdown in communal relations.

Tenants either acquire the freehold in their individual names (provided there are no more than four) in the case of house conversions or smaller properties or, more commonly, through a freehold company.  Whatever the purchase vehicle the importance of a properly drafted instrument setting out the obligations, voting rights, what happens in the event of a dispute or conflict of interest, or when one party assigns their interest in the property, is often overlooked. 

It is a common misapprehension that, because tenants own a share of the freehold, this entitles them to do what they want without proper adherence to their contractual obligations under the lease and/or their fiduciary duties. 

This distinction between the lessee’s obligations - namely occupying within the terms of a lease - and the same lessee’s duties as a director or trustee can become blurred.  It is not unusual for directors or trustees to exercise decision making in a manner detrimental to the others, whether it is by authorising expenditure to enhance the value of their own flat or by not carrying out works of essential repair which impact on the value of the freehold.  As the freeholder, the overriding obligation is to preserve the main asset and its value, while a lessee will want to rely on the rights and protections afforded under the lease and statute to curtail, in some circumstances, the freeholder. 

How does conflict start? 

Most frequently conflict arises where there are equal numbers of lessees, each owning an equal share of the freehold and each having the same voting rights.  It is often the case that since acquiring the freehold, the informal management of the block has been implemented without issue.  Those lessees with the inclination to take on the administration of the day-to-day management of the block do so frequently on an ad hoc basis with a view to limiting the cost.  This can mean that the property is not managed properly and compliance with regulations or statute can be overlooked.

Under such an informal arrangement, any changes to individual flats, including the removal of carpets, alterations to layout or extensions are often done by way of informal consent without reference to the lease terms and are often not documented. Indeed, you may ask, why not if it has worked in the past? 

This is all fine while harmony reigns.  However, experience shows that conflict arises when one lessee assigns his share in the freehold to a new entity, in particular an owner investor who does not reside in the block and who has different objectives and as such proves difficult to work with.  The absence of a proper instrument dealing with the effective management of the block or co-operation means that the simplest issue can escalate and result in the breakdown of the status quo.

Too little, too late

Without formality, works are often not supervised or approved by a surveyor/structural engineer appointed on behalf of the freeholder; fire and other safety regulations are overlooked and in some cases the works can impact on the structural integrity of the remaining flats and the building itself - all of which can impact on the validity of the building’s insurance.  The removal of traditional sound insulation materials like lathe and plaster walls or replacing carpets with wooden floors may cause a noise nuisance to other occupiers.  Similarly the appropriation of areas outside a lessee’s demise whether it is a bin storage area, communal parts, a basement or roof space can raise issues of trespass and infringe on the rights granted to other lessees. 

Disputes almost always involve an analysis of the management of the property, compliance with company law and the legislation governing the recoverability of service charge from lessees and non-compliance allows the objecting lessee to avoid liability.

These are just a few of many examples of when a recalcitrant and bullish lessee can upset the status quo. This can place the remaining lessees in the unenviable position of having to fund litigation in order to either compel compliance or allow the breaches and/or nuisance to continue, particularly where the freehold entity has failed to maintain a reserve fund to meet such costs.  Matters are complicated further as often a prejudiced lessee (who is also part of the freehold entity) may have to sue the freehold entity (and himself) in order to require the offending lessee to comply with its lease obligations.

Legal advice is often sought when it is too late and, regrettably, once relations have broken down.  It is always difficult to try and unravel the situation and it is advisable to obtain clear guidance on the freehold structure, its management functions and in particular the obligations and fiduciary duties of the trustees, directors and shareholders both under the lease or statute before conflict arises.  

Getting it right from the start

A properly drafted instrument, whether it is a trust deed or articles of association/shareholders agreement, should set out clearly the decision making procedure, whether it is by simple majority or unanimous consent.  Careful consideration should be given to the number of trustees or directors to ensure that there is no deadlock in the voting structure and whether there is a Chair with the casting vote.  Share allocation should also be considered, including whether it is determined on size of flat or on the number of flats owned by a lessee.  The document should deal with other provisions, such as how service charge funds are to be held, whether the voting arrangements need to be changed for expenditure over a certain amount and how any consents required under the lease, ie for alterations, are granted. 

It is advisable to hold proper and regular meetings, to maintain meeting minutes and resolutions so that matters are dealt with transparently.  Legal advisors, accountants and a surveyor should be appointed to represent the freeholder in dealing with all matters arising under the leases, and it is sensible to have a set of regulations governing the use of occupation of the flats.  Above all, communication is key.  Owning the freehold is a big investment both in terms of cost and energy and it works well if the freehold is run effectively.

Lara Nyman is a Partner in the Howard Kennedy Real Estate Dispute Resolution team.