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Law

Commission

Reforming the law

Reinvigorating commonhold: the alternative to leasehold ownership

Law

Commission

Reforming the law

(Law Com No 394)

Reinvigorating commonhold: the alternative to leasehold ownership

Presented to Parliament pursuant to section 3(2) of the Law Commissions Act 1965

Ordered by the House of Commons to be printed on 20 July 2020

HC 586

© Crown copyright 2020

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The Law Commission

The Law Commission was set up by the Law Commissions Act 1965 for the purpose of promoting the reform of the law.

The Law Commissioners are:

The Right Honourable Lord Justice Green, Chairman

Professor Sarah Green

Professor Nick Hopkins

Professor Penney Lewis

Nicholas Paines QC

The Chief Executive of the Law Commission is Phil Golding.

The Law Commission is located at 1st Floor, Tower, 52 Queen Anne's Gate, London SW1H 9AG.

The terms of this Report were agreed on 26 June 2020.

The text of this Report is available on the Law Commission's website at

http://www.lawcom.gov.uk.

All website footnotes in this Report were last visited on 10 July 2020.

Table of contents

GLOSSARY AND ABBREVIATIONS

• CHAPTER 1: THE FUTURE OF HOME OWNERSHIP

Introduction

Home ownership after reform: a summary

• Part A: How home ownership currently works and its problems

• Part B: Law Commission and Government recommendations for reform

• Part C: The big picture - how the various reform proposals fit together

• PART I: INTRODUCTION

• CHAPTER 2: INTRODUCTION

What is commonhold?

Problems with the current law

Our project - Reinvigorating commonhold

The Consultation Paper and consultation process

This Report and our recommendations for reform

Wider measures to reinvigorate commonhold

The impact of reform

The law in Wales

Structure of this Report

Next steps

Publications accompanying this Report

Acknowledgements

The team working on the Report

• PART II: CONVERSION TO COMMONHOLD

• CHAPTER 3: WHAT IS CONVERSION TO COMMONHOLD?

What happens on conversion to commonhold?

Why does conversion currently require unanimous agreement?

The freeholder’s interest on conversion

The leaseholders’ interests on conversion

A comparison with collective freehold acquisition

Conclusion

• CHAPTER 4: WHEN SHOULD CONVERSION BE POSSIBLE?

Introduction

When should conversion be possible, without the freeholder’s consent?

When should conversion be possible, without the unanimous consent of leaseholders?

When should conversion be possible, without the consent of tenants?

When should conversion be possible, without the consent of lenders?

Conclusion

• CHAPTER 5: HOW WOULD CONVERSION OPTIONS 1 & 2 OPERATE?

Introduction

Operation of Option 1

Operation of Option 2

Safeguarding interests under conversion Options 1 and 2

• CHAPTER 6: WHICH IS OUR PREFERRED CONVERSION OPTION?

Introduction

Overview of conversion Options 1 and 2

Is Option 1 or Option 2 preferable?

• CHAPTER 7: WHAT IS THE PROCEDURE FOR CONVERTING TO

COMMONHOLD?

Introduction

The current law

Acquiring the freehold as part of the conversion process

The streamlined acquire and convert procedure

Conversion without acquiring the freehold

Our recommendations and conclusion

• PART III: NEW COMMONHOLD DEVELOPMENTS

• CHAPTER 8: MIXED-USE AND MULTI-BLOCK DEVELOPMENTS

Introduction

Problems with the current law

Objectives for a new framework

Sections as a framework for mixed-use and multi-block commonholds

Setting up sections

Combining two or more sections

Section committees

Conclusion

• CHAPTER 9: DEVELOPMENT RIGHTS

Introduction

The current law

Problems with the current law

Objectives for reform

Building commonholds in phases

A new regime for the reservation of development rights

Developers’ ability to appoint directors

The “without unit owners” registration procedure

Developers’ voting rights

Worked example of our revised scheme

Conclusion

PART IV: THE COMMONHOLD COMMUNITY

• CHAPTER 10: THE COMMONHOLD COMMUNITY STATEMENT

Introduction

Problems with the current law

The content of the CCS

Varying the CCS

Application of the CCS to tenants, licensees and other occupiers

The layout of the CCS

• CHAPTER 11: PERMISSIBLE RESIDENTIAL LEASES IN COMMONHOLD 268

Introduction

An exception for shared ownership leases

Operation of shared ownership in commonhold

• Part 1 - Shared ownership leases granted in existing commonholds

• Part 2 - Shared ownership leases granted before a building converts to commonhold

Community land trusts and co-operatives

Other forms of affordable housing

Home purchase plans

PART V: MANAGING AND FINANCING THE COMMONHOLD

• CHAPTER 12: MANAGEMENT AND MAINTENANCE

Introduction

Appointment of directors

Ensuring that there are directors when unit owners fail to appoint them

The duties owed by directors, and ensuring compliance

Use of proxy voting

Requirements for insurance

The standard of maintenance of the building

Rights of entry

Consent to alterations

Commonholds and long-term contracts

• CHAPTER 13: CONTRIBUTIONS TO SHARED COSTS

Introduction

Approval of contributions to shared costs

Shares of the contributions to be paid by each unit

Challenging expenditure on improvements and enhanced services

Liability for contributions to expenditure on the transfer of a unit

• CHAPTER 14: RESERVE FUNDS

Introduction

Whether it should be compulsory to have a reserve fund

Reserve funds and contributions to shared costs

Minimum annual contributions to the reserve fund

Directors’ ability to set up designated reserve funds

Unit owners’ ability to set up designated reserve funds

The level of protection given to reserve funds

Redesignating reserve funds

Internal borrowing from a reserve fund

• CHAPTER 15: RESPONDING TO EMERGENCIES

Introduction

The creation of a fixed or floating charge by the commonhold association 409

Sale by the commonhold association of part of the common parts

PART VI: DISPUTE RESOLUTION, MINORITY PROTECTION AND

ENFORCEMENT

• CHAPTER 16: DISPUTE RESOLUTION

Introduction

The commonhold association’s role in unit owner and tenant disputes

Use of prescribed forms

Failure to follow the dispute resolution procedure

The role of the ombudsman

Alternative Dispute Resolution (ADR)

Transferring jurisdiction to the Tribunal

The Housing Court and pre-action protocols

Indemnity for breaches

A regulator for commonhold

• CHAPTER 17: MINORITY INTERESTS WITHIN COMMONHOLD

Introduction

When minority protection should be available

The test to be applied by the Tribunal

Time limit for bringing a claim

Remedies

• CHAPTER 18: ENFORCEMENT

Introduction

The association’s powers to enforce non-financial breaches

The association’s powers to enforce financial breaches

The rate of interest on late commonhold payments

Conclusion

PART VII: INSOLVENCY AND TERMINATION

• CHAPTER 19: PROTECTING THE COMMONHOLD FROM INSOLVENCY

AND STRIKING-OFF

Introduction

Formalities of company law

Insolvency issues

• CHAPTER 20: VOLUNTARY TERMINATION OF COMMONHOLDS

Introduction

Voluntary termination jurisdiction

The interests of mortgage lenders on voluntary termination

The position of tenants on voluntary termination

The valuation of commonhold units and terms of the termination statement 547

Preserving the value of the commonhold units

Voluntary termination where a commonhold is divided into sections

Reconstitution of a commonhold

PART VIII: SUMMARY OF OUR RECOMMENDATIONS

• CHAPTER 21: RECOMMENDATIONS

• APPENDIX 1: TERMS OF REFERENCE

• APPENDIX 2: LIST OF CONSULTEES

• APPENDIX 3: SUMMARY OF CONSULTEES’ VIEWS ABOUT THE STEPS NECESSARY TO REINVIGORATE COMMONHOLD

Glossary and abbreviations

Reinvigorating commonhold: the alternative to leasehold ownership

To the Right Honourable Robert Buckland QC MP, Lord Chancellor and Secretary of State for Justice

• Chapter 1: The future of home ownership

INTRODUCTION

• 1.1 Our homes are hugely important. It is no surprise, therefore, that housing policy is high up the political agenda. Problems that we experience with our homes can become particularly pronounced. Many leaseholders of flats would point to issues with cladding that were brought into focus following the Grenfell Tower fire tragedy as an illustration of this impact. A recent report from the UK Cladding Action Group found that 9 out of 10 leaseholders surveyed said their mental health had deteriorated as a direct result of the situation in their building.¹ For all of us, the COVID-19 pandemic, and consequential requirement to “stay at home”, has emphasised how much we depend on our homes.

• 1.2 Broadly speaking, we occupy our homes either as owners or as renters.

• (1) Owners: Many people own, or aspire to own, a home.^{1 2} The focus of our projects, and of Government’s work on leasehold and commonhold reform, is on owners.

• (2) Renters: There have been significant reforms to the way in which homes are rented in Wales,³ and Government intends to provide tenants with greater security in their homes in England.⁴ Renters are not the focus of this Report.

• 1.3 Reforms concerning home ownership have been discussed for some time, and the future of home ownership is set to change.

• 1.4 In this Report, we recommend reform of the law of commonhold. Alongside this Report, we are publishing reports with our recommended reforms to the right to manage (“RTM”) and to leasehold enfranchisement. We have already published our report setting out the options for reducing the price that leaseholders must pay to make an enfranchisement claim.⁵

Enfranchisement is the right for people who own property on a long lease (“leaseholders”) to buy their freehold or extend their lease.

The right to manage (“RTM”) is a right for leaseholders to take over the management of their building without buying the freehold.

Commonhold allows for the freehold ownership of flats, offering an alternative way of owning property which avoids the shortcomings of leasehold ownership.

• 1.5 Before we explain our recommendations for reform, it is important to consider the overall purpose of reform, to explain how our three reports fit together, and to explain their relationship with Government’s work on leasehold and commonhold reform.

• 1.6 In this chapter, we start by looking to the future and explaining what the future of home ownership could look like after reform. We then discuss the route to get there.

• (1) In Part A, we summarise how home ownership currently works and its problems.

• (2) In Part B, we discuss our recommended reforms and Government’s reforms.

• (3) In Part C, we explain how all the proposed reforms fit together.

HOME OWNERSHIP AFTER REFORM: A SUMMARY

• 1.7 The reforms proposed by the Law Commission and by Government are intended to create fit-for-purpose home ownership. They are about making our homes ours, rather than someone else’s asset.

• 1.8 The reforms fall into two categories.

Fit-for-purpose home ownership

• (1) Owners of future homes

  • 1.9 For owners of future homes:

• (1) houses will always be sold on a freehold basis - because Government intends to ban the sale of houses on a leasehold basis.⁶

• (2) flats will:

• (a) be sold solely on a freehold (that is, “commonhold”) basis - if Government requires commonhold to be used and bans leasehold; or

• (b) sometimes be sold on a commonhold basis and sometimes on a leasehold basis - if Government actively incentivises commonhold, but does not go as far as to ban leasehold; or

• (c) continue (as is presently the case) to be sold on a leasehold basis - if Government takes no action to require or incentivise the use of commonhold and/or does not ban leasehold.

• (3) commonhold will be a viable alternative to leasehold - because our recommendations will make commonhold workable.

• (4) insofar as any homes are sold on a leasehold basis, they will not contain any ground rent obligations - because Government intends to restrict ground rents to zero.⁷

• 1.10 As a consequence, for owners of future homes:

• (1) the right for leaseholders to buy the freehold of their house will be largely redundant - because houses in the future will already have been sold freehold;

• (2) if flats are only sold on a commonhold basis, the right for leaseholders (i) to extend their lease, (ii) to buy their freehold, or (iii) to take over the management of their block of flats (the RTM), will be redundant - because the flats will already have been sold freehold;

• (3) if flats continue to be sold on a leasehold basis:

• (a) it will be significantly cheaper for leaseholders to extend the lease of their flat - because (i) restricting ground rents to zero, and (ii) our options for reducing enfranchisement prices, will limit the amount that leaseholders have to pay;

• (b) it will be significantly cheaper for leaseholders (with their neighbours) to buy the freehold of their block - because (i) restricting ground rents to zero, and (ii) our options for reducing enfranchisement prices, will limit the amount that leaseholders have to pay.

• (i) Those leaseholders would then be able to convert to commonhold, if they wanted to do so.

• (ii) Those leaseholders are less likely to want or need to exercise the RTM (which involves taking over the management of a block but not buying the freehold) - because the cost of purchasing the freehold will be significantly cheaper than it is now.

• (2) Leasehold owners of existing homes⁸

• 1.11 While there can be an ambition for freehold to be the basis of home ownership in the future, it is crucial to recognise that leasehold will continue to exist for some time. Many people already own a leasehold home. And some homes may be granted on a leasehold basis in the future - namely (i) any flats granted on a leasehold basis (if commonhold is not required, or sufficiently promoted), and (ii) any houses which are exempt from the leasehold house ban. For those leaseholders:

• (1) it is necessary for various problems with leasehold ownership to be resolved; and

• (2) they will need to have the improved rights that we recommend:

• (a) to extend their lease or to purchase their freehold, and - in the case of flats - to convert to commonhold; and

• (b) to take over the management of their block.

• 1.12 The recommendations that we make in our reports on enfranchisement and the right to manage will considerably improve the position of existing leaseholders, and any future leaseholders, in a number of respects. In particular:

• (1) a lease extension will result in a lease being extended by 990 years at a peppercorn rent, so that the need to extend a lease only arises once and no ground rent is payable;

• (2) more leaseholders will be able collectively to purchase the freehold of their block or take over the management of the block: leaseholders cannot currently do so if more than 25% of the block is commercial property, and we recommend raising the threshold to 50%;

• (3) it will be possible to purchase the freehold or take over the management of multiple buildings (for example, in an estate);

• (4) the process for making an enfranchisement or RTM claim will be easier, quicker, and cheaper, with procedural traps removed;

• (5) leaseholders making an enfranchisement or RTM claim will no longer have to pay their landlord’s costs (in the case of enfranchisement, if Government sets premiums at market value); and

• (6) leaseholders making an enfranchisement claim will be better able to convert from leasehold to commonhold, if they wish to do so.

• 1.13 In addition, the options for reducing enfranchisement prices in our earlier report would reduce the amount that leaseholders have to pay to extend their lease or purchase their freehold.

  Home ownership after reform	Existing homes	Future homes
  Houses	Improved rights for leaseholders Existing leaseholders can buy the freehold - and it will be cheaper to do so	New houses are freehold
  Flats	Improved rights for leaseholders Existing leaseholders can buy the freehold and convert to commonhold - and it will be cheaper to do so	Government to decide whether commonhold is compulsory, incentivised, or optional Even if leasehold continues, the right to buy the freehold (including converting to commonhold) will be significantly cheaper

PART A: HOW HOME OWNERSHIP CURRENTLY WORKS AND ITS PROBLEMS

Freehold and leasehold ownership

• 1.14 What does “ownership” mean? When an estate agent markets a house or flat as being “for sale”, what is the asset on offer? In England and Wales, property is almost always owned on either a freehold or a leasehold basis.

• (1) Freehold is ownership that lasts forever, and generally gives fairly extensive control of the property.

• (2) Leasehold provides time-limited ownership (for example, a 99-year lease), and control of the property is shared with, and limited by, the freehold owner (that is, the landlord).

• 1.15 So we refer to “buying” or “owning” a house or a flat. But when we buy on a leasehold basis, we are in fact buying a lease of a house or flat for a certain number of years (after which the assumption is that the property reverts to the landlord). A leasehold interest is therefore often referred to as a wasting asset: while it may increase in value in line with property prices, its value also tends to fall over time as its length (the “unexpired term”) reduces. There comes a point when the remaining length of the lease makes it difficult to sell, because purchasers cannot obtain a mortgage since lenders will not provide a mortgage for the purchase of a short lease.⁹

• 1.16 In addition, leasehold owners often do not have the same control over their home as a freehold owner. For example, they may not be able to make alterations to their home, or choose which type of flooring to have, without obtaining the permission of their landlord. The balance of power between leasehold owners and their landlord is governed by the terms of the lease and by legislation. Recently, concerns have been raised that the lack of control historically associated with leasehold ownership has - in some cases - become a feature of freehold ownership. We return to that issue below.

• 1.17 As well as a division of control, landlords may have different interests from leaseholders. For instance, the landlord may see a leasehold property solely as an investment opportunity or a way of generating income, while for leaseholders the property may be their home as well as a capital investment.

  Different types of ownership	Freehold	Leasehold
  Duration of ownership	Lasts forever	Time-limited
  Control	Generally extensive	Shared with landlord

• 1.18 In summary, therefore, leasehold does not provide outright ownership. The experience of leasehold owners has been described as being that of “owners yet tenants”.^{10 11} On the one hand, they are homeowners, with some of the benefits that ownership brings, such as a financial stake in the home. On the other hand, they have a landlord who maintains some control over their use of their home, who has a financial interest in their home, and who will ultimately take back the home on the expiry of the lease.

The inherent features of leasehold “provided the impetus for the development of commonhold, and remain at the heart of many criticisms of leasehold. They do not simply suggest the need for tighter regulation of developers and landlords in the interests of their leaseholders. Instead, they call into question the ability of the landlord-tenant relationship to deliver home-ownership, and provide an imperative for a radical increase in the control held by individuals over their homes. This change, which is reflected in the Law Commission’s three residential leasehold and commonhold projects, arguably marks a renewed focus on the home as a vital element in people’s financial and personal autonomy”.¹¹

Leasehold as a valuable asset for landlords

• 1.19 As we go on to explain below, these inherent features of leasehold ownership are the root cause of many criticisms that have been levelled at it as a mechanism to deliver home ownership. Conversely, these features of leasehold ownership are the very reason that it is an attractive investment opportunity, and a valuable asset, for landlords.

• (1) Since a lease is a time-limited interest, there will come a point when the leaseholder needs to extend the lease or buy the freehold in order to retain the property. The leaseholder has to pay the landlord in order to do so. In addition, throughout the term of the lease, the leaseholder will usually have to pay ground rent to the landlord, which provides a source of income for landlords.

• (2) The landlord’s control over the property provides a further source of income. For example:

• (a) landlords can charge leaseholders a fee for certain actions, such as giving consent to alterations to a flat, or for registering a change of ownership when a leaseholder sells his or her flat; and

• (b) landlords can receive income indirectly through the service charge that leaseholders are required to pay for the costs of maintaining their block or estate. For example, the premium for insuring a block will be paid by the leaseholders, but when arranging the insurance policy the landlord might receive a commission from the insurance company. Similarly, the landlord might arrange for the services at a block (such as for management, for cleaning, or for repair work) to be undertaken by an associated company.

Why are homes owned on a leasehold basis?

Flats

• 1.20 Flats are almost universally owned on a leasehold, as opposed to freehold, basis. There is a good legal reason for that: certain obligations to pay money or perform an action in relation to a property (such as to repair a wall or a roof) cannot legally be passed to future owners of freehold property. These obligations are especially important for the effective management of blocks of flats. For instance, it is necessary that all flat owners can be required to pay towards the costs of maintaining the block, which is important since flats are structurally interdependent. There are therefore good reasons, under the current law, why flats are sold on a leasehold basis.

Houses

• 1.21 But leasehold ownership is not limited to flats. Sometimes houses are sold on a leasehold basis. That has been the case for some years.3F¹² More recently there has been an increase in new-build houses being sold on a leasehold basis. That allows developers to sell the property subject to an ongoing obligation to pay a ground rent.

• 1.22 The legal reasons for selling houses on a leasehold basis are less apparent than those for leasehold flats. One reason might be the need to impose positive obligations on house owners in relation to the upkeep (management) of an estate, but that does not apply in all cases.

A source of income

• 1.23 We have explained that there can be good legal reasons why homes are sold on a leasehold basis. The reasons why, for legal purposes, houses and flats may be sold on a long lease do not, however, require the lease to provide income streams to the landlord (see paragraph 1.19 above), beyond those needed to maintain the property, the block, or the estate.

Leasehold and feudalism

• 1.24 Leasehold is often referred to as “feudal”. In fact, leasehold developed outside of the main feudal tenures and later in time. Leases began as contracts, not interests in land. But while “feudal” is a misdescription of the landlord-tenant relationship, it is not necessarily a mischaracterisation. The language of “feudalism” reflects the power imbalance experienced by leaseholders, and concerns that the tenure has too readily facilitated the extraction of excessive monetary payments from those leaseholders.¹³

What is wrong with leasehold home ownership?

• 1.25 Residential leasehold has, for some time, been hitting the headlines and is the subject of an increasingly prominent policy debate. There is a growing political consensus that leasehold tenure is not a satisfactory way of owning residential property.

“too often leaseholders, particularly in new-build properties, have been treated by developers, freeholders and managing agents, not as homeowners or customers, but as a source of steady profit. The balance of power in existing leases, legislation and public policy is too heavily weighted against leaseholders, and this must change”.¹⁴ Housing, Communities and Local Government Select Committee

Criticisms based on leasehold ownership being inherently unfair

• 1.26 Many people have a fundamental objection to leasehold being used as a mechanism for delivering home ownership. They argue that the fact that external investors have a financial stake in a person’s home - which arises from the time-limited nature of the leaseholder’s interest and the control enjoyed by the landlord - creates an inappropriate, unbalanced and inherently unfair starting point for home ownership. Leasehold, it is argued, is fundamentally flawed as a mechanism to deliver the type of home ownership that people want and expect. The solution is said to be for home ownership - of both houses and flats - to be delivered through freehold (including commonhold) ownership.

• 1.27 Arguments about inherent unfairness are compounded by the inequality of arms that exists, broadly speaking, between leaseholders and landlords in the current leasehold regime. It is a systemic inequality between leaseholders (as a whole) and landlords (as a whole), as opposed to an individual inequality as between particular people within those groups. We discussed the inequality of arms, the opposing views on whether leasehold ownership is inherently unfair, and competing arguments about reform in our earlier report on valuation in enfranchisement.¹⁵

Criticisms of ways in which the leasehold market operates

• 1.28 While there is a strong voice that leasehold is inherently unfair and should be replaced with freehold (including commonhold), there are also criticisms of specific aspects of how the leasehold market operates.¹⁶ To those who have a fundamental objection to leasehold, they are all symptoms of what they consider to be an inherently unfair system. But these criticisms are not made solely by those who have a fundamental objection to leasehold; many who do not object to the use of leasehold nevertheless have concerns about aspects of the way that it operates. For example, concerns have been raised about:

• (1) legal, practical and financial obstacles for leaseholders seeking to exercise their statutory rights, including:

• (a) their right to extend their lease or buy their freehold (that is, their enfranchisement rights);

• (b) their right to take over management of their block (that is, the RTM);

• (c) their right to challenge the reasonableness of service charges that have

been levied by landlords;

• (d) the “right of first refusal”, which is intended to allow leaseholders whose landlord proposes to sell the freehold of their block of flats to step in to the purchaser’s shoes and themselves purchase the freehold instead;

• (e) the right to apply to the Tribunal¹⁷ for a manager to be appointed to manage the block instead of the landlord;

• (f) the right to form a recognised tenants’ association, and acquire the contact details of the leaseholders in a block in order to do so;

• (2) high and escalating onerous ground rents, with a particular concern about the imposition of ground rents which double at periodic intervals (generally ten years) during the term of a lease; such obligations can make properties unmortgageable and unsaleable, trapping the owners in their homes;

• (3) houses being sold on a leasehold, as opposed to freehold, basis, for no apparent reason other than for developers to extract a profit from owning the freehold;

• (4) the absence of any compulsory regulation of managing agents, either in terms of their qualifications or the quality of their work;

• (5) excessive service charges levied by landlords;

• (6) the ability of landlords to require leaseholders to pay all or some of the landlord’s legal costs when there has been a dispute between the parties, including in cases where the leaseholder has “won” a legal challenge against their landlord;

• (7) the legal entitlement of landlords to “forfeit” (that is, terminate) a lease if the leaseholder breaches a term of the lease;

• (8) the charging by landlords of unreasonable permission fees for leaseholders to carry out alterations to their property; and

• (9) close relationships between property developers and particular conveyancers which may threaten the latter’s independence in advising clients seeking to buy leasehold properties from the referring developers.

• 1.29 The concerns set out above lie against a background, generally speaking, of leasehold purchasers not understanding what leasehold ownership involves.

“For most consumers, buying a house or flat will be their largest purchase and investment. Because it is a relatively infrequent purchase consumers are unlikely to accumulate significant knowledge of the process or of the salient characteristics of different forms of property ownership. Further, while the value of the purchase may make the consumer cautious, the sheer magnitude of the purchase price will typically make other amounts of money involved seem insignificant by comparison”. Competition and Markets Authority¹⁸

• 1.30 Further, even when purchasers do understand what leasehold ownership involves, there is often no choice over the form of ownership. As we explained above, flats are almost invariably owned on a leasehold basis.

• 1.31 Some criticisms outlined above can fairly be described as abusive practices by landlords or developers. The Competition and Markets Authority (“CMA”) launched an investigation into leasehold home ownership in 2019 and published an interim report in 2020.¹⁹ The CMA expressed concerns about ground rents in leases, about misselling of leasehold houses, about service charges and permission fees, and about a failure of “checks and balances” in the leasehold system. The CMA stated that it intended to take enforcement action in relation to the mis-selling of leasehold property, and in relation to leases containing high and escalating ground rents.

• 1.32 While there have been abusive practices in leasehold, we would emphasise that there are other landlords who operate fairly and transparently. But however fairly the system is operated, inherent limitations of leasehold remain.

• 1.33 All of the criticisms summarised above derive, at least to some extent, from those inherent limitations - namely that the asset is time-limited, and that control is shared with the landlord. Those limitations are compounded by the fact that the landlord and leaseholder have opposing financial interests - generally speaking, any financial gain for the landlord will be at the expense of the leaseholder, and vice versa. Accordingly, the leasehold system has been reformed over the years in an attempt to create an appropriate balance between those competing interests. Given their opposing interests, it is very unlikely that leaseholders and landlords will agree that the balance that has been struck between their respective interests is fair. Their interests are diametrically opposed, and consensus will be impossible to achieve.

“For landlords, property is fundamentally about money: both the capital value in the freehold and the income that is generated from ground rent payments, commissions, enfranchisement premiums and other fees. That is not to say that the profit generated cannot be used for good ends, and landlords come in many guises. ... But the fact remains that the primary value of property to many landlords is financial. And whether a particular landlord has observed better or worse practices does not alter the fact that, systematically, leaseholders still lack autonomy and control over their homes.

For homeowners, the home is also about money, but in a very different sense. It is about having a financial stake in the property in which we live; a stake we are increasingly being asked to draw upon to support us financially into retirement, as well as to support the next generation. But the more a person’s home is used as a financial asset to benefit their landlord, the less it is an investment for the individual. The more a leaseholder’s money is providing an investment for their landlord, the less their money is providing an investment for their own future, their family and their next generation.

For homeowners, however, the home is about more than money. Britain has famously been described as a nation of homeowners. Fulfilling the dream of home-ownership has long been many people’s ambition. Much of this ambition can be attributed to the non-financial, “x-factor” values that home-ownership encompasses, and which have become embedded in an ideology of home ownership. Our home is the focal point of our private and family lives; it is integral to our identity, reflecting who we are and the community we belong to. Bad law and bad practice that affect people’s experience in their home therefore have a particular impact on them. The current programme of law reform marks an opportunity to reform the law so that it can better deliver both the financial and non-financial benefits of home ownership”.²⁰

Freehold ownership of flats: commonhold

• 1.34 In many countries, leasehold ownership does not exist. Instead, forms of “strata” or “condominium” title are used so that flats can be owned on a freehold basis.

• 1.35 In England and Wales, commonhold was introduced as an alternative to leasehold in 2002, to enable the freehold ownership of flats.²¹ Commonhold allows the residents of a building to own the freehold of their individual flat (called a “unit”) and to manage (or appoint someone to manage) the shared areas through a company. For many blocks, the homeowners would not themselves carry out the day-to-day management but would instead appoint agents to manage the block. Crucially, however, the homeowners (rather than an external landlord) would control the appointment of those agents.

• 1.36 For homeowners, commonhold offers a number of advantages over leasehold ownership. In particular:

• (1) it allows a person to own a flat forever, with a freehold title - unlike a leasehold interest, which will expire at some point in the future;

• (2) no ground rent is payable;

• (3) it gives the homeowner greater control of their property than leasehold; and

• (4) it is designed to regulate the relationship between a group of people whose interests are broadly aligned. That is in stark contrast to the leasehold regime, which has to attempt to balance and regulate the competing interests of landlord and leaseholder.

• 1.37 Despite these apparent advantages, however, commonhold has not taken off - fewer than 20 commonholds have been created since the commonhold legislation came into force.5²²

Why has commonhold failed?

• 1.38 Various suggestions have been made as to why commonhold has not taken off.

• (1) Some have suggested that shortcomings in the law governing commonhold can make it unworkable in practice and have led to a lack of confidence in commonhold as a form of ownership.

• (2) Some ascribe commonhold’s low uptake to an unwillingness of mortgage lenders to lend on commonhold units.

• (3) Some think that there may be a lack of consumer and sector-wide awareness of what is a relatively unfamiliar form of ownership.

• (4) Others point out that commonhold remains less attractive to developers than leasehold because of the opportunities that leasehold offers to secure ongoing income-streams on top of the initial purchase price paid by the leaseholders.

• (5) Others point out that Government provided no incentives for developers to use commonhold - and no disincentives to them continuing to use leasehold (for example, by removing the financial advantages for developers of selling leasehold flats).

• (6) Others suggest that the low uptake is more the result of inertia among professionals and developers. Moreover, we have been told that there is insufficient incentive (financial or otherwise) for developers of homes and commercial property to change their practices and adopt a whole new system while the existing one (from their perspective at least) does the job.

Stewardship and culture change²³

• 1.39 A common thread that runs through all three of our projects is moving management and control from a third-party landlord to homeowners. But it is in relation to commonhold that the management of land has come under the greatest scrutiny, because of the removal of the relationship of landlord and tenant. This shift from leasehold to freehold tenure has raised questions as to the stewardship of land and the utility of the landlord-tenant relationship in the residential context. Stewardship is not always defined, but in this context, we use the term to mean the management of land over time and for the next generation of owners. It has been suggested that landlords are necessary to provide stewardship over residential property. Institutional landlords are said to act as custodians who take a long-term view of the investments needed in a building or estate.²⁴ Such landlords are also said to have superior expertise in overseeing insurance, maintenance, health and safety, fire risks, planning obligations, building regulations and anti-social behaviour.²⁵

• 1.40 But this argument must address the following challenge: if owners of houses are trusted to be the stewards of their house, why can owners of flats not be similarly trusted? While leaseholders have a shorter-term interest than their landlords, it is the term of the lease granted by the landlord that so constrains them. There is no reason to assume that leaseholders would not have the same incentives as landlords presently do if they had the same enduring financial stake.²⁶ The management of a block is undoubtedly more complex than that of an individual house. It is not suggested that commonhold unit owners themselves will personally take charge. In all but small blocks, where self-management is a realistic choice, the expectation is that professional managers will be appointed.

• 1.41 This insistence on the necessity of landlord freeholders to provide inter-generational stewardship of a building or estate is symptomatic of a broader issue. The reform of leasehold, and particularly the reinvigoration of commonhold, bring about a need for cultural change, and for all participants in the housing market to re-think fundamental assumptions on which the market currently operates.

• 1.42 It has been suggested, for example, that developers will not build unless there is a professional landlord in place to manage the development. This ignores the fact that commonhold structures are used around the world and that large, mixed-use developments are built in those jurisdictions. It is also argued that commonhold owners will not take an active interest in the management of their block. Such arguments operate on the assumption that flat owners are ultimately apathetic about how their buildings or estates are run.²⁷ While commonhold is about empowering and giving responsibility to owners of flats, it is also about owners of flats being ready to accept responsibility and therefore being ready to take on that cultural change. Law reform must be matched by changes in people’s expectations of what homeownership will involve. It should not be assumed that apathy generated in a leasehold system - where the long-term financial investment and control of a building lie with an external third party - will carry over into a system in which, from the outset, investment and control lie with the unit owners.

• 1.43 In summary, therefore, commonhold should not be looked at through the lens of leasehold. Commonhold involves a culture change. It moves away from an “us and them” mindset, towards “us and ourselves”.

PART B: LAW COMMISSION AND GOVERNMENT RECOMMENDATIONS FOR REFORM

The impact of COVID-19

• 1.44 The final stage of the preparation of our reports has been undertaken against the backdrop of the COVID-19 pandemic. In common with many people in England and Wales, Law Commission staff and Commissioners found themselves working from, as well as living in, their homes, as everybody limited contact with others to benefit the health of their communities. It is a reminder of the huge importance that a home plays in a person’s life, and that individuals must work together to build and get the most out of a community. A significant part of our current work reforming leasehold and commonhold has been aimed at making sure that there exist the right tools to ensure homeowners have the comfort and certainty that they need to enjoy their homes into the future, and, where homes form part of bigger developments, the right people are involved in the decisions that enable their communities to flourish.

Law Commission recommendations for leasehold and commonhold reform

• 1.45 We have published a suite of final reports on our three projects:

• (1) leasehold enfranchisement;

• (2) the right to manage; and

• (3) commonhold.

• 1.46 Our three projects fall into two categories.

• (1) Improving leasehold: our recommendations about leasehold enfranchisement

and the right to manage are aimed at improving the existing system of leasehold ownership, to make it easier, quicker and cheaper to exercise leasehold rights.

Our starting point in these projects is the fact that leasehold ownership exists. Our recommendations are aimed at improving the law governing leasehold ownership.

• (2) Reinvigorating commonhold, so that leasehold is no longer needed: our recommendations about commonhold are aimed at creating a workable alternative to leasehold ownership, with a view to its widespread use in the future.

you can use commonhold”. Professor Nick Hopkins, evidence to the Housing Select Committee²⁸

Our starting point in this project is that it is not necessary for leasehold to be used as the mechanism for delivering home ownership. Rather, commonhold can be used instead, and we would go as far as to say that it should be used in preference to leasehold, because it overcomes the inherent limitations of leasehold ownership set out above. But commonhold can only replace leasehold if it is workable in practice.

“The right to manage and enfranchisement ... mitigate the systemic difficulties with leasehold. But commonhold alone removes those difficulties, delivering freehold ownership of individual flats or units, and collective freehold ownership and management of the common parts”.²⁹

• 1.47 We summarise our three projects below.

Our Terms of Reference

• 1.48 The Terms of Reference for all three of our projects include two general policy objectives identified by Government, which are:

• (1) to promote transparency and fairness in the residential leasehold sector; and

• (2) to provide a better deal for leaseholders as consumers.

• 1.49 Our Terms of Reference include specific provisions for each of our projects, which we set out in the following chapter and in Appendix 1 to this Report.

• 1.50 Our Terms of Reference are not neutral. They require us to make recommendations that would alter the law in favour of leaseholders. They indicate a policy conclusion reached by Government that the leasehold system in its current form is not a satisfactory way of owning homes.

• 1.51 We set out many criticisms of leasehold above. Some amount to abusive practices, which have often been a focus of concern (particularly in media reports). But the reform of leasehold is not intended simply to remove abuse. Those practices have served to highlight long-standing concerns with leasehold. Government’s work and our recommendations for reform are therefore not confined simply to removing abuses. Our Terms of Reference refer generally to providing “a better deal for leaseholders as consumers”. Our recommendations for reform are therefore intended to make the law work better for all leaseholders.

Improving leasehold: reform of leasehold enfranchisement

• 1.52 Leasehold enfranchisement is the process by which leaseholders may extend the lease, or buy the freehold. In order to exercise enfranchisement rights, leaseholders must pay a sum of money (“a premium”) to their landlord.³⁰

• 1.53 We make recommendations for a brand-new, reformed enfranchisement regime. We recommend that the enfranchisement rights, and the leaseholders who qualify for them, should be expanded, improved, simplified and rationalised. And we recommend that the process that leaseholders must follow to exercise enfranchisement rights should be improved and simplified, and that the costs that leaseholders incur doing so should be reduced.

• 1.54 We previously published our final report concerning one aspect of leasehold enfranchisement, namely the amount that leaseholders must pay to their landlords in order to make an enfranchisement claim.³¹ As required by our Terms of Reference, we set out the options for Government to reduce the premiums paid by leaseholders.

Improving leasehold: reform of the right to manage

• 1.55 The right to manage is a right for leaseholders to take over the management of their building without buying the freehold. They can take control of services, repairs, maintenance, improvements, and insurance.

• 1.56 We make recommendations which will make the RTM more accessible, less confusing, and more certain. Our recommendations would simplify and liberalise the criteria that govern which properties may be subject to an RTM claim. We have designed a new process by which information and claims are exchanged between leaseholders, landlords, and RTM companies to clear the procedural thicket which currently plagues the regime but also will facilitate better communication between all parties. We also recommend that RTM companies should not be required to cover any non-litigation costs incurred by the landlord as a result of an RTM claim.

The alternative to leasehold: reinvigorating commonhold

• 1.57 We explain above that commonhold allows for the freehold ownership of flats (and other interdependent properties), offering an alternative way of owning property which avoids the shortcomings of leasehold ownership.

• 1.58 We also summarised some of the reasons why commonhold is said to have failed in paragraph 1.38 above.

• 1.59 Our project seeks to address the first suggested barrier to the uptake of commonhold in paragraph 1.38 above: perceived shortcomings in the legal design of the commonhold scheme. Our project analyses which aspects of the law of commonhold have so far impeded commonhold’s success, for example by affecting market confidence, or making it unworkable. In accordance with our Terms of Reference, we recommend reforms to reinvigorate commonhold as a workable alternative to leasehold, for both existing and new homes.

• 1.60 Other barriers to the uptake of commonhold, including those identified in paragraph 1.38 above, are not problems with the law and do not fall within our Terms of Reference.³² They are issues which Government is considering - and Government therefore has a crucial role in seeking to reinvigorate commonhold as a mechanism for delivering home ownership.

Government proposals for leasehold and commonhold reform

• 1.61 Improving and facilitating home ownership is a priority for Government, and - as part of that - reform of residential leasehold and commonhold law has become an increasing priority. The UK Government and Welsh Government have announced various proposals for reform. Our recommendations for reform will be considered by both Governments as part of their overall programmes of reform.

• 1.62 We summarise Government’s current proposals for reform below. We do not comment on those proposals. They are all matters which fall outside the scope of our projects. Nevertheless, it is important to explain those proposals in order to explain how all proposed reforms (including those that we recommend) fit together.

Ministry of Housing, Communities and Local Government

• 1.63 The Ministry of Housing, Communities and Local Government (“MHCLG”) has announced its intention to bring forward the following measures.³³

• (1) For the future, banning the sale of houses on a leasehold basis, other than in exceptional circumstances.³⁴ As we explain further below, the only good legal reason for selling houses on a leasehold basis - namely ensuring that owners on an estate will contribute to (reasonable) shared costs - would be provided by the creation of “land obligations”: see paragraph 1.63(11) below.

• (2) For the future, when homes are sold on a leasehold basis (which, following the leasehold house ban, will predominantly be flats), restricting ground rents to zero in those leases.³⁵

• (3) Regulation of the property agent sector, including letting, managing and estate agents through mandatory licensing, mandatory codes of practice, new qualifications provisions and a new regulator with a range of enforcement options.³⁶

• (4) Consideration of reform of the regulation of the service charges that leaseholders must pay, including the requirements to consult with leaseholders before incurring expenditure on major works or on long-term contracts.³⁷

• (5) Reviewing the ability of landlords to charge leaseholders permission fees under long leases, such as fees for permission to make alterations to the property.³⁸

• (6) Reviewing the circumstances in which leaseholders are required to contribute to their landlord’s legal costs.³⁹

• (7) Requesting that the Law Commission update its previous recommendations to abolish forfeiture.⁴⁰

• (8) Protecting leaseholders from losing their homes for small sums of rent arrears.⁴¹

• (9) Reviewing loopholes in the “right of first refusal”.⁴²

• (10) Implementation of most of the Law Commission’s recommendations on fees charged in leasehold retirement properties (“event fees”), including limiting the circumstances in which event fees can be charged and requiring the disclosure of information to prospective purchasers.⁴³

• (11) To support the leasehold house ban, relying on the implementation of the Law Commission’s recommendations to reform property law, including introducing “land obligations” and reforming the way in which rights over land are created, varied, terminated and regulated.⁴⁴

• (12) Extending mandatory membership of a redress scheme to landlords who do not use managing agents.⁴⁵

• (13) Setting a cap on what leaseholders can be charged for the provision of information about the lease to potential purchasers, and a minimum time within which the information must be provided.⁴⁶

• (14) Extending rights currently enjoyed by leaseholders to freeholders of houses - in particular:

• (a) extending the right to challenge charges for the maintenance of an estate where they are unreasonable, as well as allowing freeholders of houses to apply to change their managing agent;⁴⁷

• (b) protecting freeholders from losing their homes for unpaid service charges which are owed as “rentcharges”;⁴⁸

• (c) reforming the “right of first refusal” by extending the right to leaseholders of houses;⁴⁹ and

• (d) considering regulating the ability of developers and others to charge homeowners permission fees, such as to make alterations to their property.⁵⁰

• (15) Ensuring the New Homes Ombudsman is created and requiring developers of new-build homes to belong to it, which would provide new-build homebuyers with an effective route to resolve disputes, avoiding the need to go to court.⁵¹

• (16) Considering the case for creating a Single Housing Court, to see whether it could make it easier for all users of court and tribunal services to resolve disputes, reduce delays and to secure justice in housing cases.⁵²

• 1.64 Some measures have already been implemented.

