In New South Wales, Australia, my native jurisdiction, the equivalent of commonhold was first introduced over 40 years ago, and is now the preferred way to set up joint ownership schemes. With time, the concept of commonhold may well become equally as popular and accepted by the property industry here.

The reaction of the property industry to commonhold to date has been low key. One of the reasons for this is the focus on the application of commonhold to residential schemes. However, developers will also find commonhold to be a useful tool to set up other commercial developments, such as retail parks, industrial estates, office blocks and mixed-use developments.

This is not only because commonhold is flexible. Commonhold schemes can be set up in a simple and streamlined way. This should attract those developers wanting an easier way to set up a jointly owned scheme, away from the traditional methods of long leaseholds or freehold sales of part.

Laurence Target and Peter Ward have described and commented on the provisions of the Commonhold and Leasehold Reform Act 2002 (the Act) in some detail in issues 89 and 90 of this journal. This article will instead focus on the benefits of commonhold schemes for developers, as well as some of the practical considerations when doing so.

Commencement of commonhold

On 1 May 2002, the Act was given Royal Assent. Commencement of Part 1 of the Act, which deals with commonhold, was delayed until the necessary supporting Regulations were introduced. Consultation on draft commonhold Regulations and the accompanying Land Registry regulations has taken place and we expect the final forms of these to be issued in the next few months. The government has now set a revised date for the commencement of commonhold, in summer 2004. It is expected that there will be three months from the date on which the Regulations are initially introduced to the actual date of commencement of commonhold, in order to let the property industry prepare.

Benefits over conventional schemes

To date, developments of individual plots or suites with shared facilities have been sold off by long leases of part, or, in the case of retail/industrial developments, by transfers of part. In each case, the developer will need to decide:

• how the development will be structured, and how service charges are to be levied on unit owners;
• how the development will be managed in the long term, including administration of service charge; and
• what is to be done with the developer’s residual interest in the scheme (ie the freehold reversion and/or the freehold title to the common parts).

If the developer incorporates a management company to manage the development and administer the estate service charge, it may also decide to transfer the residual interest to the management company after the sale of the last unit. Unit buyers are allotted shares in the management company, and may pay service charges direct to the management company.

Schemes such as these usually involve a plethora of documentation; documents such as the management company’s memorandum and articles of association, a management agreement, and the sale documentation all need to be prepared. The management company’s articles may restrict the new buyer’s voting rights, to protect the developer’s control of the development until all units are sold (ie the ‘developer’s golden share’).

For each unit sale, the developer must prepare a lease or a freehold transfer. If the units are being sold by way of transfer, it will contain extensive restrictive covenants and service charge/ estate rent charge provisions, and will prohibit the unit buyer from selling the unit on without ensuring that the new buyer is subject to the same obligations.

Buyers will want to negotiate the terms of these documents, and include provisions (such as management obligations) which will protect their investment.

If the terms of these documents are negotiated on each sale so that the lease or transfer for each unit differs, ongoing management and administration of the development is difficult. Non-uniform service charge provisions can make recovery of the costs of managing and administering the scheme unduly complex.

Consider instead how commonhold deals with these issues:

Freehold title

In a commonhold scheme, there is no ‘reversion’ issue. The title to each unit will be freehold. A separate freehold title will be issued for the common parts. After one unit has been sold, the commonhold association will be registered as proprietor of the common parts.

Management of the development

The developer sets up the commonhold association on creation of the commonhold scheme, and this association will be responsible for the ongoing management and administration of the scheme. Each unit holder will be a member of the association. The association also administers the scheme levies (the equivalent of service charges).

Minimal documentation

One document, the commonhold community statement, governs the whole of the commonhold scheme. It will have details and plans showing the extent of the scheme, and contain the standard obligations of each of the unit holders and the commonhold association. The title to each unit and the common parts will be subject to the commonhold community statement.

The statement will also contain provisions regulating how it can be amended. The statement provided with the draft Regulations prescribes that this can only be done by an ordinary resolution at a general meeting of the commonhold association. This will mean that an individual buyer of a unit will not be able to amend the terms of the commonhold community statement.

Owners of units will have the comfort of protections set down by law – and that all other owners of units in the commonhold scheme and the commonhold association will be subject to these standard obligations. As the commonhold community statement will be entered on the title to each of the units, its obligations will pass to new owners without the need to prepare a separate covenant.

One standard structure

The Act prescribes the standard structure of commonhold schemes, and the documents which apply to them. With time, the structure and the documents will become familiar within the marketplace and be a recognised way to develop property.

Standard provisions for service charge and ongoing management

The commonhold association levies costs of the commonhold estate on each unit owner, under standard provisions which apply to the whole scheme as set out in the Act and the commonhold community statement.

The process of managing and administering the commonhold scheme will be more straightforward, because the commonhold association will be subject to one set of standard obligations.

Considerations for developers

Developer’s control of the scheme

The method used in a conventional scheme to protect the developer’s interest in completing and selling the rest of the development scheme is outlined above. This method of suspending the voting rights attached to new owner’s shares until after the sale of the last unit is commonly referred to as the ‘developer’s golden share’.

The consultation draft articles of the commonhold association prescribe that each member will have one vote. Although the draft commonhold Regulations permit specified articles to be changed by the developer, this is not one of them.

The Act instead deals with the issue of control of the scheme by the developer in two ways, by providing for a ‘transitional period’, and an ability for a developer to reserve to itself ‘development rights’.

The transitional period

The Act prescribes two ways of creating a commonhold scheme, either with or without unit-holders. Registration of a commonhold scheme ‘with unit-holders’ will apply to conversions of an existing long leasehold development, where each tenant will be directly registered as the proprietor of the unit formerly demised to them.

