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Investing in mixed use developments: Tenant's right of first refusal under the 1987 Act

09 March 2022
'Driving Urban Change' is the key theme of MIPIM 2022 as investors emerge from the pandemic to consider how best to transform the spaces in which we all live, work and play to enable a more sustainable and prosperous future for all.

Mixed use developments present an opportunity for investors to consolidate and integrate such spaces; bringing well publicised advantages to investors (diversification of asset types and income sources); occupiers (enjoying shared community spaces and social interaction between people of different backgrounds, often in desirable city centre locations) and wider society (particularly the environmental benefits of reduction in the volume of transport between such spaces and a reduction of new development with the repurposing of existing buildings).

Clearly the environmental and social benefits of mixed use development are seen by the UK Government too, as evidenced by the recent planning reforms creating a new use 'Class E' (commercial, business and service) which caters for a broad range of concurrent uses and the relaxation of permitted development rights from office to residential.

However; investing in mixed use developments within the English and Welsh jurisdiction is not without legal challenges and risks. In particular, residential tenants of mixed use developments may acquire a 'right of first refusal' in relation to the transfer of a mixed used property pursuant to the Landlord and Tenant Act 1987 ("the 1987 Act"). 

Tenants' right of first refusal

A mixed use building may constitute qualifying "premises" (the word used in the 1987 Act to refer to the property being acquired or disposed of, as opposed to property subject to a tenancy). Where this is the case, a disposal of the whole or part of the premises by the "landlord" may trigger a right of first refusal for the benefit of the residential "qualifying tenants".

Where premises are mixed use, the right of first refusal will apply if the following conditions are satisfied:

  • The premises consist of the whole or part of a 'building';
  • The premises contain two or more flats held by 'qualifying tenants';
  • The number of flats held by qualifying tenants exceeds 50% of the total number of flats contained in the premises; and
  • Any part or parts of the premises are used for non-residential purposes and the internal floor area of that part or those parts (taken together) does not exceed 50% of the internal floor area of the premises (taken as a whole).

The right of first refusal mechanism for 'caught' premises broadly concerns the seller identifying all of the qualifying tenants and serving statutory notices which offer the premises to them (although there is an alternate notice procedure should the buyer choose to do this); waiting the requisite notice period (a minimum of two months); before proceeding with the transaction (selling to either the buyer or the qualifying tenants as appropriate). 

Clearly such uncertainty as to when and to whom a property may ultimately end up being sold to (not to mention the risk of misinterpreting the 1987 Act procedure) is undesirable for both buyer and seller; not least because of the potential remedies available to the Courts where a breach of the 1987 Act is found, including criminal liability for the seller and civil remedies to acquire the property in question from a purchaser or successor in title.

Strategies for mitigating 1987 Act risk

Unsurprisingly, the 1987 Act itself goes into greater detail concerning the various definitions and terminology employed. Indeed it is in these definitions and terminology that the best opportunity for managing the 1987 Act risk arises, so that the right of first refusal mechanism is not triggered on a sale of the premises. 

For example; section 2(1)(a) of the 1987 Act confirms that 'landlord' means the immediate landlord of qualifying tenants, so the legal structure of a mixed used development will often involve separate entities holding each of the freehold and a long leasehold interest in the whole of the premises and the freehold passing between buyer and seller. Similarly, the premises can be designed and configured so that the number of qualifying tenants holding flats does not exceed 50% of the total.

It is worth noting that the above strategies are most easily implemented when thought of prior to the development and letting of a mixed use building and so, may not be available to potential investors of property where the 1987 Act was not considered at the outset. Investors may therefore need to consider alternative strategies around physical alterations (for example, increasing the commercial space within premises or physically joining buildings to form larger commercial spaces, prior to sale).

Summary

Mixed use development is undoubtedly one of the ways in which society can drive positive urban change. The 1987 Act is a 'pitfall' rather than a 'barrier' to such change and investors who actively consider the risks involved, at the earliest possible stage, have numerous means at their disposal to avoid the pitfall and benefit from the rewards mixed used development can bring for everyone.

 

If you require any specific advice please contact Ryan Bigland

Further Reading