Landlords beware; commercial leaseholders may get round restrictions in their lease to achieve residential use which brings the potential right to forcibly acquire the freehold (enfranchisement).

Significant value may be added to a leaseholder’s property interest if they can change the use from commercial to residential and even more if, as a result, they are then able to acquire the freehold interest from their landlord by enfranchisement.

Two cases illustrate this and the problems for leaseholders and their landlords in this regard i.e. as they battle for ground to negotiate for a share of the development value.

In the first case, Shaviram Normandy Limited v Basingstoke & Deane Borough Council, the leaseholders successfully applied to modify the user restriction in its lease to enable residential use. 

In the second case, Sequent Nominees v Hautford Limited, the landlord sought to prevent the leaseholder from switching to residential use despite the lack of a user restriction in the lease to that effect. Instead it sought to hang its hat on the prohibition against making a planning application without its consent. The leaseholder succeeded at first instance but ultimately the Supreme Court [Sequent Nominees Ltd (formerly Rotrust Nominees Ltd) v Hautford Ltd [2019] EWCA Civ 765] overturning decisions of the High Court and the Court of Appeal deciding by a majority of three to two that the landlord had refused a tenant’s application for consent to apply for planning permission reasonably.

The first case concerned a purpose built office building in Basingstoke that was adjacent to two other office buildings but close to a number of apartment blocks.  Use was restricted to office premises by the lease and the local authority was entitled to a share of the net annual income received from the tenant and so there was a related obligation on the leaseholder to fully let the premises.  The leaseholder wanted to convert to residential flats in the face of opposition from the local authority landlord it made an application to modify the restriction under s84(1)(aa) of the Law of Property Act 1925 on the grounds that the restriction didn’t secure any practical benefit of substantial value or advantage for the landlord.

The Upper Tribunal found that the existence of the restriction in of itself wasn’t a practical benefit and those that flowed from the maintenance of office use, namely capital value of the landlord’s reversion and income stream did not secure a benefit. This was because the capital value would be slightly higher with residential use (while the annual income would be less that didn’t eclipse the capital value issue as the rent receipt during the long lifetime of the lease was subject to risks). 

Further the assessment of benefits was to be conducted on a wide ranging basis rather than being limited to protection of land or measuring the financial impact and it was found to be legitimate to potentially take account of the precedent effect.  The prosperity and amenity of the wider neighbourhood was a potential practical benefit to be taken into account but on the facts preservation of office use in certain areas wasn’t found to confer a substantial benefit or advantage on the landlord. 

It didn’t help that it had been willing four years earlier for the property to be marketed for sale with a potential change of use.  On the evidence it was found retention of the building and office use wouldn’t make a significant contribution to the town’s economic wellbeing.

The lesson for landlords is that they must carefully consider the development value that might be released by a leaseholder in future and to put adequate safeguards in place to protect against this and, in that regard, lease restrictions alone may not be sufficient  as even if this is negotiated for when the lease is granted it may be modified in future against the landlord’s wishes.