• (1) Changes have been made to the recognition of residents’ associations, to require landlords to provide residents’ associations with information about leaseholders.⁵³

• (2) A Government-backed pledge, designed to help leaseholders with onerous ground rent terms, has been agreed by many landlords, developers, conveyancers and managing agents.⁵⁴

• (3) Restrictions are to be placed on the properties that qualify for support from the Help-To-Buy scheme in England, reflecting the leasehold house ban and the restriction of ground rents to zero.⁵⁵

• (4) Government has committed that no new scheme will fund the building of leasehold houses.⁵⁶

• 1.65 In addition, commonhold has been brought back on to the political agenda. MHCLG has stated that, in addition to pursuing leasehold reform:

we also want to look at ways to reinvigorate commonhold. ... This will help ensure that the market puts consumers’ needs ahead of those of developers or investors. We will also look at what more we can and should do to support commonhold to get off the ground working across the sector, including with mortgage lenders.⁵⁷

Welsh Government

• 1.66 The Welsh Government has imposed restrictions on properties that qualify for support from the Help To Buy Wales scheme, namely that houses should generally be sold on a freehold basis and that ground rents should be restricted.⁵⁸ At the same time, a Help To Buy Wales conveyancer accreditation was introduced, and the use of an accredited conveyancer was made mandatory for sales through the scheme, to ensure a minimum level of information is given to purchasers on a range of issues, including information about leasehold. In addition, the major developers operating in Wales pledged not to use leasehold for new-build houses, whether sold through the Help To Buy scheme or otherwise.⁵⁹

• 1.67 In addition, the Welsh Government established a working group on leasehold reform. The group’s report, published in 2019, made a wide range of recommendations, including recommendations to:⁶⁰

• (1) legislate to ban the unjustified use of leasehold in new-build houses, with some exceptions;

• (2) legislate to ban onerous ground rents and implement the reduction of future ground rents to a nominal financial value;

• (3) improve education and awareness for all participants in the property market;

• (4) improve transparency for consumers with respect to the obligations that burden a leasehold or freehold property at the point of sale; and

• (5) introduce an updated Code of Practice in Wales for the licensing and accreditation of managing agents.

• 1.68 The Welsh Government has also published a Call for Evidence to better understand how private housing estates are maintained through the payment of estate service charges by homeowners and residents. The evidence base collected by this process will then be used by the Minister for Housing and Local Government to consider the case for reform.⁶¹

PART C: THE BIG PICTURE - HOW THE VARIOUS REFORM PROPOSALS FIT TOGETHER

Introduction

• 1.69 In Part B, we have summarised the areas in which we are recommending reform, and we have summarised (without commenting on) Government’s proposals for reform. We now explain how all those proposed reforms fit together.

• 1.70 It is important to look at existing and future home owners. Reform must cater for the needs of:

• (1) Leaseholders of existing homes: reform must cater for the needs of the leaseholders of existing houses and flats, as well as the future owners of those homes.⁶² It is estimated that there are at least 4.3 million leasehold homes in England alone.⁶³

• (2) Owners of future homes: reform must cater for the needs of the owners of houses and flats that are built in the future: 178,000 new-build properties were completed in England in 2019, of which 78% were houses and 22% were flats.⁶⁴

“The work of the Law Commission and of the Government brings onto the horizon an unprecedented level of reform of residential leasehold and commonhold. Lying at the heart of the work is an acknowledgement that leasehold home ownership has failed to deliver the benefits associated with being an owner, and that the systemic problems with leasehold mean that the tenure is ill-equipped to do so”.⁶⁵

Overall aim: fit-for-purpose home ownership

• 1.71 The aim of all the proposed reforms can be summarised as seeking to create fit-for-purpose home ownership.

• 1.72 There are two strands to that work:

• (1) paving the way for the future: laying the foundations for homes to be able to be owned as freehold; and

• (2) essential reform of leasehold: addressing problems for leaseholders in the present.

• (1) Paving the way for the future: laying the foundations for homes to be able to be owned as freehold

Owners of future homes

• 1.73 MHCLG’s proposed ban on houses being sold on a leasehold basis (see paragraph 1.63(1) above) will ensure that, in the future, houses will be sold on a freehold basis (subject to exceptions). Accordingly, houses that are built in the future will predominantly be owned on a freehold basis.

• 1.74 By implementing our recommendations for the creation of land obligations, there would no longer be any reason - from a legal point of view - for selling houses on a leasehold basis. That is because land obligations would allow for freehold owners to be subject to positive obligations. Land obligations would be a rational and controlled mechanism for requiring payments to be made.

• 1.75 Turning to future flats, as recorded in our Terms of Reference, Government wishes to reinvigorate commonhold as a workable alternative to leasehold. Our recommendations to reform the law of commonhold will overcome the defects in the current legal regime so that commonhold can be used with confidence.

• 1.76 In the future, the sale of all flats could be on a commonhold basis, rather than as leasehold (as is invariably the case currently).⁶⁶ The Law Commission’s reforms will ensure that commonhold is workable and flexible enough to cater for the wide range of modern-day developments.

We urge the Government to ensure that commonhold becomes the primary model of ownership of flats in England and Wales, as it is in many other countries. ... there is no reason why the majority of residential buildings could not be held in commonhold; free from ground rents, lease extensions, and with greater control for residents over service charges and major works. We are unconvinced that professional freeholders provide a significantly higher level of service than that which could be provided by leaseholders themselves”. Housing, Communities and Local Government Committee⁶⁷

• 1.77 If commonhold is not used (or if it is used only in some cases), the 40,000 or so flats built each year (or some of them) will continue to be sold on a leasehold basis, with the inherent limitations of leasehold.

• 1.78 Developers and other property-owners are currently incentivised to sell flats on a leasehold basis. As we explained in paragraph 1.19 above, the freehold is a valuable asset for the developer because it provides a steady income from ground rents, income from lease extension premiums, and other income from the leaseholders. Developers can therefore sell the flats that they build twice: they sell a long lease to the homeowner, and they can sell the freehold to an investor. By contrast, commonhold flats can only be sold once - to the homeowner. Developers therefore have no incentive to adopt commonhold. The restriction of ground rents to zero will remove one significant incentive to sell flats on a leasehold basis, since a developer will not receive (or be able to sell) a steady ground rent income. However, the freehold will continue to be valuable, because enfranchisement premiums might be paid and there may be additional income to be gained from owning the freehold. Accordingly, the incentive will remain to sell flats on a leasehold basis. Moreover, given the limited consumer awareness about commonhold, there may not be sufficient consumer demand to act as a catalyst for change. Even if such demand were to exist, the fact that demand for housing outstrips supply means that prospective homeowners do not have the bargaining power to demand commonhold flats.⁶⁸

• 1.79 We summarise in Appendix 3 to this Report what consultees said about the steps that would be necessary to reinvigorate commonhold.

• 1.80 Based on the evidence that we have gathered during our projects, we have concluded that commonhold will not be used unless (a) it is made compulsory, or (b) adequate incentives are put in place to make it more attractive to developers than leasehold (or conversely that leasehold is disincentivised sufficiently to makes it less attractive than commonhold). Commonhold will not take root on its own. There is no reason why developers will start selling commonhold flats for so long as there is more money to be made by selling leasehold flats.

• 1.81 Developers have had the option of using commonhold or leasehold for over 15 years, but have almost invariably used leasehold. Commonhold was not pushed by Government. Unless it is encouraged, or mandated, there is no reason to believe that the outcome will be any different from when it was first introduced. But the consequences may be even graver. For those who object to commonhold, and prefer leasehold, a second apparent “failure” of the commonhold model is likely to be claimed to be a reason that commonhold cannot and will not work. That, in our view, would be a very unfortunate outcome, and would do a great disservice to current and future homeowners. Commonhold is used around the world; it can and does work. But for so long as there is more money to be made from leasehold, and unless initial impetus can be given to overcome inherent inertia and a lack of awareness, it is not going to take root on its own. Without Government intervention, commonhold simply cannot compete with leasehold.

• 1.82 Accordingly, while implementation of our recommendations on commonhold reform is necessary for the reinvigoration of commonhold, it will not be sufficient on its own to do so.

• 1.83 For houses, Government has decided to ban the use of leasehold, so that freehold ownership is used.⁶⁹ That policy can be pursued because the legal mechanisms for owning houses on a freehold basis already exist (subject, to some extent, to the creation of land obligations: see paragraph 1.63(11) above). It would be a logical extension of that policy to ban the use of leasehold for flats, so that commonhold (freehold) ownership is used instead - once a workable legal mechanism exists. Our recommendations to reform commonhold would create that workable legal mechanism, and so banning the use of leasehold for flats becomes a realistic possibility.

• 1.84 As well as the direct loss of income that developers would suffer by selling flats on a commonhold basis, they would also have to adapt to an unfamiliar ownership model. This was one of the other barriers to the success of commonhold noted in paragraph 1.38 above, alongside inertia amongst professionals, a lack of sector-wide and consumer awareness, and caution on the part of mortgage lenders. These barriers to the uptake of commonhold all require Government intervention if they are to be overcome.

• 1.85 Government must therefore decide:

• (1) whether there should be an equivalent of the leasehold house ban for flats, so that flats cannot be sold on a leasehold basis in the future but must instead be sold on a commonhold basis. Put another way, commonhold could be made compulsory; or

• (2) whether developers and other property-owners should (as is currently the case) be left to choose between using leasehold or commonhold for the sale of flats, and if so:

• (a) whether - and how - the sale of flats on a commonhold basis should be incentivised; and/or

• (b) whether - and how - the sale of flats on a leasehold basis should be disincentivised; and

• (3) what measures it will adopt in order to overcome the other practical barriers to commonhold, in particular a lack of awareness, and caution and inertia amongst developers, lenders and professionals.

Leaseholders of existing homes

• 1.86 For leaseholders of existing houses,⁷⁰ our recommendations to reform the enfranchisement regime will provide improved rights to acquire the freehold (an “individual freehold acquisition”), and therefore move away from leasehold ownership to freehold ownership.

• 1.87 For leaseholders of existing flats,⁷¹ our recommendations to reform the enfranchisement regime will provide improved rights both to extend the lease and to acquire the freehold of the block - a “collective freehold acquisition”. In addition, our recommendations to reform the law of commonhold will allow leaseholders to then convert the block to commonhold, if they wish to do so. We recommend that leaseholders should have a choice whether (1) to undertake only a collective freehold acquisition, retaining the leasehold structure, or (2) replace the leasehold structure by converting to commonhold.

• 1.88 As commonhold becomes more prevalent, it is likely to be more desirable for leaseholders to convert to commonhold, rather than merely purchase the freehold by making a collective freehold acquisition claim. In time, Government might decide that leaseholders should only be able to convert to commonhold, rather than carry out a collective freehold acquisition claim and retain the leasehold structure.

Ensuring freehold ownership itself is fit-for-purpose

• 1.89 We have summarised above the measures that would pave the way to home ownership - of both houses and flats, and of both existing and future homes - to be freehold rather than leasehold.

• 1.90 That ambition does, however, rest on an assumption that freehold ownership is preferable to leasehold ownership. Generally speaking, for the reasons we set out in paragraphs 1.14 to 1.18 above, freehold ownership is preferable to leasehold ownership. Freehold ownership, however, is not without its own problems.

• (1) Concerns have been expressed about some features of freehold ownership.

For example, freehold house owners can be required to pay estate management charges,⁷² and there have been concerns about such charges being high or about difficulties challenging the charges. When sums are due under a “rentcharge”, any failure by the freeholder to pay the sums due can result in them losing the property.⁷³

• (2) There has been growing concern that certain undesirable features of leasehold ownership have been replicated in freehold ownership. The term “fleecehold” has been used to describe this phenomenon. Examples include obligations imposed on freehold homeowners to pay permission fees to make alterations to their home and inappropriate charges for the upkeep of neighbouring land and facilities.⁷⁴

• (3) As home ownership moves away from leasehold, the opportunity for developers and investors to make money from leasehold will evaporate. It is quite possible that they will look for ways to make money instead through freehold ownership. There is, therefore, a risk that the problems currently seen in leasehold may appear in freehold.

• 1.91 Put another way, moving from leasehold to freehold ownership is not a complete solution to the problems currently faced by homeowners, and nor does it guarantee that practices decried in the context of leasehold ownership will not also emerge as part of freehold ownership.

• 1.92 Certain reforms to freehold ownership are therefore necessary:

• (1) Government’s plans to extend certain rights currently enjoyed by leaseholders to freeholders will provide protections that do not currently exist (see paragraph 1.63(14) above); and

• (2) the implementation of our recommendations on property law reform - including the creation of land obligations - will improve the operation of freehold ownership, and introduce a more streamlined, proportionate and controlled mechanism for homeowners to contribute towards maintenance costs: see paragraph 1.63(11) and 1.74 above.

• 1.93 As well as resolving existing problems with freehold ownership, it will be necessary to continue to monitor the way in which freehold ownership is working in practice in order to address any future problems as they arise. In particular, freehold is not free from the risk of abuse, and it is necessary to ensure that bad practices in leasehold do not creep back in under the disguise of freehold ownership.

• 1.94 In the case of commonhold, our recommendations for reform are designed to ensure that this form of freehold ownership is fit-for-purpose. There are various problems with the current commonhold model, and they would be resolved by our recommendations for reform. We have said that it is important that the practical operation of freehold ownership is monitored, and commonhold is no different. In this Report, we conclude that the law of commonhold should be kept under review - just as it is in other countries which adopt a similar ownership model - in order to identify and resolve any problems as they emerge in the future.

  Summary: reforms that lay the foundations for home ownership to be freehold

  Laying the foundations for home ownership to be freehold Existing homes Future homes Houses Improved enfranchisement rights: existing leaseholders can buy the freehold Leasehold house ban: new houses to be sold on a freehold basis Flats Improved enfranchisement rights: existing leaseholders can buy the freehold and convert to commonhold Commonhold is available. Government to decide whether commonhold should be compulsory, incentivised, or optional.

• (2) Essential reform of leasehold: addressing problems for leaseholders in the present

• 1.95 While there can be an ambition for freehold to be the basis of home ownership in the future, it is crucial to recognise that leasehold currently exists, and will continue to exist - certainly in the short term, and probably for many years to come.

• (1) There are millions of existing leaseholders of houses and flats. Even if those leaseholders transition to freehold (or commonhold) ownership, that process will be gradual.⁷⁵ Unless and until existing leaseholders become freeholders, they need suitable protection as leaseholders.

• (2) Similarly, if and in so far as leasehold continues to be used in the future, there needs to be suitable protection for leaseholders.

• (a) For owners of future houses, leasehold generally ought not be relevant, since Government proposes to ban leasehold houses (subject to exceptions).

• (b) For owners of future flats, leasehold would not be relevant if commonhold becomes the norm, either because it is made compulsory or because it is sufficiently incentivised over leasehold (see paragraphs 1.75 to 1.85 above).

• 1.96 It is therefore necessary for various problems with leasehold ownership to be resolved. Of the various reforms discussed in Part B above,⁷⁶ those intended to improve the position of existing leaseholders and any future leaseholders include:

• (1) improving the enfranchisement regime, so that it is easier, quicker and cheaper for leaseholders to extend their lease or buy their freehold: see paragraphs 1.52 to 1.53. We recommend the creation of an improved right to a lease extension, and improved rights for leaseholders to acquire their freehold (either individually or with their neighbours). Exercising enfranchisement rights removes the ground rent in existing leases, whether the claim is for a lease extension or for the purchase of the freehold. We have already published our report on the options that are available to Government to reduce the premiums that leaseholders must pay in order to exercise enfranchisement rights;

• (2) improving the right to manage, so that it is easier, quicker and cheaper for leaseholders to take over control of the management of their block. We recommend improvements to the right to manage: see paragraphs 1.55 to 1.56;

• (3) (for leaseholders of future homes only) restricting ground rents to zero in future leases: see paragraph 1.63(2).⁷⁷ Having said that, houses built in the future will not generally be leasehold (as a result of the leasehold house ban) and flats built in the future would not be leasehold if commonhold is used in preference to leasehold.⁷⁸ Put another way, once the restriction on ground rents is effective, there might be very few leases to which it would apply - houses will generally be sold freehold, and flats could always be sold commonhold;

• (4) regulating property agents and requiring landlords who do not use managing agents to be members of a redress scheme: see paragraphs 1.63(3) and 1.63(12);

• (5) consideration of the reform of the regulation of service charges, permission fees, and legal costs: see paragraphs 1.63(4), 1.63(5) and 1.63(6);

• (6) reviewing our previous recommendations to abolish forfeiture in leasehold: see paragraphs 1.63(7) and 1.63(8);

• (7) reviewing loopholes in the “right of first refusal”: see paragraph 1.63(9);

• (8) reforming the regulation of event fees: see paragraph 1.63(10) above;

• (9) regulating the provision of information by landlords to prospective purchasers of

leases: see paragraph 1.63(13); and

• (10) improving the process for recognising residents’ associations: see paragraph 1.64(1) above.

• 1.97 In the following diagram, we summarise how the various reforms fit together.

Figure 2: The big picture: how the various reform proposals fit together

Fit-for-purpose home-ownership

Leasehold and commonhold reform

Objectives

Key: Law Commission reforms Government reforms Potential further reforms

• Chapter 2: Introduction

• 2.1 In the previous chapter, we outlined the inherent problems with leasehold ownership, and the criticisms made of its features and the way the leasehold market operates.

• 2.2 In this chapter, we continue the introduction to our commonhold project by setting out what commonhold is and a summary of the key deficiencies in the current law. We then give an overview of our work to date, including the consultation on our provisional proposals for reform and how we analysed the responses to the Consultation Paper. We also provide a summary of the key changes we are recommending in respect of the commonhold regime and the benefits these changes will bring.

WHAT IS COMMONHOLD?

• 2.3 Commonhold is a way of owning flats and other structurally interdependent property as freehold, and so avoiding the shortcomings of leasehold home ownership. Before we start exploring commonhold in more detail, we make the point that commonhold must not be viewed through the lens of leasehold. Commonhold is not a system that attempts to replicate leasehold; instead, it is a system built upon the autonomy and control that is associated with freehold ownership, with mechanisms that recognise the importance of the community that arises where properties are interdependent.

• 2.4 Commonhold provides a solution to managing the relationship between separately owned properties which share common parts, such as communal hallways, or gardens. Indeed, commonhold was introduced in 2004 to make possible the freehold ownership of flats. However, commonhold is equally capable of applying in a commercial context, for example, to regulate the relationship between separately-owned properties within an office block.

• 2.5 In commonhold, an individual property, such as a flat, is referred to as a “unit”. Each unit is owned freehold by a “unit owner”. Unit owners will also be members of a company, called the “commonhold association”,¹ which owns and manages the common parts.

• 2.6 The rights and obligations of all the unit owners and the commonhold association are set out in a document called the “commonhold community statement” (the “CCS”). The terms of the CCS are largely in a standard form, set down in legislation, which makes it easier for homeowners to understand their rights and obligations, and which should make conveyancing simpler and cheaper. There is the flexibility for unit owners to decide on “local rules”, which are specific to their building. It is possible for the rules to be updated, for example, to respond to changing needs, standards or advances in technology.

• 2.7 The “flexibility” inherent in commonhold might lead to worries that the regime breeds uncertainty, for unit owners and their lenders, but the flexibility is measured. We ⁷⁹ mention above that commonhold establishes a regime of autonomy and control for unit owners, but it is designed to also ensure the common interests of the commonhold community and its members are recognised.

The contrast between commonhold and leasehold

• 2.8 We explain above that commonhold must not be viewed through the lens of leasehold. That said, it is useful to draw a contrast between commonhold and leasehold in order to see the advantages of commonhold. We explain that contrast below. However, before doing so, we mention our work on the enfranchisement regime, because it is relevant when exploring that contrast.

• 2.9 As explained in Chapter 1, we have, alongside this Report, published the Enfranchisement Report, which contains recommendations to reform the enfranchisement regime. One aspect of that regime is the right for leaseholders⁸⁰ to act together to buy their landlord’s interest in a property. In our Enfranchisement Report we call that process collective freehold acquisition (“CFA”). We explain CFAs in Chapter 5 of the Enfranchisement Report.

• 2.10 CFAs attempt to address some of the more harsh effects of leasehold ownership on leaseholders, but they do not remove the leasehold ownership structure or its inherent defects. When leaseholders undertake a CFA, it may be because they wish to replace a landlord who is felt to be doing a poor job, or not operating in a way that benefits the leaseholders. However, despite the aspirations of leaseholders when a CFA is undertaken, it remains the case that, following a CFA, the leasehold structure is still in place and there is a landlord that sits at the “apex” of the community.

• 2.11 We now explore the key contrasts between the commonhold and leasehold regimes.

• (1) Commonhold allows people to own their properties forever, with a freehold title, unlike leasehold interests, which expire at some point.

• (2) There is no landlord in commonhold, and no requirement to pay ground rent.

• (3) There is no risk of forfeiture in commonhold. In leasehold, if a leaseholder

breaches the terms of the lease, the landlord may take back the property and the leaseholder loses everything that he or she invested in it.

• (4) All the rights and obligations in a commonhold are contained in the CCS and

there is greater standardisation inherent in the regime. It follows that commonhold should result in savings, in particular during the conveyancing process. In leasehold developments, leases will vary, perhaps significantly, between developments and, sometimes, within developments.

• (5) The mechanisms for setting costs and resolving disputes within commonhold reflect the reality that there is a community of unit owners. In leasehold, the landlord will set the costs to be paid, and mechanisms for the resolution of disputes between the landlord and the leaseholders are based largely on the assumption that a landlord needs to attempt to enforce the terms of the lease against leaseholders.

• (6) Membership of the commonhold association is mandatory for all unit owners. Even following a CFA the company landlord often has to resort to various devices to attempt to ensure that new leaseholders become members (and that those who no longer own a lease do not continue to be members).

• (7) Our recommendations will make it easier for commonholds to raise funds to carry out emergency repairs through granting charges over the common parts or the income of the commonhold association. It is rarely possible for the company landlord, following a CFA, to borrow on the security of its freehold reversion.

• (8) Commonhold offers a more fair and orderly way of dealing with redevelopment when a building has reached the end of its useful life. Leasehold makes poor provision for how a block of flats, for example, should be redeveloped when it is no longer capable of being repaired or renovated.

• 2.12 Some differences between commonhold and leasehold warrant more detailed explanation, and we explore these below.

• 2.13 In commonhold, homeowners can make democratic decisions about how their building is run, rather than a third-party landlord retaining control, which will be the case in leasehold blocks unless the leaseholders undertake a CFA. The structure of commonhold is intended to foster participation; as members of the commonhold association, unit owners can vote on decisions about how their building is managed.⁸¹ Unit owners in commonhold can also respond to changing circumstances by amending the CCS.⁸² We explained above that this makes commonhold a “flexible” system.

• 2.14 In contrast, while the terms of a lease might give a degree of certainty, it can result in inflexibility; so even if it is possible, changing the terms of every lease to standardise them, or to adapt to changes in circumstances, can be time-consuming and costly. However, we note that leases can be drafted (either deliberately, or through inadvertence) to provide for flexibility, but whether that is good, bad or neutral for leaseholders will depend on the behaviour and priorities of the current landlord and leaseholder.

• 2.15 In leasehold, landlords will often have different motivations from homeowners. Landlords may see leasehold as an investment opportunity or a way of generating income, such as through the receipt of ground rents. The landlord will make decisions about how a building is run, the rules which apply to the occupiers and the amount those occupiers will need to pay towards maintaining the property. But the landlord will not need to comply with these rules about occupation, or pay the costs. The relationship of landlord and leaseholder is one in which the parties’ interests in the property are different; it is inherently based on an adversarial “us and them” footing. Even in a situation where there is a CFA, there remains a tendency towards the creation of an adversarial relationship between the landlord and leaseholders.⁸³

• 2.16 In commonhold, the interests of those who make the decisions, and those who are affected by them, are aligned. It is a relationship between parties with the same interest in the property, and is inherently based on a footing of “we and ourselves”. The commonhold structure favours decisions which are fair and tailored to the needs of unit owners. For example, owners in a commonhold will be at a lower risk of excessive payments, and they will find it easier to install energy efficiency improvements within their building. That is because the same people who benefit from the upgrades will be those who are paying for them.^{84 85}

• 2.17 In leasehold - for example, in a block of leasehold flats - there is a tendency to create an adversarial relationship between those who own the flats and those who manage the building. Commonhold is designed to remove this adversarial system and replace it with a more democratic system of home ownership. There are bespoke provisions which govern every aspect of the commonhold’s management. In particular, the collective management of the building is simplified by having one document - the CCS - which sets out the rights and obligations of all parties in the building, rather than numerous leases, the terms of which might be inconsistent with each other.

• 2.18 In commonhold, unit owners have greater control over expenditure within their building. The procedures which apply in commonhold in relation to consultation on commonhold contributions have been designed with the commonhold in mind. The procedures recognise that there is a commonality of interests between the directors of the commonhold association and the unit owners. The consultation procedures, and regulation of service charge contributions which apply in leasehold including the period after a CFA, take as a starting point that there is an external landlord.

• 2.19 Following on from the above, the expenses relating to the administration of the commonhold association can automatically be included in the contributions to shared costs. These expenses include items such as accountancy fees, fees payable to Companies House and the costs incurred in holding meetings of the members and directors. However, landlords which own the freehold, including following a CFA, may sometimes have difficulty in recovering these expenses.

An international perspective

• 2.20 Systems of ownership analogous to commonhold (“analogous systems”) feature extensively in other countries, including the USA, Canada, Australia, New Zealand and across Europe.⁸⁵ However, while commonhold has been available in England and Wales since 2004,⁸⁶ take-up has been poor; fewer than 20 commonholds have been created.

• 2.21 In the course of our work, we have considered whether there have been calls for the replacement of the analogous systems in countries where they are established, in order to see whether the significant dissatisfaction with leasehold in England and Wales is also found in analogous systems. If there was evidence of such calls, then it might indicate that there is a wider concern around home ownership in interdependent properties (and that dissatisfaction with leasehold is a symptom of that wider concern), or that the analogous systems, and therefore commonhold, might not in fact be the solution to the problems found within leasehold. We have come across nothing to suggest that there are, or have been, calls to replace wholesale the analogous systems.

• 2.22 However, the experience of other systems does cast light on the divergent history and culture of land ownership, which help explain how leasehold came to be used in England and Wales, and the more recent calls for reform.

• 2.23 We explained in Chapter 1 that describing the landlord-tenant relationship as “feudal” is a misdescription, but it is not necessarily a mischaracterisation.⁸⁷ The history of England and Wales is such that large parcels of land were held by a relatively small, “landed” group. That is not necessarily the case in other countries. As Dr Cathy Sherry explained to us,⁸⁸ in England and Wales:

[w]hen feudalism [ended], land was not taken away from the aristocracy. They retained their ownership of far more land than they could ever personally use. They then used long ... leases ... as a way of allowing others to exploit land for the benefit of both landlords and tenants.

'New World' countries like Australia, the United States, Canada and New Zealand, never had feudal systems or aristocracies. . Australia has never had a small section of the population who owned the vast majority of land, and if some people began to amass more land than they could ever reasonably use, government policy broke up those large land holdings. The result is that freehold titles are widely dispersed in the Australian population.

Dr Sherry went on to observe that:

The English leasehold system is a result of its history. Countries like Australia, that do not share that history, do not share a leasehold tradition.

• 2.24 Leasehold ownership is not banned in Australia, rather, as Dr Sherry observed, it is associated with temporary housing.

• 2.25 That message - that residential leasehold is not seen as “ownership” in some other parts of the world - has been heard by us on a number of occasions, including by experts in countries where systems analogous to commonhold are long established.

• 2.26 The position in England and Wales is different. The exploitation of land has been shared: landlords give to leaseholders the use of their properties for something in return, usually money, and the leaseholder uses the land. For various reasons, the leasehold regime has been accepted, or at least tolerated, as a method of owning land in England and Wales, whereas in other nations, it has not.

• 2.27 However, “sharing” implies a degree of mutual benefit. The clarion call to address a significant number of issues affecting residential leasehold,¹¹ including demands for leasehold to be used only where it is justified,^{89 90} or for leasehold to be abolished altogether⁹¹ suggests that homeowners are unlikely to think the bargain is fair. In hindsight, it is arguable that a change in attitude to land ownership in England and Wales has been a long time coming; the right to manage,⁹² enfranchisement rights⁹³ and a number of other rights and protections for leaseholders, have been building for some considerable time; the state has had to step in to try to make more fair the way in which land is “shared”. But despite these changes, the message heard from other countries - that leasehold is not seen as ownership - is increasingly being echoed in England and Wales; and that message is being given to us most strongly by leaseholders’ powerful accounts of their personal experience of leasehold.

• 2.28 Commonhold takes change to the next step, and delivers the sense of ownership, autonomy and control that homeowners in other jurisdictions, without our feudal past, have had for some time.

PROBLEMS WITH THE CURRENT LAW

• 2.29 To help us identify defects in the current law, we launched a public Call for Evidence in February 2018. In the Call for Evidence we set out the problems with the law of commonhold that we had been told about and which we had uncovered in our research. We asked whether those issues created a problem in practice and whether there were any other problems that we had not identified.

• 2.30 Alongside the Call for Evidence, we reached out to existing commonhold unit owners and those managing commonholds to complete a survey in order to share their personal experiences. Responses received were invaluable in identifying how issues with the current law might affect individuals in practice, and brought to light a number of additional concerns.

  11

• 2.31 The following issues with the current law of commonhold have been identified and they form the basis of our recommendations for reform that we set out in this Report.

Lack of flexibility in new commonhold developments

• 2.32 The commonhold legislation has been criticised for not being sufficiently flexible to cater for developments which combine both residential and non-residential elements, such as shops and leisure facilities.

• 2.33 Additionally, it is not currently possible to accommodate shared ownership leases within commonhold. These leases play an important role in Government’s plans to increase the availability of affordable housing.

• 2.34 There is also a concern that the current commonhold legislation does not strike the correct balance between:

• (1) providing the developer with flexibility to complete the development once some, but not all, of the commonhold units have been sold; and

• (2) providing certainty to those unit owners who buy before the development is complete.

Difficulty converting existing buildings to commonhold

• 2.35 Leaseholders can join together to convert their building (or buildings) to commonhold and replace their existing leasehold structure with the commonhold structure. Under the current law, to convert a building to commonhold, it is necessary to obtain the consent of everyone with a significant interest in the property, including the freeholder and all the leaseholders and their mortgage lenders. In practice this will be almost impossible to achieve, especially in larger buildings.

Lack of effective enforcement powers to recover commonhold costs

• 2.36 Unit owners contribute towards the commonhold association’s costs of running the commonhold and maintaining the common parts through the payment of “commonhold contributions”. Those contributions are to ensure the property is well maintained and to pay contractors. Where unit owners fail to pay their share on time, there is a concern that other unit owners may need to make up the shortfall until the debt can be recovered. In an extreme case, a shortfall in contributions might put the solvency of the commonhold association at risk. Furthermore, despite the importance of ensuring sums are paid, there is currently no quick and effective way for an association to recover money from those who fail to pay.

Limited control over expenditure and lack of flexibility in apportioning costs

• 2.37 Commonhold unit owners must contribute a percentage towards the cost of the commonhold. However, a unit owner must contribute that percentage towards every cost, regardless of the extent to which the commonhold’s facilities or services benefit that person. The lack of flexibility in the apportionment of costs has the scope for unfairness.

• 2.38 Furthermore, the expenditure will be controlled by the commonhold association’s directors. While unit owners can appoint and remove the directors, unit owners currently have limited direct say on the level of expenditure in the commonhold and, therefore, on how much each unit owner much contribute.

• 2.39 It has also been argued that there are insufficient remedies available to protect unit owners against excessive expenditure on improvements to the building’s structure, or on services provided to the commonhold. As the principle of democracy applies within commonhold, there is no provision to challenge the decision of a majority in respect of costs.

Insufficient protection for those affected by commonhold decisions

• 2.40 One of commonhold’s key advantages is that each commonhold exists with a view to benefiting the community comprised of its unit owners. Commonhold achieves that outcome by giving to unit owners a vote in collective decisions about how the commonhold is run.

• 2.41 Currently, the majority of unit owners decide what is to happen and there is no remedy for those in the minority who are disadvantaged by a decision. There is a concern that the existing law does not go far enough to protect those who might be adversely affected by the decisions of a majority.

• 2.42 The concern about protecting those who might be disadvantaged by a decision extends beyond the running of the commonhold. Over and above the prescribed rules of the CCS (which will be the same in every commonhold and cannot be amended), unit owners can vote to add and vary local rules, which are specific to their commonhold. Local rules can cover almost anything; for example, the rules might dictate whether unit owners can run a business from their properties, or keep a pet.⁹⁴

• 2.43 Currently, local rules can be changed by a majority vote of those attending a meeting. However, it has been argued that some rules should be harder to change to help protect the expectations of unit owners when they purchase their units.

Lack of certainty surrounding the effects of insolvency and voluntary termination

• 2.44 Consultees reported a lack of certainty surrounding the effect of a commonhold association’s insolvency and the voluntary termination of the association by the unit owners. Mortgage lenders were particularly concerned about the impact these events might have on their security interests within a commonhold.

• 2.45 There is also a concern that the current process by which unit owners can voluntarily agree to bring a commonhold to an end does not afford sufficient protection to those opposed to the termination.

Inefficiencies in the dispute resolution process

• 2.46 Disputes and tensions between neighbours are unavoidable, and they can be compounded where individuals live in close proximity, which will often be the case in commonhold. Commonhold has its own, bespoke dispute resolution process. However, the existing process can be inefficient and there is a concern that its reliance on prescribed forms represents a trap for the unwary.

OUR PROJECT - REINVIGORATING COMMONHOLD

• 2.47 A project on commonhold was included in our Thirteenth Programme of Law Reform,⁹⁵ published in December 2017, following discussions with Government. Government supported the inclusion of the project in our Thirteenth Programme, as required by our Protocol with Government.⁹⁶

Terms of Reference

• 2.48 While we work independently from Government, our project is designed to pursue certain objectives, which have been identified by Government and which are set out in Terms of Reference that span all three residential leasehold and commonhold projects.⁹⁷ The Terms of Reference are not neutral.

• 2.49 So far as our work on commonhold is concerned, and in addition to two general objectives,⁹⁸ our Terms of Reference make clear our objective is to “re-invigorate commonhold as a workable alternative to leasehold, for both existing and new homes”.

• 2.50 As mentioned at paragraph 1.59 above, our project seeks to address the perceived shortcomings in the legal design of the commonhold regime. In addressing those shortcomings, and in accordance with our Terms of Reference, we have analysed the aspects of the law which have so far impeded commonhold’s success, for example, by affecting market confidence or making the regime unworkable. We have made recommendations to meet the objective of reinvigorating commonhold as a workable alternative to leasehold, for both existing and new homes.

THE CONSULTATION PAPER AND CONSULTATION PROCESS

The Consultation Paper

• 2.51 In December 2018, we published the Consultation Paper. In that paper, we made provisional proposals and asked questions about how the law of commonhold might be improved, in response to the issues highlighted above.

Consultation events

• 2.52 During the consultation period, we organised and attended a large number of events in England and Wales in order to explain our provisional proposals for reform, encourage discussion and debate about our proposals, gather attendees’ views and encourage people to provide written responses to the Consultation Paper. We encouraged attendance from all those affected by our proposals for reform, including leaseholders and prospective homeowners, legal professionals, social and private landlords, mortgage lenders, residential management companies and developers.

• 2.53 We held consultation events in Birmingham, Brighton, Cardiff, London, Manchester, Newcastle and Southampton, including symposia at the law faculty at University College London and at Manchester Metropolitan University. We also attended several events and meetings hosted by other organisations. We heard from a wide range of stakeholders with diverse perspectives.

The consultation responses

• 2.54 We received 524 responses to the Consultation Paper,⁹⁹ from a wide range of consultees including leaseholders, residents’ management companies, commercial freeholders, charity freeholders, social housing providers, developers, law firms, surveyor firms and other professional bodies, and organisations representing leaseholders.

• 2.55 Most consultees answered at least one question in the Consultation Paper. However not all questions received the same level of engagement. Questions on conversion to commonhold and financing the commonhold attracted the greatest number of responses. This suggests that conversion to commonhold, coupled with a robust regime to manage how a commonhold is financed, is of most significance to consultees. This is unsurprising given the criticisms that have been made of leasehold ownership in recent years and the reports of excessive, or opaque fees charged by landlords.¹⁰⁰

The analysis of responses

• 2.56 Since our consultation closed in March 2019, we have been analysing the responses as part of the process of developing our recommendations that we set out in this Report.

• 2.57 In framing our recommendations, we have carefully considered all consultees’ comments and the reasons why they favoured or opposed a provisional proposal, and weighed the arguments made. So, while the number of responses for or against a proposal was helpful in deciding whether to pursue the proposal, the level of support received was not the only factor in our decision making.

• 2.58 To assist in us in making our recommendations, we prepared a statistical analysis of the responses received to the Consultation Paper. A copy of this analysis has been published on our website alongside this Report.

• 2.59 We categorised consultees into a number of categories. For example, some individuals identified as leaseholders and others said that they were responding on behalf of an organisation such as a law firm, a housing association, or a particular trade association.

• 2.60 Categorising consultees assisted our understanding of how different groups of consultees responded to the issues raised in the Consultation Paper, including which topics were supported or opposed by which groups, and helped us to ensure that we had properly accounted for the breadth of different views. Our categorisation sets out those consultees who broadly have the same or similar interests. However, we do not wish to suggest that everyone within a given category would have a single opinion, or one that is necessarily different from those in other categories.

• 2.61 When analysing the responses received, we acknowledged that certain groups of consultees have particular expertise or experience in relation to certain topics. For example, developers’ views have been particularly helpful in preparing our recommendations to make commonhold work in larger, mixed-use developments. Those who will eventually live in a commonhold, such as current leaseholders or prospective purchasers, will have a greater understanding of whether our proposals to resolve disputes, or to change local rules, will work satisfactorily.

• 2.62 Some proposals in the Consultation Paper might have had a particular impact on certain groups, which might influence whether they favoured or opposed a proposal. For example, leaseholders are likely to favour removing as many barriers to conversion as possible, including removing the need for a freeholder’s and mortgage lender’s consent, whereas freeholders and lenders would be likely to argue the opposite. Additionally, consultees’ responses are likely to be coloured by the broader issue of whether they are in favour of, or are opposed to, the reinvigoration of commonhold. Leaseholders are generally strong proponents of the commonhold model of ownership, as it has the potential to overcome many of the problems that they have seen or experienced in the leasehold context. Other categories of consultees might object, or be more equivocal in their support, possibly because a proposal would require them to alter existing practices, or might result in the loss of an income stream.

THIS REPORT AND OUR RECOMMENDATIONS FOR REFORM

• 2.63 In this Report, we present consultees’ views in response to the Consultation Paper and make 121 recommendations.

