Conversion of commercial buildings to flats: Part 2 – landlord and tenant issues

In our first article, we considered the regime of permitted development (PD) rights, which forms the legal basis for the widespread trend towards the conversion of commercial buildings to residential use.  In this second article, we go on to consider landlord and tenant related issues which can arise when undertaking a commercial to residential conversion using PD rights.

If the premises which are to be redeveloped are leasehold rather than freehold, the developer will need to take account of the terms of the lease under which the premises are held as part of the preparation ahead of making the decision to go ahead with the redevelopment.  The most common issues which can arise relate to the need to obtain landlord’s consent under various covenants in the lease before works, a change of use or subdivision into flats can be effected, or even a prohibition against such works or changes.

The main covenants which would need to be considered are:

• Dealings/alienation;
• Permitted user;
• Alterations and additions; and
• Restrictions on making planning applications.

There are also different types of covenant that we will consider:

• absolute – a covenant containing an outright prohibition, e.g., on the tenant making any structural alterations.
• partially qualified – a covenant preventing the tenant from doing something without first obtaining the landlord’s consent, but without an express obligation on the landlord to act reasonably.
• fully qualified – like partially qualified, but with an obligation on the landlord not to unreasonably withhold consent.

The first port of call for a developer or a leasehold proprietor looking to dispose for redevelopment needs to be the terms of the lease.  Are there alienation, user, alterations and/or planning covenants in the lease which potentially inhibit or preclude redevelopment/change of use?  If there are, are these restrictions absolute or qualified in some way?

Having considered the lease, the next step is to consider the effect of the provisions of the Landlord and Tenant Acts 1927 and 1988.  These Acts imply certain provisions into leases which the parties are not able to contract out of.  These are:

• Section 19 of the Landlord and Tenant Act 1927 (the 1927 Act) relating to improvements, changes of use and dealings.
• Section 1 of the Landlord and Tenant Act 1988 (the 1988 Act) relating additionally to dealings.

Improvements

Section 19(2) of the 1927 Act provides that a partially qualified covenant in a lease against making improvements without landlord’s consent is deemed to be subject to a proviso that the landlord’s consent is not to be unreasonably withheld (i.e., it becomes fully qualified).  This does not preclude the right to require, as a condition of consent, the payment of a reasonable sum in respect of any damage to or diminution in value of the premises or any neighbouring premises belonging to the landlord and of any legal other expenses properly incurred by the landlord.

This has the effect of making a partially qualified covenant against alterations into a fully qualified covenant if the alterations amount to improvements.  If there is an absolute prohibition on making alterations, the 1927 Act does not assist.

Please note that this does not apply to leases of agricultural holdings, statutory tenancies or secure tenancies.

Changes of use

Section 19(3) of the 1927 Act does not change a partially qualified covenant relating to obtaining landlord’s consent to a change of use into one that is fully qualified.  However, it does impose a proviso that the landlord is not able to levy a fine or sum of money in the nature of a fine as a pre-condition to the grant of consent.  The landlord may require payment of a reasonable sum in respect of any damage to or diminution in the value of the landlord’s premises or neighbouring premises as a result of the change of use and a reasonable sum in respect of any legal or other expenses incurred.

The question of what constitutes a reasonable level of costs came up in a recent case in the Court of Appeal, No.1 West India Key Ltd v East Tower Apartments Ltd (2018) in which, the upon an application for consent to assign, the Court upheld the first instance decision that landlord’s legal fees of £1,250 were considered unreasonable with £350 being considered a reasonable sum.  (Suffice to say, the normal level is nearer £1,250!!).

Dealings

Section 19(1) of the 1927 Act converts a partially qualified alienation covenant (preventing assignment, subletting or charging without first obtaining landlord’s consent) into a fully qualified covenant by the addition of the provision that the landlord’s consent is not to be unreasonably withheld (but not precluding the right of the landlord to require payment of a reasonable sum in respect of any legal or other expenses incurred in connection with such licence or consent).

Additionally, on leases for more than 40 years made in consideration wholly or partially of the erection, or the substantial improvement, addition or alteration of buildings (where the landlord is not a Government department or local or public authority, or a statutory or public utility company) it is deemed under Section 19(1) of the 1927 Act that no consent is required for assignment, subletting or charging (save in the last 7 years of the term).

Section 1 of the 1988 Act places statutory duties (and an evidential burden of proving that he has fulfilled those statutory duties) on the landlord to act reasonably and not delay in giving consent to an application for consent to assign, underlet or charge where there is a fully qualified covenant (whether or not implied by section 19(1) of the 1927 Act).

Please note that these statutory duties do not apply to provisions implied under the 1927 Act in relation improvements/alterations or changes of use.

Conclusion

Having considered the provisions in the lease and whether the 1927 Act provisions provide any assistance to a developer seeking to convert commercial premises to residential use, if the way is clear, all well and good.  If not, there is always a negotiation to be had. However, if there is any doubt about whether a landlord is entitled to unreasonably withhold consent or, indeed, is acting unreasonably in withholding consent, we advise you to contact us ahead of any negotiation for specific advice on the terms of the lease and those Acts.  Our team of ‘landlord and tenant’ lawyers will be able to assist in steering you through the legal minefield.