For lenders, conventional leasehold schemes are a cause for concern. As a form of security, leases are a wasting asset and are at risk of forfeiture by the landlord. Generally, lenders are not prepared to lend on leases that have an unexpired term of less than 25-30 years (or those which will have an unexpired term of less than 25-30 years at the end of the term of the loan). Lenders may also not be prepared to lend on leases that allow forfeiture to take place if the borrower is insolvent.

As the underlying estate in commonhold is freehold, none of these concerns will apply. However, as it is a new type of property interest, lenders will be keen to know how a commonhold scheme will operate and if there are any potential pitfalls for them. Lenders will come across commonhold in two main ways:

(1) In an application to finance commonhold property, such as:

• to fund the construction and development of a commonhold scheme;
• to fund the acquisition of a commonhold unit; or
• (in limited circumstances) to fund the commonhold association; and

(2) In a request for consent for conversion of an existing leasehold property to commonhold.

We consider each of these below, and in particular, the implications for the lender’s security in each case.

The lender's role in the creation of commonhold schemes

The Commonhold and Leasehold Reform Act 2002 sets out how a commonhold scheme can be created. A commonhold scheme can be created by the registered freeholder of the land in one of two ways:

• ‘without unit-holders’, where a developer creates a commonhold scheme from scratch, with the intention of selling on the units in the scheme to third-party buyers; and
• ‘with unit-holders’, which will apply to conversions of an existing long leasehold development, where each tenant will be directly registered as the proprietor of the unit formally demised to them.

The Act provides that the consent of any registered proprietor of a charge over the whole or part of the land (together with the consent of the freeholder and any leaseholder with a term of lease of more than 21 years) must be provided to register a commonhold scheme.

New commonhold developments

As discussed in my previous article on commonhold, lenders funding the construction of new commonhold schemes (ie created ‘without unit-holders’) will need to be aware that their charge over the commonhold scheme will go through two phases.

The first phase is during the transitional period, which applies from the date the scheme is registered until the first unit is sold. In this case, the developer will have total control of the scheme, and will be registered as the proprietor over each of the units and the common parts. During this first phase, the lender’s security or charge will be over the common parts and each of the units.

However, when the transitional period ends, and one unit is sold, the commonhold association will be registered as proprietor of the freehold title to the common parts, and the lender’s charge will be extinguished over those areas. During this second phase, the lender’s charge will remain over the title to each of the unsold units.

The lender’s concerns here will be:

• to ensure that adequate control of the development can be exercised by the lender until the development is completed and the units are sold – the lender will therefore want to ensure that the developer has reserved to itself full and detailed development rights in the proposed form of the commonhold community statement; and
• that the valuation of the commonhold units supports the level of finance sought.

Lenders funding new commonhold schemes will be in a position to approve the proposed form of the commonhold community statement and proposed memorandum and articles of association of the commonhold association, and to require that these documents include any additional provisions that the lender may deem necessary.

For example, s47(2) of the Act allows the commonhold community statement to include additional provisions that must be covered by a termination statement on winding-up of a commonhold scheme voluntarily by the unit-holders. Alender may want additional provisions here to deal with its security interest.

Leasehold conversions to commonhold

A commonhold scheme which is being created with unit-holders may involve a myriad of lenders, with charges over the existing freehold and leasehold interests in the property. These lenders will want to ensure that:

• If the charge is over the underlying freehold land, that the loan is repaid or suitable alternative security is provided. This is because, once the commonhold association is registered as the proprietor to the freehold estate in the common parts, any charge over the common parts will be extinguished. It will be difficult to create a charge over the common parts under s29 of the Act (this is further discussed below).
• If the charge is over an existing leasehold interest, their charge is registered on the freehold title to the commonhold unit, which formerly comprised the leasehold demise.
• They are happy with the proposed forms of the commonhold community statement and memorandum and articles of association of the commonhold association.

Funding the acquisition of a commonhold unit

In practice, funding of the acquisition of a commonhold unit will be similar to funding freehold property that benefits from services provided by a management company. However, with commonhold, the commonhold community statement (being the document which contains these rights) will be registered on the title to each of the units. These rights will therefore automatically pass with ownership of a commonhold unit.

The lender will require a charge to be registered over the whole of the freehold title to the commonhold unit (note that a charge of part only of an interest in a commonhold unit is prohibited under s22 of the Act). The lender will also need to carry out considerable due diligence on the commonhold scheme (see box below).

Funding the commonhold association

During the life of a commonhold scheme, the commonhold association may need to carry out significant work to repair or maintain the common parts, but may not have sufficient funds within its reserve fund to pay for this work. The commonhold association may therefore want to seek finance for this expenditure.

Section 29 of the Act provides that a legal mortgage may be created over the common parts of a commonhold if the creation of the mortgage is approved by way of a unanimous resolution of the commonhold association. In larger schemes with numerous unit-holders, a unanimous resolution of the commonhold association may be difficult to obtain and the unit-holders may be reluctant to allow the common parts to be at risk in this way.

Conclusion

For commonhold to be a success, it will need lenders to be happy to finance commonhold property. As it is a new form of freehold property, lenders will want to be comfortable that they understand the concept and have covered all of the potential pitfalls. Many of these will need to be dealt with by careful consideration of the proposed forms of the commonhold community statement and the memorandum and articles of association of the commonhold association. Lenders may also require additional provisions to be included in these documents to protect their security.

Lenders’ due diligence

Below is a non-exhaustive list of some factors lenders will need to take into account when dealing with commonhold.

• Lenders will want to check the freehold title to the common parts, as well as the freehold title to the unit to be charged.
• They will also want to review the current version of the commonhold community statement, looking in particular at points such as:

  – the development rights of the developer (if these still apply);

  – what the commonhold unit comprises (ie the equivalent of a non-structural internal demise or otherwise) and the permitted use of the commonhold unit;

  – the commonhold assessment and reserve fund provisions (as well as seeking from the borrower a statement of the levies payable to the commonhold association);

  – provisions for insurance of the commonhold;

  – any restrictions on leasing in the relevant commonhold scheme; and

  – any variations to the standard form of voting provisions under the commonhold regulations.

• It will also be worth checking that any occupational lease of the commonhold unit complies with the Act and includes provisions for reimbursement of commonhold assessment and reserve fund levies (and any emergency fund levies demanded from time to time).
• The lender will require confirmation that the unit-holder selling the unit is up to date with its payments to the commonhold association and that the accounts and records of the commonhold association are in order.
• Any contracts (such as management agreements) which may have been entered into by, and bind, the commonhold association may also need to be disclosed and considered.
• Lenders will want to ensure that the security documentation includes an obligation on the unitholder to notify the lender of any commonhold disputes involving the unit-holder, and of any changes to the commonhold community statement which may be made from time to time.
• Lenders will need to review the standard provisions of their security documentation to ensure these provisions adequately cover commonhold property interests. No doubt detailed lender’s requirements applying to residential commonhold units will be included in the CML Lender’s Handbook.

Susan Samuel is an associate in the real estate group at Pinsents.  © Property Law Journal