• 2.64 Our recommendations will result in a commonhold regime that is fit for purpose for all those involved with a commonhold, whether because they wish to convert leasehold premises to a commonhold, are living in a commonhold, are building a new commonhold, or are lending in respect of a commonhold. The recommendations we make will deliver a fair and cost-effective commonhold regime that has the flexibility, safeguards and streamlined processes that are necessary for modern life. Our recommendations will improve confidence in commonhold across the property sector and will assist in making commonhold a prevalent form of ownership in England and Wales.

• 2.65 We are confident that our recommendations will ensure that the commonhold regime offers not just a workable alternative to residential leasehold for all involved, but a preferred alternative.

Key policy considerations

• 2.66 When preparing our recommendations, we have considered the various ways in which the law might be improved and its current problems addressed. When deciding which route to pursue, we have benefited enormously from the input of consultees, as well as the experience from other countries where analogous systems to commonhold are the prevalent means by which flats are owned. We have also been guided by certain key objectives and policy considerations, which we set out below. Those objectives take into account our Terms of Reference as well as the wider context of our, and Government’s, work on leasehold.¹⁰¹

• 2.67 First, we have sought to produce a scheme which, so far as possible, prevents the abuses which have been seen in the leasehold sector being replicated within commonhold.

• 2.68 Second, we have aimed to provide unit owners with the real benefits of autonomy and control associated with freehold ownership, while acknowledging that that must be shared with other unit owners in the commonhold community in view of the interdependence of units.

• 2.69 Third, we have aimed to produce a regime that balances the interest of parties where unanimity is not forthcoming. Any scheme in which the management of the building is controlled by the homeowners requires mechanisms to overcome stalemate where unanimity among owners is not achievable. In those circumstances, we think the prevalence of the wishes of the majority is the most desirable principle and, we suspect, is in keeping with most people’s expectations. However, we have been conscious of the impact of a majority’s decision on those who object, and we have developed protections within the commonhold regime to ensure that the minority are protected where necessary.

• 2.70 Fourth, we have sought to help preserve the solvency of the commonhold association. The commonhold association plays a fundamental role in the management of the commonhold by ensuring that the common parts are adequately maintained and by overseeing unit owners’ compliance with the CCS. Properly functioning commonhold associations are inextricably linked to unit owners’ enjoyment of their commonhold units; in order to function properly, a commonhold association must have sufficient resources.

• 2.71 Fifth, we have pursued simplicity over complexity. So, for example, our approach has been to adopt the same general rules for commonhold associations that apply to all companies, wherever possible, rather than create new, bespoke rules.

• 2.72 Finally, where there is no clear evidence that a particular reform would improve the existing commonhold model, we have not made a recommendation. In some cases, we have suggested that the law should be kept under review.

Key recommendations and benefits

• 2.73 Our key recommendations to reinvigorate commonhold will ensure the following.

• (1) That commonhold is sufficiently flexible to cater for large, mixed-use developments. Our recommendations will ensure developers have a number of mechanisms at their disposal to tailor a commonhold scheme to suit its context. In particular, developers will be able to set up different “sections” within a commonhold to separate the management of different types of interest, such as residential and commercial interests. Sections will enable commonholds to be established where only the unit owners within a particular section are able to vote on matters affecting that section, and only those who benefit from a particular service or facility will be responsible for paying for it.

• (2) That developers can build new commonhold developments in phases, allowing for units in completed phases to be sold, while retaining control of the parts of the site still under development. Our recommendations will provide developers with the flexibility and control they need to complete the development through the reservation of rights in the CCS. However, our revised scheme carefully balances the needs of the developer in completing the development with the needs and rights of unit owners who have bought their units before the development is complete.

• (3) That commonhold developments are made more attractive by enabling them to accommodate shared ownership leases and lease-based financing (called home purchase plans).

• (4) That it is much easier for leaseholders to convert from leasehold to commonhold. Our recommendations will enable conversion to commonhold to be possible without the agreement of every person with an interest in the property. At the same time, we ensure safeguards are in place to protect those who have not agreed to the conversion. The process of converting to commonhold will also become easier, quicker and more cost-effective. Our reforms will place leaseholders in control of the conversion process and will prevent tactical delays by those who are opposed.

• (5) That there is a robust financing regime that is appropriate for all commonholds, regardless of their size and facilities. Our recommendations provide flexibility in how commonhold costs are apportioned between unit owners; will ensure unit owners have greater involvement in approving commonhold costs, by enabling them to vote on the budgets proposed by the directors; will also provide greater protection to unit owners, by giving them a new right to challenge certain costs in the First-tier Tribunal (Property Chamber) in England or the Leasehold

Valuation Tribunal in Wales (the “Tribunal”); to protect unit owners from disproportionate contributions to the commonhold’s expenditure; and ensure that commonholds have adequate funds available for future routine repairs or unexpected expenditure.

• (6) The powers of commonhold associations to recover contributions from unit owners who fail to pay their share are enhanced. We recommend a new right for an association to apply to court for the sale of a commonhold unit in order to recover arrears. This new right will help to preserve the solvency of the association and will protect other unit owners from being required to cover the defaulting owner’s share. We build protections into this process to ensure unit owners are not at risk of losing their properties in respect of trivial amounts, and to ensure lenders are kept informed of the arrears and can take steps to protect their security. Our recommendations will also mean that defaulting unit owners retain the balance after the arrears and any mortgage lenders have been paid.

• (7) That commonhold associations can respond effectively to emergencies by raising the necessary finance to undertake essential works. We recommend an express power for commonhold associations to offer the common parts as security to lenders, enabling them to access finance on favourable terms, and provide safeguards for unit owners and their lenders to ensure that this action is only taken where necessary. We further recommend protections for unit owners where a commonhold decides to sell part of its land in order to raise emergency funds.

• (8) That directors of the commonhold association are appointed in a fair and democratic manner and can be removed if they are failing to comply with their duties. The directors play an important role in managing the commonhold on behalf of unit owners. The failure of the directors to comply with their obligations can impact negatively on unit owners, lenders and anyone else with a stake in the commonhold. Our recommendations ensure that directors are subject to the oversight of unit owners and can be removed and replaced if they fail to comply with their duties.

• (9) That unit owners adversely affected by a decision of the commonhold association are protected by providing a right to apply to the Tribunal for an appropriate remedy. Our recommendations ensure that unit owners in the minority are able to challenge decisions that are not in their interests, while still enabling the commonhold association to function effectively on democratic lines.

• (10) The CCS is made a more transparent and easy to navigate document for unit owners. Our recommendations will also ensure that the CCS provides unit owners and other occupants with certainty as to their rights and obligations, while retaining sufficient flexibility to change the rules of their commonhold when desirable.

• (11) That the commonhold is kept in good repair and properly insured. It is vital for all unit owners that the fabric of the building is properly maintained and protected in the event of damage. Our recommendations clarify how the commonhold association should deal with routine management and maintenance of the common parts, and ensures that adequate insurance can be procured.

• (12) That lenders in the commonhold regime are reassured and their positions protected, including in the unlikely event of a commonhold association’s insolvency, or on the voluntary termination of the commonhold. Our recommendations also ensure that the court has a greater role in safeguarding the interests of unit owners who oppose termination.

• (13) That there is improved efficiency and cost-effectiveness in resolving disputes through the encouragement of early communication between unit owners and the commonhold association. We make recommendations to simplify the dispute resolution processes and prevent owners from being caught out by technicalities. We also recommend that unit owners, who breach the terms of the CCS, should be required to reimburse those who have incurred legal and other costs when taking action.

Implementing our recommendations for reform

• 2.74 Reforming the law of commonhold will necessitate changes to both primary and secondary legislation. The law which governs commonhold can be found in a mix of statute - the Commonhold and Leasehold Reform Act 2002 (the “2002 Act”) - and secondary legislation:

• (1) the Commonhold Regulations 2004¹⁰² (the “Commonhold Regulations”), as amended by the Commonhold (Amendment) Regulations 2009¹⁰³ (the “2009 Amendment Regulations”); and

• (2) the Commonhold (Land Registration) Rules 2004.¹⁰⁴

  • 2.75 There are 70 sections in the 2002 Act, leaving the Commonhold Regulations to provide much of the detail of how commonhold operates. For example, regulations set out the provisions which must be contained in every CCS, and the rules which govern the commonhold association.

  • 2.76 Leaving the detailed operation of the commonhold regime to regulations is advantageous. It “future-proofs” the law of commonhold by allowing Government to update, relatively easily, but with due scrutiny, the terms of the CCS and the rules which apply to every commonhold in order to respond to changing needs. For example, Government could introduce terms which improve fire safety measures (or other health and safety measures) and encourage the use of “green” energy initiatives such as electric car charging points. We recognise that such flexibility is a key advantage of the commonhold legislation and our recommendations ensure this benefit is retained upon implementing our reforms.

  • 2.77 In addition to legislation, we suggest, at various points throughout this Report, that practical guidance should be introduced. Given that commonhold is a relatively unfamiliar form of ownership at present, the existence of guidance will act to encourage best practice, reduce the risk of disputes about how the law should be interpreted and bring confidence to the market. We suggest, for example, that guidance could be produced which will assist:

• (1) developers when building new commonhold developments and when reserving development rights in the CCS;

• (2) the commonhold association’s directors in understanding their obligations, both under commonhold legislation and company law;

• (3) those preparing the CCS (which may be the developer in new developments or the leaseholders on a conversion to commonhold) to decide on which local rules would be appropriate for their building or development, or on how to allocate expenditure between different units; and

• (4) the unit owners and the commonhold association to resolve disputes informally and to know when it is appropriate to take more formal action.

• 2.78 Furthermore, as part of Government’s wider measures to reinvigorate commonhold, it would be helpful for a consumer guide to be produced which covers the key features of commonhold ownership.

WIDER MEASURES TO REINVIGORATE COMMONHOLD

• 2.79 Alongside our work to reform the commonhold regime, Government is separately considering wider measures to help reinvigorate commonhold.

• 2.80 In the Consultation Paper, we asked two questions, which were intended to ascertain consultees’ views on whether our proposals would be sufficient in themselves to reinvigorate commonhold, and how far additional Government measures were likely to be necessary.¹⁰⁵ Consideration of these issues falls to Government, rather than the Law Commission. However, we report on consultees’ views in Appendix 3.

THE IMPACT OF REFORM

• 2.81 Our recommendations constitute a significant revision of the law of commonhold. The recommendations, when implemented, will have financial and non-financial implications for a wide range of actors in the property market, including existing leaseholders, future homeowners, developers and mortgage lenders.

• 2.82 We have had in mind the potential impact of our recommendations throughout their development. We are confident that our recommendations will address problems and inefficiencies in commonhold’s existing legal framework.

• 2.83 We have agreed with Government that, if it accepts our recommendations, it will take the lead on the formal impact assessments to ascertain the effects of implementing our reforms and which accompany legislation as it passes through Parliament.

• 2.84 In order to assist Government in preparing the impact assessments, we used the Consultation Paper to gather evidence from consultees on the likely impact of our provisional proposals. For example, we asked consultees about the time and cost savings that are likely to arise through transferring the jurisdiction for resolving commonhold disputes from the court to the Tribunal. We have shared the responses received with Government.

THE LAW IN WALES

• 2.85 The extent of Welsh devolution in relation to commonhold is unclear. “Housing” was expressly devolved to Wales in the Government of Wales Act 2006.¹⁰⁶ Following the Wales Act 2017, rather than expressly devolving competence in certain areas, competence is devolved unless expressly reserved. The Senedd Cymru (Welsh Parliament) cannot modify “the private law”, which includes the law of property. But that does not apply if the modification “has a purpose (other than modification of the private law) which does not relate to a reserved matter”.¹⁰⁷ In other words, the Senedd Cymru has power to amend the law of property in Wales, provided the purpose of the amendment is related to a matter which is devolved (for example, housing).

• 2.86 Under our Protocol with the Welsh Ministers, the Law Commission will only undertake a project concerning a matter that is devolved to Wales if it has the support of the Welsh Ministers.¹⁰⁸ To the extent that any of the matters in our Terms of Reference are devolved to Wales, the Welsh Ministers have indicated their support for the Commission undertaking this project.

• 2.87 Our project, therefore, is intended to cover both England and Wales, and to result, where reasonably possible, in a uniform set of recommendations that are suitable for both England and Wales. Nevertheless, in Chapter 16 of the Consultation Paper, we asked consultees whether any specific considerations in England or in Wales call for particular issues to be treated differently.

• 2.88 The overwhelming majority of consultees who answered that question thought that there should not be any difference in how commonhold is treated in England and Wales.

• 2.89 Only two consultees suggested ways in which the approaches in England and Wales might differ.

• (1) The Property Bar Association thought that commonholds based in Wales should be required to produce their CCS in both English and Welsh, and should be required to identify which should be treated as the primary document for interpretation purposes.

• (2) One consultee thought that, if the Welsh Government wished to proceed faster than England, it should be able to do so.¹⁰⁹

• 2.90 The need for, and status of, a CCS that is produced in both English and Welsh is an issue that arises whether or not legislative competence in respect of commonhold is devolved. When implementing our reforms, Government should consider whether, and the extent to which, prescribed documents (and any relevant guidance) that will be used within the commonhold regime should be produced in both English and Welsh.

• 2.91 The question of whether our recommendations could be implemented at a different point in time in England and in Wales will depend on whether legislative competence on commonhold is devolved. We explained above that the answer to that question is not simple. However, we do not think it is a question which requires us to reach a conclusion. That is because neither of the consultee responses mentioned above, nor anything else, has caused us to question whether our recommendations should apply equally to properties in England and Wales.

STRUCTURE OF THIS REPORT

• 2.92 This Report consists of 21 chapters - considering each stage in the life of a commonhold, from creation, to operation, to termination - separated into eight parts and three appendices.

Chapter 1 comprises an overview of our three residential leasehold and commonhold projects, how they interrelate and how these projects fit into Government’s own leasehold reform work. This chapter also sets out our post-reform vision for home ownership.

• (1) Part I: Introduction

This Chapter 2 introduces our project, our consultation process and this Report.

• (2) Part II: Conversion to commonhold

• Chapter 3 explains what we mean by “conversion to commonhold” and how it compares with buying a “share of the freehold” in a collective freehold acquisition claim.

• Chapter 4 explains the difficulties currently caused by the requirement for unanimous consent to convert and sets out recommendations to enable conversion without the agreement of every interested person (including the freeholder and all leaseholders).

• Chapter 5 sets out two potential models for conversion to commonhold and explains how each would work in practice, including the safeguards that should be put in place to protect those who have not agreed to the conversion. The recommendations we make in this chapter are summarised in Chapter 6.

However, we provide a more detailed analysis in Chapter 5 for completeness, and for those who wish to consider the operation of the two options in more detail.

• Chapter 6 analyses the main advantages and disadvantages of both conversion options and puts forward our preferred option to Government.

• Chapter 7 makes recommendations that will ensure the practical steps involved in converting to commonhold are as straightforward and as cost-effective as possible.

• (3) Part III: New commonhold developments

Chapter 8 concerns the commonhold regime’s ability to accommodate complex mixed-use and multi-block developments. We make recommendations for the introduction of sections to facilitate the separation of different interests within a commonhold.

Chapter 9 explains how developers may create new commonhold developments. Our recommendations will provide developers with the flexibility they need to complete new commonhold developments while ensuring sufficient protections are in place to protect unit owners who buy whilst the development is ongoing.

• (4) Part IV: The commonhold community

Chapter 10 sets out our recommendations to reform the commonhold community statement. We make recommendations that will strike a better balance between flexibility and certainty and achieve greater transparency by targeting both the content and the form of the CCS.

Chapter 11 considers the exceptions to the prohibition of long leases in commonhold that we recommend should be made for leases and lease-based products. We set out proposals for giving those with shared ownership leases and lease-based home purchase plans a greater say in the management of the commonhold and binding them closer to the commonhold rules.

• (5) Part V: Managing and financing the commonhold

Chapter 12 makes recommendations to assist the directors of commonhold associations in managing and maintaining commonholds, and provides unit owners with protections to ensure that their developments are kept in good repair.

Chapter 13 concerns how a commonhold sets its expenditure and raises the necessary funds from unit owners. We make recommendations to ensure that unit owners have a greater degree of control over expenditure, to protect unit owners against excessive expenditure and disproportionate contributions, and to ensure that the commonhold association can recover arrears upon the sale of a unit.

Chapter 14 sets out our recommendations to ensure that commonholds build up adequate funds to cover the cost of future repairs.

Chapter 15 explains how the commonhold may cover the cost of emergency repairs. We make recommendations for mechanisms to finance such works, while protecting the interests of unit owners and third parties.

• (6) Part VI: Dispute resolution, minority protection and enforcement

Chapter 16 sets out proposals for making the existing commonhold dispute resolution procedure more transparent and accessible to users, with greater protection for unit owners who have suffered losses following a dispute. We make recommendations to give greater prominence and importance to alternative dispute resolution (“ADR”) and to better integrate ADR into the dispute resolution process. Finally, we make recommendations in respect of the Tribunal’s jurisdiction and the potential roles for the New Homes Ombudsman and a possible regulator.

Chapter 17 concerns our recommendations for the protection of the minority in a commonhold, following a majority vote which affects their interests. We make recommendations dealing with the circumstances in which unit owners should have the right to apply to the Tribunal to protect their interests, the test that should be applied by the Tribunal in such cases and the remedies that the Tribunal should be able to grant.

Chapter 18 considers the powers available to the commonhold association to enforce compliance with the CCS. We make recommendations that will enable the association to take much swifter action against owners who fail to pay their share of the commonhold costs on time.

• (7) Part VII: Insolvency and termination

Chapter 19 considers how unit owners in a commonhold should be protected from the consequences of the commonhold association’s insolvency or striking-off. We make recommendations that protect unit owners from inroads being made into their limited liability and to ensure that a successor association can be set up to take over the role and functions of an insolvent commonhold association.

Chapter 20 sets out our recommendations to enable the redevelopment of commonholds following substantial damage, or which have reached the end of their life. We make provisions to protect both unit owners and lenders during the termination process.

• (8) Part VIII: Summary of our recommendations

Chapter 21 gathers together all of the recommendations we make in this Report.

• (9) Appendix 1 sets out our Terms of Reference.

• (10) Appendix 2 contains a list of consultees.

• (11) Appendix 3 sets out a summary of consultees’ views about the steps necessary to reinvigorate commonhold.

NEXT STEPS

• 2.93 The recommendations we make in this Report will not directly change the law; rather, they will be considered by Government and a decision made as to whether to implement them.

• 2.94 Assuming that our recommendations are accepted, then there are a number of steps to take before our recommendations become law. One of the most important steps would be Parliament’s consideration of a Bill.

• 2.95 Unlike some of our work, there is no draft Bill attached to this Report. The process of drafting a Bill is valuable. It can assist in clarifying certain aspects of policy. That process may be particularly valuable in the case of our Reports on residential leasehold and commonhold, because, not only do our Reports interact, to a greater or lesser degree, with one another, they may also interact with work that Government is undertaking.

• 2.96 During the implementation process, including the drafting of the Bill, we will assist Government with any need for clarification of policy, or other matters relating to implementation, that may arise.

PUBLICATIONS ACCOMPANYING THIS REPORT

• 2.97 Alongside this Report, we have published on our website:¹¹⁰

• (1) a summary of our three residential leasehold and commonhold law reform projects;

• (2) the responses to the Consultation Paper, which have been redacted to remove consultees’ personal information, and to protect those who have provided their responses confidentially or anonymously; and

• (3) a statistical summary of how consultees responded to the consultation questions.

ACKNOWLEDGEMENTS

• 2.98 We are very grateful to everyone who responded to the Consultation Paper, listed in Appendix 2.

• 2.99 During the course of preparing this Report, we have held a number of meetings with individuals and organisations. We are grateful to them all for giving generously of their time and expertise.

• 2.100 We are also grateful to all those who attended and contributed at the events that we hosted and attended,¹¹¹ and also to those who allowed us the use of their facilities.

• 2.101 In particular, we extend our thanks to the members of our advisory groups, whose details were listed in Appendix 2 to the Consultation Paper. We also extend our particular thanks to: Sir Peter Bottomley MP, Justin Madders MP and Sir Edward Davey MP (co-chairs of the All Party Parliamentary Group on Leasehold and Commonhold Reform) and Jim Fitzpatrick, who was co-chair before standing down from Parliament; the Leasehold Knowledge Partnership; and officials from the Ministry of Housing, Communities and Local Government and the Welsh Government. We also thank UK Finance and Berkeley Group Holdings PLC for their continuing engagement on technical aspects of our recommendations.

• 2.102 Finally, we would like to acknowledge here the assistance of Louie Burns and Professor James Driscoll, both of whom were members of advisory groups associated with our projects on residential leasehold and commonhold, and who sadly died prior to publication of this Report.

THE TEAM WORKING ON THE REPORT

• 2.103 The following members of the Law Commission’s Property, Family and Trust Law team have contributed to this Report:¹¹² Gary Bennett; Emily Fitzpatrick; Matthew Jolley; Alicia Kaupp-Roberts; Christine Land; Simon Marciniak; Colin Oakley; Rachel Preston; Nicholas Roberts; Daniel Robinson; Harley Ronan; and Shani Taggart.

• Chapter 3: What is conversion to commonhold?

• 3.1 Commonhold offers leaseholders an alternative way of owning their flats. It enables leaseholders to own the freehold of their flats, and provides a structure to regulate the relationship between them and manage any shared areas. Conversion is the process by which leaseholders can take advantage of the commonhold structure, and obtain the freehold of their homes. Leaseholders can join together to convert their building (or buildings) to commonhold and replace their existing leasehold structure with the commonhold structure.

• 3.2 The overall aim of our commonhold project is to “reinvigorate commonhold as a workable alternative to leasehold, for both existing and new homes”.¹ Commonhold therefore needs to be available to both prospective homebuyers and existing leaseholders. Conversion is the means by which commonhold is made available to existing leaseholders. However, currently it is extremely difficult for leaseholders to convert their building to commonhold. As conversion results in property interests being changed, the consent of everyone with a property interest in the building is needed, including the freeholder, all leaseholders and their mortgage lenders. This requirement for unanimity makes conversion to commonhold almost impossible, in all but the smallest buildings.

• 3.3 In this Part of the Report, we make numerous recommendations that will make it easier for existing leaseholders to convert to commonhold. Our recommendations will also ensure that a workable management structure is in place once conversion has occurred.

• 3.4 While we refer frequently in this Part to leaseholders in a block of flats converting to commonhold, we acknowledge that conversion has wider application. For example, owners of houses on an estate might wish to put in place the commonhold structure to manage the common parts between their houses. However, we anticipate that it will be predominantly leaseholders in blocks of flats who seek to take advantage of the conversion process. We therefore adopt the terminology “leaseholder” and “flat” throughout for simplicity, and explain how our recommendations will apply to house owners specifically in Chapter 4.^{113 114}

• 3.5 There are five chapters in this Part of the Report which address the following questions.

• (1) What is conversion to commonhold? In this chapter, we provide an overview of our recommendations for conversion. We describe what happens, practically speaking, when a building converts from leasehold to commonhold and explain why conversion currently requires unanimous agreement. We also discuss how conversion compares with buying a “share of the freehold”, through a process known as “collective freehold acquisition”.

• (2) When should conversion be possible? In the next chapter, Chapter 4, we revisit the unanimity requirement. We consider the circumstances in which it should be possible to convert to commonhold without the agreement of every person with an interest in the building.

• (3) How will conversions Options 1 and 2 operate? In Chapter 5 we consider two different ways in which conversion to commonhold might operate which we refer to as “Option 1” and “Option 2”. The differences between these two options stem from the interest that those leaseholders who have not agreed to the conversion will receive at the point of conversion, but each option has wider implications for others in the building. We refer to leaseholders who have not agreed to the conversion as “non-consenting leaseholders”.

After conversion under Option 1, non-consenting leaseholders’ leases would simply continue, although they may be required to take the title to their commonhold unit at some point in the future. Under Option 2, non-consenting leaseholders would be required to take the title to their commonhold unit at the point of conversion, in exchange for their leasehold interest. In the Consultation Paper, we asked a number of questions about how conversion Options 1 and 2 might operate in practice, if adopted by Government. In Chapter 5 we consider each of these consultation questions in turn, setting out consultees’ responses and our recommended approach. The recommendations we make in this chapter are summarised and discussed in Chapter 6. However, we provide a more detailed analysis in Chapter 5 for completeness, and for those who wish to consider the operation of Options 1 and 2 in more detail.

• (4) Which is our preferred conversion option? In Chapter 6, we summarise how each conversion option will operate under our recommendations and explain which option was preferred by consultees. We analyse the main advantages and disadvantages of both options before recommending Option 2 as our preferred approach to Government.

• (5) What is the procedure for converting? In Chapter 7 we make recommendations that will ensure the practical steps involved in converting to commonhold (such as preparing the commonhold community statement (“CCS”) and registering the commonhold at HM Land Registry) are as straightforward and as cost-effective as possible.

• 3.6 We begin, however, in this chapter, by introducing the key features of conversion to commonhold and the relevant terminology that will form the basis for discussion in subsequent chapters.

WHAT HAPPENS ON CONVERSION TO COMMONHOLD?

• 3.7 Following both conversion Options 1 and 2, the freehold of each individual flat in a building (referred to as a “commonhold unit” after conversion) will be owned by a commonhold “unit owner”. Leaseholders who consent to the conversion to commonhold under both options (the “participating leaseholders”), will obtain the freehold of their flats and become the commonhold unit owner, in exchange for their leasehold interest. Depending on whether conversion Option 1 or Option 2 is pursued, leaseholders who did not agree to the conversion (“non-consenting leaseholders”) will either retain their leasehold interest or take a commonhold unit on conversion.¹¹⁵

• 3.8 On taking commonhold units, the former leaseholders (now as unit owners) will no longer be bound by the terms of their lease or by leasehold legislation. Instead, the former leaseholders will comply with the rules of their commonhold building and with commonhold legislation. The rules of their building will be set out in the CCS. So rather than each leaseholder having their own rights and obligations set out in their lease, there will be one document relating to the whole building which sets out the rights and obligations of all the unit owners.

• 3.9 Before converting to commonhold, leaseholders will need to set up a company which will own and manage the common parts of the building following conversion. This company is called the “commonhold association”. The association has articles which are prescribed by regulations and which govern how the company is run (for example how directors are appointed). Each unit owner will be a member of the commonhold association, and will be able to vote in decisions about the commonhold.

A worked example

• 3.10 To best illustrate the effects of conversion, we provide a worked example of a block of five leasehold flats that converts to commonhold. In this example, we assume that each leaseholder is a participating leaseholder. The situation can become more complicated where not all leaseholders agree, and in paragraph 3.36 below we discuss the consequences where some leaseholders have not consented to the conversion. To start with, however, we adopt a simple scenario for illustrative purposes only.

• 3.11 In this block of five flats, each flat is held by a leaseholder under a long lease of 99 years. Each lease requires the leaseholder to pay an annual “ground rent” to Z, an external landlord¹¹⁶ who owns the freehold of the block. Ground rent is a sum payable at regular intervals under the terms of the lease (usually every year) over and above the initial purchase price.

• 3.12 The relationship between the leaseholders and Z is governed by the terms of the leases and by leasehold legislation. For example, the leaseholders are likely to be required to pay service charges to Z under the terms of their leases. These charges would pay for Z’s costs of managing the block, such as the cost of insuring and repairing the block. Service charges payable to Z under the leases are subject to a statutory requirement that the costs must be reasonable, and expenditure above certain levels requires Z to consult with the leaseholders in advance.¹¹⁷

• 3.13 The leaseholders will have statutory “enfranchisement” rights.¹¹⁸ These rights are the subject of a separate Law Commission project. First, leaseholders have a statutory right to a lease extension. Currently, on exercising this statutory right, leaseholders will receive a new lease which extends their remaining lease term by 90 years. We recommend in the Enfranchisement Report that leaseholders should instead be able to require their landlord to grant them a new lease which extends their remaining lease term by 990 years.¹¹⁹ In the example above therefore, A could require Z to grant him or her a new lease of 1089 years (calculated by adding a further 990 years to A’s remaining 99-year lease). Additionally, some or all of the leaseholders can join together to purchase the freehold of their block from Z. This collective right to acquire the freehold is currently known as the “right of collective enfranchisement”. In the Enfranchisement Report, we refer to this right as the right of “collective freehold acquisition” (“CFA”) and we adopt this new terminology in this Report. On exercising either of these enfranchisement rights, leaseholders will be required to pay compensation to Z for the improved property interest they will acquire. We discuss the value of the freeholder’s interest, and the amount it will cost to buy this interest, when considering the freeholder’s position from paragraph 3.16 below.

• 3.14 Following conversion, each former leaseholder (now as a unit owner) will own their flat (or “unit”) on a freehold basis and the common parts will be owned by the commonhold association. In particular, on conversion:

• (1) the former leaseholders would become commonhold “unit owners” and the freehold owners of their homes;

• (2) the former leaseholders’ property interests would no longer be time-limited, and they would not be required to pay ground rent;

• (3) the former leaseholders would become members of the commonhold association, which owns and manages the common parts of the building;

• (4) there would be no requirement to pay service charges; rather, the commonhold association would demand “commonhold contributions” from the unit owners to cover the shared costs of (for example) repairing the block and maintaining the reserve fund;

• (5) each unit would be allocated a percentage share of the votes in decisions of the commonhold association and a percentage contribution towards the commonhold’s costs of managing the common parts. The percentage allocation will likely to vary from unit to unit, depending, for instance, on the size and of the particular unit;

• (6) the leases, and the statutory regulation of leasehold ownership, would disappear. The mutual rights and obligations between the unit owners and the commonhold association would instead be governed by the terms of a CCS, and by the statutory regulation of commonhold;

• (7) there would be no landlord controlling the building;

• (8) two or more directors would be appointed by the unit owners (who could be the unit owners themselves or external third-parties) to carry out the management functions of the commonhold association; and

• (9) the unit owners would be able to vote on decisions about the management of the building by majority.

WHY DOES CONVERSION CURRENTLY REQUIRE UNANIMOUS AGREEMENT?

• 3.15 As can be seen from the above example, commonhold results in leaseholders taking a commonhold unit and changing their property interests from leasehold to freehold. Conversion also results in the freeholder losing his or her property interest. Before the conversion, the external landlord (Z) owns the freehold of the whole building. After conversion, the former leaseholders will own the freehold of their flats, and the commonhold association will own the freehold of the common parts. The way the current law protects the leaseholders and the freeholder from changes to their interests is simply by requiring everyone to agree to the conversion in order for the conversion to take place. In the above example, therefore, Z would need to agree to the conversion, as would each of the leaseholders. Requiring this level of agreement can quickly create difficulties, especially in larger blocks. In this Part, we therefore recommend an alternative regime which will allow conversion to proceed without unanimous agreement, while still protecting those whose interests stand to be affected. We now look at the freeholder’s interest, and that of the leaseholders, in more detail.

THE FREEHOLDER’S INTEREST ON CONVERSION

• 3.16 On conversion to commonhold, the freeholder will lose his or her interest in the building. The freeholder’s consent to the conversion is therefore currently required. Consent will be more likely forthcoming where the leaseholders already own the freehold collectively.

What is the difference between freeholds owned by an “external landlord” and “leaseholder-controlled” freeholds?

• 3.17 In the worked example above, we refer to Z as an “external landlord”. By external landlord we mean that the freehold of the building is owned by a third-party, rather than by the leaseholders collectively. In some instances, the freehold of the building may already be owned, or rather “controlled”, by the leaseholders collectively. For example, leaseholders may have already bought the freehold of the building through a collective freehold acquisition claim (see paragraph 3.13 above), or the building may have been structured so as to be leaseholder-controlled from the outset.

• 3.18 Where the freehold is leaseholder-controlled, a company will often have been set up to own the freehold of the building. The leaseholders will then be members of (or shareholders in) this company and will be able to vote in decisions affecting the building. Leaseholders in this scenario are often referred to as owning a “share of the freehold”. While they remain leaseholders (and not freeholders) of their individual flats, leaseholders who own a share in the freehold will have a say in how the building is run due to their membership of (or shares in) the company which owns the freehold.¹²⁰ Where the freehold is owned in this way, the need for the freeholder’s consent to the conversion will not present much of an obstacle. The leaseholders themselves will be in control of the freeholder’s decisions (through their membership or shares in the freehold company) which will include the decision to convert. Following conversion of a building which is leaseholder-controlled, the leaseholders would still control the freehold together, but in a different way. Each individual leaseholder would obtain the freehold of their individual flat in exchange for their lease, and would participate in decisions about the building through their membership of the commonhold association.

• 3.19 Conversely, where an external landlord owns the freehold, the freeholder will be much less likely to agree to the conversion, as conversion will result in the freeholder losing his or her interest in the building. The freeholder’s interest is often very valuable.

Why is the freehold interest often valuable?

• 3.20 The freeholder will often have the right to receive some or all of the following sums from the leaseholders.

• (1) The terms of the lease may require the leaseholders to pay ground rent to the freeholder, which can range from a nominal sum to a large annual sum and may increase on a periodic basis.¹²¹ In figure 3 above, leaseholders pay the freeholder, Z, an annual ground rent of £100.

• (2) The terms of the lease may also require the leaseholders to pay the freeholder for the performance of administrative tasks, such as giving permission for alterations to be made to their flats.

• (3) The freeholder will benefit from the fact that leases will expire at some point in the future. The freeholder will receive an amount of money (referred to as “a premium”) when leaseholders exercise their statutory right to a lease extension and/or when granting new leases when existing leases expire.

• (a) Leases are granted for a fixed period of time, for example, 99 or 125 years. At the end of that period, the leases expire. Leases lose value over time as their length reduces and are therefore referred to as “wasting assets”. At the same time, the freeholder’s interest (which is worth more when not subject to any leasehold interests) will increase in value. When the leases expire, the freeholder will be free to grant a new lease over the property, and can charge a premium for doing so.

• (b) To avoid losing their property on expiry of their lease, leaseholders may exercise their statutory right to a lease extension, which involves paying the freeholder for a new lease, adding a further 990 years to their original term (under our recommendations in the Enfranchisement Report). Such new leases are granted with a peppercorn ground rent which will replace the ground rent previously payable.^{122 123} Leaseholders might alternatively agree a lease extension with the freeholder on a voluntary basis (that is, without invoking the statutory rights). In order to obtain a lease extension, leaseholders must pay a premium to the landlord and that right to receive a premium is a valuable right. The premium compensates the landlord for the loss of income received through the ground rent and for the fact that the property will be subject to a lease for an additional 990 years.

What happens if the freeholder does not agree to the conversion?

• 3.21 We explain above that where the freeholder is an external landlord, he or she is unlikely to agree to a conversion to commonhold. However, under the current law, leaseholders wishing to convert to commonhold could rely on their existing enfranchisement rights as a stepping-stone to conversion. As noted above, leaseholders have an existing statutory right to join together to buy the freehold of their building (or buildings¹¹) without the freeholder’s consent, through the process of collective freehold acquisition. After exercising this right, the freehold would be “leaseholder-controlled”. The leaseholders would be in control of the freeholder’s decisions and so could control the decision to convert.¹²⁴

• 3.22 The legislation relevant to CFA claims¹²⁵ sets out the circumstances in which leaseholders might acquire the freehold compulsorily, and what they should pay the freeholder to compensate him or her for the loss of the freehold interest. We conclude in Chapter 4 that the freeholder’s consent to the conversion should not be required, provided that the leaseholders carry out a CFA as part of the process of converting to commonhold. Carrying out the CFA claim will protect the freeholder, and will ensure he or she is sufficiently compensated for the freehold interest.

How much will it cost to buy the freehold?

• 3.23 Where the freeholder does not consent to the conversion to commonhold, the leaseholders will therefore need to carry out a CFA and, as part of the CFA process, pay for Z’s freehold interest, in order to convert.

• 3.24 It should be noted that the amount that leaseholders will be required to pay to the freeholder when acquiring the freehold in order to convert will not be any different to where leaseholders are simply acquiring the freehold on an ordinary CFA claim and not also converting.¹²⁶

• 3.25 The amount of money that will need to be paid to acquire the freehold as part of the CFA claim is the subject of a separate Law Commission report. In the Enfranchisement Valuation Report, we present options to Government to reduce the price payable to acquire the freehold on a CFA claim, while ensuring that sufficient compensation is paid to the freeholder to reflect his or her legitimate property interests. The valuation options presented in the Enfranchisement Valuation Report will compensate the landlord for the loss of his or her right to receive some or all of the payments listed at paragraph 3.20 above.

A worked example

• 3.26 Taking the block of flats depicted in figure 3 above, assume that Z does not agree to the conversion. A, B, C, D and E therefore need to pursue a CFA claim as part of the conversion to commonhold. In this example, each participating leaseholder contributes towards the cost of purchasing the freehold from Z in an equal amount. Figure 5 demonstrates how the purchase price might be paid.

  
  
  
  

• 3.27 In the figure above, Z is entitled to be paid compensation of £15,000, in order for the leaseholders to acquire the freehold. The sums used in the figure are, however, purely illustrative. The cost of buying the freehold will vary from building to building and will often be higher. Additionally, the amount each leaseholder may have to contribute can vary, for example, depending on the number of years remaining on the lease and the size of the flat.

• 3.28 The above example also assumes that each flat in the building is owned by a leaseholder who participates in the conversion. At paragraph 3.36 below, we explain the consequences (including in relation to financing the freehold purchase), where not all leaseholders participate.

What process will leaseholders follow to buy the freehold and convert to commonhold?

• 3.29 Where the freeholder does not agree to the conversion, converting to commonhold will involve two processes:

• (1) buying the freehold of the building through a CFA claim. The CFA legislation sets out a process to determine matters such as the purchase price payable to the freeholder and the land to be acquired. In the Enfranchisement Report and Valuation Report, we make a number of recommendations which will make the process of acquiring the freehold easier, quicker and cheaper; and

• (2) putting in place the commonhold management structure, which will include

preparing the CCS and registering the new commonhold at HM Land Registry.

• 3.30 To avoid the delays and costs which might otherwise be created by following two distinct processes, in Chapter 7, we explain how leaseholders will be able to streamline the processes of acquiring the freehold through a CFA claim and putting in place the commonhold management structure. We recommend a bespoke “acquire and convert” procedure that leaseholders wishing to convert can choose to follow. The acquire and convert procedure incorporates all the procedural steps required in a CFA claim, and any additional steps necessary to convert to commonhold.

THE LEASEHOLDERS’ INTERESTS ON CONVERSION

• 3.31 Conversion to commonhold under our recommendations will result in some or all (depending on which conversion option is pursued) of the leaseholders in the building, who are eligible to participate in the conversion, upgrading their leasehold interest to a freehold commonhold unit.

Which leaseholders are eligible to participate in the conversion?

• 3.32 As, in many cases, leaseholders will be following the “acquire and convert” process described above, we consider it logical that the same leaseholders should be eligible to participate in both the CFA and conversion claims. As explained in Chapter 4, it would add too much complexity if a different group of leaseholders were eligible to participate in the CFA claim and the conversion to commonhold. We recommend that the same category of leaseholders who are eligible to participate in a CFA claim should therefore be able to participate in the conversion to commonhold.

• 3.33 In the Enfranchisement Report we consider which leaseholders should be eligible to participate in a CFA claim.¹²⁷ In summary, a leaseholder will be eligible to participate in a CFA claim (and therefore participate in a conversion to commonhold) if:

• (1) The leaseholder has been granted a “long lease”. Subject to certain exceptions,¹²⁸ a “long lease” is a lease which has been granted for more than 21 years.

• (2) The lease has been granted over a “residential unit”. The term “residential unit” is explained in full in the Enfranchisement Report.¹²⁹ For the purposes of this Part of the Report, however, it suffices to explain that individual flats within a purpose-built block of flats are intended to fall within the definition of residential unit. As we anticipate that it will be predominantly leaseholders in blocks of flats who will seek to convert, we retain the terminology of “flats” for simplicity, rather than adopting the term “residential units”.