For developers, the more common route will be to register a scheme ‘without unit-holders’ (ie where a developer intends to sell on the units). In this case, a transitional period will apply from the date the scheme is registered until the first unit is sold.

During the transitional period the developer will have total control of the scheme. The developer will be registered as the proprietor of each of the units and the common parts, and the provisions of the commonhold community statement will not yet have effect. Importantly, if the developer finds that it cannot sell the scheme, it can apply to the Land Registry for the commonhold scheme to be de-registered.

The transitional period ends when one of the units is sold. The commonhold association will be registered as the proprietor of the freehold estate in the common parts, and the rights and duties conferred and imposed by the commonhold community statement will come into force.

Development rights

The Act allows developers to reserve to themselves the right to complete the development works and market the development until all of the units are sold. The Act refers to this as ‘development business’, and the developer can include clauses dealing with this in the commonhold community statement. These clauses may:

• require unit holders and the commonhold association to co-operate with the developer;
• deal with what happens if the development rights are breached; and
• enable the developer to add land to the commonhold scheme without obtaining the consent of the commonhold association.

Developers wanting development rights to apply to a commonhold scheme will need to ensure that the memorandum and articles of association of the commonhold association allow for development business.

Development rights will apply during the transitional period and beyond (although it is expected that the Regulations will cap the period of time during which development rights can apply).

If a development is not yet finished, the developer can transfer its interest in the development (which must comprise a freehold estate in more than one unit) with development rights. However, if the transfer takes place after the transitional period, the developer must include express provisions to also transfer its development rights. This will be a point of particular note to buyers and funders of unfinished commonhold developments.

The draft commonhold Regulations regulate the exercise of development rights, to protect new unit buyers against misuse of these rights by unscrupulous developers. For example, the draft provisions require a developer exercising these rights to ensure that it does not unreasonably interfere with a unit holder’s quiet or peaceful enjoyment of the commonhold unit.

Development rights will be important to developers and buyers of commonhold units. We can expect there will be much interest in the final form of this provision.

Appointment of developer as buyer’s proxy

In Australia, developers concerned with the issue of control require buyers of units to give to the developer an irrevocable proxy in respect of their commonhold association voting rights in the contract for sale of the unit.

The draft articles of the commonhold association published by the government to date include provisions entitling a member of the commonhold association to appoint a proxy to attend all meetings held over a period of time and to vote on their behalf.

Until we have the final form of the commonhold Regulations, including the articles of the commonhold association, we cannot say with any certainty whether or not this type of arrangement can be used here. If it can, it is likely that buyers will only agree to do so if they are given the same protections which apply to the exercise by the developer of development rights.

Financing commonhold Developments

Lenders will want to ensure that if their security needs to be enforced mid-way through construction of the development and/or the sale process, they will have control of the development to finish building and/or sell off the remaining units. In conventional schemes, lenders may require that their charge remains over the whole of the estate until all units are sold.

In a commonhold scheme, a lender’s charge over the common parts will be extinguished when the transitional period ends and the commonhold association is registered as proprietor of the freehold title to the common parts. The lender’s charge will remain over the title to each of the unsold units.

Lenders wanting to retain control of a commonhold development could require a developer to reserve to itself development rights at the outset. This will enable the lender to continue to exercise those rights if the lender appoints an administrator or receiver to the development company, or transfer them to a buyer of the development.

Transfers of part of a unit

Selling part of a commonhold unit (such as a parking space or storage area) is a little more complex with commonhold than in conventional schemes.

Although the Act provides that the commonhold community statement may not prevent or restrict the transfer of part of a unit, the transfer requires the consent of the commonhold association. Consent may only be given by resolution of the association, with 75% of those who vote on the resolution voting in favour. The Act also prohibits the creation of a charge over part only of an interest in a commonhold unit.

This means that an owner wanting to sell off a parking space that forms part of a unit will need to get the consent of the commonhold association to the sale. In addition, by creating an interest in part of a unit, the owner will be creating an interest which cannot be charged.

Developers can avoid this situation by setting up commonhold schemes so that areas such as parking spaces and storage rooms are given separate unit numbers. This will mean, however, that owners of garages and storage units will have additional voting rights over and above their voting rights for their main commonhold unit. This situation may not be desirable in a small commonhold scheme with few members.

Leases of commonhold units

The draft Land Registry Regulations require the consent of the commonhold association to be obtained before any lease of a commonhold unit can be registered. The requirement would be in the form of a restriction, which will be entered onto the title of each commonhold unit.

The Land Registry included this draft provision early on in the process, on the basis of the government’s proposals to restrict the grant of leases of commonhold units. Its view was that the registrar should not have to check whether a disposition by a unit holder was in accordance with the Act or the supporting Regulations.

Whilst the current draft of the commonhold Regulations does prohibit leases of residential commonhold interests for 21 years or more, the draft contains no restriction on the grant of leases of non-residential commonhold units.

Pinsents has commented to the Land Registry that if the commonhold Regulations do not restrict the grant of non-residential commonhold units, the Land Registry’s Regulations should reflect this. It advises that it is awaiting the final form of the commonhold Regulations but is considering our proposed amendments to this restriction.

A development worth considering

With around six months to go until the expected start date of commonhold, developers should be thinking about whether a commonhold scheme would be suitable for them.

Developers who create commercial commonhold schemes will find that the standard structure and documentation involved will result in a scheme of subdivision that will be simple to set up, avoiding the complexities involved with conventional schemes.

For these reasons, and given the popularity of similar structures worldwide, commonhold schemes will very likely become a major force in the property market in the years to come.

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