KEY POINTS

• Commonhold is now on the statute book, but is not expected to come into force until 2003.

• A "commonhold association" will own the freehold of the common parts.

• Each unit holder will own the freehold of their unit.

• Rights and obligations will be readily enforceable among all those involved.

The Commonhold and Leasehold Reform Act is in two distinct parts. Part 1 introduces commonhold, an entirely new land ownership structure (new to the UK, at least). Part 2 makes a large number of detailed changes to the rights of residential lessees, including a new "right to manage". We looked at Part 2 of the Act in our last issue .

This article concentrates on the new commonhold system.

Timing and implementation

The Bill became an Act on 1 May this year, but detailed rules still need to be promulgated. The only draft rules which have been published to date are those relating to the Land Registry procedures for registering commonhold properties. The remaining rules, such as those concerning the memorandum and articles of the commonhold association and the "commonhold community statement" (see below), have not yet appeared.

We don't know precisely when the new regime will come into force, but the Government seems to be aiming for commencement sometime in the latter part of 2003.

Why commonhold?

We last looked in detail at commonhold in our September 2000 newsletter . The basic thinking behind commonhold has not really changed in the last two years, although some of the details have.

The antiquated leasehold system in England and Wales is unsuitable for modern communally owned property. It works reasonably well for short residential tenancies or commercial lettings. But long leases of flats cause recurring problems. Most other parts of the developed world have found better ways to manage this. Readers may be familiar with condominium in the USA or strata title in Australia, for example.

Splitting multi-occupied buildings into freehold units ("flying freeholds") is not viable under English law because the burden of positive covenants, such as to repair or to pay service charges, cannot be attached to the freehold. It can only be attached to leasehold properties.

Commonhold is designed for situations where a building or estate has been split up into units each of which is separately owned, the classic example being a block of flats. Usually there will also be some common parts. Commonhold is therefore particularly suitable for residential property, as a replacement for the present unsatisfactory system of selling off long leases of flats at low or nominal rents.

Long leases of a part of a building are less common in commercial property. Where long leases are granted in the commercial sector, they often comprise a whole building and are created for different reasons, e.g. to create a side by side rent, or to enable the Crown, a local authority or even an ancient livery company to retain historic ownership or local control. It is quite rare in the UK to see a commercial property divided into 30 small units, each held on a long peppercorn lease, as would be normal in a block of flats.

Although the commonhold issue has always been driven by the residential market, commonhold will be available as an ownership structure for all types of property except agricultural land.

How will commonhold work?

A "commonhold association" will be incorporated. This will be a private company limited by guarantee. It will hold the freehold in the common parts of the property.

Each owner of a unit in the building (eg each flat owner) will have two interests. First, he/she will directly own the freehold of their individual unit (ie their own flat). Secondly, he/she will be a member of the commonhold association which in turn owns the freehold of the common parts.

The association will manage the building, carry out repairs and levy service charges. Each unit holder will have a vote on management matters through the commonhold association. The memorandum and articles of the association will be in a standard form prescribed by the Government. On top of this there will be a "commonhold community statement" or "CCS" setting out management provisions, service charge arrangements and obligations of the unit holders.

The basic format of the commonhold community statement will, again, be in a prescribed form. There will be no distinction between positive and negative covenants. Regulations are to make provision for the commonhold obligations to be enforceable by and against all the parties involved, such as the unit holders, the commonhold association or certain tenants.

The obligations of the unit holders will be pretty similar to what you would find in a lease, eg payment of service charge, repair and maintenance, restrictions on use and alterations, good neighbour covenants and insurance provisions. The commonhold association's obligations will roughly mirror the obligations of a landlord or management company in a conventional lease setting.

Setting up a commonhold

It will be easiest to introduce a commonhold set-up on a new development. At the outset the developer can incorporate a commonhold association, register a commonhold without unit holders, and then grant membership to each person who buys a unit in the development.

It will be more complicated to convert an existing development to commonhold:

Example 1

A block of 30 flats has a freeholder plus 30 long lessees. All 31 of these interested parties must consent to the conversion to commonhold. Conversion to commonhold can be prevented by just one lessee, or the freeholder, refusing to co-operate.

Consent is not required from any lessee whose lease, when granted, was for a term of 21 years or less. But consent is required from any person holding a charge over any part of the property, whether that charge is over a freehold or leasehold interest.

Example 2

A block of 30 flats has a freeholder plus 25 long lessees who own 25 of the flats. The other 5 flats are let on short tenancies. Of the 25 long lessees, 18 have mortgaged their properties.

Consent is therefore needed from the freeholder, all 25 long lessees and all 18 mortgagees, making a total of 44 consents required. Consent is not required from the short term tenants. Conversion to commonhold can be prevented by just one of the 44 refusing to co-operate.

Regulations will provide a power for the court to dispense with consent requirements in certain situations. But the principle is still unanimity.

In the long term, there remains a possibility that compulsion may be introduced, allowing the majority to insist on converting to commonhold over the objections of the minority. But for the time being, the Government has rejected that option.

Advantages of commonhold

Commonhold will remove the problem of leasehold property being a wasting asset. Unit holders will each own the freehold of their individual unit.

Commonhold will address the problem of lessees being beholden to an absentee landlord who cannot be bothered to carry out building maintenance and management, or who is more interested in trying to make a profit out of the services at their expense.

Standardised commonhold constitutional documents - the memorandum and articles of the company and also the commonhold community statement - should be of general benefit. Too often the residential long leasehold market suffers from problems caused by poor lease drafting. The management structure will be standardised and, hopefully, will work.