• (3) The lease is not a “business lease”.¹³⁰

• (4) The leaseholder (who would otherwise be eligible) has not sub-let his or her flat

to another long leaseholder who satisfies the eligibility criteria above. There can only be one leaseholder in respect of any one flat who is eligible to participate in the CFA claim and therefore the conversion. For example, in the diagram below, if long leaseholder (A) sub-lets his or her flat to another long leaseholder (B), it would be the latter, (B) who would be eligible to participate in the CFA claim, and therefore the conversion.

• 3.34 In summary therefore, a leaseholder of a flat who has a residential lease of over 21 years, and who has not sub-let his or flat on a long lease, will be eligible to participate in a CFA claim and the conversion to commonhold. In this Part, we refer to leaseholders who are eligible to participate in a decision to convert, and who do in fact participate, as “participating leaseholders”.

• 3.35 Conversely, individuals who have been granted tenancies of 21 years or less, or of commercial premises, or who have been granted business leases will not be eligible. Additionally, where a leaseholder who would otherwise be eligible has sub-let his or her flat to another leaseholder on a residential lease of over 21 years, he or she would not be eligible.

What happens where a leaseholder, who is eligible to participate, does not agree to the conversion?

• 3.36 There may be leaseholders in the building who, despite being eligible to participate in the decision to convert, do not agree to the conversion to commonhold. We refer to these leaseholders as “non-consenting leaseholders”. Such leaseholders may have specific reservations about the commonhold model or may be unable to afford to participate in the conversion. Leaseholders who fail to respond to a request for consent due to apathy would also fall within the category of non-consenting leaseholders.

• 3.37 Currently, conversion to commonhold would require the consent of every leaseholder in the building. Consultees told us that this level of support would, in most cases, be impossible to achieve. In order to make commonhold a realistic alternative for existing leaseholders, we therefore recommend in Chapter 4 that conversion to commonhold should be possible where eligible leaseholders of at least 50% of the flats in the building support the conversion. That is the same threshold of leaseholder support as is required for leaseholders to bring a CFA claim.¹³¹ If leaseholders are able to acquire the building collectively through a CFA claim they will also be able to convert to commonhold under our recommendations. In Chapter 5 we recommend a new system of safeguards that will protect leaseholders (and others) who have not agreed to the conversion.

• 3.38 The consequences of conversion for non-consenting leaseholders will depend on whether conversion Option 1 or Option 2 is adopted. Under conversion Option 1, nonconsenting leaseholders will retain their leasehold interest at the point of conversion. However, in order to ensure the full advantages of commonhold are realised at some point in the future, the continuation of leases under Option 1 will be a temporary, transitional measure. At some stage in the future, all non-consenting leaseholders will be required to upgrade their leasehold interest to a commonhold unit. Under Option 2, all non-consenting leaseholders will be required to take a commonhold unit at the point of conversion to commonhold. In Chapter 6 we compare the main advantages and disadvantages of both conversion options. We explain that conversion Option 2 creates the most desirable management structure as all leaseholders would obtain the same type of interest from the point of conversion. However, there are certain practical difficulties when it comes to implementing Option 2, particularly when it comes to the method of financing the freehold purchase.

Financial consequences where not all flats are held by participating leaseholders

• 3.39 The figure at 5 above assumes that each flat in the building is held by a leaseholder who is eligible to participate and who also agrees to the conversion (a “participating leaseholder”). In reality, a number of the flats in the building may be held by leaseholders who, while eligible to participate, do not consent to the conversion (“nonconsenting leaseholders”). Other flats might not be let to a leaseholder who is eligible to participate. For example, flats which are empty, or have been let by the freeholder to business tenants or to tenants on short-term agreements. Where this is the case, participating leaseholders will need to find a way to finance:¹³²

• (1) their own share of the freehold value attributable to their own flats;

• (2) a share of the freehold value attributable to flats which have been let to nonconsenting leaseholders; and

• (3) a share of the freehold value attributable to flats which have not been let to any leaseholder who is eligible to participate.

• 3.40 So, as a variation to the worked example in figure 5 above, if only A, B and C were participating leaseholders, D was a non-consenting leaseholder and E was a business tenant (and therefore not eligible to participate), A, B and C would need to finance (with or without external assistance):

• (1) £3,000 each in respect of their own flats;

• (2) £1,000 each in respect of D’s flat; and

• (3) £1,000 each in respect of E’s flat.

• 3.41 That is assuming A, B and C contribute equally to the purchase price. In Chapter 5 we explain the ways in which leaseholders might be able to finance non-consenting leaseholders’ shares of the freehold value, and the shares relating to any flats which have not been let to an eligible leaseholder.

A COMPARISON WITH COLLECTIVE FREEHOLD ACQUISITION

• 3.42 We note above that leaseholders already have the right to acquire their freehold collectively through a CFA claim. The question arises therefore, as to what differences there are between a CFA claim and conversion to commonhold, and what additional advantages commonhold offers.

A worked example: where all leaseholders participate in a CFA claim

• 3.43 Considering again the block of five leasehold flats depicted in figure 3. If the five leaseholders in the block wished to carry out a CFA, they would nominate a person (or persons) known as the “nominee purchaser” to acquire the freehold from Z on their behalf. The nominee purchaser is usually a company, and the leaseholders will be members of (or shareholders in) this company.

• 3.44 The only immediate change following a CFA is that the freehold of the building will be owned by the nominee purchaser, rather than the external freeholder Z, after the CFA claim. The leaseholders will retain their leasehold interests and will continue to be bound by the terms of their leases and by leasehold legislation. As the leaseholders will control the decisions of the nominee purchaser that acquires the freehold, they will be able to make certain changes to their leasehold interests. Usually, they will arrange to grant themselves 999-year lease extensions at a peppercorn ground rent.

• 3.45 Where all five leaseholders in the block participate in the CFA claim, and vary their leases subsequently, the position following the CFA would look like this:

• 3.46 Here, the leaseholders have set up a company “T Co” as the nominee purchaser which acquires the freehold from external landlord Z. The leaseholders are all members of T Co. Following the CFA:

• (1) the leasehold structure remains, but T Co is now the freeholder in place of Z. T Co is the landlord of each of the leaseholders. While the leaseholders now, together, control the building, the two opposing interests (landlord and leaseholder) continue to exist. Effectively, the leaseholders “wear two hats”, both as leaseholders and as members in T Co;

• (2) the relationship between the leaseholders and T Co continues to be governed by the terms of the leases, and by leasehold legislation. For example, the statutory regulation of service charges continues (meaning that T Co, as landlord, must still consult the leaseholders before incurring costs above a certain amount and the leaseholders would be able to challenge the reasonableness of service charge costs levied by T Co); and

• (3) the leaseholders, as shareholders or members of T Co, have control over the management of the building (or could appoint a third-party to manage it), including, for example, setting the service charges.¹³³

• 3.47 While following a CFA claim the leaseholders will gain control of the building, the CFA claim will not provide the leaseholders with the full advantages of converting to commonhold. Collective freehold acquisition and other enfranchisement rights attempt to address some of the harsher effects of leasehold ownership, but do not remove the leasehold ownership structure, or its inherent defects. After exercising a CFA claim, leaseholders will retain a leasehold interest which will expire at some point in the future (or will need to be extended), can be brought to an end through forfeiture and is inflexible to changing needs. For this reason, CFA has been described to us as “commonhold lite”. Only on conversion to commonhold can leaseholders obtain the freehold of their flats, remove the landlord and tenant relationship and the risk of forfeiture, and receive greater flexibility to set the rules of their building.

• 3.48 Many other advantages of conversion over a CFA claim stem from the fact that the commonhold legislation has been designed specifically for the collective ownership of buildings without an external landlord. Following a CFA claim, leaseholders will remain bound by leasehold legislation which has been designed to suit an adversarial relationship between those who own the flats and those who manage the building. Commonhold removes this adversarial system. In commonhold, the same individuals who decide on the rules of the commonhold and set the costs (the unit owners, through their membership in the association), will be responsible for complying with these decisions and paying the costs (also the unit owners). The commonhold legislation has been tailored to suit this context. The legislation provides for unit owners to make collective decisions about the management of their building and there are bespoke provisions which govern every aspect of the commonhold’s operation. This generates a number of advantages over CFA claims. We provided a list of these advantages at paragraph 1.33 of the Consultation Paper, but some examples include:

• (1) the collective management of the building will be simplified by having one document (the CCS) which sets out the rights and obligations of all owners in the building, rather than numerous leases, the terms of which might be inconsistent with each other.

• (2) the mechanism for setting costs and resolving disputes within the commonhold reflect the fact that there is a community of owners in the building who share control of the building, rather than a landlord who dictates the costs to be paid, and enforces the rules against the owners, which is the starting point in leasehold.

• (3) Additionally, there are provisions that will make it easier for unit owners to raise funds to carry out emergency repairs, and to redevelop the commonhold when the building has come to the end of its useful life.

Worked example: where some, but not all, of the leaseholders participate in a CFA claim

• 3.49 The adversarial leasehold relationship which exists following a CFA claim is more pronounced when not all leaseholders in the block participate in the CFA. As we note above, a CFA claim is possible where eligible leaseholders of at least 50% of the flats in the building support the claim. It will usually be the case, especially in larger blocks, that the claim takes place without unanimous agreement. Where some, but not all of the leaseholders participate, the participating leaseholders and non-participating leaseholders will hold different interests after exercising the claim. At present, this inequality is permanent.¹³⁴ There is no mechanism for non-participating leaseholders to buy a share of the freehold after the CFA claim has taken place.¹³⁵ After the claim:

• (1) The leaseholders who participated in the CFA claim, will acquire “a share of freehold” and gain control of the building. As these leaseholders would now control the building, they would be able to vary the terms of their own leases, for example by extending the term of their leases to 999 years and by removing any requirement to pay ground rent. However, they would not be able to vary the terms of non-participating leaseholders’ leases. In managing the building those who had purchased a share of the freehold would still need to comply with the (unchanged) terms of the non-participating leaseholders’ leases.¹³⁶

• (2) The leaseholders who do not participate in the CFA claim would continue to own their leases on the same terms and from their point of view, the only change would be the identity of the freeholder. Those who participated in the CFA claim would become their landlord.¹³⁷ Non-participating leaseholders would continue to pay any ground rent due under the terms of their lease and any premiums for a lease extension to the participating leaseholders.¹³⁸

• 3.50 Using the same example at figure 3, it might be that leaseholders A, B, C and D want to participate in the CFA claim, but E does not wish to do so. Since a CFA claim can be made by the leaseholders of 50% of the flats in a building, the claim can go ahead without E’s agreement.¹³⁹ After the purchase, T Co might grant A, B, C and D lease extensions. E’s lease would remain unchanged. A, B, C and D would each have “a share of the freehold”. E would not.

• 3.51 Following a CFA claim where not all leaseholders participate:

• (1) T Co is the freeholder in place of Z. A, B, C and D are members of T Co and have control over the management of the building.

• (2) A, B, C and D have 999-year leases with no ground rent. By contrast, E retains his or her 99-year lease and will continue to pay ground rent. E will now pay this ground rent to T Co.

• (3) E would have a statutory right to extend his or her lease by 990 years under our recommendations in the Enfranchisement Report but would not have any right to acquire a share in T Co subsequently. Any premium payable for a lease extension would be paid by E to T Co.

• 3.52 While the majority of the leaseholders now, together, control the building, the two opposing interests (of landlord and leaseholder) would continue to exist. Indeed, the opposing interests are more prominent, and have more potential to cause problems in the future, given the two tiers of interest in the building. E’s interest in his or her flat is a lesser interest than that of the other leaseholders in the block: E has a shorter lease, must continue to pay ground rent, and has no say (through T Co) in the management of the block. Commonhold, by contrast, is intended to put all owners on the same footing, as freehold unit owners, and to remove such tiers of interest. All owners will collectively own and manage the common parts by virtue of their ownership of the units.

• 3.53 We acknowledge in Chapter 6 that the position following conversion Option 1 has similarities with a CFA claim where not all leaseholders participate. Following conversion under Option 1, non-consenting leaseholders would retain their leasehold interests, whereas participating leaseholders would take commonhold units and become members of the commonhold association. This would create two tiers of interest in the building. However, unlike the position following a CFA, this inequality of interests will be a temporary, rather than a permanent, feature. Following conversion under Option 1, leaseholders who did not participate at the outset, will have a right to buy their commonhold unit at a later date and become members of the commonhold association. We also recommend other measures to ensure that, at some point in the future, all leaseholders in the building will upgrade their interest to a commonhold unit and the full advantages of commonhold can be realised.

CONCLUSION

• 3.54 In this chapter, we have set out the fundamental concepts which underpin conversion to commonhold. We have explained why conversion to commonhold currently requires unanimous agreement, looked at issues surrounding the freehold purchase, and compared the position with both leasehold and “share of freehold” arrangements. In the table below, we summarise the key differences between leasehold with an external landlord, collective freehold acquisition and commonhold.

Figure 9: Key differences between leasehold with an external landlord, collective freehold acquisition, and commonhold

• Chapter 4: When should conversion be possible?

INTRODUCTION

• 4.1 Commonhold facilitates the freehold ownership of flats. Currently, leaseholders can -in theory - obtain the freehold of their flats by converting their building to commonhold. However, conversion to commonhold requires the agreement of almost every person who has an interest in the property. Agreement is required because conversion results in various property interests being lost or changed. In the Consultation Paper, we explained that, under the existing law, conversion requires the consent of the following persons for the following reasons.¹

• (1) The freeholder. On conversion, the freeholder’s interest in the property will be lost.^{140 141} The freeholder’s consent to conversion is therefore required. However, where the freeholder does not agree, leaseholders will have a legal mechanism to buy the freehold without the freeholder’s consent, through the right of collective freehold acquisition (“CFA”).¹⁴²

• (2) The leaseholders. On conversion, all leasehold interests originally granted for more than 21 years will be brought to an end and replaced with permanent commonhold interests in the flats. Each individual leaseholder must therefore consent to the conversion.

• (3) Tenants. Any tenancies originally granted for 21 years or less will be terminated at the point of conversion, and unless the tenants will be regranted new tenancy agreements after the conversion, they must also consent to the conversion.

• (4) Lenders.¹⁴³ On conversion, lenders will lose any charges (such as mortgages) they have over the leasehold flats to secure the repayment of their loans. Lenders must therefore agree to the conversion. As lenders would be losing their security on conversion, it is inevitable that a lender would only agree to the conversion if it was willing to accept a new charge over the commonhold unit following the conversion.

• 4.2 Not surprisingly, stakeholders have told us that, in all but the smallest blocks of flats, it will be almost impossible to obtain the unanimous agreement of every interested party. Conversion to commonhold may therefore be out of the reach of the vast majority of existing leaseholders.

• 4.3 Our Terms of Reference require us to reinvigorate commonhold as a workable alternative to leasehold, not only for new homeowners, but also existing homeowners. In order to make commonhold accessible to existing leaseholders, it will need to be possible to convert to commonhold without unanimous agreement.

• 4.4 In this chapter, we make a number of recommendations that will make it easier for leaseholders to convert to commonhold and obtain the freehold ownership of their flats. At the same time, we ensure safeguards are in place to protect those whose property interests will be affected by the conversion to commonhold. In particular, we recommend that:

• (1) conversion should be possible without the freeholder’s consent, provided that the leaseholders carry out a CFA claim as part of the conversion process;

• (2) conversion should be possible where leaseholders of 50% of the flats in the building support the decision to convert - subject to appropriate safeguards;

• (3) tenancies should automatically continue on conversion, and so the consent of tenants should not be required; and

• (4) mortgages should transfer automatically from the lease to the commonhold unit - but only if Government works with lenders to ensure that such an automatic transfer will be accepted.

• 4.5 We now consider, in more detail, the circumstances in which it might be possible to convert to commonhold without the agreement of each interested party listed above.

WHEN SHOULD CONVERSION BE POSSIBLE, WITHOUT THE FREEHOLDER’S CONSENT?

• 4.6 As noted above, conversion to commonhold will result in the freeholder losing his or her interest in the building.¹⁴⁴ The freeholder’s consent to conversion is therefore currently required. In the previous chapter, we explained that where leaseholders already own the freehold collectively, the need for freeholder consent will not present much of an obstacle. But where an external landlord owns the freehold, the freeholder will be less likely to agree to the conversion. The freeholder’s interest is often a very valuable asset which the freeholder will be reluctant to give up voluntarily.¹⁴⁵

• 4.7 However, even where the freeholder does not agree to the conversion, that is not necessarily the end of the matter. Leaseholders already have a statutory mechanism available to acquire the freehold collectively, without the freeholder’s consent. After obtaining the freehold, the leaseholders will then be able to consent to the conversion to commonhold on the freeholder’s behalf. This mechanism to acquire the freehold is currently known as the right of “collective enfranchisement”. In the Enfranchisement

Report we refer to this right as “collective freehold acquisition” (“CFA”), and so we adopt that terminology throughout this Report.

• 4.8 The enfranchisement legislation sets out:

• (1) Qualifying criteria

These are the criteria that need to be met before a CFA claim can be made. The criteria are designed to identify the conditions that should have to be satisfied before a group of leaseholders can acquire the freehold compulsorily. We consider the qualifying criteria in detail in our Enfranchisement Report.⁷ In summary, to bring a CFA claim under our revised regime:

• (a) there must be at least two flats⁸ in the building which are held by leaseholders who are eligible to participate in the CFA claim. We explain which leaseholders are eligible to participate in a CFA claim in the previous chapter at paragraph 3.32, but in general a residential leaseholder who has been granted a lease of more than 21 years over a flat will be eligible;

• (b) at least two-thirds of the flats in the building must be held by leaseholders who are eligible to participate in the CFA claim;

• (c) eligible leaseholders of at least 50% of the flats in the building must participate in the CFA claim; and

• (d) no more than a certain percentage of the floor space in the building can be occupied for non-residential use. Under the existing law, no more than 25% of the internal floor area (excluding common parts) may be occupied or intended to be occupied for non-residential use (for example, commercial purposes). However, as we explain below, we recommend increasing this limit to 50% in the Enfranchisement Report.

• (2) Procedure

This is the procedure for bringing a CFA claim. In particular, the procedure provides a mechanism to determine the amount of compensation to be paid to the freeholder, and the extent of the freeholder’s land that can be acquired. In our Enfranchisement Report and Valuation Report, we make recommendations that will make the process of acquiring the freehold cheaper and more efficient.

• 4.9 In the Consultation Paper, we proposed that, in order to convert to commonhold where the freeholder does not consent to the conversion, the participating leaseholders would need to satisfy the same qualifying criteria as for a CFA claim and acquire the freehold through the CFA procedure.⁹ Given the existing legal framework

For a full description the existing qualifying criteria, see Enfranchisement Report, Ch 6.

The Enfranchisement Report adopts the terminology “residential unit”. See Enfranchisement Report, para 3.33(2).

In the CP, we asked consultees two separate consultation questions. At para 3.31 we asked consultees whether they agreed that it should only be possible to convert to commonhold if either the freeholder for acquiring the freehold compulsorily, we considered it unnecessary and undesirable to create a similar, but slightly different procedure to enable leaseholders to acquire the freehold as part of the conversion to commonhold. Under our proposals, where the freeholder does not consent to the conversion, leaseholders would therefore need to satisfy the same qualifying criteria that apply to CFA claims.^{146 147 148} We were concerned that if leaseholders could convert to commonhold, and obtain the freehold as part of the process, with different or less stringent qualifying criteria than for a CFA claim, leaseholders might be able to circumvent the qualifying criteria for CFAs.

Consultees’ views

• 4.10 The majority of consultees agreed that, where the freeholder does not consent to the conversion to commonhold, leaseholders should need to satisfy the same qualifying criteria as for a CFA and acquire the freehold through the CFA procedure.

• 4.11 Those in favour argued that it made practical sense to use the right of CFA as a basis for conversion to commonhold, particularly in the light of the Commission’s plans to improve the CFA process, and reduce the cost of acquiring the freehold for leaseholders.¹¹ FirstPort (managing agents) said:

Enfranchisement being a current right and a tested process would seem to be the logical route to begin a conversion and it must be right that this is the minimum requirement should the freeholder not consent from the outset.

• 4.12 The Property Bar Association (“PBA”) commented that our proposal made sense “given that the criteria for collective enfranchisement are tried and tested and have been held to strike a fair balance between freeholder/leaseholders”.

• 4.13 Those who disagreed with our proposal were generally leaseholders, residents’ associations and individuals. These consultees referred to the complexity of the CFA process and said that the qualifying criteria for CFA claims were too restrictive. Consultees were especially critical of the current restriction on exercising a CFA claim where more than 25% of the building’s floor space is occupied (or intended to be occupied) for non-residential use. Joy Dickinson (leaseholder) referred to the increasing number of mixed commercial and residential developments in England and Wales which would be prevented from converting:

The proposal to keep the 25% rule on non-residential premises is wrong. You are excluding many, many leaseholders from being able to move on to a better system and revive their property values. Mixed-use schemes are common in the city centres.

• 4.14 Consultees were also concerned that if commonhold takes off for new-build developments, leaseholders who do not meet the qualifying criteria for a CFA claim could be trapped in a discredited form of homeownership. Alice Brown (leaseholder) explained:

Other existing leaseholders that qualify for collective enfranchisement will be able to benefit from a more secure homeownership structure and an asset that is not wasting like our leases. This will put the leaseholders such as the five flats in our building at a further disadvantage in comparison.

• 4.15 One leaseholder, responding confidentially, argued that there is more scope for “profit extracting” within mixed-use developments and so the need for commonhold is even greater. The Leasehold Knowledge Partnership (“LKP”) and the All-Party Parliamentary Group on Leasehold and Commonhold Reform (“APPG”) said that the proposed ability to use sections¹⁴⁹ to separate out the management of different types of interest in commonhold would remove the need for the 25% restriction.

• 4.16 A number of consultees went further and argued that conversion should happen “automatically”, without needing to satisfy any particular criteria or making any form of payment to the freeholder. Some consultees referred to the automatic conversion of leasehold interests into outright ownership which took place in Scotland in 2015. In addition, several consultees suggested that there should be an individual right for leaseholders to convert their flats into commonhold.

• 4.17 Other consultees did not answer the question specifically, but argued that certain types of property (for example, land held by the National Trust, for charitable purposes or for the provision of specialist housing with care) should be excluded from enfranchisement rights, and from the right to convert. In these scenarios, they argued, it was important for the land to remain in the ownership of the existing freeholder.

Discussion

Could conversion to commonhold happen automatically?

• 4.18 Several consultees argued that leaseholders should acquire the freehold of their flats “automatically”, and a number referred to the Scottish model.¹⁵⁰ However, the position in England and Wales is very different from the position in Scotland, with the result that the analogy is not an appropriate one.

• 4.19 Although the conversion of leasehold interests happened automatically in Scotland, leaseholders were still required to pay an amount of compensation to their landlord to purchase the freehold of their properties. Leaseholders were able opt out of the conversion, for instance, where they were unable to pay the statutory compensation to the landlord.¹⁵¹ As we explained further in the Enfranchisement Valuation Report, in Scotland it was possible to apply a relatively simple formula to calculate the amount of compensation that each leaseholder should pay for their freehold interest.¹⁵² That is because the Scottish legislation only applied to very long leases with little or no reversionary value and with a very low annual rent.¹⁵³

• 4.20 In the Enfranchisement Valuation Report, we explained that it would be impossible to create one statutory formula in England and Wales that would offer sufficient compensation to the freeholder in respect of every leasehold flat.¹⁵⁴ A compensation scheme similar to that used in Scotland could be introduced in respect of leases which are similar to those covered by the Scottish scheme, namely very long leases (so with little or no reversionary value) where the ground rent is fairly low. But many leases in England and Wales would not fall within a scheme based on the Scottish legislation. That is because a wide range of leases exist in England and Wales, including those with more significant reversionary value, or with high ground rents or complex rent review structure.

• 4.21 There is also a significant difference of scale. At the time the Scottish Law Commission recommended the automatic conversion of long leases to freehold ownership, there were fewer than 13,000 leasehold interests in Scotland.¹⁵⁵ By contrast, it is estimated that there are at least 4.3 million leasehold properties in England alone. Practically speaking, it would therefore be much harder in England and Wales to ensure the registration of all the converted leasehold interests.

• 4.22 However, given that, in response to the Consultation Paper, several consultees called for an automatic conversion process, we have explored whether there might be a different way of facilitating an “automatic” conversion to commonhold which is better suited to the position in England and Wales.

• 4.23 We considered an alternative approach, whereby the freeholder’s interest in the building could be broken down so that he or she would become the owner of all the commonhold units in the building at the point of conversion (rather than being the freehold owner of the building as a whole). The leaseholders could then be given an individual right to buy their commonhold unit from the freeholder. The freehold of each flat could be valued on a case-by-case basis, rather than relying on a statutory formula. Under this approach, conversion would be automatic in the sense that the commonhold structure would be put in place at the point of conversion, albeit that the freeholder would be the owner of all the individual commonhold units at the point of conversion, and the leaseholders would retain their leases. Each leaseholder in the building would be able to decide whether or not to buy the commonhold unit of his or her individual flat, rather than needing to rely on the leaseholders making a collective claim. Obtaining a commonhold unit would not, under this approach, depend on whether the leaseholder’s neighbours were willing or able to purchase their own units. To put this alternative structure into place:

• (1) the freeholder’s interest in the building could be broken down, so that rather than owning the freehold of the entire building, the freeholder would be the commonhold unit owner of each of the flats in the building;

• (2) the common parts of the building could be transferred to the commonhold association at the point of conversion;

• (3) a commonhold community statement (“CCS”) would need to be prepared, to replace the leases in the building;

• (4) the freeholder could be required to delegate his or her voting rights in the commonhold association to the existing leaseholders, so that the leaseholders would take over the management of the building from that point; and

• (5) to obtain greater security in their properties, the leaseholders would be able to buy their commonhold units from the freeholder.

• 4.24 However, this alternative approach would be complicated to achieve in practice. It is difficult to see how the steps required to facilitate this alternative scheme could happen “overnight”. In particular: (1) the freeholder would need to become the registered owner of each of the individual commonhold units at HM Land Registry; (2) a commonhold association would need to be created and registered at Companies House; (3) a CCS would need to be agreed upon, which would replace all the leases in the building; and (4) it may be necessary to compensate the freeholder for any development value attached to the common parts.¹⁵⁶

• 4.25 More fundamentally, as the leaseholders would not be required to purchase the freehold collectively, the freeholder’s interest in the building would continue until all the leaseholders had decided to exercise their individual right to buy the freehold of their flat. Leaseholders would not, under this alternative approach, be able to acquire the whole of the freehold at the point of conversion. In response to the Consultation Paper, many leaseholders were sceptical about the freeholder’s ongoing role in the building following conversion. For many, the main purpose of converting to commonhold would be to remove the freeholder’s interest in the building, and to assume collective control.

• 4.26 We therefore remain of the view that the most sensible and practical approach is for the leaseholders to make a collective decision to acquire the freehold collectively from the freeholder.

Cost, complexity and qualifying criteria

• 4.27 We note that the main objection to our proposal for leaseholders to carry out a CFA claim in the absence of the freeholder’s consent was that it would prevent existing buildings, where more than 25% of the building is in non-residential use, from converting to commonhold. In the Enfranchisement Consultation Paper, we provisionally proposed retaining the existing 25% restriction.¹⁵⁷ However, as we explain in the Enfranchisement Report, we have been persuaded by consultees that this criterion should be expanded so as to enable more leaseholder to exercise CFA rights. We have therefore recommended increasing the 25% limit to 50%.¹⁵⁸ Following our recommendations in the Enfranchisement Report, leaseholders will be able to enfranchise, and therefore convert to commonhold, where up to 50% of the building is occupied (or intended to be occupied) for non-residential use.

• 4.28 In the Enfranchisement Report, we also recommend the introduction of a right for leaseholders to pursue a “multi-building CFA” claim. This right would enable leaseholders of multiple buildings to bring a joint claim to acquire the freehold of each of those buildings and convert to commonhold. At present, a CFA claim can only be brought in respect of a single building. Under our recommendations in the Enfranchisement Report, provided that each building meets the necessary qualifying criteria, the leaseholders of two or more buildings would be able to make a single claim to acquire the freehold of those buildings and certain additional land or premises. The introduction of such a right was strongly supported by consultees, who said that it would provide leaseholders with more control over their surroundings, improve the management of estates, and save costs due to economies of scale.¹⁵⁹

• 4.29 Under our recommendation in the Enfranchisement Report, leaseholders of houses, as well as of flats, would be able to join in with a multi-building CFA claim, as long as they were able to meet the eligibility requirements set out above at paragraph 4.8(1) (for example, they must have a lease which was granted for more than 21 years which is not a business lease). Consequently, it will be possible for leaseholders (of both houses and flats) on a shared estate to join together to acquire the freehold and convert to commonhold.

• 4.30 In response to the Consultation Paper, some consultees asked whether freehold house owners on an estate would be eligible to convert. As a result of adopting the same qualifying criteria as for a CFA, the answer to this question will depend on the eligibility of freehold house owners to join in a multi-building CFA.

• 4.31 The qualifying criteria set out in our Enfranchisement Report have been carefully considered and rationalised, so that there will now be one “unified scheme” of qualifying criteria that will apply across all buildings in England and Wales. To qualify for rights under this unified scheme, it is necessary to be a leaseholder.

Enfranchisement legislation has been designed to provide leaseholders with greater security in their properties by enabling them to buy the freehold of their homes. Freehold house owners will already have a permanent interest in their homes, and so are not provided with enfranchisement rights. Freehold house owners on a shared estate would therefore not be eligible to be part of a multi-building CFA claim or to convert to commonhold. However, if the house owners were to grant themselves leases over their properties (meeting the necessary eligibility requirements), they would then be able to participate in the CFA claim, and the conversion to commonhold.

• 4.32 As we note below, it may be possible in the future to establish different, less stringent qualifying criteria where leaseholders are converting to commonhold. If different criteria are established in the future, which exist independently of the CFA regime, it would be possible to reconsider the ability of freehold house owners to participate in the conversion process (without first needing to grant themselves a lease), if there is a demand for such a right.

• 4.33 We note the concerns of some consultees responding to this question that it should not be possible for leaseholders to acquire certain types of property compulsorily. In our Enfranchisement Report, we consider the types of property which should be exempt from enfranchisement claims, and which should not be capable of being acquired compulsorily by leaseholders.¹⁶⁰ The result of adopting the same criteria as for CFA claims will be that land which cannot be acquired compulsorily by leaseholders pursuing a CFA claim also cannot be acquired without the freeholder’s consent on a conversion to commonhold.

• 4.34 With regard to the cost and complexity of pursuing a CFA claim, in the Enfranchisement Report we make numerous recommendations that will make the CFA process quicker and simpler. These recommendations include, for example, the introduction of simple, prescribed notices which will help leaseholders navigate the acquisition process. Technical mistakes on these forms will not invalidate the leaseholders’ claim. Separately, the Enfranchisement Valuation Report presents options for Government to reduce the price payable to acquire the freehold under a CFA. The Enfranchisement Reports therefore go a long way to alleviating consultees’ concerns about the complexity and cost of the freehold acquisition process, and requiring the same qualifying criteria to be satisfied.

• 4.35 Further, in Chapter 7 of this Report, we explain how leaseholders will be able to streamline the processes of buying the freehold through a CFA claim and putting in place the commonhold structure, which will save leaseholders’ time and expense.

Recommendations for reform

• 4.36 Having carefully considered consultees’ concerns, we remain of the view that, where the freeholder does not consent to the conversion, leaseholders should be required to pursue a CFA claim as part of the process of converting to commonhold.

• 4.37 Relying on an established procedure is logical, and will avoid creating an additional layer of complexity. Further, the CFA criteria are set in such a way as to carefully balance the interests of the leaseholders and the freeholder. As conversion to commonhold will also result in the freeholder losing his or her interest, we think the

CFA criteria should be the starting point for deciding whether it should be possible to dispense with freeholder consent.

• 4.38 In the Consultation Paper, we did not rule out the possibility that in the future, to incentivise conversion to commonhold, Government might wish to revisit the qualifying criteria for conversion to commonhold. Adopting the same process and qualifying criteria as for a CFA reflects the current position that commonhold is rarely used. But as commonhold becomes more prevalent, different considerations will apply. For example, leasehold could be seen in the market as a less desirable or valuable asset when compared to commonhold. It might become undesirable simply to make a CFA claim and retain the leasehold structure, as opposed to converting to commonhold. As commonhold becomes more prevalent, and as the market, practice, expectations and housing policy develops, it would be appropriate to revisit the circumstances in which leaseholders might acquire the freehold in order to convert to commonhold.¹⁶¹

Recommendation 1.

• 4.39 We recommend that it should be possible to convert to commonhold if either:

• (1) the freeholder consents; or

• (2) the leaseholders carry out a collective freehold acquisition claim as part of the process of converting to commonhold.

• 4.40 We recommend that the circumstances in which leaseholders may acquire the freehold on conversion to commonhold without the freeholder’s consent should be kept under review.

WHEN SHOULD CONVERSION BE POSSIBLE, WITHOUT THE UNANIMOUS CONSENT OF LEASEHOLDERS?

Removing the requirement for unanimity

• 4.41 Given our objective of making conversion to commonhold a viable option for existing leaseholders, we provisionally proposed in the Consultation Paper that it should be possible to convert to commonhold without the unanimous agreement of leaseholders.¹⁶²

Consultees’ views

• 4.42 The vast majority of consultees supported our provisional proposal to remove the unanimity requirement amongst leaseholders. In particular, almost all leaseholders, leaseholder representative groups, individuals and residents’ associations were in favour. Support for our proposal was also strong amongst law firms and legal representative bodies. Conversely, two developers and three commercial freeholders responding to this question disagreed with our proposal.

• 4.43 The arguments raised in support of our provisional proposal largely reflected those given in response to the Call for Evidence. Namely, that conversion with unanimous agreement would be virtually impossible, and that reducing the threshold of leaseholder support would be necessary for commonhold to suceed. One consultee, Colette Boughton, argued that if unanimity were not removed, there would be “no reform”.

• 4.44 Consultees offered numerous reasons why obtaining the agreement of all leaseholders is difficult. LKP summarised:

At any one point, in a large block there will be a number of properties which are a) in the process of being sold, b) have leaseholders who cannot be contacted, c) have leaseholders who may be under the court of protection and d) be awaiting probate or part of an ongoing disputed inheritance.

• 4.45 Lucas Burchard said that it would not be fair to allow a minority of leaseholders to “hold current leaseholders ‘hostage’^” and prevent them from benefiting from the commonhold structure. Christopher Harris agreed that removing unanimity “is essential to prevent single objections, inertia, or misunderstandings preventing many people from getting to commonhold”.

• 4.46 Consultees who disagreed with our proposal said that removing the unanimity requirement could cause tensions and resentment within the commonhold, leading to disputes. The Wallace Partnership Group Ltd (landlord) argued that interests “cannot be said to be aligned” without the unanimous agreement to convert to commonhold. Several consultees argued that leaseholders may have good reasons for not wanting to convert, in particular, elderly residents may not want to be responsible for the management of their building. Other consultees said that the practical difficulties created where unanimity is removed are so great that it would be preferable to retain unanimity.

Discussion and recommendations for reform

• 4.47 We note concerns that, without the unanimous agreement of leaseholders, conversion might cause a division between “consenters” and “non-consenters” in the commonhold, which might sustain the “them and us” mentality. In the Consultation Paper, we explained that one of commonhold’s advantages was in removing such a mentality.¹⁶³ We said that, in leasehold, the landlord is likely to have different interests from the leaseholders, which can foster an attitude of “them and us”. The landlord may see leasehold as an investment opportunity or a way of generating income, whereas for most leaseholders, the leasehold property is their home. It is this disparity between the freeholder’s and the leaseholders’ interests which conversion to commonhold will overcome by placing control in the hands of the owners. Conversion to commonhold will create an alignment of interests between those who set the commonhold’s rules and decide on the costs to be incurred, and those who are required to comply with the rules and pay the costs.

• 4.48 It would be impossible to create a system under which every owner in the building had the same priorities and the same degree of interest in managing the building. However, commonhold is set up to cater for these differences. In commonhold, decisions will be taken democratically through a vote of the unit owners, or by the directors appointed by them. At the same time, unit owners who stand to be particularly affected by decisions of the majority will receive protection under our recommendations for minority protection see Chapter 17. In addition, commonhold offers a robust dispute resolution procedure which has been specifically designed for its context. Further, each unit owner will be able to choose his or her own level of engagement in the commonhold. Unit owners who are interested in managing the building can actively attend meetings and can put themselves forward as the commonhold’s directors. Others who do not wish to be so involved do not have to attend the meetings, or can appoint a proxy to exercise their vote.¹⁶⁴ Unit owners are also free to appoint professional directors and managing agents who, in providing their services, will be answerable to the owners, rather than an external landlord.

• 4.49 We also acknowledge concerns about the practical difficulties that arise where unanimity is removed. We agree that conversion to commonhold without unanimous agreement does throw up challenging practical issues. However, the difficulties are not insurmountable. In this Part we set out a workable scheme for facilitating conversion to commonhold. Although some level of complexity is inevitable, this complexity is justified by the need to make commonhold a realistic alternative for existing homeowners.

• 4.50 Given the strong support for this proposal, and our objective of reinvigorating commonhold not only for new but also for existing homeowners, we recommend that the requirement for unanimity be removed and replaced with a new threshold of leaseholder support.

Recommendation 2.

• 4.51 We recommend that conversion to commonhold should be possible without the unanimous agreement of the leaseholders.

Setting a new threshold of leaseholder support

• 4.52 As a result of our recommendation to remove the requirement for unanimous agreement amongst leaseholders, the following questions arise.

• (1) Which leaseholders should be eligible to participate in the decision to convert to commonhold?

• (2) What percentage of leaseholders should be required to support a decision to convert to commonhold?

Which leaseholders should be eligible to participate in a decision to convert?

• 4.53 We provisionally proposed in the Consultation Paper that the same individuals who are eligible to participate in a CFA claim should be eligible to participate in a conversion to commonhold.¹⁶⁵ We considered this to be a logical conclusion given that leaseholders will need to carry out a CFA claim as part of the conversion to commonhold where the freeholder does not consent. We explained that using the same eligibility criteria would help to facilitate a streamlined procedure under which leaseholders could simultaneously acquire the freehold and convert to commonhold. We discuss this streamlined procedure in Chapter 7. It would add significant complexity to the process if a different group of leaseholders were eligible to participate in a CFA claim and the conversion to commonhold.

• 4.54 In the previous chapter we explained which leaseholders will be eligible to participate in a CFA claim. In general, residential leaseholders who have been granted a lease of longer than 21 years will be eligible. Leaseholders of commercial property or who have been granted business leases will not be eligible. Nor will tenants on short-term tenancy agreements. Additionally, Government has decided that, as a matter of policy, shared ownership leaseholders (“shared owners”) will not be eligible to participate in a CFA claim prior to having purchased 100% of the value of their property.¹⁶⁶

• 4.55 In the Consultation Paper we said that the 21-year requirement had the additional advantage of distinguishing between those who are likely to have paid a substantial premium for their lease, and to separate out “owners” from “renters”. We thought that only “owners” of a lease should be eligible to take a commonhold unit on conversion.

Consultees’ views

• 4.56 Our provisional proposal to adopt the same eligibility requirements as are used in CFA claims received support from the majority of leaseholders, individuals and professionals responding to this question, largely for the same reasons as those we set out in the Consultation Paper.

• 4.57 The British Property Federation, who agreed with our provisional proposal, said that only those “with a material financial stake in the building should be able to make this decision which will have legal and financial consequences”. FirstPort and Peter Smith (academic) commented that our proposal would be necessary to streamline the processes of acquiring the freehold and converting to commonhold.

• 4.58 However, certain consultees said that it would be wrong to prevent shared owners from participating in a decision to convert. Teresa Velasco, for example, said that our proposal would put shared owners “in a disadvantaged situation in relation to other leaseholders”. A number of consultees also argued in favour of business tenants being able to participate in a decision to convert. For example, Berkeley Group Holdings PLC (developer) said that “commercial tenants should be given the choice to be able to fully participate in the commonhold, given their long term interest and investment in the property”.

• 4.59 Other consultees argued that only owner-occupiers’ views should be taken into account and the decision should exclude properties where the leaseholder is connected to the freeholder.

