Developer’s – don’t forget your commercial leases in your residential schemes – Landlord and Tenant Act 1987 section 5 (LTA)

Nicola Sutton, our Commercial Property partner in the Southampton team, frequently handles commercial landlord and tenant matters as well as mixed-use development schemes. In the past, clients have approached her to grant business leases to commercial tenants for a duration of 5 or 10 years. Interestingly, this request often occurs unbeknownst to the developer or landlord when the right of first refusal has already been triggered. This note is a brief overview of the issue:

• What’s the issue? Generally speaking, where a private landlord/developer of a mixed use residential and commercial scheme is proposing to lease its commercial premises then beware, (under certain circumstances) qualifying tenants of flats have a right of first refusal to purchase that interest. Whilst this may seem unrealistic and therefore not likely to be an issue (why would the tenants want to run a shop or take a lease of commercial space), if the legislation is caught there is most likely a delay in time of disposal of that interest and the inevitable costs both legally and rent expectation date which may not have been expected/ planned for. A landlord will need to serve what is commonly known as section 5 notices on qualifying tenants. Failure to comply (without reasonable excuse) is a criminal offence.
• When will this bite? The right of first refusal applies to premises if they consist of the whole or part of a building and contain two or more flats held by qualifying tenants and the number of flats held by such qualifying tenants exceeds 50% of the total number of flats contained in the premises, and they are used entirely for residential purposes, or where use is mixed residential and commercial 50% or more of the internal floor area of the premises (excluding the floor area of common parts) is used for residential purposes.
• Why is this? Although it is likely the LTA 1987 was not supposed to catch a business lease, in view of the criminal sanctions and lack of authority on the point, it seems safe to consider the grant of such lease as being caught.
• Who is involved? Offer notices will need to be issued to all qualifying tenants and these have to be produced (correctly) and therefore relevant ownerships checked. The notice must state it constitutes an offer by the landlord to make a disposal on those terms.
• How long does it take? The notices shall include a period of at least two months within which the offer may be accepted, and a further period of at least two months within which the tenants can nominate a person to whom the disposal is to be made (if accepted). Should no acceptance notice be served, or no nomination made within the specified periods and any agreed extension of time, the landlord may dispose of the protected interest during the period of 12 months from the date the landlord specified in its notice as the date by which a person must be nominated as purchaser by the tenants. The consideration and deposit must be no less than, and the other terms must be the same as, set out in the offer notice.

Summary & solution

So, if you want to grant a lease for a café or shop on your development scheme then look to secure your tenant at an early stage and get them under contract before you have to comply with the Act. The legal costs of serving notices and the inevitable delay in proceeding with a business tenant could put off that tenant you have been searching for some time.

A solution to this potentially recurring event in a mixed use development is to grant a long lease of the commercial space to an entity controlled by the developer/ landlord which will circumvent the problem when granting business leases.

Speak to a specialist

Clarke Willmott boasts a team of experienced property lawyers within our new homes team, led by Kate Saunders. They specialise in structuring site setups to proactively prevent the issue from arising. However, if the issues continue to occur, partner Kary Withers and senior associate Gabrielle Roberts from our property litigation team are adept at navigating the intricate landscape of Section 5 notices.

Get in touch with one of Clarke Willmott’s property litigation experts for a free, confidential conversation if you have an issue that you need support with.