What should you do as a developer of land when faced with a restrictive covenant that restricts or limits your proposed development? Do you insure against the risk of a claim being made by anyone who can claim the benefit of the covenant? Do you apply to the Lands Tribunal to modify or discharge the covenant under s84 of the Law of Property Act 1925? Or do you simply carry on regardless and risk an objection?

The financial consequences of breaching a restrictive covenant can be severe but the financial effects of an application to the Lands Tribunal can also be significant, both in terms of the compensation that an applicant may be liable for and the costs that they will have to pay. These elements are often underestimated or overlooked, which can have serious repercussions.

Insurance

It may be that you consider that the covenant is unlikely to be enforceable. In these circumstances you could consider either obtaining insurance cover in respect of any attempt to enforce the covenant or seeking a declaration from the Lands Tribunal that the covenant is invalid.

To insure against the risk is likely to be by far the cheaper and quicker option, but beware of any correspondence with third parties in connection with the covenant that has the effect of warning them of it, as this may lead to insurers declining cover.

Lands Tribunal

What are the consequences if you decide to apply to the Lands Tribunal to discharge or modify the covenant?

The position under s84 of the Act

Under s84(1A) of the 1925 Act the Lands Tribunal may discharge or modify a restrictive covenant that impedes user of land if it either:

1. does not secure any practical benefits of substantial value or advantage to those persons entitled to the benefit of it; or

2. it is contrary to the public interest.

In either case money will be adequate compensation for the loss or disadvantage (if any) which any person shall suffer from the discharge or modification. So what is the level of compensation likely to be?

Compensation

Section 84(1) of the Act defines adequate compensation as either a sum to make up for any loss or disadvantage suffered as a consequence of discharge or modification, or a sum to make up for any reduced price for the land received when the restriction was imposed. The two bases of compensation are mutually exclusive: an objector is entitled to one or the other but not to both.

The basis for compensation was considered by the president of the Lands Tribunal in the case of Re Skupinski’s Application [2003].

The person with the benefit of the covenant argued that compensation should be based on the amount that would have been accepted in negotiation for the release of the covenant and that this should be based on a percentage of the profit the applicant would derive from the release.

The owner contended that compensation should be assessed by reference to the diminution of the value of the land with the benefit of the covenant – on that basis damages would be nominal. The president concluded that in general compensation awards, if made, will be low and that there is no right to compensation based on any ransom, or release-fee basis as in Stockport Metropolitan Borough Council v Alwiyah Developments [1983].

He reasoned that compensation should be assessed for any loss or disadvantage to the objector in relation to the enjoyment of its own land rather than on any gain made by the applicant. Consequently no compensation was awarded.

The president went on to say that if, contrary to his view, it was decided that compensation should be paid to the objector, he would go along with the objector’s argument that it should be based on what the parties would have agreed as the figure for the release of the covenant and that there was no reason to disagree with a figure that represented one-third of the uplift in value of the land as a consequence of the release of the covenant.

So much for compensation. What about costs?

Costs

If the application can be agreed or no objection is made to it, it is likely that a decision could be obtained in less than three months and both sides’ costs are likely to be less than £10,000, particularly if agreement is reached shortly before or after the application is made. If – as is more likely – agreement is not possible, the matter will proceed to a final determination. The costs that each side will incur will be comparable to those in the Chancery Division of the High Court.

However, the most important point is that even if an applicant succeeds in discharging or modifying a covenant, they may not get their costs from the objectors. This is because the applicant is seeking an indulgence from the Tribunal to release them from an otherwise binding obligation.

A successful objector will usually get their costs paid by the applicant. Even if they appear at the hearing and are unsuccessful the objector will not usually be ordered to pay the applicant’s costs unless it transpires that they are not entitled to the benefit of the covenant or they have acted unreasonably. In Re Fairclough Homes’ Application [2001], the president of the Lands Tribunal said:

In exercising its power to award costs the Tribunal will always bear in mind the nature of the proceedings, which must ordinarily put an objector in a more favourable position in relation to costs than the unsuccessful party in ordinary civil litigation.

These words were echoed in the later decision on costs in Re Fairclough Homes’ Application [2004].

So are you likely to be worse off if you simply go ahead?

What damages can you be ordered to pay?

If an action for breach of covenant succeeds there are two types of damages that might be awarded. The first type is for breach of covenant at common law and these damages are compensatory: they reflect the diminution in the value of the benefited land by reason of the breach. However, the second and more significant basis of damages are those for breach of covenant in equity, where damages are awarded in lieu of an injunction. The court may take into account in awarding such damages not only the effect of future breaches but also what the parties would have negotiated for the release of the covenant, which recognises the fact that a decision not to order an injunction has the same effect as a release.

In Stokes v Cambridge [1951] the starting point for damages was one-third of the profits derived from the breach. In the later case of Gafford v Graham [1999] the claimant secured damages of £25,000 despite having stood by throughout the planning process and for a period of almost four years as the business of a riding school built in breach of covenant was developed.

In Amec Developments v Jury’s Hotel Management [2001] the court considered that ‘the deal has to feel right’. This was a trespass case involving about 11% of the area of a hotel in Manchester. The cost of the site was £2,650,000. The claimant sought £2,300,000 in damages; the defendant argued for £281,000. The court awarded damages of £375,000 based on the profit that would be generated by the bedrooms that projected over the building line, which was the subject of the covenant.

Conclusion

The developer who proceeds with a development in the face of a covenant that impedes or prevents it takes a huge risk. They may have to deal with a hefty damages claim, the starting point for which will be one-third of the profit they make on the development. The first step should undoubtedly be to seek insurance, but the risk then is that it will not be available.

An application to the Lands Tribunal may end up being just as expensive as action in breach of the covenant in the future.

Although compensation may not, at present, be a significant issue in light of the Tribunal’s approach, it is not inconceivable that in future compensation will be more commonly awarded, particularly where covenants provide for such compensation to be payable in the case of release or modification of covenants.

Similar amounts are then likely to be awarded either as damages for breach or as compensation for the discharge or modification. In any event, an applicant under s84 of the Act may be liable for significant sums in costs. The developer will almost certainly need to bear their own costs in relation to the application, and perhaps those of any objectors as well.