Discussion and recommendations for reform

• 4.60 As we are recommending that participating leaseholders should carry out a CFA claim where the freeholder does not consent, and streamlining the CFA and conversion procedures, it makes practical sense to ensure that the same individuals can participate in both claims. It would be an odd result if someone could not buy a share of the freehold (under a CFA claim) but could buy a commonhold unit - and vice versa.¹⁶⁷ We therefore recommend that only leaseholders who are eligible to participate in a CFA claim should be eligible to participate in the conversion to commonhold and to take a commonhold unit.

• 4.61 We understand concerns that adopting the same eligibility requirements as used in CFA claims would mean that shared owners would be prevented from participating in a conversion to commonhold, prior to purchasing 100% of the value of their property. However, as we note above, this reflects a policy decision made by Government. In Chapter 11 we consider the position of shared owners following conversion to commonhold. Our recommendations will ensure that the terms of any shared ownership leases will be preserved following conversion, and that the relationship between the shared owner and the shared ownership provider will remain intact. Additionally, under our recommendations in Chapter 11, should a shared owner staircase to 100% ownership after the conversion has taken place, the shared owner would then become entitled to buy his or her commonhold unit at that later date.

• 4.62 We also note that, as a result of adopting the same eligibility requirements as for a CFA, tenants of commercial property would be prevented from participating in a decision to convert to commonhold, and would not have a statutory right to obtain the freehold of their units.¹⁶⁸ This position is consistent with the purpose of enfranchisement legislation, which has always been directed towards providing residential tenants, rather than commercial tenants, with greater security in their homes.¹⁶⁹ While there would be nothing to prevent a commercial tenant from negotiating with the participating leaseholders to buy a commonhold unit on a voluntary basis, our understanding is that most commercial tenants prefer to rent business premises on short-term agreements (rather than own their freehold), in order to maintain flexibility. We acknowledge that, while primarily designed to enable the freehold ownership of residential flats, commonhold is equally capable of applying in a commercial and mixed-use context. Should a different procedure for conversion be adopted in the future which is independent of CFA legislation, and has different qualifying criteria, it would be possible to consider whether business tenants should also be provided with a right to participate in a decision to convert and take a

commonhold unit on conversion, if there is a demand. However, such a right should only then be available to commercial tenants on leases of over 21 years, rather than short-term tenancies, as the latter would not have a sufficient stake in the building.

Recommendation 3.

• 4.63 We recommend that leaseholders who are eligible to participate in a collective freehold acquisition claim should have a statutory right to participate in a decision to convert to commonhold and take a commonhold unit on conversion.

What percentage of eligible leaseholders should be required to support a decision to convert?

• 4.64 In the Consultation Paper, we presented two options for how the revised threshold of leaseholder support could be set.¹⁷⁰ We said that the percentage of leaseholder support required for conversion should take account of the interests and rights that leaseholders who do not participate in the conversion (“non-consenting leaseholders”) would receive following conversion.

• 4.65 We explained that any change to non-consenting leaseholders’ interests should be considered in accordance with leaseholders’ rights under Article 1 of Protocol 1 to the European Convention of Human Rights (“A1P1”). A1P1 gives every person the right to peaceful enjoyment of his or her possessions, which includes property interests. Changing leaseholders’ property rights on conversion will only be justifiable where the change is in pursuit of a legitimate aim and is a proportionate way of achieving that aim.

• 4.66 Our view, expressed in the Consultation Paper, was that if the interests and rights of non-consenting leaseholders would not be substantially affected by the conversion, then conversion with a lower percentage of leaseholder support might be justifiable. Conversely, if leaseholders’ interests were to change substantially as a result of the conversion, it would be harder to justify this change unless a higher proportion of leaseholders supported the conversion.

• 4.67 The following two options were presented.

• (1) “Option 1” would be a threshold of 50% support, on the basis that nonconsenting leaseholders would retain their leasehold interests on conversion to commonhold. That would be adopting the same threshold of leasehold support as is required to bring a CFA claim see paragraph 4.8 above. Our view was that, following conversion under Option 1, non-consenting leaseholders would be placed in a similar position to leaseholders who have not participated in a CFA claim. As explained in Chapter 3 both following a CFA claim and conversion under Option 1, non-consenting leaseholders would retain their leases but the management of the building would change. We therefore considered that the same threshold of support as required for a CFA claim should be required to convert under Option 1.

• (2) “Option 2” would be a higher threshold of 80% support, on the basis that all non-consenting leaseholders would be required to take a commonhold unit on conversion, alongside the participating leaseholders.

• 4.68 In respect of both options, we asked consultees whether they agreed or disagreed with our proposed threshold.¹⁷¹

Consultees’ views

Option 1 non-consenting leaseholders retain their lease: threshold of 50%

• 4.69 Most consultees responding to this question agreed that the threshold of 50% was appropriate for Option 1. One confidential consultee, for example, argued that a threshold of 50% was an obvious choice as the will of the majority should prevail, while careful though would be needed to protect the minority who couldn’t afford to participate.

• 4.70 A number of consultees supported our proposal for the reason provided in the Consultation Paper, that the threshold is consistent with a CFA claim. These consultees argued that non-consenting leaseholders’ position would not be significantly affected by the conversion under Option 1; they would simply have a different landlord following the conversion. Rowan Hodgson, for example, said “those wishing to stay as leaseholders will simply have those in the commonhold as their landlord”.

• 4.71 Of those who opposed our proposal, in general, more leaseholders, individuals and residents’ associations said that the proposed threshold of 50% was too high, whereas other categories of consultees who disagreed (including the only developer, the two commercial freeholders and two housing associations responding) argued that the proposed threshold was too low.

• 4.72 Leaseholders, individuals and residents’ associations who thought 50% was too high explained that it is currently very difficult to reach the threshold of 50% support necessary to bring a CFA or right to manage claim, predominantly due to leaseholder apathy or difficulty contacting absent leaseholders. The Chartered Institute of Legal Executives (“CILEx”) also felt the threshold of support could be reduced, but for a different reason. This consultee argued that a minimum threshold would be unnecessary as a result of our separate proposal to provide non-consenting leaseholders with a statutory right to buy their commonhold unit at a later date on which see 5.8 onwards.

• 4.73 Other consultees said that the proposed threshold was too low and would not justify the interference with non-consenting leaseholders’ property rights. The Association of

Residential Managing Agents (“ARMA”) argued that the position of non-consenting leaseholders following conversion Option 1 would be very different to that of leaseholders who have not participated in a CFA claim. In particular, ARMA argued that following conversion under Option 1, leaseholders would be left in a more complex management structure, due to the mix of long leasehold and commonhold interests in the building. Additionally, one consultee responding confidentially said that non-consenting leaseholders would be prejudiced by our separate proposals to phase out leasehold interests and replace them with commonhold units in the future.¹⁷²

• 4.74 A few other consultees were concerned that a threshold of 50% could leave “just as many leaseholders opposing the conversion” as supporting it. Christopher Jessel (solicitor) and Villandry Property Ltd thought that conversion might cause resentment within the commonhold unless a clear majority could be obtained. Additionally, a number of consultees argued that unanimity should be retained.

Option 2 non-consenting leaseholders take a commonhold unit: threshold of 80%

• 4.75 Consultees were less supportive of the proposed threshold for Option 2. Only slightly more consultees supported than opposed it. Most categories of consultee were divided on the question, including law firms and housing associations. More leaseholders opposed than supported the proposal.

• 4.76 Of those providing a comment in support of the proposal, many said that the threshold of support needed to be high to reflect the fact that non-consenting leaseholders’ property interests would be altered by the conversion. Peter Smith acknowledged that the threshold might “significantly reduce access to commonhold” but “given the element of compulsion against non-consenting qualifying long lessees envisaged, adopting a higher consent threshold to conversion would seem to strike the right balance”.

• 4.77 Millbank Residents Company Ltd also agreed with the proposal on the basis that a high threshold would demonstrate leaseholders’ commitment to the commonhold structure. A further consultee, Iain Macfarlane (solicitor), felt that if the threshold for conversion were not met, the leaseholders would have other leasehold rights to fall back on, such as the right to a CFA, which only requires 50% support.

• 4.78 Of those who opposed the proposal, again there was a divide between the categories of consultees who thought the threshold was too high and those who thought the threshold was too low. Leaseholders and other individuals generally argued that the threshold was too high whereas other consultees who disagreed with the proposal tended to conclude that the threshold was too low.

• 4.79 A significant number of consultees who opposed the proposal argued that a threshold of 80% would be too high. Consultees again referred to the difficulties obtaining leaseholder support, particularly where a number of leaseholders are absent from the property. Several leaseholders responding advised us that buy-to-let landlords would not be interested in the conversion or would be difficult to contact. Some consultees said that the proposal would have a particularly unfair impact on leaseholders in smaller properties, including Antonia Batty (leaseholder) who noted that in a building of four flats, a threshold of 80% would require each leaseholder to agree, which would be an “unlikely outcome for many”.

• 4.80 Some consultees said that to impose a higher threshold than that required to carry out a CFA claim would lead leaseholders to acquire the freehold collectively rather than convert, and would defeat the object of reinvigorating commonhold as a viable alternative to leasehold.

• 4.81 Many consultees responding therefore suggested a lower threshold of 50% in order to convert under Option 2. Jo Darbyshire (leaseholder) for example, said:

I would like to see a lower percentage; 50%. 80% is simply too high. 50% is consistent with collective enfranchisement. The default position must be to make conversion to commonhold as easy to achieve as possible. 80% creates a huge barrier in large blocks, of which we have many in city centres across England and Wales, and will only perpetuate leasehold and its associated abuses for years to come.

• 4.82 Paul Stevens agreed with Jo Darbyshire on the basis that:

if 50% of leaseholders can decide to enfranchise, that same proportion should be acceptable for a commonhold conversion. The non-consenting leaseholder is not really losing their actual property (i.e. the flat/unit itself); they are simply being forced to adapt to a new legal regime for flat-ownership.

• 4.83 Other consultees suggested that the threshold should take into account the percentage of those who “actively object” to the conversion so that apathy does not prevent a majority of leaseholders in favour from proceeding. Thomas Bygott explained that:

currently when considering a joint purchase of a freehold, there can be a large amount of inertia, with many leaseholders not particularly interested or motivated in the outcome. It may be that a large proportion of leaseholders want to ‘wait and see’. It would be better to say that no more than 20% actively object.

• 4.84 A smaller number of consultees thought that the proposed threshold of 80% was too low, including several who argued that conversion should not be possible without the unanimous agreement of leaseholders. These consultees argued that a threshold of 80% support would not be sufficient to justify the interference with non-consenting leaseholders’ property interests.

Discussion and recommendations for reform

• 4.85 If commonhold is to provide a workable alternative to leasehold in existing developments, the threshold of support required to convert needs to be realistic. We are persuaded by arguments that it is already very difficult for leaseholders to obtain the degree of support necessary to bring a CFA claim. Requiring leaseholders to meet any higher threshold would likely prevent conversions from taking place in most buildings, despite our reforms. We also do not think that the threshold could be any lower than 50%. A change in the management structure of the building should be supported by at least half of leaseholders in the building.

• 4.86 We therefore recommend that, in order to facilitate Government’s objective of making commonhold available to existing leaseholders, the threshold for conversion needs to be the same as for a CFA claim. Namely, conversion to commonhold should be possible where eligible leaseholders of at least 50% of the flats in the building support the conversion. If leaseholders are able to acquire the property collectively, they should also be able to convert to commonhold.

• 4.87 Adopting the same threshold as for a CFA claim has the additional advantage of allowing a streamlined process to be put in place whereby the same leaseholders can acquire the freehold under a CFA claim and convert to commonhold. Taking this approach would therefore preclude introducing an additional percentage threshold of “active objectors” as suggested by some consultees or having two schemes operating in tandem.

• 4.88 For the avoidance of doubt, we consider that our recommended threshold of 50% should also be required even if the freeholder of the building does consent to the conversion, and a CFA claim is not required.¹⁷³ To balance the interests of those leaseholders who wish to convert, and those who may not want to convert, eligible leaseholders of at least 50% of the flats should still support the decision to convert.

• 4.89 We acknowledge concerns that both conversion options might, in one way or another, alter the way in which leaseholders own their homes. However, these changes are being made to enable leaseholders to access an improved form of homeownership. We note that few leaseholders raised concerns about the impact of the conversion on their interests, and in fact, many argued that the threshold of leaseholder support should be lower. On reflection, we do not consider that the lower threshold creates questions of compatibility with A1P1 as long as sufficient protections are in place to protect those whose interests would be affected by the conversion. In Chapter 5 we consider in detail how each conversion option will operate in practice, and the safeguards that should be built into the process.

Recommendation 4.

• 4.90 We recommend that, to convert to commonhold, eligible leaseholders of at least 50% of the flats in the building must support the decision to convert.

WHEN SHOULD CONVERSION BE POSSIBLE, WITHOUT THE CONSENT OF TENANTS?

• 4.91 Currently, all tenancies granted for 21 years or less will be brought to an end on conversion to commonhold. However, it is not necessary to obtain the consent of such tenants if (1) they will be regranted new tenancy agreements after conversion and (2) the right to a new tenancy agreement has been protected by registration at HM Land Registry. We argued in the Consultation Paper that the current approach creates an unnecessary administrative burden. We provisionally proposed that tenancies simply to continue automatically on the conversion to commonhold, rather than requiring tenants’ consent.¹⁷⁴

Consultees’ views

• 4.92 Our provisional proposal was overwhelmingly supported by consultees. Consultees agreed that if tenancies granted for 21 years or less were simply to continue on conversion, tenants’ consent should not be required. Further, consultees argued that the proposal would simplify the conversion process and remove unnecessary barriers. Peter Smith said:

Requiring the consent of such tenants to conversion is an example of an unnecessary barrier to conversion, especially as tenants ordinarily do not have a substantial interest in the property.

• 4.93 Chris Marshall (leaseholder) agreed that allowing tenancies to continue automatically would “cause the least disruption and minimise uncertainty for renting tenants”.

• 4.94 Those who opposed the proposal argued that the consent of tenants should be required in every case. Lucy Shepherd (solicitor) argued that it is:

over simplistic and inaccurate to say the interests of short-term lease tenancies will not be affected by conversion to commonhold. The ‘landlord’ will be a different entity with different interests than before and the views of such tenants could be completely disregarded.

Discussion and recommendations for reform

• 4.95 While we accept that the identity of the freeholder of the building will change on conversion, the fact of this change is not sufficient to justify requiring tenants’ consent to a conversion. The freeholder of a building can already change without any requirement of consent on the part of the tenants. That is the case, for example, if the freeholder were to sell the freehold to another landlord or if the leaseholders acquired the freehold collectively.

• 4.96 Further, our proposal does not alter the existing position of tenants on conversion. Under the current procedure, if tenants are regranted tenancy agreements on equivalent terms following conversion, their consent is not required. Our proposal replicates this position but without additional administrative steps. The tenancy will simply continue on conversion, rather than needing to be terminated and regranted.

• 4.97 Finally, we recommend above that in order to facilitate a streamlined procedure of acquiring the freehold and converting to commonhold, the same individuals who can participate in a CFA claim should be able to participate in a decision to convert and take a commonhold. Only leaseholders who have been granted a residential lease of more than 21 years will be entitled to participate in a CFA claim and, therefore, a decision to convert to commonhold. Any tenancies which are not so eligible should simply continue automatically on conversion, without requiring the tenants’ consent. Tenancies which continue on conversion would therefore include any residential tenancies of 21 years or less, any business tenancies (irrespective of their term) and any shared ownership leases, where the shared owner has not yet staircased to 100% ownership.

Recommendation 5.

• 4.98 We recommend that, on conversion to commonhold, any tenancies which are not held by individuals who are eligible to participate in a collective freehold acquisition claim, should continue automatically on conversion and that the consent of such tenants should not be required in order to convert to commonhold.

WHEN SHOULD CONVERSION BE POSSIBLE, WITHOUT THE CONSENT OF LENDERS?

• 4.99 Currently, all lenders who have an interest (such as a mortgage) secured over any of the leases in a building must consent to conversion. This requirement exists because, under the current law, all leases will be brought to an end by the conversion and the lenders’ security would therefore be lost. In the Consultation Paper, we asked consultees whether it should instead be possible for mortgages over leaseholders’ flats to transfer automatically to the commonhold units on conversion without requiring the consent of lenders.¹⁷⁵

• 4.100 We drew an analogy with our proposals for enfranchisement reform set out in the Enfranchisement Consultation Paper. Under these proposals, where a leaseholder of a house or a flat obtains a lease extension, any charge secured over the lease would transfer automatically to the new extended lease, without requiring the lender’s consent. (We explained that, while referred to as a “lease extension”, what happens as a matter of law is that the existing lease is brought to an end, and a new lease is granted for the remaining term plus an additional number of years). Further, where a leaseholder of a house is looking to buy his or her freehold, the charge could (under our enfranchisement proposals) transfer automatically to the freehold.¹⁷⁶ These provisional proposals were made on the assumption that a lender would generally prefer to take security over a new, longer lease or the freehold title in exchange for their existing security.

• 4.101 As commonhold would offer lenders security over a freehold commonhold unit (which, unlike a lease, would not reduce in length or be at risk of forfeiture), it can be argued that commonhold offers lenders an improved security and that the charge should transfer automatically.

Consultees’ views

• 4.102 The vast majority of consultees, and particularly leaseholders and individuals, argued that charges should transfer automatically from the leasehold title to the commonhold unit title on conversion to commonhold and that lender consent should not be required. These consultees said that conversion needs to be simple, removing as many barriers to conversion as possible. Further, they argued that lenders should not object to a transfer of their security because they will be in at least the same, if not a better, position following conversion. Trowers & Hamlins LLP (solicitors), for example, made the point that following conversion, “the land will be the same, and the estate will be freehold, albeit within a different structure”. Consultees also referred to the lack of forfeiture within commonhold and to the permanent nature of commonhold units which offer lenders an advantage over leasehold security.

• 4.103 A number of consultees made reference to anaologous situations where a lender’s charge can transfer automatically to a different interest without requiring the lender’s consent, including where a leaseholder seeks a lease extension. Paul Stevens said that:

Conversion to commonhold is of course more than just extending the lease, but much the same principle applies, in that lender consent should not be required for something that clearly benefits the subject matter of the security.

• 4.104 However, the Building Societies Association and UK Finance (trade associations representing building societies and mortgage lenders respectively) argued strongly that lender consent should be required to transfer the lender’s security from the lease to the commonhold unit. These consultees said that it would not be acceptable to interfere with a lender’s commercial decision whether or not to lend on commonhold units. The Building Societies Association warned of adverse implications if such an automatic transfer were to be made possible:

Lenders should retain the right to object to a conversion as the 1st charge holder and the independent commercial decision to either adopt commonhold or chose not to should be respected. Any compulsion would have unintended consequences which could lead to a much more cautious approach to property risk and lending generally which could have a wider impact.

• 4.105 Irwin Mitchell LLP (solicitors) gave a similar warning, suggesting that lenders would react by “treating leasehold/commonhold units differently when considering if they are adequate security for borrowing, or when considering the terms of mortgages or remortgages”.

• 4.106 UK Finance referred to additional practical difficulties which would arise if the charge were to transfer automatically:

In many cases existing contracts with consumers may not mention commonhold at all, which would potentially cause legal difficulties during the lifetime of the mortgage, not least around the enforcement of security where there are arrears. It is of significant concern that the terms and conditions governing existing mortgages may be incompatible with commonhold. The legal rights and obligations of lenders and consumers could be adversely affected by the imposition of a conversion to commonhold.

• 4.107 Some other consultees argued that lenders should have the opportunity to consent on the basis that other proposals in the Consultation Paper might have an adverse impact on lenders. Consultees referred, for example, to our proposal to provide the commonhold association with a first-ranking charge over the commonhold units for the payment of commonhold contributions.¹⁷⁷ However, for reasons explained in Chapter 18 of this Report, we have decided not to take that proposal forward.

• 4.108 In addition, some consultees expressed the view that the security available over commonhold units cannot be compared with that over a freehold house, and that lenders should have a choice whether to accept units as adequate security. Consensus Business Group (landlord), for example, suggested that lenders may be concerned about the collective decision-making powers of commonhold owners, rather than decisions being made by a single freehold owner. Additionally, a few consultees said that commonhold units should be distinguished from freehold houses on the basis that commonhold is an unfamiliar form of ownership “which is largely untried and untested in the market”.¹⁷⁸ And lenders should be able to “view each transfer on its merits pending greater familiarity with this procedure”.¹⁷⁹

• 4.109 Jo Darbyshire and the National Leasehold Campaign commented, however, that lenders’ willingness to accept commonhold would increase over time:

as the prevalence of commonhold increases, mortgage lenders will be under pressure from consumers and in respect of their competitive position to lend on commonhold.

• 4.110 Several consultees argued that Government has an important role to play in encouraging lenders to accept commonhold. A number argued that Government could provide incentives for lenders to accept commonhold. The British Property Federation went further, suggesting “it may initially be necessary for Government to underwrite or guarantee such title (as occurred in America when condominium was introduced, and mortgagees were suspicious of commonhold-equivalent units)”. Belgravia Residents Association suggested “the Government may wish to legislate to compel them [lenders] to accept as mainstream this form of tenure”.

Discussion and recommendations for reform

• 4.111 Our view, as supported by the majority of consultees, is that commonhold will offer lenders security superior to that available over leasehold interests and that it ought, in principle, to be possible for charges to transfer automatically from the lease to the commonhold unit. In exchange for the lender’s security over the time-limited leasehold interest, which would reduce in value as the term runs down, the lender would receive security over a permanent, freehold interest on conversion. In addition, leasehold interests are susceptible to forfeiture. Forfeiture enables a landlord to bring the leasehold interest to an end where the leaseholder breaches a term of the lease and, on forfeiting the lease, the lender would lose its security over the leasehold interest. An advantage of commonhold for lenders is that a commonhold unit can never be forfeited or terminated. We discuss the implications of leasehold forfeiture, and the Law Commission’s recommendations to replace the law of forfeiture in more detail in Chapter 18.

• 4.112 The automatic transfer of a charge from one interest to another is already provided for in enfranchisement legislation. Where a leaseholder of a flat exercises his or her statutory right to a lease extension, a charge secured on the existing lease will automatically transfer to the new longer lease. In the Enfranchisement Report, we recommend that charges should also transfer automatically to the new lease where a leaseholder of a house seeks a lease extension.¹⁸⁰ Additionally, we recommend in that Report that where a leaseholder of a house exercises his or her right to buy the freehold (and the leaseholder wishes to merge the leasehold and freehold titles) a charge over the lease (along with all other proprietary interests affecting the lease) should transfer automatically to the freehold title.¹⁸¹ Our view, expressed in the Enfranchisement Report, is that the freehold title should provide the lender with greater security than the leasehold interest.

• 4.113 The automatic transfer of charges from leases to commonhold units, without requiring lender consent, would greatly simplify the process of converting to commonhold.¹⁸² From a purely administrative perspective, obtaining the consent of every mortgage lender in the building would be a difficult and time-consuming task and would present a significant barrier to conversion. While lenders would receive an improved interest on conversion, a number of lenders may simply fail to respond to a request for consent or take a standard approach of denying every request. As a result of these difficulties, leaseholders may instead decide to acquire the freehold through a CFA claim (which would not require the consent of every mortgage lender)¹⁸³ and not convert to commonhold. Without the automatic transfer of charges, therefore, there remains a concern that conversion to commonhold will not offer leaseholders, particularly in larger blocks, a realistic alternative to leasehold.

• 4.114 Lenders’ acceptance of commonhold is, however, fundamental to the reinvigoration of commonhold. We note that many of the concerns raised by those opposed to the automatic transfer of charges stem from the fact that currently commonhold is a relatively unfamiliar form of ownership. Government is however considering wider measures to raise awareness and encourage the reinvigoration of commonhold. As pointed out by consultees, lenders’ willingness to accept commonhold should increase as their familiarity with commonhold increases. In response to the Call for Evidence, UK Finance advised us that a “significant number of lenders” were already willing to accept commonhold and that:

other lenders would probably be prepared to offer mortgages on commonhold properties but have not made provision to because of the very low numbers of commonhold properties [...]. Mortgage lenders are generally open to the possibility of lending on commonhold properties.

• 4.115 To facilitate the automatic transfer of charges from leasehold interests to commonhold units on conversion, we recommend that Government works with lenders as part of its wider measures to reinvigorate commonhold, in order to raise awareness of commonhold and its advantages for lenders, and to ensure lenders will accept the transfer of their security to the commonhold units on conversion.

Recommendation 6.

• 4.116 We recommend that Government work with lenders to facilitate the automatic transfer of charges from the leasehold title to the commonhold unit title on conversion.

CONCLUSION

• 4.117 In this chapter, we have made several recommendations that will make it much easier for leaseholders to convert to commonhold. Conversion will no longer require the agreement of every interested party in the building. Rather than requiring unanimous agreement, the interests of those who have not agreed to the conversion will be safeguarded in other ways. In the following chapter, we consider how conversion to commonhold will operate, and the safeguards that will need to be in place to protect the interests of those who have not consented to the conversion.

• Chapter 5: How would conversion Options 1 & 2 operate?

INTRODUCTION

• 5.1 In the Consultation Paper, we presented two potential schemes for conversion to commonhold. The differences between these two schemes stem from the interest that non-consenting leaseholders¹ will hold following conversion, but each option has wider implications for others in the building.

• 5.2 Under the first option (“Option 1”), non-consenting leaseholders’ leases will continue on conversion to commonhold. Under the second option (“Option 2”), non-consenting leaseholders will be required to take a commonhold unit at the point of conversion, in exchange for their leasehold interest. We made a number of provisional proposals about how each conversion option might operate in practice, including how the freehold purchase price might be financed and the safeguards that should be put in place to protect those who have not consented to the conversion.

• 5.3 The effects of conversion on those who have not agreed to the conversion warrants close attention. We recommend in the previous chapter that, to make conversion a realistic option for existing leaseholders, conversion will need to be possible without the unanimous agreement of all interested parties. We recommend that leaseholders should be able to convert to commonhold without the freeholder’s consent. However, as conversion would result in the freeholder losing his or her interest in the property, leaseholders should acquire the freehold compulsorily though a collective freehold acquisition (“CFA”) claim as part of the process of converting.^{184 185} Pursuing a CFA claim will ensure that the freeholder is compensated fairly for his or her freehold interest. In addition, we recommend that conversion to commonhold should be possible (under both conversion options) where at least half of the leaseholders in the building support the decision to convert. We express our view that, if the threshold of leaseholder support were any higher, conversion to commonhold would likely be prevented in the majority of leasehold blocks. Sufficient safeguards will therefore be necessary to protect those leaseholders who have not consented to the conversion.

• 5.4 In this chapter, we present consultees’ views on the operation of each conversion option, including the safeguards that should be in place. We then make recommendations for how each option should work in practice if adopted by Government. In the following chapter, after providing a brief summary of the recommendations made so far in respect of each option, we explain which option received the most support from consultees and we recommend our preferred option to Government.

OPERATION OF OPTION 1

• 5.5 In the Consultation Paper, we asked consultees several questions about how conversion under Option 1 might operate in practice. As noted above, we have already considered the threshold of support required to convert in Chapter 4.¹⁸⁶

The replacement of leases with commonhold units under Option 1

• 5.6 In the Consultation Paper we explained our view that, if non-consenting leaseholders were to retain their leasehold interest on conversion, they should only do so as a temporary measure.¹⁸⁷ At some stage in the future, non-consenting leaseholders should upgrade their leasehold interest to a commonhold unit. As commonhold was designed to improve the way in which flats are owned, and to overcome the shortcomings of leasehold ownership, it would be counterproductive to allow these leases to continue indefinitely.

• 5.7 We put forward the following mechanisms by which non-consenting leaseholders might exchange their leasehold interest for a commonhold unit.

A new statutory right to buy the commonhold unit

• 5.8 We provisionally proposed that non-consenting leaseholders should be provided with a statutory right to purchase the freehold of their unit at a later date.¹⁸⁸ After exercising this right, the individual would no longer be a leaseholder but a unit owner and a member of the commonhold association. We asked consultees whether or not they agreed with this proposal.

Consultees’ views

• 5.9 This proposal received almost unanimous support. Consultees felt that, as a matter of fairness, non-consenting leaseholders should not miss the opportunity to own a commonhold unit. Consultees argued that non-consenting leaseholders may want to take a commonhold unit after commonhold becomes a more familiar form of ownership. Elizabeth Charmian Spickernell (leaseholder) for example, said that “once leaseholders see that commonhold can work well, they may want to convert especially as it will make the sale of their flat or house easier”. Alternatively, as consultees pointed out, leaseholders may not have been in a position to pay for a commonhold unit at the point of conversion. Zaman Ali (leaseholder) argued that “we have to give people a chance to save up so they can purchase when they can afford to”.

• 5.10 Other consultees, including The Guinness Partnership (housing association), supported the proposal as it would speed up the point at which every leaseholder in the building owns a commonhold unit (and therefore the point at which the building’s management structure would be simplified).

• 5.11 Most consultees who opposed the proposal reiterated their general disagreement with Option 1, rather than raising specific objections about the new statutory right. However, Christopher Jessel (solicitor) (who neither agreed nor disagreed with the proposal), expressed concern that an ability for leaseholders to join in at a later stage might disincentivise participation at the outset. He said that “the non-consenters could let others do all the work and raise the money and then join in later”.

• 5.12 To address the potential lack of incentive to participate in the conversion, the Federation of Private Residents’ Associations (“FPRA”) suggested:

the price paid by latecomers should be more than it would have been at the start to encourage as many leaseholders as possible to participate and convert as soon as possible.

• 5.13 A couple of other consultees suggested than an amount of interest could be added to the cost of buying the commonhold unit. However, other consultees stressed that the cost of buying the unit at a later date needs to be affordable, and some suggested Government assistance should be available.

Discussion and recommendations for reform

• 5.14 We agree with consultees that leaseholders who are unable to, or choose not to, buy a commonhold unit at the point of conversion under Option 1 should not be deprived of the opportunity to own a unit in the future. In addition, providing leaseholders with a right to buy their unit would expedite the point at which all flats in the building are owned on a commonhold basis. We take Christopher Jessel’s point that the ability to buy a unit in the future might create a disincentive to participate in the conversion at the outset. However, there would be financial incentives to participate in the initial claim. The costs associated with the conversion process would be shared between all participating leaseholders,¹⁸⁹ whereas the cost of buying a commonhold unit at a later date would fall on that individual leaseholder alone.

• 5.15 We therefore recommend that, if Option 1 is adopted, there should be a statutory right for non-consenting leaseholders to buy their commonhold unit at a later stage.

• 5.16 We note that some consultees queried the cost of buying the commonhold unit. Leaseholders would be required to pay a premium to purchase the freehold of their unit, which would be calculated in the same way as existing enfranchisement rights. How this premium would be calculated would therefore depend, to a large extent, on which option Government adopts to reduce the price payable on the exercise of enfranchisement rights.¹⁹⁰

• 5.17 Our view is that the cost of buying the commonhold unit should be calculated at the time the leaseholder wishes to exercise his or her right to buy the commonhold unit, rather than being “fixed” at the time the conversion takes place. In other words, the leaseholder would be required to pay the market value for the commonhold unit at the time he or she decides to exercise the right. There would therefore be an inherent incentive for leaseholders to buy their commonhold unit sooner rather than later because, as the leaseholder’s term continues to run down, the premium payable to buy the commonhold unit would increase. The amount that the participating leaseholders actually paid to acquire the freehold from the freeholder as part of the conversion would therefore not be factored into the calculation. Our view is that this is the correct approach, given that non-consenting leaseholders will not have had any control over the purchase price paid to the freeholder by the participating leaseholders.

• 5.18 Depending on a number of variables, a leaseholder, on buying his or her commonhold unit, may also contribute towards the commonhold’s “development value”. Under existing valuation methods, on acquiring the freehold compulsorily, participating leaseholders might need to pay an additional amount to the freeholder to compensate him or her for the loss of certain development opportunities. For example, there may be potential to build a further floor of flats on the roof. When the participating leaseholders acquire the freehold to the block, they will then have the ability to build an extra floor of flats and realise that development value. Whether a non-consenting leaseholder would pay any additional amount in respect of development value on purchasing his or her commonhold unit would depend on a number of factors.

• (1) Whether the common parts of the building (or buildings) do in fact have any development potential.

• (2) Which valuation methodology Government adopts in the light of the Enfranchisement Valuation Report. We suggest, as one of the potential options to reduce the cost of acquiring the freehold, that participating leaseholders might be able to elect to take a type of restriction on development, rather than paying development value to the freeholder.¹⁹¹

• (3) Whether the participating leaseholders wish to retain the benefit of any development potential between themselves, or to allow a leaseholder to “buy into” this development potential on purchasing a commonhold unit.

Recommendation 7.

• 5.19 We recommend that, if conversion Option 1 is adopted, non-consenting leaseholders should be provided with a statutory right to buy the commonhold title in respect of their unit following the conversion to commonhold.

Exchanging leaseholders’ existing enfranchisement rights for the new right to buy the commonhold unit

• 5.20 We provisionally proposed that, should non-consenting leaseholders be provided with a statutory right to purchase the freehold of their unit at a later date, this new right should replace leaseholders’ existing statutory right to seek a lease extension. We also proposed that it should not be possible for non-consenting leaseholders to acquire the freehold from the commonhold association compulsorily after the conversion has taken place.¹⁹²

Consultees’ views

• 5.21 The vast majority of consultees supported this proposal. Support was particularly strong amongst leaseholders, other individuals and residents’ associations. Most law firms and legal representatives responding also agreed with the proposal. However, both commercial freeholders responding to the question opposed the proposal.

• 5.22 The main reason provided in support of this proposal was that it would enable leases to be phased out within commonhold. Stephen Collins argued that:

lease extensions and such will perpetuate the already outdated leasehold method of ownership. By discontinuing extensions it will allow for them to be phased out quickly.

• 5.23 Catherine Williams (leaseholder) agreed saying, “it makes sense to promote a move towards commonhold rather than perpetuate feudal leasehold”.

• 5.24 Damian Greenish (solicitor) and Matt Osborne commented that it would also be necessary to prevent non-consenting leaseholders from reacquiring the freehold from the commonhold association by exercising a CFA. Otherwise the “ping-pong problem” would arise, whereby a certain group of leaseholders might convert to commonhold, only for the freehold bought back by a different group of leaseholders.

• 5.25 Other than general objections about the desirability of Option 1, consultees who disagreed with the proposal raised concerns about consumer choice. They felt that leaseholders should have the option either to obtain a lease extension or to buy their commonhold unit. Irwin Mitchell LLP (solicitors), for example, said “we believe this would be taking away individuals’ rights rather than adding to them”. The Association of Residential Managing Agents (“ARMA”) argued that if “commonhold is successful the market advantage should instead passively influence leaseholders to convert”. The argument was also made by Boodle Hatfield LLP (solicitors) and ARMA that this proposal could impose commonhold upon non-consenting leaseholders “by the back door”.

• 5.26 Other consultees queried how the cost of buying a commonhold unit would compare to the cost of a lease extension, and HM Land Registry asked how the proposal would affect shared ownership leaseholders (“shared owners”).

Discussion and recommendations for reform

• 5.27 We recommend that, on conversion under Option 1, the non-consenting leaseholders’ new statutory right to buy their commonhold unit should replace their existing statutory right to a lease extension. As we explain in more detail below, the difference in value between a lease extension and the commonhold unit will be negligible (if, in fact, there is any difference). However, the commonhold unit will offer the leaseholder greater security than that afforded by a lease extension, and would prevent the perpetuation of leasehold within commonhold. We now consider these points in more detail.

• 5.28 We note that some consultees viewed the proposal as taking away leaseholders’ existing statutory right to a lease extension. However, the right to a lease extension is a by-product of leasehold ownership which carries with it all the inherent limitations of leasehold tenure. Currently, lease extensions are the only way in which leaseholders of flats can obtain greater security in their homes.^{193 194} Outside of the commonhold model, there is no satisfactory way for leaseholders of flats to obtain the freehold of their properties. Where a lease term is running down, the leaseholder will be forced to make a choice between losing his or her leasehold interest, or paying the freeholder for a new, longer term. That new leasehold interest will also expire at some point in the future, due to the wasting nature of leasehold interests.

• 5.29 Commonhold, however, enables leaseholders to own their flats on a freehold basis, and, as we note in Chapter 1 freehold interests are capable of lasting forever. Given that commonhold enables leaseholders to obtain greater security in their properties, we consider it preferable to replace the limited right to a lease extension (designed for the leasehold context) with a right to obtain a freehold unit (designed for the commonhold model). We also note that this proposal was strongly supported by leaseholders and other individuals: the categories of consultee who would be affected by the replacement of existing statutory rights.

• 5.30 In addition, given the objective of phasing out leases within commonhold under Option 1, it would be counterproductive to enable existing leaseholders to obtain lease extensions following conversion. Lease extensions would perpetuate the difficulties caused where there is a mix of leasehold and commonhold interests within the same building and would delay the point at which all owners hold the same type of interest.¹¹

• 5.31 Some consultees queried the cost of buying the commonhold unit, as opposed to obtaining a lease extension. In the Enfranchisement Report, we recommend that on exercising the statutory right to a lease extension, the leaseholder will acquire a new lease which adds a further 990 years to the remaining term of his or her existing lease.¹⁹⁵ The difference in value between a 990-year lease extension, and the freehold of the commonhold unit will be negligible, if indeed there is any difference. However, we note above that in certain limited circumstances, leaseholders who take a commonhold unit might also contribute towards the building’s development value, which is rarely payable in lease extension claims.

  11

• 5.32 We also recommend that it should not be possible for leaseholders to exercise a CFA claim once the building has converted to commonhold. While it may be unlikely that there would be a sufficient number of non-consenting leaseholders in the building to pursue a CFA claim following conversion Option 1,¹⁹⁶ we think this possibility should be put beyond doubt. If a further CFA were not prevented, a different group of leaseholders to those who supported the conversion might be able to acquire the freehold of the building compulsorily and revert back to the leasehold structure.¹⁹⁷ Our view is that once a building has converted to commonhold, it should remain as a commonhold, and there should not be a risk of the commonhold reverting back to the leasehold structure. If non-consenting leaseholders wish to participate in the management of their building, they will be able to buy their commonhold unit and become a member of the commonhold association. Preventing further CFAs would also avoid introducing the ping-pong problem often encountered in the context of enfranchisement, into the commonhold model.¹⁹⁸

• 5.33 For the avoidance of doubt, we further recommend that, following conversion to commonhold, it should not be possible for non-consenting leaseholders to take over the management functions of the commonhold association by exercising the right to manage.¹⁹⁹ To permit such a right would be to undermine fundamentally the commonhold management structure, whereby the commonhold association owns and manages the common parts, and unit owners can make collective decisions about management through their membership of the association. If non-consenting leaseholders are concerned about how the directors of the commonhold association are managing the building, they will be able to seek the replacement of the directors in the First-tier Tribunal (Property Chamber) in England or the Leasehold Valuation Tribunal in Wales (the “Tribunal”) under our recommendations in Chapter 12.²⁰⁰

• 5.34 In the above discussion, we only refer to the position of non-consenting leaseholders following conversion Option 1. We note HM Land Registry’s specific query about the position of shared owners following conversion. In Chapter 11 of this Report, we consider the position of shared owners in detail, including the enfranchisement rights available to shared owners. However, we summarise the position below for the purposes of clarity.

Recommendation 8.

• 5.35 We recommend that, if conversion Option 1 is adopted, non-consenting leaseholders’ statutory right to buy their commonhold unit should replace their existing statutory right to a lease extension.

• 5.36 We recommend that it should not be possible for leaseholders to carry out a collective freehold acquisition or a right to manage claim once conversion has taken place.

Requiring an incoming purchaser to buy the commonhold interest

• 5.37 We invited consultees’ views on whether, if a non-consenting leaseholder decides to sell his or her property in the future, the incoming purchaser should be required to buy the commonhold unit (as opposed to the leasehold interest) and become a member of the commonhold association.

Consultees’ views

• 5.38 The majority of consultees responding to this question were in favour of requiring an incoming purchaser to buy the commonhold unit. However, while more leaseholders, individuals, residents’ associations, and the two housing associations responding to this question supported such a requirement, more consultees from other categories, including law firms and legal representatives, were against the requirement.