What commonhold will not achieve

Commonhold will not make it any easier to live alongside difficult neighbours who play drum-and-bass music in the middle of the night or refuse to pay reasonable service charge bills.

Large multi-occupied buildings of a certain age are expensive to maintain. Commonhold will not make any difference to this, but unit holders may feel happier about spending large amounts of money on building maintenance if they feel they are in control and no one is trying to rip them off.

When might commonhold directly affect commercial property landlords?

Examples of this could include:

(a) Mixed use properties, such as modern developments comprising shops, offices and flats, or older high street shops with flats above. Commonhold could be relevant even if the residential accommodation has been sold off on long leases and 99% of the freehold investment value is in the commercial units.

(b) Business parks or industrial estates sold off on a building by building basis, or plot by plot, to a number of different funds or owner/occupiers. Under the present law, a typical arrangement is that each purchaser gets the freehold of their building or plot, and enters into standard "good neighbour" covenants and easements preserving rights of way. Each purchaser also executes a deed addressed to the park management company, agreeing to pay a park service charge, and a Land Registry restriction prevents future disposals unless the subsequent purchaser signs a deed in similar form. This is all rather cumbersome, so some developers or investors may prefer to take advantage of the commonhold system when it is up and running.

However, the key benefit of commonhold for residential property is that it gives flat owners the freehold of their individual unit. This benefit will be of relatively little interest to commercial property. It is pretty rare for the capital interest in office suites, for example, to be sold off to individual purchasers. Individual parts of commercial buildings are normally rented, with a single investor owning the freehold of the property.

How should residential leaseholders go about converting their building to commonhold?

In practice, this is likely to be a two stage process. First, the lessees will have to club together to buy the freehold of their building from their landlord. This may be by agreement, or by compulsion under the enfranchisement provisions of the Leasehold Reform, Housing and Urban Development Act 1993. Secondly, once the freehold is in the hands of a company controlled by the lessees, there must be a unanimous vote to convert to commonhold.

Can an individual unit comprise separate properties?

Yes. For example, a flat in the main building, and a garage or permanent parking space on the other side of the estate, can make up one freehold unit in a commonhold.

Can commonhold units be transferred?

Yes. A unit holder can transfer his/her freehold interest in the unit without restriction. The transferee automatically takes the burden and benefit of all the provisions in the commonhold community statement.

Can commonhold units be mortgaged?

Yes, without restriction.

The common parts of the estate - which are owned freehold by the commonhold association - cannot be mortgaged unless members of the association unanimously agree ("unanimously" here meaning nem con). This will probably be very rare in practice.

Can commonhold units be let?

Yes, but there are separate rules for residential and commercial properties.

In the case of residential properties, regulations will prevent any tenancy being granted for longer than seven years. Tenancies must also be at a rack rent without taking a premium. A tenancy which contravenes these rules will be void.

The aim is to prevent residential commonhold units being let for long unbroken periods, as the Government fears this would simply repeat all the difficulties which exist in leasehold blocks now.

In the case of commercial property, letting is allowed without restriction unless the commonhold community statement provides otherwise. The CCS should also define which parts of the estate are residential.

Government regulations will provide a framework for a tenant to be bound automatically by obligations set out in the commonhold community statement, and to pay service charge direct to the commonhold association (ie bypassing the unit holder who is his/her landlord).

Can you have joint unit holders?

Yes. The joint unit holders will jointly own the freehold of their flat (or other unit). However, only one of them can be a member of the commonhold association (eg for voting purposes). Where two or more people are joint owners of a commonhold unit, then the one who is named first in the proprietorship register is entitled to be the member of the association, unless they jointly agree otherwise or a court orders otherwise.

Service charges payable by residential lessees are limited by statute to a "reasonable amount". Does this apply to commonhold unit holders?

No. The unit holders own the freehold. They are no longer lessees. But when the prescribed form of commonhold community statement is published, we will probably find that it limits service charges by reference to a reasonableness test anyway.

Can commonhold units be forfeited?

No. If a unit holder fails to pay a service charge, for example, all the commonhold association can do is sue him/her for the debt or, perhaps, serve a statutory demand under the Insolvency Act threatening bankruptcy.

What happens to existing leases when a building is converted to commonhold?

All the existing leases are extinguished. Where the original term of a lease was over 21 years, the current lessee will have been asked for its consent (see above) and will therefore have had a veto over the conversion to commonhold.

But a lessee for 21 years or less - eg a short term tenant - will not have been asked for consent. Nevertheless, such a tenant's lease will still be extinguished. He/she will merely have a damages claim against their own landlord - the holder of a long lease (or if there was no long lessee of that unit, then the freeholder) - who consented to the scheme. In practice, one would imagine that the landlord will solve the problem by granting a fresh lease.

Neighbours become good friends

There are many other detailed provisions in the Act concerning commonhold. Space does not permit us to deal with all of them, but we would mention section 35 of the Act. This section informs the directors of the commonhold association that when a unit holder has defaulted, they

"(a) need not take action if they reasonably think that inaction is in the best interests of establishing or maintaining harmonious relationships between all the unit-holders, and that it will not cause any unit-holder (other than the defaulter) significant loss or significant disadvantage, and

(b) shall have regard to the desirability of using arbitration, mediation or conciliation procedures instead of legal proceedings wherever possible."

Worthy sentiments indeed. Will this happen in practice? © Lovells