• 5.39 The main argument made in support of the requirement was that it would speed up the point at which leasehold is phased out under conversion Option 1. A number of consultees said that the proposal would enable commonhold to replace leasehold as the primary form of flat ownership in England and Wales. Some consultees also questioned why an incoming purchaser would not want to buy the commonhold unit. For example, one consultee who responded anonymously said, “I can’t see why a purchaser would not want to purchase a commonhold interest, as it appears highly advantageous compared to leasehold”. And Debbie Davies suggested that if the purchaser does not want to buy a commonhold unit “they may wish to reconsider buying the property”.

• 5.40 A number of those who were opposed to the requirement were concerned about the effect of the requirement on the marketability of the property. These consultees felt that the incoming purchaser should have the option of buying the commonhold unit, but that it should not be made compulsory. For example, Boodle Hatfield LLP argued that the requirement would restrict “a non-consenting leaseholder wishing to sell its unit to a limited market i.e. to only those proposed buyers willing to take a commonhold unit”. Mark Chick (solicitor) suggested the proposal might disadvantage those with short leases, as the cost of buying the unit would be particularly high,²⁰¹ which might deter purchasers. He suggested that those with short leases should be permitted to sell their leasehold interest freely to anyone prepared to buy it. Catherine Isbell thought that the requirement would add complexity to the process which might make the purchase unattractive. Other consultees were concerned that the proposal would limit leaseholders’ ability to deal with their property as they wish.

• 5.41 Christopher Jessel and FPRA queried whether the requirement to buy the commonhold unit would only arise where the leaseholder sells the property, rather than where the property is transferred automatically, such as on the death of the leaseholder. They argued, for example, that it would be inappropriate to require the personal representatives of a deceased leaseholder to choose between buying the commonhold unit or receiving nothing.

Discussion and recommendations for reform

• 5.42 We note concerns that a requirement for incoming purchasers to buy the commonhold unit might affect the marketability of the property. However, we do not share these concerns. Our view is that commonhold offers an improved form of flat ownership to leasehold, and, particularly as commonhold becomes more prevalent, there should not be any reason why incoming purchasers would not wish to accept a commonhold unit. Indeed, several consultees responding to this question commented that purchasers would prefer to buy an outright freehold interest, rather than a leasehold interest.

• 5.43 We also note arguments that those who own short leases should be able to sell their short leasehold interest freely, as the cost of purchasing the unit may be particularly high. However, as has been demonstrated in the leasehold context, there is a restricted market for short leasehold interests. Generally, the shorter the lease, the harder it is to find a mortgage lender who would be willing accept the leasehold interest as adequate security for its lending. An incoming purchaser, who relies on mortgage financing, would therefore require the short lease to be extended as part of the purchase. In the commonhold context, a mortgage lender would also likely require greater security than that offered by the existing short leasehold interest. Rather than obtaining a lease extension (which would not be compatible with our objective of phasing out leasehold interests) the purchaser would be able to obtain greater security by buying the commonhold unit. As we explain above, in most cases there will be negligible (if any) difference in value between the cost of a lease extension and the cost of buying a commonhold unit, although the commonhold unit will offer the purchaser greater security.

• 5.44 Certain consultees framed the proposal in terms of “money being deducted” from the proceeds of sale, and the remainder being paid to the leaseholder. However, in reality, the leaseholder would receive the value of his or her leasehold interest, and any additional value (representing the difference in value between the leasehold interest and the freehold of the commonhold unit) would be paid to the commonhold association. The leaseholder would be in a similar position financially as if he or she had simply sold his or her leasehold interest independently of the commonhold unit.

• 5.45 Additionally, we do not think that prospective purchasers would necessarily be deterred by the complexity of the conveyancing process. We envisage that the purchase would operate in a similar way to the “back-to-back” staircasing of a shared ownership lease. Before a shared owner has purchased 100% of the value of his or her property, an incoming purchaser would be able to purchase the shared owner’s interest and the interest belonging to the shared ownership provider as part of the same transaction.

• 5.46 As our policy objective is for the existence of leasehold in commonhold to be a temporary measure if Option 1 is adopted, we therefore recommend that incoming purchasers should be required to buy the commonhold unit, not only the leasehold interest. At the point of conversion under Option 1 there may be numerous long leases left in the building (for terms 125 or 999 years, for example). The owners of these leases will already have a significant amount of security in their homes and so may never seek to buy their commonhold unit due to their lease term running down. Without making this recommendation, we cannot see a realistic way of phasing out such existing long leases within the building.

• 5.47 We agree with comments made by Christopher Jessel and FPRA that the requirement to buy the commonhold unit should not be activated by all transfers of the leasehold interest. In particular, the requirement should not apply to dispositions of the lease that arise “by operation of law”. These are dispositions that arise because of a statutory requirement or a court order, rather than because of the voluntary actions of the parties. Such dispositions include, for example, the transfer of a bankrupt’s property to the Official Receiver and the transfer of a deceased person’s property to his or her personal representatives.²⁰² The requirement also should not arise where the personal representatives distribute the deceased person’s assets following his or her death. In these situations, it would not be appropriate for the person receiving the property to pay an additional amount to buy the freehold of the property. In many cases the person receiving the property may not have the funds available to buy the freehold and should not be required to borrow the money.

Recommendation 9.

• 5.48 We recommend that, if conversion Option 1 is adopted, on the transfer of a leasehold property owned by a non-consenting leaseholder, the transferee should be required to purchase the commonhold title, as well as the leasehold interest.

• 5.49 We recommend that a person who receives a leasehold property by operation of law should not be required to buy the commonhold title.

Position of shared owners on conversion, a summary

• 5.50 A number of consultees responding to the questions above queried the position of shared owners following a conversion to commonhold. We discuss the position of shared owners in more detail in Chapter 11. However, as there are parallels between the position of non-consenting leaseholders under Option 1 and the position of shared owners once they have staircased to 100% ownership (under both conversion options), we also summarise the position here for clarity.

• 5.51 In Chapter 11 we explain that, as an exception to the general ban on residential leases of over seven years within commonhold, shared ownership leases will be permitted to be granted. Shared ownership plays a key role in the provision of affordable housing in England and Wales, and a failure to accommodate it could seriously damage commonhold’s uptake. Shared ownership leases will therefore be permitted in new commonhold developments and will simply continue following a conversion to commonhold under both conversion options. We make a number of recommendations to accommodate shared ownership leases successfully within the commonhold model. With regards to shared owners’ enfranchisement rights, we draw a distinction between the position of the shared owner before and after final staircasing.

Position of shared owners prior to staircasing to 100% ownership

• 5.52 As we explain in more detail in Chapter 11, shared owners can buy percentage shares in the ownership of their house or flat through a process known as “staircasing”, often with a view to taking full ownership on staircasing to 100%.

• 5.53 Prior to having staircased to 100%, Government has decided that, as a matter of policy, shared owners should have a statutory right to a lease extension. However, Government’s policy is that, prior to final staircasing, shared owners should not have a statutory right to buy the freehold of their properties (either individually or collectively with the other leaseholders in the building). That is because the shared ownership lease is specifically designed to enable those who cannot afford to purchase the property outright to do so in stages, via the staircasing provisions which form part of all shared ownership leases. It would not be the correct result if leaseholders were able to circumvent these provisions by relying on statutory enfranchisement rights to acquire the freehold of their home or building.

• 5.54 To that end, we consider it correct that, prior to final staircasing, shared owners should not have a statutory right to buy the freehold of their commonhold unit. To provide otherwise would be to circumvent the staircasing provisions in the shared ownership lease. However, shared owners would retain their right to a lease extension in order to obtain greater security in their homes.

Position of shared owners on purchasing 100% of the value of their properties

• 5.55 On staircasing to 100% ownership, the shared owner will retain his or her lease but the terms of the lease which are specific to shared ownership would fall away. From final staircasing, our view is that the shared owner should be treated in the same way as any other leaseholder in a building that has converted to commonhold. In other words, the shared owner should now be in the same position as a non-consenting leaseholder under Option 1. In particular, following final staircasing:

• (1) the shared owner would have a statutory right to buy his or her commonhold unit;

• (2) this right would replace his or her statutory right to a lease extension (and to participate in a CFA or a right to manage claim); and

• (3) an incoming purchaser would be required to buy the commonhold unit, rather than the shared owner’s leasehold interest.

• 5.56 Shared owners would therefore be encouraged to take the freehold of their unit following final staircasing, and become members of the commonhold association.

Financing the freehold purchase under Option 1

• 5.57 As we explain in Chapter 4, where the freeholder does not consent to the conversion to commonhold, the participating leaseholders will need to carry out a CFA claim in order to convert to commonhold. As part of the CFA process, participating leaseholders will need to pay for (or find a way of financing):

• (1) their own share of the freehold purchase, attributable to their own flats;

• (2) a share of the freehold value attributable to flats let to non-consenting leaseholders; and

• (3) a share of the freehold value attributable to flats which have not been let to a leaseholder who is eligible to participate (for example flats which are empty or which have been let to short-term or business tenants: see paragraph 3.32).

• 5.58 In the Consultation Paper, we explained the importance of ensuring that participating leaseholders have a realistic way of financing the shares of the freehold value which belong to the non-consenting leaseholders, and to flats which have not been let to any eligible leaseholder. We look at each of these scenarios in turn.

Financing Option 1: flats let to non-consenting leaseholders

• 5.59 On conversion under Option 1, participating leaseholders would have the same options available to finance non-consenting leaseholders’ shares of the freehold value as are available on a CFA claim. In the Consultation Paper we explained that nonconsenting leaseholders’ shares of the freehold value could be financed by:

• (1) some or all of the participating leaseholders;

• (2) a third-party investor who is then granted a 999-year lease (at a “peppercorn” rent²⁰³) over flats which are let to the non-consenting leaseholders; or

• (3) the leaseholders could require the freeholder to take a new 999-year lease at a peppercorn rent over the flats held by non-consenting leaseholders (referred to as a “leaseback”). Currently, under enfranchisement legislation, leasebacks are matter for negotiation between the freeholder and the participating leaseholders. In the Enfranchisement Report we recommend that the leaseholders should be able to require the freeholder to take a leaseback over flats let to non-consenting leaseholders.²⁰⁴ In contrast to (1) and (2) above -both of which are ways of raising the money - a leaseback means that the value attributed to a non-consenting leaseholder’s share of the freehold does not have to be raised, and the price payable to the freeholder is reduced accordingly.

• 5.60 The person(s) providing the finance, or the former freeholder if taking a leaseback, would then be entitled to receive the following sums from the non-consenting leaseholders during the term of their lease:

• (1) any ground rent payable under the non-consenting leaseholders’ continuing leases;²⁰⁵

• (2) the premium payable when non-consenting leaseholders buy the commonhold interest in their property at a later date; and

• (3) the additional value realised on the sale of any non-consenting leaseholder’s property as a commonhold unit.²⁰⁶

• 5.61 We explained in the Consultation Paper that where participating leaseholders finance non-consenting leaseholders’ shares of the freehold purchase (method (1) above), there needs to be a mechanism in place which ensures that only those who have contributed towards the finance would be entitled to receive the above sums from nonconsenting leaseholders. Without such a mechanism, there is a risk that a nonconsenting leaseholder, who decides to buy his or her commonhold unit at a later date, might stand to receive the above sums from the other non-consenting leaseholders, without having contributed towards the share belonging to those other non-consenting leaseholders. We presented two potential mechanisms to ensure that only those who have paid towards the non-consenting leaseholders’ share would stand to receive the above sums and recoup their expenditure.²⁰⁷

• (1) The commonhold association could own the units let to non-consenting leaseholders on conversion. When any non-consenting leaseholder (or a purchaser of his or her interest, see Recommendation 9 above) acquires the commonhold interest, he or she would have to pay the premium to the commonhold association, which would then be distributed to the members of the commonhold association. The premium payable would need to reflect the incoming unit owner’s new right to receive ground rent and premiums from the remaining non-consenting leaseholders.

• (2) Alternatively, those leaseholders providing the finance could set up a company solely for the purpose of receiving ground rent and premiums from the nonconsenting leaseholders. This company could then own the units which are let to the non-consenting leaseholders on conversion. As the landlord of the nonconsenting leaseholders, the company would be entitled to receive the above payments from the non-consenting leaseholders. Only those who contributed towards financing the non-consenting leaseholders’ shares would be entitled to be members of the special purpose company and receive these sums. Where a non-consenting leaseholder (or a purchase of his or her interest) acquires the commonhold interest, he or she would become a member of the commonhold association but would not become a member of the special purpose company.

• 5.62 The various ways of financing the freehold purchase under Option 1 are summarised in figure 10 below.

• Figure 10: Summary of options for financing non-consenting leaseholders shares under Option 1

Using the same example of a block of five leasehold flats as depicted in figure 3 (paragraph 3.10 above). Leaseholders A, B, C and D wish to convert to commonhold under Option 1 but E does not consent to the conversion. The price payable to the freeholder to acquire the freehold is £15,000 and each flat’s contribution is valued at £3,000. In this example, A, B, C and D each pay £3,000 in respect of the value attributed to their own flats and each take a commonhold unit. E will retain his or her leasehold interest. E’s share of the freehold could be funded in one of the following ways.

• (1) By A, B, C and/or D. They would then be entitled to receive the £100 per year ground rent payable under E’s continuing lease, any premium payable if E buys the commonhold unit, and any additional value realised on the sale of the property. The freehold of E’s flat could be held by the commonhold association, with the sums received from E distributed between the members of the association (A, B, C, D), or by a special purpose company made up of A, B, C and/or D.

• (2) By a third-party investor. This investor would be granted a new, superior lease over E’s flat, and would be entitled to receive the ongoing ground rent of £100 per annum, the premium payable if E buys the commonhold unit, and any additional value realised on the sale of the property.

• (3) By granting a leaseback to the former freeholder (Z). A, B C and D could require Z to take a new 999-year lease over E’s flat. This would reduce the purchase price for A, B, C and D. The result is that the £3,000 attributable to E’s flat never has to be raised and paid because Z’s 999-year lease will reflect the value of his or her freehold interest. Z would be entitled to receive the ongoing ground rent of £100 per annum, any premium payable if E buys the commonhold unit, and any additional value realised on the sale of E’s property.

• 5.63 We asked consultees whether the financing options set out from paragraph 5.59 above should be available to fund non-consenting leaseholders’ shares of the freehold purchase price, and how participating leaseholders might be protected if they fund these shares between them.

Consultees’ views

Finance provided by participating leaseholders

• 5.64 A high number of consultees said that it would be preferable for the participating leaseholders to fund the freehold purchase between themselves in order to avoid the freeholder, and other parties, retaining an interest in the building following conversion. Teresa Velasco, for example, preferred this method of financing “so that total control of developments can fall into leaseholders’ hands once and for all”. A number of consultees were also wary of the former freeholder, and other third parties, diluting the former leaseholders’ control on conversion. Katherine Mickleson said it would be “important to keep the decision-making powers with the people who own/live in the building rather than the original freeholder or an outside investor”.

• 5.65 With regard to how participating leaseholders might recoup their initial expenditure (see paragraph 5.61 above) only a handful of consultees expressed a preference. The Property Bar Association (“PBA”) thought that it would be more straightforward, both practically and conceptually, for the units of non-consenting leaseholders to be owned by the commonhold association. Conversely, Notting Hill Genesis (housing association) said that “given the experience of enfranchisement” it would be better for leaseholders to set up a special purpose company to own the units. Graham Webb (leaseholder) also thought that the special purpose company would offer greater flexibility in that it (1) could be structured differently from the commonhold association and (2) it would allow other investors to participate in the same company. Damian Greenish suggested that it would only be appropriate for the commonhold association to own the units if all the consenting leaseholders had provided the funding, rather than a proportion of them. He also queried whether it was necessary to specify the funding vehicle.

Leaseback to the former freeholder

• 5.66 A smaller number of consultees supported the ability of the participating leaseholders to require the former freeholder to take a 999-year leaseback as a way of funding the shares belonging to non-consenting leaseholders. Several consultees queried whether leaseholders would have the funds available to finance non-consenting leaseholders’ shares without such an ability. Aisling Rollason (leaseholder) said that if leaseholders were required to fund consenting leaseholders’ shares themselves, conversion might change “from an affordable option to a totally unaffordable option for the leaseholder”.

• 5.67 On the other hand, a few consultees were opposed to the suggestion that the former freeholder might be required to take a leaseback against his or her wishes. Lu Xu (academic) said that it:

seems rather unfair to the freeholders, who have just been told that the leaseholders collectively would not want their presence in the building anymore, yet they are then compelled to continue to be part of it by having a leaseback forced upon them.

• 5.68 Other consultees were concerned that, if the former freeholder were required to take a leaseback within the commonhold model, there might be a conflict between the terms of the commonhold community statement (“CCS”) and the former freeholder’s responsibilities under the 999-year leaseback.

Finance provided by a third-party investor

• 5.69 The option of obtaining financing from an external investor, and granting the investor 999-year leases over flats let to non-consenting leaseholders, received the lowest amount of support. Consultees reiterated their scepticism about the role of third-parties in commonhold. A couple of consultees thought that the involvement of external investors might saddle the association or non-consenting leaseholders with debt. The PBA also felt that it would be unattractive for the third-party investor to become the immediate landlord of the non-consenting leaseholder.

A flexible model

• 5.70 Several consultees argued that all options set out in the Consultation Paper should be available to leaseholders when seeking to acquire the freehold and convert to commonhold. The Leasehold Advisory Service (“LEASE”) explained:

ultimately it is down to the preference of those embarking on the conversion process as to how they choose to fund the non-consenting leaseholders’ share of the freehold purchase.

• 5.71 Mark Chick agreed that “if the reforms are to be successful there must be as much commercial flexibility as possible”.

Government assistance

• 5.72 In addition to the options presented in the Consultation Paper, a number of consultees responding to this question argued that Government funding should be available to help finance the conversion.

Discussion and recommendations for reform

• 5.73 We agree with arguments that the funding options should not be prescriptive. We recommend that all the options available to finance a CFA claim should be available where leaseholders are acquiring the freehold and converting to commonhold under Option 1.

• 5.74 If their funds allow, participating leaseholders will have the option of financing the freehold purchase themselves, and controlling the involvement of external investors and the former freeholder.

• 5.75 Where participating leaseholders fund the freehold purchase, our view is that it should be open to the leaseholders either to set up a special purpose company to own the units which are let to non-consenting leaseholders, or for the units to be owned by the commonhold association. Which mechanism is appropriate will depend on the circumstances of the case. As was rightly pointed out by consultees, setting up a special purpose company is likely to offer greater flexibility, as it would not be bound by the prescribed rules of the association.²⁰⁸ However, in some cases, it may be more straightforward for the commonhold association simply to own the commonhold units and distribute income from the non-consenting leaseholders to its members. Currently, there is a prohibition within the commonhold association’s articles which would prevent the association distributing profits to its members.²⁰⁹ We recommend a limited exception to this rule, if Option 1 is adopted, to enable the distribution of ground rent and premiums received from non-consenting leaseholders to the members of the commonhold association. We note Damian Greenish’s comment that it would only be appropriate for the commonhold association to own the units where all participating leaseholders have contributed to the funding. However, there would be no requirement for the commonhold association to distribute income equally between the members. Participating leaseholders would be able to agree on a level of distribution proportionate to the amount of money they had contributed to the freehold purchase.

• 5.76 Leaseholders will also be able to require the freeholder to take 999-year leasebacks over flats let to non-consenting leaseholders. This ability will make conversion more affordable, and therefore accessible, to participating leaseholders. We note concerns that the freeholder, when granted a 999-year leaseback, might be required to comply with CCS terms which are inconsistent with the terms of the non-consenting leaseholder’s lease. For example, a requirement in the CCS not to keep a pet where the non-consenting leaseholder’s lease permits pets. However, this difficulty would not arise. Only unit owners who take a commonhold unit on conversion and their tenants, (and therefore not leaseholders or their tenants) would be required to comply with the terms of the CCS on conversion. The commonhold association would not be able to impose any requirements on the former freeholder which do not exist within the terms of the 999-year lease. The association would be bound by the terms of the former freeholder’s 999-year lease, which would be prepared so as to ensure the terms do not conflict with the non-consenting leaseholder’s inferior lease.²¹⁰

• 5.77 Further, the option of granting an investor a 999-year lease over flats let to nonconsenting leaseholders would not increase the indebtedness of the association or the unit owners. Simply, the investor would pay for the non-consenting leaseholder’s share of the freehold value and, in return, the investor would be entitled to receive the sums set out in paragraph 5.60 above. Nor do we have concerns about the investor becoming the direct landlord of a non-consenting leaseholder. Leases to external investors are already commonplace in CFA claims and leaseholders cannot prevent their landlord granting a head lease to an external investor.

• 5.78 It should be noted that granting 999-year leases to the former freeholder and/or external investors will not dilute the control of the unit owners. Only those who own a commonhold unit on conversion to commonhold (and not therefore a former freeholder or investor with a leasehold interest) will be members of the commonhold association and will be able vote on management decisions.

• 5.79 Further, granting the investor or the former freeholder 999-year leases over flats which have been let to non-consenting leaseholders would not perpetuate the existence of leases within commonhold. As explained above, our policy objective is for all the leasehold interests in the building to be phased out and to be replaced with commonhold units. To achieve this objective, all non-consenting leaseholders would, under our recommendations, have a statutory right to buy their commonhold unit, and this right would replace their existing right to a statutory lease extension. The premium payable to buy the commonhold unit would, at the same time, buy out the former freeholder’s/investor’s superior 999-year lease.²¹¹ Similarly, if the non-consenting leaseholder decided to sell his or her interest, the incoming purchaser would be required to buy the commonhold unit under our recommendations, and the former freeholder’s/investor’s lease would be bought out as part of this process. This scenario is to be contrasted with the position where the former freeholder takes a 999-year lease over a flat which has not been let to an individual who is eligible to buy their commonhold unit (considered below). In this scenario, as pointed out by consultees, the new 999-year lease could perpetuate the mix of commonhold and leasehold interests almost indefinitely.

Recommendation 10.

• 5.80 We recommend that, in order to finance the share of the freehold value attributable to flats which are held by non-consenting leaseholders, any of the methods available to finance a collective freehold acquisition should also be available where leaseholders are acquiring and converting to commonhold under conversion Option 1.

• 5.81 We recommend that, if conversion Option 1 is adopted, the commonhold association’s articles of association should permit the association to distribute ground rent and premiums received from non-consenting leaseholders to its members.

Financing Option 1: Flats which have not been let to eligible leaseholders

• 5.82 Flats which have not been let to an eligible leaseholder would be particularly expensive to purchase.²¹² As explained paragraphs 3.32 and 4.54, this category includes: flats which have been left empty; flats which have been let on tenancies of 21 years or less; flats let to commercial tenants; and flats which have been let to shared owners who have not yet staircased to 100% ownership.

• 5.83 As a way of financing the shares of the freehold value attributable to such flats, it may be possible for the participating leaseholders to enter into arrangements with external investors for them buy some or all of these flats (as commonhold units) as part of the conversion process.

• 5.84 Additionally, it is currently possible in a CFA claim for the freeholder of the building to elect to take a 999-year leaseback over any flats which have not been let to a leaseholder who is eligible to participate. As we explain above, granting the freeholder 999-year leasebacks would reduce the purchase price payable by the participating leaseholders as the value attributable to these flats would not then need to be raised. In the Enfranchisement Consultation Paper, we proposed that the participating leaseholders should be able to require the former freeholder to take new 999-year leases of such flats in order to reduce the purchase price.²¹³ In the Commonhold Consultation Paper, we proposed adopting the same approach on conversion to commonhold.²¹⁴

• 5.85 In the Consultation Paper we also explained that it may be particularly important for the former freeholder to retain an interest in certain flats which have not been let to an eligible leaseholder.²¹⁵ For example, the former freeholder of the building may be a local authority which has let out one or more of the flats in the building on secure tenancies. These tenancies are granted for less than 21 years and so will not be eligible to participate in a conversion to commonhold. Secure tenants benefit from a significant amount of statutory protection, especially when it comes to ending these tenancies. Secure tenants can lose their status and statutory protection if a person other than a local authority becomes their landlord. We therefore proposed that under Option 1, new 999-year leases should always be granted to the former freeholder in respect of flats let to certain statutorily-protected tenants (whether the participating leaseholders or the freeholder request this leaseback or not). Such mandatory leasebacks are already provided for in enfranchisement legislation. In addition, we proposed that new 999-year leases should always be granted to the former freeholder in respect of flats let to shared owners who have not yet staircased to 100% ownership, in order to preserve the shared ownership relationship on conversion.

Consultees’ views

• 5.86 Well over half of the consultees responding to this question supported the proposal, including a high number of leaseholders and other individuals. However, unfortunately, a number of consultees misunderstood our proposal, taking it to mean that individuals who were not eligible to participate in the conversion should be granted new 999-year leases on conversion. That was not our intention. The proposal related to the ability to require the former freeholder to take a leaseback over such flats in order to reduce the purchase price. The position of those ineligible to participate would not be affected by the conversion under our recommendations. We explain in Chapter 4 that their tenancies would simply continue automatically on conversion to commonhold.²¹⁶

• 5.87 Consultees who were in favour of an ability to require the freeholder to take a leaseback argued that the proposal would reduce the cost of purchasing the freehold.

Conversely, consultees who opposed the proposal generally argued that such a requirement would be unfair to the freeholder. Boodle Hatfield LLP said that:

to impose upon the freeholder a requirement (rather than offering it a right) to take on a wholly different role (as tenant to the Commonhold Association, and head landlord to an occupational tenant) is unjust.

• 5.88 Christopher Jessel also disagreed with the proposal on the basis that it “would be simpler to require the former freeholder to take a unit as commonhold from the outset”.

• 5.89 Gerald Eve LLP (surveyors) and the PBA did not agree or disagree with the proposal but pointed out a difficulty with our approach. Both consultees said that granting the former freeholder a 999-year lease over flats let which have not been let to any eligible leaseholder might perpetuate the existence of leases under Option 1 almost indefinitely, so long as the former freeholder wishes to retain ownership of the flat.

• 5.90 No consultee commented specifically on our recommendation for the former freeholder to be granted, on a mandatory basis, new 999-year leases over flats let to statutorily-protected tenants and shared owners.

Discussion and recommendations for reform

• 5.91 We note the high level of support for this proposal. The equivalent proposal in the Enfranchisement Consultation Paper was also strongly supported, and in the Enfranchisement Report, we recommend its adoption.²¹⁷ We agree that there needs to be a mechanism in place to reduce the cost payable in respect of flats which have not been let to any eligible leaseholder, as these flats can be particularly expensive to purchase. However, comments made by Gerald Eve LLP and the PBA have caused us to reconsider the mechanism by which this reduction in price might be achieved. Given our objective of making the existence of leases a temporary measure under Option 1, it would be inconsistent for the former freeholder to be granted new 999-year leases over such flats. Unlike where the former freeholder has taken a leaseback over a flat let to a non-consenting leaseholder (see discussion from paragraph 5.59 above, there would not be any leaseholder in the flat who would be eligible to buy the commonhold unit, and in so doing buy out the freeholder’s 999-year lease.²¹⁸

• 5.92 We therefore recommend that, should Option 1 be adopted, the participating leaseholders should be able to require the freeholder to take the commonhold unit of any flats which have not been let to an eligible leaseholder. Additionally, the former freeholder may request that he or she be granted the commonhold unit in respect of such flats (rather than being able to require a 999-year leaseback, as is presently the case). Further, while no consultee commented specifically on this point, we also consider it important to recommend that the former freeholder should always take the commonhold unit over flats let to statutorily-protected tenants and to shared owners on conversion, in order to protect the tenants’ and shared owners’ interests. As explained further below, we are recommending that safeguards should be put in place to protect a former freeholder who is required to take a commonhold unit on conversion.

• 5.93 From the perspective of the participating leaseholders, we note concerns that, on taking a number of commonhold units, the former freeholder might retain control of the development following conversion. The former freeholder would be able to exercise the votes attached to the commonhold units which he or she owns following conversion. However, where the freeholder does not consent to the conversion, leaseholders would need to satisfy the same qualifying criteria as for a CFA claim.²¹⁹ It would only be possible to acquire the freehold (and convert to commonhold) without the freeholder’s consent where two-thirds of the flats in the building are held by leaseholders who are eligible to participate. There would therefore never be more than a third of the flats in the building which are not held by an eligible leaseholder and in respect of which the freeholder might take the commonhold unit. The freeholder would therefore never be able to exercise votes in respect of more than a third of the flats. Most decisions of the commonhold association need either 50% or 75% of the votes cast to be in favour in order for the decision to be carried.

• 5.94 Where some or all of the participating leaseholders finance the shares of the freehold attributable to flats in respect of which there is not an eligible leaseholder, and do not require the freeholder to take the commonhold units in respect of such flats (and the freeholder does not elect to take the commonhold units) the commonhold units should be held by the commonhold association in default of any other arrangement between the leaseholders.²²⁰

Recommendation 11.

• 5.95 We recommend that, if conversion Option 1 is adopted, the participating leaseholders should be able to require the freeholder to take the commonhold unit in respect of any flats which have not been let to a leaseholder who is eligible to participate in the conversion. Additionally, the freeholder should be able to require that he or she be granted the commonhold unit in respect of such flats (rather than being able to require a leaseback, as is presently the case).

• 5.96 We recommend that the freeholder should automatically become the unit owner in respect of any flats let to statutorily-protected non-qualifying tenants and shared ownership leaseholders on conversion.

• 5.97 We recommend that, where some or all of the participating leaseholders finance the shares of the freehold value attributable to flats in respect of which there is not an eligible leaseholder (and so do not require the freeholder to take the units and the freeholder does not request the units) the commonhold units should be owned by the commonhold association as a default rule.

Safeguarding interests on conversion Option 1

• 5.98 In the Consultation Paper, we expressed our view that Option 1 would sufficiently protect the interests of non-consenting leaseholders on conversion, as they would be permitted to retain their leasehold interests on conversion.²²¹ However, following consultation we have revised our position. As a result of our recommendations to phase out leases and replace leaseholders’ interests with commonhold units (see paragraphs 5.6 to 5.49), non-consenting leaseholders might be required to take a commonhold unit in the future and, at that point, they would be required to comply with the terms of the CCS. It would therefore be necessary to ensure that the terms of the CCS have not been prepared in such a way as to prejudice the interests of the nonconsenting leaseholders upon taking a unit.

• 5.99 Additionally, we are now recommending (see paragraphs 5.82 to 5.97 above) that the participating leaseholders should be able to require the freeholder to take the commonhold unit in respect of flats which have not been let to leaseholders who are eligible to participate. On taking a commonhold unit, the former freeholder would become a member of the commonhold association and would be required to comply with the terms of the CCS which he or she had no role in preparing.

• 5.100 We are therefore recommending a new regime which will protect all individuals who will or might be required to take a commonhold unit on or following conversion, including non-consenting leaseholders and the former freeholder under both conversion options. The details of this revised scheme are set out from paragraph 5.171 onwards below.

OPERATION OF OPTION 2

• 5.101 Under the second conversion option, all leaseholders would be required to take a commonhold unit at the point of conversion. We asked a number of questions about how this conversion option might operate in practice. Again, we have already considered the threshold of support required to convert in Chapter 4 and have concluded that conversion should be possible where eligible leaseholders of at least 50% of the flats in the building support the decision.²²²

Financing the freehold purchase under Option 2

• 5.102 As we explain at paragraph 5.57 above, in order to convert to commonhold where the freeholder does not consent to the conversion, eligible leaseholders will be required to acquire the freehold compulsorily and in so doing finance (with or without the help of external funding or investment): (1) their own share of the freehold purchase cost attributable to their own flat; (2) a share of the freehold value attributable to flats let to eligible but non-consenting leaseholders; and (3) a share of the freehold value attributable to flats which have not been let to leaseholders who are eligible to participate.

• 5.103 We now look at how (2) and (3) might be financed in the context of conversion Option 2.

Financing Option 2: flats let to non-consenting leaseholders

• 5.104 On conversion under Option 2, all eligible leaseholders will take a commonhold unit in exchange for their leasehold interest at the point of conversion, including nonconsenting leaseholders. No long residential leases over the flats will be permitted to continue.²²³ It would therefore not be possible (unlike under Option 1) to grant the former freeholder or an external investor a superior 999-year lease over nonconsenting leaseholder’s flats in order to reduce the purchase price.

• 5.105 On conversion to commonhold, all non-consenting leaseholders’ property interests would be upgraded from leasehold to freehold. These leaseholders would no longer have an asset which reduces in value as the lease term runs down and would not be required to pay any ground rent. In the Consultation Paper, we explained that it would not be appropriate to require non-consenting leaseholders to pay for their upgraded interest at the point of conversion. Participating leaseholders would therefore need to find a way to finance non-consenting leaseholders’ shares of the freehold value. However, it would be unfair for non-consenting leaseholders to obtain their upgraded commonhold interest for free. There would need to be a way for non-consenting leaseholders to pay for the increase in the value of their property which will have changed from leasehold to commonhold on conversion, and to reimburse those who initially financed their share of the freehold purchase.

Example

Using the same example of a block of five leasehold flats depicted in figure 3 (paragraph 3.10), leaseholders A, B, C and D wish to convert to commonhold under Option 2 but E does not agree to the conversion. The price payable to acquire the freehold is £15,000 and each flat’s contribution is valued at £3,000. In this example, A, B, C and D each pay £3,000 in respect of the value attributed to their own flats. As it would be unfair (and impractical) to require E to pay for his or her own share at the point of conversion, A, B, C and D finance E’s contribution between them. On conversion however, E obtains a freehold interest which is worth £3,000 more than his leasehold interest even though he or she has not paid anything towards the freehold purchase. There would therefore need to be a mechanism for E to repay A to D who have provided the necessary finance, at some point in the future.

• 5.106 As a mechanism for those financing non-consenting leaseholders’ shares under Option 2 to recoup their expenditure, we provisionally proposed that non-consenting leaseholders should have a charge placed over their commonhold units on conversion in favour of those who provided their share of the finance. The charge would ensure that, on the subsequent sale of their commonhold units, the non-consenting leaseholders would be required to repay their share of the freehold value to those who provided the necessary finance, although they would have the option to repay their share sooner if they wished.

• 5.107 We asked a number of questions about how the charge might operate,²²⁴ including the following.

• (1) What priority should the charge have in relation to existing mortgages? We said that it might be appropriate for the charge in favour of those providing the finance to take priority over any existing mortgages.²²⁵ Before the conversion, any mortgage lender would only have had a charge over the leasehold interest, rather than the upgraded commonhold interest. We therefore suggested that the best way to maintain the status quo might be to give the new charge priority over existing mortgages. We invited consultees’ views on this point.

• (2) Who should be able to provide the funding and take the benefit of the charge? We suggested that the finance could be provided by the participating leaseholders, a lending institution or by a third-party investor. We also asked whether the former freeholder might be required to take a charge over the nonconsenting leaseholders’ units on conversion. The freeholder would not be paid non-consenting leaseholders’ shares at the point of conversion. Instead the freeholder would be granted charges over the non-consenting leaseholders’ units. As these units come to be sold on, the freeholder would be paid the nonconsenting leaseholders’ share from the proceeds of sale. Under this option, the former freeholder would not receive periodic payments of ground rent in respect of the non-participating leaseholders’ leases, or benefit from the wasting nature of the leases, but would be paid the freehold value of the flat (plus a share in the increase in value, see below) at the point of sale.

• (3) How might the charge be set? We explained that the fairness of requiring the freeholder to accept a charge over non-consenting leaseholders’ units, and the charge’s attractiveness to third-parties as an investment, would depend on whether any interest or “added value” could be attached to the charge. That is, a sum over and above the amount paid on behalf of the non-consenting leaseholder on conversion. If no added value were attached to the charge, there might also not be sufficient incentive for leaseholders to participate in the conversion at the outset, as non-consenting leaseholders would effectively be receiving an interest-free loan to obtain their unit. Such considerations need to be balanced against the fact that non-consenting leaseholders will not have agreed to the charge. The charge should therefore not give rise to onerous obligations or a risk of repossession. We made the following suggestions as to how the charge could be set and we invited consultees’ views. The charge could be set:

• (a) as a fixed amount representing the non-consenting leaseholder’s share of the freehold purchase at the point of conversion (but that would effectively amount to an interest-free loan);

• (b) as a fixed amount, with interest;

• (c) as a fixed amount, which may increase or decrease in line with house

price inflation; or

• (d) as a percentage share in the market value of the commonhold unit. This percentage would represent the increase in value of the non-consenting leaseholder’s interest which would have changed from leasehold to freehold on conversion.

• 5.108 To implement the approach in (d) it would be necessary to calculate the percentage increase in value of the non-consenting leaseholder’s interest which would have resulted from the conversion to commonhold. In other words, the difference in value between the non-consenting leaseholder’s leasehold interest before the conversion, and the commonhold unit he or she would receive following conversion. On the subsequent sale of the commonhold unit, those providing the finance would be paid that same percentage from the proceeds of sale. For example, assume that conversion to commonhold results in a 10% increase in the value of the leaseholder’s interest. If the non-consenting leaseholder decided to sell the commonhold unit in the future, he or she would be required to pay 10% of the proceeds of sale to those providing the finance. A mechanism would need to be in place to ensure that the unit could not be sold for less than the unit’s open market value.²²⁶ Our view was that this option would strike the best balance between “added value” and protecting the nonconsenting leaseholder. It would mean that the person(s) providing the finance would be able to share in any increase in the value of the property. The non-consenting leaseholder would also benefit from the increase in the value of his or her interest, and would no longer be prejudiced by the wasting nature of his or her leasehold interest. Both parties would also share the risk of the property decreasing in value between conversion and the date of sale.

• 5.109 We also asked consultees whether there might be any alternative way of financing non-consenting leaseholders’ shares of the freehold, other than using a charge.

Consultees’ views

• 5.110 A sizeable majority of consultees agreed with our provisional proposal for a charge to be placed over non-consenting leaseholders’ units if Option 2 were to be adopted. In particular, most leaseholders, individuals, residents’ associations and leaseholder representative groups were in support. Views amongst other groups were more divided, and the only developer and two commercial freeholders responding were against the proposal.

• 5.111 Most of those who supported the proposal did not provide a substantive comment or they simply said that the proposal was “sensible”. A few consultees made the point that the proposal would help leaseholders who wanted to convert to commonhold but who could not afford to contribute at the point of conversion. They said that leaseholders who were unable to participate could still take a commonhold unit at the point of conversion, subject to the charge. Mariyam Zaman (leaseholder) argued that non-consenting leaseholders stand to benefit from taking a commonhold unit, particularly as no ground rent would be payable thereafter.

• 5.112 Conversely, some consultees argued that the proposal would operate unfairly for nonconsenting leaseholders and might contravene leaseholders’ property rights under A1P1.²²⁷ In particular, if there were a downturn in the property market and the unit decreased in value, there would be a concern that non-consenting leaseholders would not have sufficient equity in their properties to repay the charge and any mortgage over the property. ARMA argued that the proposal:

requires that the sale price of the unit is always higher than the purchase price. If it is not then the charge on the cost of commonhold cannot be recovered by the giver. Market fluctuations combined with date of purchase and sale or distressed sales cannot guarantee the required profit to repay the lender based purely upon sale proceeds. To impose a further loss upon the non-consenting converted leaseholder in order to repay the giver would be unreasonable and could significantly harm someone who may already be in a vulnerable position.

• 5.113 Irwin Mitchell LLP was concerned that non-consenting leaseholders would not have any control over the price paid by the participating leaseholders to purchase the freehold. Non-consenting leaseholders might therefore be required to repay a share of the freehold purchase price on the sale of their units, even if the amount paid to the freeholder was considered by them to be unreasonable. This consultee also asked what impact the proposal might have on the ability of non-consenting leaseholders to obtain additional mortgage finance. In addition, Julia Burgess felt that the proposal added too much complexity to the commonhold model.

What priority should the charge have in relation to existing mortgages?

• 5.114 Well over half of the consultees responding to this question were in favour of the charge taking priority over any existing mortgages. Significantly more leaseholders and individuals supported the suggestion. Views amongst other consultees, including law firms and their representative bodies, were more evenly split, and the two housing associations responding disagreed with the charge taking priority.

• 5.115 Consultees who supported the charge taking priority over existing mortgages generally did so for the reasons set out in the Consultation Paper. They thought the charge should take priority because conversion would have created additional value over and above the leasehold interest, which the mortgage would have been secured against before conversion. Lu Xu said that the charge in favour of those providing the finance should rank:

above mortgages since it is incurred to discharge liabilities and acquire various rights in the previous freehold, which would have superseded the mortgage of the leasehold.

• 5.116 Some consultees also pointed out that the existing lender would receive improved security over the commonhold unit following conversion to commonhold, particularly as the lender would not be at risk of losing its security through forfeiture or due to the lease term running down (unlike the position in leasehold).

• 5.117 Berkeley Group Holdings PLC (developer) thought that, if the charge were to take priority, there would be an incentive for lenders, who already have a mortgage secured over non-consenting leaseholder’s flats, to provide the additional finance. If the additional finance to cover the non-consenting leaseholder’s share were instead provided by the participating leaseholders, or by an investor, these individuals would obtain an interest in the commonhold unit superior to that of the existing mortgage lender.

• 5.118 The PBA commented that “on balance, the charge should have priority” but thought that the uplift in value resulting from conversion was “unclear”. Consequently, this consultee said, “it is possible that lenders secured against leasehold units in negative equity would be unfairly prejudiced by this proposal. That said, we assume this to be comparatively rare”.

• 5.119 Those consultees who were opposed to the charge taking priority over existing mortgages made similar arguments to the PBA. Concerns were raised about the charge eroding the equity available in the property to discharge existing mortgages on the sale of the unit.

• 5.120 A number of consultees thought that the proposal could result in existing lenders being unwilling to offer further finance in respect of the converted commonhold units, or might result in lenders charging increased rates. Others argued that the proposal would reduce the prospect of lenders accepting commonhold in the first instance. Pamela Hughes, for example, said that the charge would have to come second to existing mortgages “otherwise mortgage companies would not provide funds. Mortgage companies will always insist on having the first charge”.

Who should provide the finance and take the benefit of the charge?

Lending institutions and third-party investors

• 5.121 The most popular selection amongst consultees was for a commercial bank or building society to provide the necessary finance and take the benefit of the charge. However, Tiara Hardy (leaseholder) argued that the finance should only be provided by “ethical firms” which are “heavily regulated in terms of the charge and fees applicable”. A few consultees suggested that the existing mortgage lender might provide the additional finance. ARMA said that:

the simplest mechanism would be for the mortgage [lender] to take the charge against the presumably increased value of the flat. In this scenario there is no complication with regards to a willing commonholder (e.g. B) later selling and hence trying to establish where the charge benefit flows to.

• 5.122 Lu Xu thought that financing could be provided by “anyone who sees this as an investment opportunity. If people nowadays buy the reversion of leasehold flats, surely they would consider investing in commonhold conversion charge”.

• 5.123 Conversely, some consultees were sceptical about whether commercial lenders and investors would be interested in providing the finance and taking the benefit of the charge. A. L Hughes & Co (solicitors) argued that, currently, lenders only agree to help fund CFAs on the basis that they will receive premiums when non-participating leaseholders buy lease extensions, and these premiums will increase in value over time (as the lease term decreases). Consensus Business Group (landlord) set out a number of reasons why a commercial lender would likely be uninterested in providing the necessary finance. These reasons included that the “loan would be for an indeterminate period” and “lenders would likely consider such a loan as a bet on the housing market and require a high rate of interest”. While the PBA agreed in principle that it would be possible for a third-party investor to provide the finance, it thought it was “unclear how initial investors would recoup their outlay within a sensible time frame”.

• 5.124 Additionally, some consultees were generally opposed to external investors playing a role in commonhold. For example, Shira Baram (a leaseholder), said “I do not agree that the purchase of commonhold should be seen as an investment for third-parties”.

Participating leaseholders

• 5.125 Slightly fewer consultees provided a comment in support of the participating leaseholders providing the necessary finance between themselves and taking the benefit of the charge. Those that provided a comment generally made similar arguments to those expressed by Shira Baram, that the presence of third-party investors within commonhold should be prevented.

The freeholder

• 5.126 A number of leaseholders and individuals supported the suggestion that the freeholder might be provided with a charge over the non-consenting leaseholders’ units, rather than receive non-consenting leaseholders’ shares of the purchase cost at the point of conversion. The freeholder would be paid non-consenting leaseholders’ share of the purchase price when these leaseholders come to sell their units. The National Leasehold Campaign argued that, while the freeholder would not receive any periodic payments of ground rent following conversion, the capital injection from the participating leaseholders would “offset in cash flow terms, the ground rent income they would continue to receive if nothing changes”.

• 5.127 Other consultees strongly disagreed with the suggestion, saying that it would be unfair and would effectively require freeholders to fund the non-consenting leaseholders’ shares of the initial freehold purchase price. In particular, Consensus Business Group said that the charge would be “a wholly different property asset in the hand of the former freeholder than the investment it made” and that it would replace “an investment which secures a consistent income stream” with “an unsure charge for an indeterminate period”. Berkeley Group Holdings PLC said that requiring the freeholder to take the charge “offends strongly the principles of A1P1”.

A flexible model

• 5.128 Additionally, several consultees argued that the funding options available should be flexible. Teresa Velasco said that unit owners should be able to consider how the conversion might best be financed and, accordingly, who should benefit from the charge. And the Chartered Institute of Legal Executives (“CILEx”) said “so long as the rules around the creation of the charge are fair to the non-consenting leaseholder it should be immaterial where the finance comes from”.

How might the charge be set?

A fixed amount

• 5.129 The option that received the most support from consultees, and particularly leaseholders, was for the charge to be set as a fixed amount, representing the nonconsenting leaseholder’s share of the initial freehold purchase at the point of conversion. Consultees said that this option would be the least oppressive option for non-consenting leaseholders. Catherine Williams (leaseholder) argued that those financing the conversion should not be able to “take advantage of a non-consenting leaseholder’s lack of funds at that time”. The Buckingham Court Residents’ Association said that conversion to commonhold should not be a “profit-based system”. A couple of consultees also argued that this option for setting the charge would be the easiest to administer. However, a few consultees pointed out that this option would amount to an interest-free loan which would not be an attractive investment. As Brenda Fearns (leaseholder) suggested, the non-consenting leaseholder could “wait for inflation to take away the expense of the purchase”.

A fixed amount, plus interest or inflation

• 5.130 A smaller number of consultees were in favour of setting the charge as a fixed amount, plus interest or inflation. Those in favour of this option said that it would: (1) offer an incentive to provide the financing; (2) encourage leaseholders to participate at the outset as otherwise they would be required to pay an additional amount; and (3) avoid participating leaseholders being “out of pocket”. However, a few consultees were concerned that non-consenting leaseholders would be disadvantaged under this option if the value of the commonhold unit were to fall. In this scenario, the leaseholder would remain liable to repay the full amount to those providing the finance, plus interest or inflation (which may have been accruing for a long period of time), but may not have sufficient equity in their unit from which to make the payment.

As a percentage share in the value of the unit

• 5.131 This was the second most popular option amongst consultees.²²⁸ Consultees, including two members of our advisory panel, Lu Xu and Mark Chick, argued that this option would provide a return on the investment of those financing non-consenting leaseholders’ shares and would therefore offer an incentive to provide this financing. Paul Stevens said that it would be fair for those providing the finance to share in any increase in value of non-consenters’ units.

[When] commonhold becomes widely used, it is highly likely that a commonhold unit will be worth more than a leasehold flat, and it is only fair that whoever pays the enfranchisement premium should have the benefit (or part of it) of the increase in value. It is less fair that a non-consenting leaseholder should have the full benefit of the increase in value since they have chosen not to take part in the conversion to commonhold.

• 5.132 On the other hand, some consultees including the Leasehold Knowledge Partnership (“LKP”), expressed concern that if the charge were set as a percentage, those providing the finance might not be repaid in full should the property decrease in value. Further, while the PBA thought that setting the charge as a percentage amount would be “the most principled way to set the charge” it thought the option could lead to valuation disputes at the point of sale.

What alternatives might there be?

• 5.133 With regards to whether there might be an alternative way to finance non-consenting leaseholders’ shares of the cost of converting, some consultees argued that participating leaseholders should fund the shortfall between themselves, without requiring any form of reimbursement.

• 5.134 A number of other consultees suggested that, rather than repaying the debt on the sale of the property, non-consenting leaseholders might be able to pay their share of the freehold purchase price in instalments. Graham Webb (leaseholder) argued that “non-consenters will have benefited from the elimination of their ground rent, so a significant regular repayment is entirely justifiable”. He argued that regular repayments would benefit those who provided the finance, given that “any sale of the unit (and recouping of the charge) might be decades in the future”.

• 5.135 In addition, many consultees argued that Government support should be available to help finance the cost of converting. Berkeley Group Holdings PLC said that a Government-backed scheme might help “avoid the need to resort to charges”. Jo Darbyshire (leaseholder) explained that many leaseholders “will struggle to afford the outright cost of the conversion of their own property without having to also fund the conversion of others”. Consultees put forward a number of suggestions as to what Government assistance might look like, including low interest loans, a Help to Buy scheme and a Government fund.

Discussion and recommendations for reform

• 5.136 Our view is that, in the vast majority of cases, and even if subject to a charge, nonconsenting leaseholders would be in a better position following conversion under Option 2 than if they had remained leaseholders (under Option 1). On conversion, non-consenting leaseholders would obtain an interest which no longer reduces in value as the term runs down and no ground rent would be payable.²²⁹

• 5.137 We agree with the view expressed by a number of consultees that it would be important not to put the former non-consenting leaseholders in a position whereby, at the point of sale of the unit, the amount owing under the charge exceeded the property value. We therefore agree with arguments that setting the charge as a fixed amount would be particularly disadvantageous for the former non-consenting leaseholders if property prices were to go down. In this scenario, the former leaseholders would be required to repay the fixed amount secured by the charge, plus any interest or inflation, regardless of the value of the property at the point of sale.

• 5.138 Our view is that these concerns could be addressed by setting the charge as a percentage increase in the value of the property which results from the conversion (option (d) at paragraph 5.107(3) above). The commonhold unit and the leasehold interest would be valued as part of the conversion process, and the percentage uplift in value resulting from the conversion to commonhold would be calculated at this point. On conversion, the relative value between the non-consenting leaseholder’s leasehold interest and the commonhold unit would be therefore “fixed” or “crystallised”. The percentage, once set, would remain constant, regardless of whether the commonhold unit subsequently increased or decreased in value. On the sale of the unit, that same percentage amount would be paid from the proceeds of sale to those financing the non-consenting leaseholder’s share. If the charge were set in this way, the amount owing under the charge would never exceed the equity available in the property at the point of sale. If the value of the unit had increased between the point of conversion and sale, those financing the conversion, and the non-consenting leaseholder, would both be able to share in any increase in value of the property. Both parties would also share the risk of there being a downturn in the property market. Any losses which result would be shared in a way that was proportionate to their property interest, again by taking account of the set percentage.

• 5.139 Setting the charge as a percentage of the value of the property would also address Irwin Mitchell LLP’s concern set out in paragraph 5.113 above that non-consenting leaseholders would not have any control over the purchase price paid to acquire the freehold. The percentage figure would represent, on an objective basis, the additional value generated by the conversion to commonhold, rather than the amount of money paid by the participating leaseholders to acquire the freehold.

• 5.140 That being said, we do, at this stage, have reservations about imposing a charge over the units of non-consenting leaseholders in the manner described in the Consultation Paper.

• 5.141 Our proposal relies upon the charge being a sufficiently attractive investment for investors. Otherwise, these parties would not be willing to help finance non-consenting leaseholders’ shares of the freehold purchase and accept charges over the units in return. While many individuals and leaseholders were sceptical about the involvement of third-party investors, in practice, leaseholders may not be able to raise the necessary funds between themselves. If leaseholders were unable to raise the necessary funds, conversion would be prevented unless external investment became available. Despite our suggestion that the charge could be set as a fixed percentage of the value of the property, which would allow those providing the finance to share in any increase in the unit’s value between conversion and sale, some consultees were still not convinced that the charge would be sufficiently attractive to investors. They argued that, unlike the position on CFA claims, investors would not be interested in helping to finance conversion under Option 2, as they would not stand to receive any ground rent or lease extension premiums from non-consenting leaseholders.

• 5.142 In addition, while it should almost certainly be the case that non-consenting leaseholders, who take a unit subject to a charge, would be in better position financially than if they had remained leaseholders, we are concerned that the charge could have unforeseen financial implications for non-consenting unit owners. In particular, the charge is only likely to be attractive to those providing the finance, if the charge takes priority over any existing mortgages. If, on the subsequent sale of the unit, the mortgage lender were to be paid in advance of those funding the nonconsenting leaseholder’s share, there may be insufficient equity in the property after paying the mortgage amount to reimburse those providing the finance. However, a number of consultees warned that if the charge were to take priority, lenders might be unwilling to offer additional finance to those taking a commonhold unit, or be unwilling to remortgage on the same terms. Consultees also said that the charge would likely affect lenders’ willingness to support commonhold more generally.

• 5.143 However, we remain of the view, expressed in the Consultation Paper, that nonconsenting leaseholders should be required, at some point, to contribute towards the freehold purchase price. These leaseholders will have benefited from improved security in their homes, and will not be required to pay any ground rent following conversion. Given these advantages, we do not agree with the view expressed by some consultees that the participating leaseholders should be required to finance the non-consenting leaseholders’ shares of the freehold purchase without obtaining any form of reimbursement. It would be unrealistic to expect participating leaseholders to have the available funds to do so. Further, if non-consenting leaseholders were not required to contribute financially, many leaseholders might hold back their consent in the hope that they would obtain a free commonhold unit. Consequently, unless nonconsenting leaseholders are required to repay their share, it would be more difficult for leaseholders to obtain the support necessary to convert and to finance the conversion.

• 5.144 We note that a number of consultees called for financial assistance from Government in order to help leaseholders meet the costs of converting to commonhold. If Option 2 is to be pursued, our view is that such assistance from Government would be necessary. We suggest that such assistance could take the form of an equity loan which would operate in a similar way to how shared equity loans currently operate under Government’s Help to Buy scheme. Under such existing schemes, prospective homeowners are able to obtain loans representing a percentage of the value of the property (typically of up to 20%) in order to buy the property. The Government secures its financing by way of a charge over the property, which ranks after any existing mortgages. If the borrower decided to sell the property, he or she would need to repay Government the percentage of the value of the property, as at the date of sale. The Government scheme does not require the borrower to make up any shortfall if the property drops in value.²³⁰ In this way, the buyer would be able to purchase the property for a lower upfront cost, and Government could share in any increase in the value of the property. Both parties would also share the risk of the property decreasing in value.

• 5.145 We therefore recommend that, if Option 2 is adopted, Government should provide equity loans to non-consenting leaseholders to cover their share of financing the freehold. Non-consenting leaseholders should take their commonhold unit subject to a charge in favour of the Government, which ranks after any existing mortgage, and which would be repayable on the sale of the unit. In order to provide the correct incentive structure, we suggest that Help to Buy loans should also be offered to participating leaseholders on an optional basis.

Recommendation 12.

• 5.146 We recommend that, if conversion Option 2 is adopted, Government should provide equity loans to non-consenting leaseholders to cover their share of purchasing the freehold. Government should also offer such loans to participating leaseholders on a voluntary basis.

Financing Option 2: Flats which have not been let to eligible leaseholders

• 5.147 In this scenario, there would be no leaseholder in the flat who would be eligible to take the commonhold unit on conversion. The participating leaseholders would therefore need to find a way to finance the share of the freehold value attributable to these flats. As with Option 1, participating leaseholders may be able to find an investor who would be willing to buy these flats on conversion. Additionally, in the Consultation Paper, we provisionally proposed that the participating leaseholders should be able to require the freeholder to take the commonhold unit of any flats which have not been let to eligible leaseholders, in order to reduce the purchase price.²³¹

• 5.148 Further, in order to safeguard certain statutorily-protected tenancies (such as secure tenancies where the tenant’s security would otherwise be lost), we provisionally proposed that freeholders who have granted such tenancies should automatically become the unit owner in respect of these flats on conversion. We also proposed that any freeholder who grants a shared ownership lease should take the commonhold unit on conversion, to ensure that the shared ownership relationship is preserved.²³²

Consultees’ views

• 5.149 The majority of consultees responding to this question supported the proposal. However, most consultees did not provide a reason for their agreement, other than saying that the proposal “made sense”. Of those who did provide a substantive comment, the main argument raised was that the proposal would make conversion easier to achieve.

• 5.150 Arguments against the proposal mirrored those discussed above in relation to Option 1. Those leaseholders and other individuals who opposed the proposal generally did so because of concerns about the level of control which the freeholder might exert following conversion. Damian Johnson, for example, was concerned that the proposal might result in the former freeholder becoming the “dominant force in the commonhold association”. James Taylor (leaseholder) also thought that the proposal was contrary to the aim of commonhold, to give people the “complete right to organise and live in the dwellings which they have purchased, to their own satisfaction”.

• 5.151 Other consultees who opposed the proposal generally argued that it was unfair to require the freeholder to retain an interest in the building, and that it would “force hostile parties into a management structure together”.²³³ A couple of consultees expressed concern that the proposal might result in the former freeholder, as a unit owner, being required to comply with terms of the CCS which are inconsistent with the terms of any tenancy agreement granted by the freeholder, or becoming liable for commonhold contributions which then cannot be recovered from the tenant.

Discussion and recommendations for reform

• 5.152 To facilitate more conversions to commonhold, we consider it necessary to provide leaseholders with a realistic way of financing the freehold purchase of flats which have not been let to a leaseholder who is eligible to participate. We therefore recommend that participating leaseholders should be able to require the freeholder to take the commonhold unit in respect of flats which have not been let to an eligible leaseholder on conversion. The former freeholder should also be able to elect to take the commonhold units of such flats (if not required to do so by the leaseholders) instead of being able to require a leaseback, as is the position currently on a CFA claim. Additionally, for the same reasons as discussed in relation to Option 1 (see paragraph 5.92 above), we recommend that the former freeholder should always take the commonhold unit over flats let to statutorily-protected tenants and to shared owners on conversion.

• 5.153 We acknowledge concerns that the obligations of the former freeholder, as a unit owner, may conflict with those owed under any tenancy agreement granted by the freeholder before the conversion. We consider this particular difficulty separately below.

• 5.154 As explained above in the context of Option 1, there is not a significant risk of the former freeholder exerting majority control of the commonhold association following conversion. While the former freeholder would be able to exercise the votes attached to any commonhold units he or she takes on conversion, flats which have not been let to an eligible leaseholder would never make up more than a third of the flats in the building.

• 5.155 Where some or all of the participating leaseholders finance the shares of the freehold attributable to flats in respect of which there is not an eligible leaseholder, and do not require the freeholder to take the commonhold units in respect of such flats (and the freeholder does not elect to take the commonhold units) the commonhold units should be held by the commonhold association in default of any other arrangement between the leaseholders.²³⁴

Recommendation 13.

• 5.156 We recommend that, if Option 2 is adopted, the participating leaseholders should be able to require the freeholder to take the commonhold unit in respect of any flats which have not been let to a leaseholder who is eligible to participate in the conversion. Additionally, the freeholder should be able to require that he or she be granted the commonhold unit in respect of such flats (rather than being able to require a leaseback, as is presently the case).

• 5.157 We recommend that the freeholder should automatically become the unit owner in respect of any flats let to statutorily-protected non-qualifying tenants and shared ownership leaseholders on conversion.

• 5.158 We also recommend that, where some or all of the participating leaseholders finance the shares of the freehold value attributable to flats in respect of which there is not an eligible leaseholder (and so do not require the freeholder to take the units and the freeholder does not request the units) the commonhold units should be owned by the commonhold association as a default rule.

SAFEGUARDING INTERESTS UNDER CONVERSION OPTIONS 1 AND 2

• 5.159 In the Consultation Paper, we explored two potential difficulties which might arise where a non-consenting leaseholder or the former freeholder is required to take a commonhold unit on conversion. We identified these difficulties as relating solely to Option 2. However, as a result of our recommendations above, the issues also need to be considered in the context of Option 1. As explained at paragraph 5.98 above, because of our recommendations to phase out leasehold interests, non-consenting leaseholders under Option 1 might also be required to take a commonhold unit at a later date. Additionally, under Option 1, we recommend that the former freeholder might be required to take the commonhold unit of flats let to leaseholders who are not eligible to participate.

• 5.160 We consulted on the following potential difficulties in the Consultation Paper.

• (1) A potential inability for a non-consenting leaseholder or the former freeholder (now as a unit owner) to pass commonhold costs down to their tenant (or a shared owner). This is a specific difficulty which might arise where an individual, who takes a commonhold unit on conversion, had let out his or her property to an individual who was ineligible to participate in the conversion (for example, a short-term tenant or a shared owner who has not staircased to 100% ownership) and that tenant or shared owner pays a variable service charge in addition to their rent. The issue stems from a potential incompatibility between the regime for the payment of commonhold contributions (payable by the unit owner to the commonhold association) and service charges (payable by the tenant/shared owner to the unit owner).

• (2) An inability for a non-consenting leaseholder or the former freeholder (now as a unit owner) to participate in preparing the CCS. This is a broader risk that, because non-consenting leaseholders and the former freeholder will not have had any say on the preparation of the CCS, the terms of the CCS might be prejudicial to their interests, or might conflict with the terms of any tenancy agreement or shared ownership lease granted before the conversion.

• 5.161 We now look at each of these issues in more detail.

Recovering costs from tenants and shared owners following conversion

• 5.162 In the Consultation Paper we explained that, where the former freeholder (or a nonconsenting leaseholder) takes a commonhold unit on conversion, they may face a particular difficulty if, before the conversion, they had let their property to an individual who was not eligible to participate.²³⁵ For example, if they had let their property on a short-term tenancy agreement, or to a shared owner (where the shared owner had not yet staircased to 100%).²³⁶ Such tenancies will continue automatically on conversion to commonhold under our recommendations in Chapter 4. Where the former freeholder or a non-consenting leaseholder takes a commonhold unit on conversion, he or she will be treated in the same way as any other unit owner and will be required to pay commonhold contributions to the commonhold association.

• 5.163 We explained in the Consultation Paper that the former freeholder, or non-consenting leaseholder, could be placed in a difficult position if his or her tenant or shared owner is required to pay a variable service charge in addition to their rent.²³⁷ Different statutory regimes apply to variable service charges under leasehold legislation, and to commonhold contributions under commonhold legislation. Variable service charges are only recoverable to the extent that they have been reasonably incurred. A tenant or shared owner who pays a variable service charge will therefore be able to challenge the reasonableness of any costs passed down to him or her. Consequently, the former freeholder, or the non-consenting leaseholders (now as unit owners) would only be able to recover from their tenant or shared owner costs which have been reasonably incurred. However, as a unit owner, the former freeholder or nonconsenting leaseholder would be required to pay commonhold contributions to the commonhold association without an equivalent right to challenge the reasonableness of costs levied by the association.

• 5.164 As we discuss in Chapter 13, there is a specific regime attached to the payment of commonhold contributions which has been designed to suit the commonhold context. To help protect the solvency of the commonhold association, any challenges to the costs demanded by the association must be brought before the costs have been incurred. On taking a unit, the former freeholder or non-consenting leaseholder could therefore be placed in the position of paying costs to the commonhold association which are subsequently challenged by the tenant or shared owner and found not to be recoverable. We asked consultees whether this disadvantage might be mitigated either by:

• (1) placing a restriction on the sums which the commonhold association may recover from the former freeholder or non-consenting leaseholder until the relevant tenancy or lease is brought to an end or expires (or until the shared owner purchases the commonhold unit), to reflect the costs that are recoverable from the tenant or shared owner; or by

• (2) modifying the tenant’s or shared owner’s property interest by removing his or her right to challenge service charge costs in accordance with leasehold legislation and replacing it with a right to make representations about commonhold costs in the same way as unit owners.

Consultees’ views

• 5.165 More consultees responding were in favour of the second suggestion: exchanging the tenant’s or shared owner’s existing rights to challenge service charges with new rights under commonhold legislation. Of those who supported this second suggestion, the main argument was that this option would be simpler to administer. The Guinness Partnership commented that the second suggestion “allows for the most simple and streamlined approach and avoids the freeholder or non-consenting leaseholder being trapped between two systems of regulation”. Antonia Batty (leaseholder) agreed, saying that “everyone should function under the same rules to make it as easily managed as possible”.

• 5.166 Other consultees said that conversion to commonhold warranted a change to the rights of those within the building “to reflect the fact that the fundamental structure of the building has changed from leasehold to commonhold”.²³⁸ A few consultees also argued that it was fair to provide tenants and shared owners with the same rights as unit owners to approve or challenge commonhold costs. CILEx said that “it makes sense that those who are ultimately expected to finance these costs would have a direct means by which to challenge the body responsible for determining what these costs actually are”. A couple of consultees argued that the alternative option of a cap on the sums which could be demanded by the commonhold association might leave the association with a shortfall in expenditure.

• 5.167 Conversely, those consultees who preferred the first option (placing a cap on the recoverable expenditure) argued that it would not be appropriate to alter tenants’ and shared owners’ rights retrospectively. Damian Greenish for instance, favoured the first suggestion on the basis that “anything else interferes further with existing rights of tenants who have no say in the collective, conversion to commonhold or the subsequent management of that commonhold”. Other consultees, including the PBA, thought it would not be satisfactory to provide tenants on short-term agreements with the same say on commonhold expenditure “as those with a longer-term outlook”. Further, this consultee argued that if both the tenant and unit owner could challenge the costs levied by the commonhold association, that particular unit will get “two bites at the cherry”.

• 5.168 Some consultees commented that neither of the two suggestions presented were appropriate. As an alternative, Neil Pothecary thought that any difficulties could be resolved by the Tribunal. A few further consultees said that it was not necessary to recommend any reform to address this particular situation.

Discussion

• 5.169 Following consultation and further discussion with consultees, it appears that the problem outlined above would not arise frequently for the following reasons.

• (1) In many buildings, particularly those in the private rental sector, tenants will pay a fixed, rather than a variable service charge. A fixed service charge means that the amount the tenant is required to pay will not fluctuate in relation to the actual costs of providing services. Instead, the amount the tenant will pay will stay the same from week-to-week or from month-to-month. Only tenants who pay a variable service charge will be able to challenge the reasonableness of costs after they have been incurred.

• (2) Our understanding is that variable service charges are more likely to be payable in the social housing sector. However, the risk of the problem occurring in the social sector is also likely to be low, for two main reasons.

• (a) Many buildings in the social sector are unlikely to be eligible to convert to commonhold in the first instance. Where a high percentage of the flats in a building are let on shared ownership leases or short-term tenancies (which will often be the case in the social housing sector) conversion to commonhold would be prevented unless the freeholder consents. That is because, if the freeholder does not agree to the conversion, the leaseholders who wish to convert to commonhold would need to satisfy the same qualifying criteria as for a CFA claim. These criteria require at least two-thirds of the flats in the building to be let to leaseholders who are eligible to participate in the claim. And, as noted above, shared ownership leaseholders and tenants on short term tenancies are not eligible for the purposes of this claim.

• (b) We are making a specific recommendation in Chapter 11 that would address this particular difficulty in respect of flats let to shared owners. We note that while shared ownership leases can be granted in the private sector, they are far more prevalent in the social housing sector. In Chapter 11 we recommend that providers of shared ownership leases, who become unit owners on conversion, should be able to transfer all commonhold voting rights to the shared owner, including the right to vote on the cost budget. Where votes are transferred in this way, the shared owner would have the same rights as other unit owners to challenge commonhold costs under commonhold legislation, in exchange for their existing rights to challenge costs under leasehold legislation. While we agree with the PBA’s point (at paragraph 5.167 above) that it would not be satisfactory to provide short-term tenants with the same say on commonhold decisions as unit owners, a different approach is justified for shared owners. Unlike short-term tenancy arrangements, shared ownership is a method of financing eventual outright ownership. The shared owner will therefore have the same long-term outlook on the management of the building as other owners in the building.

• (3) In the rare event that the former freeholder or non-consenting leaseholder does become the landlord of a tenant who pays a variable service charge on conversion, they would only be prejudiced by a shortfall in sums if the costs incurred by the commonhold association are in fact unreasonable and cannot be passed down to the tenant. However, there are clear incentives in the commonhold context for costs to be set at a reasonable level. Leasehold legislation, including the protections available for those who pay a variable service charge, is based on the presumption that an external landlord will decide on the works and services to be carried out in the building. The external landlord will be able to pass on these costs to leaseholders and tenants under the terms of their leases and tenancy agreements, and so will ultimately not be responsible for paying these costs. Without imposing a requirement that leasehold costs must be reasonable, the external landlord might therefore not be provided with any incentive to ensure that the works and services provided are good value for money. Within the commonhold model, there are built-in incentives for owners only to incur reasonable costs. Where the units are owner-occupied, those who agree the cost budget, and pay for the works, will be the same individuals. Where participating leaseholders have granted tenancy agreements before the conversion, they will also want to ensure that the costs incurred by the association are reasonable and can be passed on to their tenants.

• (4) In addition, while we consider it unlikely that many short-term tenancy agreements would require the tenant to contribute towards the cost of major works and improvements, we explain in Chapter 13 that it is possible for the CCS to include a threshold on the expenditure that can be incurred on improvements and enhanced services without the risk of challenge. Where the majority of owners wish to incur costs on services or improvements in excess of this threshold, those who are affected by the decision (for example, if the costs would not be recoverable from their tenant) would have a right to challenge these costs before they are incurred.

• 5.170 At this stage, therefore, we do not consider there to be sufficient evidence to recommend further changes to the commonhold legislation. However, we recommend that this position be kept under review, particularly if the qualifying criteria for conversion should be relaxed in the future. Should differences between the variable service charge regime applicable to tenants and the regime applicable to commonhold contributions become a problem in practice, we recommend that the law should be reformed to address this difficulty.

Ensuring the terms of the CCS sufficiently protect those who have not consented

• 5.171 We provisionally proposed in the Consultation Paper that any application to convert to commonhold under Option 2, with less than unanimous agreement, should require the approval of the Tribunal.²³⁹ Our view was that Option 2 represented a more significant interference with non-consenting leaseholders’ property rights and that this additional protection was therefore necessary. We suggested that the Tribunal would verify that the necessary consents had been obtained and that the terms of the CCS adequately

protected the minority. The Tribunal would not have a general power to overrule the wishes of the majority and prevent the conversion taking place. Rather, the Tribunal would only be able to reject the application if the leaseholders did not provide the necessary evidence of required consents, or if the terms of the CCS did not adequately protect the minority. If the Tribunal suggested amendments to the CCS in order to protect the minority, the participating leaseholders could either accept these amendments and continue with the conversion, or reject the amendments and decide not to convert.

Consultees’ views

• 5.172 More consultees agreed than disagreed with our provisional proposal. Support for the proposal was especially strong amongst law firms and their representative bodies.

• 5.173 The main argument made by those consultees who supported the proposal was that a Tribunal application would be necessary to protect non-consenting leaseholders’ interests on conversion. FirstPort (managing agents) said “we believe that it is right that the Tribunal play an oversight role in situations where the property rights of an individual are being changed without their express consent”. Peter Smith (academic) thought that an application to the Tribunal at the outset of a conversion claim was desirable to prevent challenges later on in the process.

• 5.174 Those consultees who were opposed to the proposal said that the cost of applying to the Tribunal would likely be prohibitive. They argued that the requirement to apply to the Tribunal would create an additional barrier to conversion and would leave leaseholders reluctant to convert to commonhold. In addition, consultees warned against the freeholder using his or her “financial power” to deter leaseholders from converting to commonhold by threatening legal fees. The National Leasehold Campaign (“NLC”) said:

for many leaseholders going to an organisation such as the Tribunal means two things; legal jargon and cost. I cannot stress enough how off-putting this is for the average person. It will be a deterrent to conversion.

• 5.175 NLC argued in favour of a new body or organisation “that does not require expensive professionals and is accessible for leaseholders”.

• 5.176 Paul Stevens suggested that, as an alternative, a Tribunal application might be avoided by building adequate safeguards into the CCS. He said:

if the concern is that the terms of the CCS should adequately protect the interests of non-consenting leaseholders, this should be provided for (so far as possible) by statute and in the standard form of CCS (to apply to all commonholds). In addition, non-consenting leaseholders should have the right to apply to the Tribunal for amendments to the CCS if they feel that their interests are not adequately protected, but it would be hoped that such applications would be rare.

• 5.177 Stephen Desmond made a similar argument that the “CCS should be based on and compatible with the terms of the existing lease, so far as possible, albeit with powers [for the Tribunal] to make appropriate modifications”. LKP, the All-Party Parliamentary Group on Leasehold and Commonhold Reform (“APPG”) and A L Hughes & Co agreed that a Tribunal application should not be required as a matter of course, only where there was an objection from an interested party.

• 5.178 A few consultees, including Damian Greenish, the Berkeley Group Holdings PLC and the PBA argued that the Tribunal application should also take into account the extent to which the CCS protects the freeholder and individuals who are not eligible to participate, such as commercial and short-term tenants, not only the non-consenting leaseholders.

Discussion and recommendations for reform

• 5.179 We note the support for this proposal and agree that it is important to protect the interests of those who have not agreed to the conversion. However, concerns raised by a number of consultees have caused us to reconsider our proposal.

• 5.180 First, we have reconsidered the scope of the available protection. In the Consultation Paper, we envisaged that safeguards as to the terms of the CCS would only be necessary on conversion under Option 2, and then only to protect the non-consenting leaseholders. However, as we note above, under our recommended conversion regime set out in this chapter, there may be other individuals in the building who might take a commonhold unit, and be required to comply with the CCS, without having consented to the conversion. In particular, non-consenting leaseholders under Option 1 might take a unit in the future as a result of our recommendations to phase out leasehold interests and replace them with commonhold units. The former freeholder, under both conversion options, might also be required to take a commonhold unit on conversion. That is as a result of our recommendations that, in order to reduce the cost of purchasing the freehold, the participating leaseholders should be able to require the freeholder to take the commonhold units in respect of flats which have not been let to a leaseholder who is eligible to participate.²⁴⁰

• 5.181 In addition, participating leaseholders under both conversion options would benefit from safeguards as to the eventual terms of the CCS. To ensure that the process of conversion is quick and cost-effective, it is likely that the participating leaseholders will nominate one or more individuals to prepare the CCS on their behalf, rather than each leaseholder agreeing to every individual term of the CCS. By creating a regime that also protects participating leaseholders, leaseholders will be offered greater certainty as to the eventual terms of the CCS which will encourage participation at the outset.

• 5.182 In summary, therefore, we recommend a regime that protects: (1) any individual who will take a commonhold unit at the point of conversion; and (2) any individual who might become a unit owner in the future under our recommendations to phase out leasehold interests and replace them with commonhold units. Our regime will therefore cover the former freeholder and the non-consenting leaseholders under both options. Protections will also cover shared owners, as they too might be required to take a commonhold unit in the future after having staircased to 100% ownership (see paragraph 5.55 above).

• 5.183 We note that some consultees called for additional protections for commercial tenants and other individuals who would not be eligible to participate in the conversion.

However, as we explain in Chapter 4, these tenants would not be required to take a commonhold unit on conversion, or at any point in the future under our recommendations. The tenant would continue to be able to enforce the terms of his or her tenancy agreement against his or her landlord on conversion. The unit owner in respect of that flat, would, however, benefit from protection under our regime. In particular, the protections would ensure that the unit owner is not disadvantaged by any inconsistency with the terms of the CCS, and the terms of the business tenancy.²⁴¹

• 5.184 Second, we have reconsidered whether it ought to be necessary for participating leaseholders to apply to the Tribunal in every case, or whether there might be an alternative way to adequately protect interests on conversion. We are sympathetic to arguments that requiring leaseholders to apply to the Tribunal in every case would create an additional barrier to conversion and might lead leaseholders to carry out a CFA, rather than convert to commonhold. A number of consultees suggested that protections could be built into the terms of the CCS, which would reflect the terms of the existing leases in the building. We were drawn to this suggestion. Following consultation, we have revised the mechanism by which interests in the building will be protected on conversion. We recommend that, under both conversion options, participating leaseholders should be able to elect either:

• (1) to comply with certain prescribed conditions when preparing the terms of the CCS; or

• (2) to make an application to the Tribunal to approve the terms of the CCS as part of the conversion process.

• 5.185 We now consider each scenario in more detail.

Scenario (1): prepare the CCS in accordance with statutory conditions

• 5.186 We recommend that a list of conditions should be prescribed by Regulations. These conditions should ensure that all leaseholders who will or might take a commonhold unit (see paragraph 5.182):

• (1) are not subjected to more extensive obligations in the CCS than those which existed under the terms of their lease (for example, more extensive repairing obligations in respect of their properties);

• (2) are not subjected to more extensive restrictions than those which existed under the terms of their lease (for example, a new restriction on keeping pets); and.

• (3) possess rights over the building and common parts which are equivalent to their rights under their lease (for example, an exclusive right to use a balcony).

• 5.187 The prescribed conditions should transpose the main rights and obligations which existed in the leasehold context before conversion (through the lease terms) into the commonhold context (through the CCS). The conditions should take the existing lease terms as a starting point, and ensure that leaseholders’ rights under the terms of their lease are not reduced following the conversion, nor their burdens increased.

• 5.188 As we explain further below, these conditions ought to provide adequate reassurance to all individuals (including non-consenting leaseholders and the former freeholder under both conversion options) who might wish (or be required) to take a commonhold unit on conversion to commonhold that their interests are properly protected. We recommend that the prescribed list should include (but not exhaustively) the following.

• (1) A unit should not be allocated a higher percentage of the costs contribution than that currently allocated under the terms of the long lease of that flat. For example, if the lease in respect of a particular flat requires the leaseholder to pay 10% of the service charge, the unit cannot be allocated any more than 10% of the commonhold contributions. If the lease requires the leaseholder to pay a “reasonable share” towards the commonhold’s costs, the CCS would only be able to allocate a percentage share that was reasonable in the context of the building. Additional protection is provided for in this respect by our recommendation in Chapter 13 which requires commonhold contributions to be allocated in a way which is reasonably proportionate in relation to the other units.

• (2) The CCS should not require a unit owner to pay for a higher level of repairs or improvements than that provided for under the terms of the lease, or for additional services.²⁴²

• (3) The allocation of voting rights must be reasonably proportionate to the service charge allocation.

• (4) The CCS should not impose any obligations or restrictions on unit owners by way of local rules which did not exist under the terms of the leases.

• (5) Where a leaseholder has rights over the land to become commonhold, he or she must be granted equivalent rights and/or protections over the land in the CCS. In particular, where the leaseholder has been demised part of the building in the lease (for example the roof), which must form part of the common parts on conversion, the unit must be allocated equivalent rights over that part. (Where a building is horizontally divided (ie a block of flats), the structure and exterior of the building must form part of the common parts which will be owned by the commonhold association after conversion). If the leaseholder had been demised part of the structure and exterior of the building in the lease, he or she must be given equivalent protections and/or rights over these common parts on conversion. This could be achieved by designating that part of the building as a limited use area (for the sole benefit of the unit) or by providing the unit owner with rights over that part in in the CCS, as appropriate. The unit owner’s consent must be obtained before the association can make any changes to limited use areas, or the rights which have been granted in the CCS over common parts.²⁴³ The requirement for the unit owner’s consent in these circumstances is set out in the commonhold legislation, and cannot be removed by a vote of the unit owners. In respect of areas demised by the lease, which are not required by the commonhold legislation to form part of the common parts on conversion, these areas should form part of the individual commonhold unit on conversion.

• 5.189 Setting the CCS in accordance with these conditions will protect the non-consenting leaseholders and the former freeholder in the following ways.

• (1) Non-consenting leaseholders would be offered a degree of continuity as to their existing rights and obligations, and would be protected against any onerous new obligations.

• (2) The former freeholder and non-consenting leaseholders would be protected against the risk of incompatibility between the terms of the CCS and the terms of any tenancy agreement they had granted before conversion. We discuss above (from paragraph 5.169) that inconsistences between the statutory regime for the recovery of costs between the unit owner (regulated by the commonhold legislation) and the tenant (by leasehold legislation) would be unlikely to cause a problem in practice. However, without the above conditions, there is a concern that that there might be an inconsistency between the terms of the CCS and the tenancy agreement. For example, rules regarding the use of the particular unit. By preparing the CCS in accordance with the terms of the existing leases in the building, it is highly unlikely that such an inconsistency would arise. That is because, any tenancy agreements in the building would also likely have been drafted in accordance with the terms of the other leases in the building. Leases will often contain a requirement that any other lease or tenancy agreement granted by the landlord in the building must contain the same, or substantially the same, rights and obligations. That is to ensure that all obligations in the building are enforceable against all the occupiers. For example, a rule preventing noise after certain hours in the building would only be effective if everyone were required to adhere to it.²⁴⁴

Scenario (2): Tribunal application

• 5.190 Alternatively, leaseholders would be able to apply to the Tribunal to approve the terms of the CCS. The Tribunal would ensure that the terms of the CCS adequately protect all individuals who will take a commonhold unit on conversion or who might take a unit in the future under our recommendations to phase out leasehold interests. While the Tribunal may consider the statutory conditions set out above when making its determination, it will not be limited to simply applying these conditions. The Tribunal might suggest alternative ways in which the CCS would adequately protect those individuals who will or might take a commonhold unit. For example, the Tribunal would be able to suggest the creation of sections within the development, such as a commercial section, so that only unit owners within the commercial section would be able to vote on decisions affecting that part of the development. In addition, the Tribunal could suggest a cost threshold in the CCS on the expenditure which can be incurred on improvements or enhanced services without challenge.²⁴⁵ The participating leaseholders would be free either to accept these amendments and proceed with the conversion, or to reject the amendments and not convert. Any individual who will or might be required to take a commonhold unit on conversion (including the former freeholder and non-consenting leaseholders under both options) would be able to make representations at the Tribunal hearing.

Deciding which route to pursue

• 5.191 Our revised approach will provide participating leaseholders with a clear basis on which to agree the terms of the CCS. Both routes will adequately protect their own interests, and the interests of others in the building.

• 5.192 We recommend that guidance should be produced to assist leaseholders when deciding which route to pursue. When deciding which route to pursue, relevant factors for the leaseholders to consider are likely to include the following.

• (1) The complexity of the development. The more complex the development, the more likely that participating leaseholders will benefit from the assistance of the Tribunal. In a simple residential block where all leases have been granted on the same terms, it should be relatively straightforward to prepare the CCS in accordance with the statutory conditions set out above. However, in larger developments, where lease terms vary substantially, it may be difficult to work out which lease terms should be carried across, and an application to the Tribunal would be advisable.

• (2) The benefits of departing from the prescribed conditions for the participating leaseholders. If the benefits are slight, it may not be worth the time and expense of applying to the Tribunal. Particularly if Option 1 is pursued, there would be advantages in simply adopting the statutory conditions. Carrying over existing lease terms would help simplify the management of the building should conversion Option 1 be adopted. There would be less risk of inconsistency between the terms of the CCS, which bind unit owners, and the terms of the continuing leases.

• (3) The impact of departing from the prescribed conditions on those who have not consented. Departures which are prejudicial to owners, and which do not offer equivalent protections, are unlikely to be approved by the Tribunal.

Consequences of a failure to prepare the CCS in accordance with (1) or (2) above

• 5.193 We anticipate that, in the vast majority of cases, participating leaseholders will be keen to ensure that the CCS has been prepared correctly in order to avoid future disputes. In the following chapter we recommend that, as part of the application to register the new commonhold, the applicant must sign a statement of truth confirming that the CCS has been prepared in accordance with the statutory conditions, or that a

Tribunal has approved the terms. However, in the rare cases in which the leaseholders do not prepare the CCS in accordance with the above approach, we recommend that the individuals affected should have the following protections.

• 5.194 If, at the point of conversion, the CCS has not been prepared in accordance with the statutory conditions and the departure has not been approved by the Tribunal:

• (1) terms which are inconsistent with the statutory conditions, because they place more extensive obligations or restrictions on a unit owner than those which existed under the terms of their lease, should not be enforceable against that unit owner; and

• (2) where a unit owner, who had certain rights over the land to form the commonhold in his or her lease, has not been provided with equivalent protections in the CCS, he or she should have the right to apply to the Tribunal. The Tribunal may order that the terms of the CCS should be amended to protect that owner’s right, or may award the payment of compensation for the loss of that right.

• 5.195 The scenario may also arise in which unit owners seek to vary the CCS at a later date, so that the terms of the CCS are no longer consistent with the statutory conditions, or the terms which have been approved by the Tribunal. Our view is that such changes should bind all those who were unit owners at the time the variation was made, as the unit owners would, at that point, benefit from other protections in the commonhold regime. The primary purpose of the safeguards set out above is to protect those who have not had a say on the terms of the CCS, before they become unit owners. Once a leaseholder or a former freeholder becomes a unit owner, they will then become involved in the democratic process of the commonhold and will be able to vote on any decisions to amend the local rules of the CCS. Under our recommendations in Chapter 10 such decisions will not be made lightly within the commonhold. In order to balance the competing objectives of providing unit owners with certainty as to their rights and obligations in the CCS, and flexibility to amend the local rules CCS, we recommend that a special resolution will be required to vary the local rules. In addition, unit owners will be able to challenge decisions of the commonhold association which might have an impact on them, under our minority protection recommendations in Chapter 17.

• 5.196 We note that in the Consultation Paper we also suggested that it should be within the Tribunal’s remit to check that the necessary consents to conversion had been provided. However, on reflection, we consider that our regime for evidencing consents as set out in the following chapter will be sufficient. Under the current law, there is no requirement for the Tribunal to check that the necessary consents have been obtained, and we see no reason to depart from the current law in this respect.

Recommendation 14.

• 5.197 We recommend that those wishing to convert to commonhold must either:

• (1) prepare the CCS in accordance with conditions which should be prescribed by Regulations; or

• (2) make an application to the Tribunal as part of the process of converting to commonhold.

• 5.198 We recommend that, if the participating leaseholders elect to apply to the Tribunal, the Tribunal should authorise the conversion unless the terms of the CCS do not adequately protect the individuals who will take a unit on conversion, and individuals who might take a unit in the future under our recommendations to phase out leasehold interests.

• 5.199 We recommend that, if the terms of the CCS, as presented to the Tribunal, do not adequately protect these individuals, the Tribunal may suggest revisions to the CCS. Participating leaseholders may choose to accept these revisions and proceed with the conversion, or reject the suggestions and not proceed. Any individual who will or might take a unit should be able to make representations to the Tribunal.

• 5.200 We recommend that, unless the Tribunal has authorised a departure from the prescribed statutory conditions:

• (1) any terms of the CCS which were approved before the individual in question became a unit owner, and which place more extensive obligations or restrictions on the unit owner than those which existed under the lease terms, should not be enforceable against that unit owner; and

• (2) a unit owner who had certain rights in his or her lease over the land that will form the commonhold but has not been provided with equivalent protections in the CCS, should have the right to apply to the Tribunal. The Tribunal may order that the terms of the CCS should be amended to protect that owner’s right, or may award the payment of compensation for the loss of that right.

• Chapter 6: Which is our preferred conversion option?

INTRODUCTION

• 6.1 In the previous chapter, we considered, in detail, two potential models for conversion to commonhold which we named “Option 1” and “Option 2”. Following a brief recap of the recommendations we have made so far in respect of each option, in this chapter we explain which option was preferred by consultees and why. We present the key advantages and disadvantages of both conversion options arising from consultees’ views before recommending Option 2 as our preferred option to Government.

OVERVIEW OF CONVERSION OPTIONS 1 AND 2

• 6.2 We begin with an overview of our recommendations so far in respect of conversion Options 1 and 2.

• 6.3 As explained in Chapter 3, under both conversion options, conversion to commonhold will result in:

• (1) each flat in the building being registered as an individual freehold unit with a registered “unit owner”; and

• (2) the commonhold association being registered as the freehold owner of the common parts.

• 6.4 Each flat in the commonhold building must be owned by a commonhold unit owner, who will be a member of the commonhold association.

• 6.5 In Chapter 4, we recommend that only leaseholders who would be eligible to participate in a CFA claim should be eligible to participate in a decision to convert to commonhold and become the commonhold unit owner. That is because, where the freeholder of the building does not agree to the conversion, leaseholders will need to acquire the freehold through a CFA claim as part of the process of converting to commonhold. As leaseholders will be able to pursue a streamlined process of acquiring the freehold and converting to commonhold, it makes practical sense to adopt the same eligibility criteria. We explain in Chapter 4 that, subject to certain exceptions, residential leaseholders who have been granted leases of over 21 years will be eligible to participate in a decision to convert and will be eligible to take a commonhold unit on conversion.

• 6.6 Under both conversion options, conversion will be possible where eligible leaseholders of at least 50% of the flats in the building support the decision to convert.

• 6.7 Eligible leaseholders who decide to participate in the conversion will be able to take a commonhold unit at the point of conversion to commonhold under both options.

• 6.8 Flats which have not been let to any eligible leaseholder (for example, flats which are empty or which have been let to a short-term or business tenant) will also be treated in the same way under both options. In order to reduce the cost of acquiring the freehold from the freeholder on a CFA claim, the participating leaseholders will be able to require the former freeholder to take the commonhold unit in respect of such flats.¹ But if they do not (and the participating leaseholders finance the purchase between themselves), the commonhold units will be held by the commonhold association in default of any other agreement.

• 6.9 The key difference between the two conversion options is the treatment of those leaseholders who, while being eligible to participate in the conversion, have not agreed to the process (“non-consenting leaseholders”).

Position of non-consenting leaseholders under Option 1

• 6.10 Under conversion Option 1, non-consenting leaseholders will retain their leasehold interest at the point of conversion. The commonhold unit owner in respect of such flats will be the commonhold association as a default rule.^{246 247}

• 6.11 However, we recommend that the continuation of such leases should be a transitional measure under Option 1. At some stage in the future, all non-consenting leaseholders should upgrade their leasehold interest to a commonhold unit. We recommend in Chapter 5 that non-consenting leaseholder’s leases should be “phased out” under the following provisions.

• (1) All non-consenting leaseholders should have an individual statutory right to purchase the freehold of their unit and become a member of the commonhold association.

• (2) This new statutory right to buy the commonhold unit should replace nonconsenting leaseholders’ existing statutory rights under leasehold legislation to seek a lease extension, and there should be no further CFAs once a building has converted to commonhold; and

• (3) When a non-consenting leaseholder decides to sell his or her property in the future, the incoming purchaser should be required to buy the commonhold unit (as opposed to just the leasehold interest) and become a member of the commonhold association.

Option 1: worked example

• 6.12 Taking the block of five leasehold flats depicted in figure 3 (paragraph 3.10 above). Assume that leaseholders A, B, C and D are all eligible to participate in the decision to convert, having residential leases of 99 years. A, B and C wish to convert to commonhold (they are “participating leaseholders”), but D does not. D is therefore an eligible leaseholder who does not agree to the conversion (a “non-consenting leaseholder”). E is a business tenant and is not eligible to participate in the decision to convert or take a commonhold unit.

• 6.13 Following conversion under Option 1, the participating leaseholders A, B, and C will each obtain freehold, commonhold units and will become members of the commonhold association. The non-consenting leaseholder, D would remain on his or her 99-year lease.

A owns the commonhold unit and is a member of the commonhold association

B owns the commonhold unit and is a member of the commonhold association

C owns the commonhold unit and is a member of the commonhold association

The commonhold association owns the commonhold unit and D retains a 99-year lease under the same terms

Either the commonhold association or Z will own the commonhold unit, E is a business tenant

Position of non-consenting leaseholders under Option 2

• 6.14 Under the second conversion option, all non-consenting leaseholders would take a commonhold unit at the point of conversion to commonhold, in exchange for their leasehold interest. No long leases would be permitted to continue.²⁴⁸ Following conversion, the rights and obligations of the former non-consenting leaseholders would be governed by the commonhold community statement (the “CCS”) and by commonhold legislation, rather than by leases and leasehold legislation.

• 6.15 In the Consultation Paper we expressed our view that, as Option 2 would require all leaseholders to take a commonhold unit at the point of conversion, conversion under Option 2 should require a higher threshold of support than for Option 1, for which we had proposed a threshold of 50%. We provisionally proposed in the Consultation Paper that conversion Option 2 should require the support of 80% of eligible leaseholders in the building. However, several consultees warned that a threshold of 80% would not be achievable in most leasehold blocks. We therefore recommend in Chapter 4 that, in respect of both options, conversion to commonhold should be possible where eligible leaseholders of 50% of the flats support the decision to convert.

Option 2: worked example

• 6.16 The same leasehold block depicted in figure 3 is converting to commonhold, this time under Option 2. Again A, B and C want to convert but D is opposed to the conversion. E is a business tenant and so is not eligible to participate in the decision to convert or take a commonhold unit. Rather than being permitted to retain his or her leasehold interest, D will be required to take a commonhold unit at the point of conversion.

IS OPTION 1 OR OPTION 2 PREFERABLE?

• 6.17 We explained in the Consultation Paper that both conversion options have advantages and disadvantages.²⁴⁹ Our view was that allowing leases to continue automatically on conversion (Option 1) would be less intrusive for non-consenting leaseholders. On the other hand, commonhold was designed to facilitate the freehold ownership of flats and overcome the shortcomings of leasehold ownership. If leases were permitted to continue within commonhold, this may be seen as perpetuating the problems of leasehold ownership within the system designed to overcome its shortcomings. Further, under Option 1, the commonhold association would not be free to run the building by majority vote. Instead, the association would be constrained by the terms of the continuing leases and by the various pieces of leasehold legislation which attach to them.

• 6.18 If Option 2 were implemented, and all leaseholders were required to take a commonhold unit on conversion to commonhold, the management of the building would be simplified. Commonhold would be able to work as intended with all unit owners having the same type of interest following conversion. However, this option might be viewed as a more significant interference with non-consenting leaseholders’ property rights, particularly as they would be required, in one way or another, to pay for their upgraded freehold interest received at the point of conversion.

• 6.19 After presenting the advantages and disadvantages of both conversion options in the Consultation Paper, we asked consultees which option for conversion they preferred.²⁵⁰

Consultees’ views

• 6.20 The majority of consultees, and particularly leaseholders and individuals, preferred Option 1. However, leaseholders and individuals who supported Option 1 generally did so because we had provisionally proposed a higher threshold of support for Option 2. They argued that a threshold of 80% support would be extremely difficult to achieve. Their support for Option 1 was therefore predominantly based on a desire for a lower threshold, rather a desire to enable leases to continue. A couple of consultees even said that if the threshold of support were the same, they would prefer all leaseholders to take a commonhold unit at the point of conversion. In the Consultation Paper we did not present an option under which non-consenting leaseholders might be required take a commonhold unit with less than 80% support. Therefore, we do not consider that leaseholders and individuals who supported Option 1 necessarily favoured the continued existence of leases following conversion. In response to this question, Paul Stevens said:

I would prefer Option 2 but only if the threshold remained around 50%, to make conversion as easy and as likely to happen as possible. If Option 2 is not possible on this basis, then Option 1 is to be preferred. I have dealt with leasehold enfranchisement cases in private practice and I therefore know from experience how difficult it can be to get large numbers of leaseholders to agree and to actually sign up to something that might have upfront costs. In the long term though, conversion to commonhold would likely benefit all leaseholders and so it should be as easy as possible to convert.

• 6.21 Other consultees, particularly law firms and other organisations, who were in favour of leases continuing on conversion (and therefore supported Option 1) argued that it would be unfair to require leaseholders to take a commonhold unit against their wishes (as would be the case under Option 2). They argued that leaseholders may have many reasons for not wanting to take a commonhold unit (for example, not wanting to become involved in managing the building) and that requiring them to do so might constitute a breach of their property rights under the European Convention on Human Rights.²⁵¹ The Association of Residential Managing Agents (“ARMA”) also argued that taking a unit could affect a leaseholder’s existing mortgage agreement over the flat, and subject the non-consenting leaseholder to “onerous mortgage risks and costs”.

• 6.22 Conversely, those in favour of Option 2, and therefore of requiring all leaseholders to take a commonhold unit on conversion, said that this option would create a much simpler system with all the advantages that commonhold offers. Lu Xu (academic) argued that allowing leases to continue would “dilute most of the advantages of commonhold”. PM Property Lawyers Limited (solicitors) agreed that, while it may be harder to achieve the position where all leaseholders take a commonhold unit on conversion, Option 2 is a more direct attempt at realising the objectives of commonhold. Some consultees, including the National Leasehold Campaign (the “NLC”), called for a more radical approach that would “take bigger steps forward to reduce the footprint of leasehold in England and Wales”.

• 6.23 Several consultees who preferred Option 2 expressed concern about the practical difficulties of managing a building comprising a mix of leasehold flats and commonhold units under the first option, particularly with regards to recovering the commonhold’s expenses. Gerald Eve LLP (surveyors) said that the “interaction between leasehold law and commonhold law for units in the same building is completely untried and is likely to increase costs for all concerned for managing the building on a day-to-day basis”. And the Guinness Partnership (housing association) argued that “the commonhold association will have enough risks to manage without having to navigate the issues that exist within the leasehold system too”.

Discussion

• 6.24 We note above that most leaseholders and individuals who preferred Option 1 generally did so due to concerns that the proposed threshold of leaseholder support for Option 2 was unrealistic. Some consultees said that if the threshold to convert were the same under Options 1 and 2, they would prefer all leaseholders to take a commonhold unit at the point of conversion. Concerns about the high threshold of support required to convert under Option 2 however fall away due to our recommendation that conversion under both Options 1 and 2 should be possible with a threshold of 50% support.

• 6.25 In addition to the threshold, other comments from consultees generally focussed on the following.

• (1) The impact of the conversion on non-consenting leaseholders. A number of individuals preferred Option 1 due to concerns that requiring leaseholders to take a unit against their wishes under Option 2 would be unfair, or might subject the leaseholder to unreasonable financial risks.

• (2) The management structure created on conversion to commonhold. The main concern with Option 1 was that it would produce a complicated management structure on conversion, given the mix of leasehold and commonhold interests. Consultees said that Option 2 would produce a simplified management structure, which would immediately allow the full advantages of commonhold to be realised.

• 6.26 Below, we compare the main advantages and disadvantages of both schemes in more detail. We focus on the impact of conversion on non-consenting leaseholders under Options 1 and 2 and the desirability of the management structure that will be in place following conversion. We also compare the practicalities of financing the conversion under both options.

Impact of the conversion on non-consenting leaseholders

• 6.27 We note above that one of the reasons why consultees preferred Option 1 was because they considered Option 1 to be less intrusive to non-consenting leaseholders. However, these arguments were predominantly made by professional organisations, rather than leaseholders themselves. Indeed, many leaseholders and other individuals responding to the Consultation Paper referred to the advantages of commonhold over leasehold and called for leasehold to be abolished and replaced with commonhold.

• 6.28 While we acknowledge that conversion would result in changes to non-consenting leaseholders’ property interests, these changes are to the benefit of those leaseholders, by providing them with an improved form of ownership. Conversion to commonhold will offer leaseholders an opportunity to own their homes on a permanent, freehold basis, rather than owning a time-limited interest which will decrease in value as the term runs down. While, as was pointed out by a few consultees, some leaseholders might not want to be involved in the management of the building, whether they do become involved on taking a unit, and the extent of their involvement, will be a decision for them.

• 6.29 In the Consultation Paper, we drew a clear dividing line between the impact of conversion Options 1 and 2 on non-consenting leaseholders. Our view was that Option 2 was a more intrusive option as it would require all non-consenting leaseholders to change their property interests on conversion. However, in response to the Consultation Paper, a number of consultees pointed out that the difference between Options 1 and 2 is, in reality, more nuanced. These consultees argued that our proposals to phase out leasehold under Option 1 would be requiring leaseholders to take a commonhold unit “by the back door”.

• 6.30 On reflection we have concluded that the distinction between Options 1 and 2 is not as clear cut as we had originally suggested. Our proposals to phase out leasehold within Option 1 would also see leaseholders taking a commonhold unit on the occurrence of certain events.

• 6.31 The difference between Options 1 and 2 in terms of impact on non-consenting leaseholders is one of scale. Option 2 would see up to 50% of these leaseholders in the building taking a commonhold unit at the point of conversion. Option 1 would be a more gradual route, under which the individual leaseholders would upgrade their leasehold interest to commonhold at a point in the future.

• 6.32 In the previous chapter, we recommend a system of safeguards that will protect nonconsenting leaseholders under both conversion options. Additionally, the regime will protect the former freeholder, if he or she is required to take a commonhold unit ²⁵² We discuss our recommended regime in detail in the previous chapter, but, in summary, under both options, participating leaseholders will need to either:

• (1) prepare the CCS in accordance with certain statutory conditions. These conditions are intended to transpose the main rights and obligations which existed in the leasehold context before conversion (through the lease terms) into the commonhold context (through the CCS). The conditions take the existing lease terms as a starting point, and ensure that non-consenting leaseholders are not subject to any new, onerous requirements following conversion, and that they do not risk losing important rights.

• (2) apply to the First-tier Tribunal (Property Chamber) in England or the Leasehold Valuation Tribunal in Wales (the “Tribunal”) to approve the terms of the CCS. The Tribunal will ensure that the terms of the CCS adequately protect all individuals who will take a commonhold unit at the point of conversion, or who might take a unit in the future under our recommendations to phase out any continuing leasehold interests.²⁵³ This will include, therefore, non-consenting leaseholders and the former freeholder under both options.

• 6.33 Other concerns about the impact of conversion on non-consenting leaseholders arise from the context of our reforms. Currently there is a lack of awareness about commonhold ownership due to the low number of commonholds in existence. In this respect, our recommendations for conversion need to be considered alongside Government’s plans for wider measures to reinvigorate commonhold. While recommendations in this Report will address concerns about the commonhold legislation, Government is also reviewing ways to raise awareness of and confidence in commonhold in the property sector (for example, amongst developers and lenders).

Management structure

• 6.34 Consultees’ main argument in favour of Option 2, and requiring all leaseholders to take a commonhold unit at the point of conversion, was that it would create a more desirable management structure. We agree with this analysis. Our view is that Option 2 creates a better management structure at the point of conversion to commonhold. Option 2 would enable the commonhold structure to work as intended and would replicate the position in new commonhold developments. The management of the commonhold would be simplified as all owners would have the same type of interest (a commonhold unit), and all unit owners would be governed by the terms of the building’s CCS and by commonhold legislation. There would no longer be any long leases in the building,²⁵⁴ and so leasehold legislation would no longer apply to the owners.

• 6.35 Conversion under Option 2 would immediately produce all the advantages of commonhold over leasehold.

• (1) All leaseholders would become unit owners and would acquire an asset which no longer reduces in value as the lease term runs down. Additionally, as unit owners, no payment of ground rent would be required.

• (2) All leaseholders, now as unit owners, would be members of the commonhold association and would be able to participate in decisions about the management of the building.

• (3) There would only be one document, the CCS, which sets out the rights and obligations of all the owners in the building. Unit owners would be able to vote on amendments to the local rules of the CCS, providing them with flexibility to respond to changing needs and concerns.

• (4) Unit owners would not be at risk of losing their commonhold unit through forfeiture.

• (5) As well as many other advantages set out in Chapter 2.

• 6.36 Where only some leaseholders take a commonhold unit at the point of conversion, the advantages set out above would be diluted. Only those leaseholders who decided to participate in the conversion would become unit owners at that point. Therefore, only these leaseholders would obtain greater security in their homes and take over the management of the building through their membership in the commonhold association.

• 6.37 If Option 1 were adopted, at the point of conversion the CCS would apply to some, but not all, occupiers of the building. Namely, the CCS would apply to the unit owners and their tenants, but not the continuing leaseholders or their tenants. Many of the key advantages of the CCS would therefore be lost. The CCS is intended to simplify the management of the building by setting out the rights and obligations of all owners (and their tenants) in one document. This benefit will not be realised where there is a mix of commonhold and leasehold ownership in the same building. Additionally, as unit owners, the participating leaseholders would be able to vote to vary the rules which apply to them in the CCS, but they would not be able to impose new rules on the leaseholders in the building, which reduces the benefits of the CCS’s flexible nature.

• 6.38 Further, under Option 1, the participating leaseholders (now as unit owners) would not be free to make any decision they deemed appropriate for the management of the building. Instead, in making decisions, the unit owners would be constrained by the terms of the continuing leases and by leasehold legislation. For example, the unit owners might wish to carry out a programme of refurbishment works to the commonhold but find that the cost of such works cannot be recovered under the terms of the continuing leases. Unit owners might therefore decide only to provide services and carry out works the cost of which can be recovered under the terms of the continuing leases. Alternatively, unit owners might decide to carry out these works or provide these additional services anyway, but fund the cost themselves. The converse situation might also arise whereby the terms of the continuing leases require the building to be maintained to a higher standard than felt desirable by the unit owners. Participating leaseholders (as unit owners) would also need to comply with the various pieces of statutory legislation which attach to leasehold interests, such as the requirement to carry out a specific consultation procedure before incurring costs above a certain amount.²⁵⁵

• 6.39 In many respects, the position following conversion under Option 1 would be similar to that following a CFA where not all leaseholders participate. We explain this scenario in more detail, and provide a worked example, in Chapter 3. In summary, those leaseholders who decided to participate in the CFA claim would acquire the freehold collectively and gain control of the management of the building (although they would retain their leasehold interests). Leaseholders who did not participate in the CFA claim would not gain any say in the management of the building. Their leasehold interests would simply continue on the same terms and, from their point of view, the only change would be the identity of the freeholder. In managing the building, the leaseholders who participated in the CFA claim would still need to comply with the unchanged terms of the non-participating leaseholders’ leases. Participating leaseholders would not be able to vary the terms of non-participating leaseholders’ leases without their agreement. However, as the participating leaseholders would now own and control the freehold collectively, they would be able to vary the terms of their own leases (for example by extending the term of their leases to 999 years and by removing any requirement to pay ground rent).

• 6.40 While the management structure under Option 1 is not as desirable as that created under Option 2, our view is that, given the similarities between conversion Option 1 and the position following a CFA claim, concerns about the complexities of managing a building under Option 1 may have been overstated by consultees. We suggest in the previous chapter that, if Option 1 is adopted, there would be advantages for the participating leaseholders in preparing the CCS in accordance with the statutory conditions discussed above (at paragraph 6.32(1)). The statutory conditions route takes the existing lease terms as a starting point, which will reduce the risk of inconsistencies between the terms of the CCS and the terms of the continuing leases. We appreciate, however, that there are likely to be additional formalities within the commonhold context. Such formalities arise from the fact that participating leaseholders under Option 1 would need to be familiar both with commonhold legislation (which applies to unit owners) and leasehold legislation (which applies to the continuing leases). For example, when incurring costs, participating leaseholders would need to consult unit owners and leaseholders in different ways.¹¹ Conversely, leaseholders who participate in a CFA claim will only need to be familiar with leasehold legislation.

• 6.41 Conversion under Option 1 does, however, have an important advantage over CFA claims. Conversion under Option 1 carries the potential that, at some point in the future, all leaseholders would acquire their commonhold unit and the full, undiluted advantages of commonhold would be realised. Our view is that it would only be worthwhile pursuing Option 1, if our recommendations to phase out leasehold interests and replace them with commonhold units are also adopted.^{256 257} If leases were to continue indefinitely within the commonhold, the full benefits of converting to commonhold would never be realised. Without measures to phase out leasehold, there would be little advantage in leaseholders converting to commonhold under Option 1, rather than acquiring the freehold collectively.

  11

• 6.42 While making leasehold a temporary measure would mitigate the long-term consequences of retaining leases in commonhold at the point of conversion, they do not remove the disadvantages of doing so. Therefore, we see Option 2 as the preferable structure, due to immediate benefits it provides at the point of conversion. However, as we now discuss, there are certain difficult practical issues when it comes to financing conversion under Option 2.

Financing non-consenting leaseholders’ share of the freehold purchase

• 6.43 As considered in more detail in the previous chapter, particular difficulties arise when considering how to finance non-consenting leaseholders’ share of the freehold purchase under Option 2.²⁵⁸

• 6.44 On conversion under Option 2, all non-consenting leaseholders’ property interests would be upgraded from leasehold to freehold. That is an enhanced interest, and a valuable one. Non-consenting leaseholders would no longer have an asset which reduces in value as the lease term runs down and they would not be required to pay any ground rent. We therefore considered that there ought to be a mechanism for non-consenting leaseholders to pay for their upgraded interest, which will have changed from leasehold to freehold at the point of conversion.

• 6.45 In the Consultation Paper, we explained that it would not be appropriate to require non-consenting leaseholders to pay for their upgraded, freehold interest at the point of conversion.²⁵⁹ However, it would be unfair for non-consenting leaseholders to obtain their upgraded commonhold interest for free. There would need to be a way for nonconsenting leaseholders to pay for the increase in the value of their property, which will have changed from leasehold to freehold on conversion, and to reimburse those who initially financed the conversion. As a mechanism to achieve this, we provisionally proposed that non-consenting leaseholders should have a charge placed over their units on conversion in favour of those who provided the finance. This charge would take priority over any existing mortgages and would ensure that, on the subsequent sale of the commonhold unit, those providing the finance would be repaid from the proceeds of sale, although the former leaseholders would have the option to repay their share sooner if they wished.

• 6.46 While a sizeable majority of consultees agreed with our provisional proposal for a charge to be put in place, several consultees expressed reservations about how such a charge might operate in practice.²⁶⁰ These concerns are more fully explained in Chapter 5, but the three main concerns were that:

• (1) there may be unforeseen negative financial implications for non-consenting leaseholders, particularly as the valuation of commonhold units is currently largely untested;

• (2) the charge would not be a sufficiently attractive investment for third-party investors. Unless such parties were willing to help finance non-consenting leaseholders’ shares, it is doubtful that many conversions to commonhold would take place; and

• (3) if the charge were to take priority over mortgages, lenders would be unwilling to lend on commonhold units more generally.

• 6.47 As a result of these concerns, we have concluded that, at present, the mechanism we proposed in the Consultation Paper would not offer a viable way of financing nonconsenting leaseholders’ shares under Option 2. Consequently, if Option 2 were adopted and leaseholders were required to take a commonhold unit on conversion, we consider that financial assistance from Government would be necessary. We suggest in the previous chapter that such assistance could take the form of an equity loan which would operate in a similar way to how shared equity loans currently operate under Government’s Help to Buy scheme. The loan could be secured by way of a charge over non-consenting leaseholders’ commonhold units on conversion, which would take effect subject to any existing mortgages. To provide the correct incentive structure, we also suggest that financial assistance should be made available to participating leaseholders on an optional basis.

Existing mortgage finance

• 6.48 Another potential difficulty with Option 2 relates to non-consenting leaseholders’ existing mortgage finance. Most leaseholders will have purchased their flats with the assistance of a mortgage. Leaseholders may find it difficult to convert to commonhold unless there is a way of transferring their mortgage finance from their leasehold flat to the commonhold unit.

• 6.49 We explain in Chapter 4 that currently, the consent of every mortgage lender who has an interest secured over any of the flats in the building will be required. As lenders will lose their security on conversion, it is inevitable that they will only consent to the conversion if they are prepared to accept a charge over the commonhold unit after conversion.

• 6.50 Obtaining the consent of every lender would present a significant hurdle to overcome. We therefore recommend in Chapter 4 that it should be possible for mortgages to transfer automatically from the leases to the commonhold units without requiring lender consent. Such an approach can be justified on the basis that commonhold units will provide lenders with an improved security to that available over leasehold flats.

However, in adopting this recommendation, it would be necessary for Government to work with lenders to ensure that such an automatic transfer will be accepted by them.

• 6.51 In the Consultation Paper, we explained that conversion under Option 1 would be difficult, but not impossible to achieve, without the automatic transfer of mortgages to commonhold units. Conversely, we said that Option 2 would not be workable unless mortgages could transfer automatically from the leasehold interest to the commonhold unit.²⁶¹

• 6.52 If it were not possible for charges to transfer automatically, and lender consent were instead required:

• (1) Under Option 1, only participating leaseholders, who would be taking a commonhold unit on conversion, would be required to seek the consent of their lender. If lender consent were not forthcoming, the participating leaseholder would need to source an alternative lender who would be willing to accept security over the commonhold unit. It would not be necessary, under Option 1, to obtain lender consent in respect of non-consenting leaseholders’ leases.²⁶² Following conversion under Option 1, non-consenting leaseholders’ leases would simply continue, as would any charges secured against these leases. We therefore said that lenders, who have an interest secured over a lease which continues on conversion, should not be required to consent to a conversion to commonhold.

• (2) Under Option 2, all leaseholders would be required to take a commonhold unit on conversion, including non-consenting leaseholders. All lenders with an interest secured over any of the leases in the building which would become units on conversion would be required to consent to the conversion. While participating leaseholders would be able to seek the consent of their mortgage lender, and source alternative financing if the lender refuses (in the same way as under Option 1), it would not be possible for participating leaseholders to:

• (a) seek lender consent on behalf of all the non-consenting leaseholders; or

• (b) source alternative financing for the non-consenting leaseholders if their lenders were to refuse consent.

To do so would require the participating leaseholders to access personal financial information about the non-consenting leaseholders, and require the non-consenting leaseholders to sign new lending terms against their will.

• 6.53 Whether Option 2 can be pursued will therefore depend on the success of Government’s plans to work with lenders to improve their confidence in commonhold, and ensure charges can transfer automatically from the leases to the commonhold units on conversion.

Recommendations for reform

• 6.54 In this chapter, we have presented the main advantages and disadvantages of both options for conversion to commonhold. We have compared the impact of conversion on non-consenting leaseholders, the management structure created on conversion, and the practicalities of financing each option.

• 6.55 We have concluded that the difference between Options 1 and 2, in terms of impact on non-consenting leaseholders, is not as stark as we originally suggested in the Consultation Paper. While all non-consenting leaseholders will be required to take a commonhold unit at the point of conversion under Option 2, such leaseholders might also take a commonhold unit at a later date under Option 1, due to our recommendations to phase out leases and replace them with commonhold units. The same safeguards need to be available to protect all non-consenting leaseholders who will or might take a commonhold unit on or following conversion to commonhold.

• 6.56 Our view is that Option 2 creates the preferred management structure on conversion to commonhold. Conversion under Option 2 will immediately produce all the advantages of commonhold over leasehold and will make the building easier to manage, as all owners will hold the same type of interest. We therefore recommend that Option 2 should be adopted. However, implementing Option 2 creates difficult issues in practice, particularly with regards to how the conversion might be financed. As a result of these difficulties, it will only be possible to pursue Option 2 at this present stage if Government is willing to assist leaseholders to finance the conversion, and will work with mortgage lenders to address any reservations about the commonhold model.

Recommendation 15.

• 6.57 We recommend that all eligible leaseholders should be required to take a commonhold unit on conversion (which we call “conversion Option 2”), but only if:

• (1) Government provides an equity loan to non-consenting leaseholders to cover their share of purchasing the freehold, and offers such loans to consenting leaseholders on a voluntary basis; and

• (2) Government works with lenders to ensure that charges over leasehold flats can transfer automatically to the commonhold units on conversion.

• 6.58 If the actions listed at (1) and (2) above are not feasible, non-consenting leaseholders should retain their leasehold interests on conversion (which we call “conversion Option 1”) but:

  (1)	non-consenting leaseholders should have the option to buy the commonhold title in respect of their unit at a later date;
  (2)	the new right to buy the commonhold unit should replace leaseholders’ existing rights to a lease extension; and
  (3)	incoming purchasers should be required to buy the title to the commonhold unit in addition to the leasehold interest.

• Chapter 7: What is the procedure for converting to commonhold?

INTRODUCTION

• 7.1 In our Terms of Reference with Government, we were asked to consider whether the procedure for creating and registering commonholds might be simplified. In this chapter, we make a number of recommendations that will make the process of converting to commonhold simpler, quicker and cheaper. Our recommendations will put leaseholders in control of the conversion process, and prevent tactical delays by those opposed to the conversion.

• 7.2 We illustrate how conversion might take place in two distinct scenarios. First, we consider the procedure for converting where leaseholders need to acquire the freehold compulsorily as part of the conversion process. We explain in Chapter 4, that where the freeholder does not consent to the conversion to commonhold, leaseholders will need to acquire the freehold compulsorily through a collective freehold acquisition (“CFA”) claim. In order to make the process of converting as quick and as cost-effective as possible, leaseholders will however be able to follow a streamlined “acquire and convert” procedure. We begin in this chapter by setting out how the streamlined acquire and convert procedure will operate. This procedure will enable leaseholders to acquire the freehold and put the commonhold structure in place at the same time. By following the streamlined procedure, leaseholders will be able to avoid unnecessary delay and costs which might otherwise arise by following a two-stage process of acquiring the freehold through a CFA, and then converting to commonhold.

• 7.3 Second, we discuss the scenario where leaseholders do not need to acquire the freehold compulsorily in order to convert. Where the freeholder agrees to the conversion, there will not be any need for the leaseholders to carry out a CFA claim as part of the conversion to commonhold. This scenario will most frequently arise where the leaseholders already own the freehold collectively, for example, where the leaseholders have already purchased the freehold through a CFA claim and now want to convert to commonhold.

• 7.4 When considering both scenarios, we make a number of recommendations that will lighten the administrative burden on those wishing to convert. We reduce the number of forms that must be completed as part of the conversion process and prevent conversion claims being blocked at a late stage in the process. Our recommendations will also enable leaseholders to take control of the process by allowing them (in addition to the freeholder) to register the new commonhold at HM Land Registry. In the words of one consultee responding to the Consultation Paper, the package of reforms:

places the long leaseholders concerned in the driving seat. It simplifies the procedures and aims to prevent any freeholders minded to do so from blocking the process as well as limiting the power of originally participating long leaseholders to change their minds on grounds later on.¹

THE CURRENT LAW

• 7.5 Before setting out our recommended procedure for converting to commonhold, we provide a brief overview of the existing conversion process, and the forms that need to be submitted to HM Land Registry. We explain the current procedure in more detail in the Consultation Paper.^{263 264}

• 7.6 A building can be converted to commonhold by applying to HM Land Registry to register the land as commonhold “with unit holders”.²⁶⁵ At present, the application can only be made by the registered freehold owner of the land.

• 7.7 The person applying to register the land as commonhold (referred to as “the applicant”) must submit the following documents.

• (1) Application form “CM1” to register a freehold estate in commonhold land. This form includes a number of tick-boxes that must be completed to demonstrate that the requisite documents have been lodged alongside the application form.

• (2) A statement that the applicant is registering “with unit holders”.²⁶⁶ This statement must be in prescribed form COV²⁶⁷ and must contain a list of individuals who will take a commonhold unit on conversion to commonhold.

• (3) The commonhold community statement (“CCS”) and a detailed plan of the land to become commonhold. The CCS sets out the rights and obligations of all the unit owners in the commonhold.

• (4) The certificate of incorporation of the commonhold association (which demonstrates that the commonhold association has been set up as a company) and its articles of association.²⁶⁸

• (5) A certificate given by the directors of the commonhold association that the articles of association and CCS comply with the 2002 Act and the Commonhold Regulations 2004.²⁶⁹

• (6) Evidence that the necessary consents have been obtained. Every individual who is required to consent to the conversion (including each leaseholder and all lenders with an interest secured over their flats, see Chapter 4) must complete a prescribed form CON1.²⁷⁰ The applicant (which, currently, can only be the freeholder) must provide a statement of truth confirming that the necessary consents have been obtained. This statement is conclusive proof to HM Land Registry that no further consents are required.²⁷¹ If any individual has provided consent subject to conditions (that is, their agreement only stands if a particular circumstance does or does not occur), the statement of truth provided to HM Land Registry must confirm that the necessary conditions have been fulfilled at the time of the application.^{272 273}

• 7.8 Once the necessary information has been provided to HM Land Registry, the Registrar will register the land as a freehold estate in commonhold land. At the same time:

• (1) the individuals named as the new unit owners on form COV provided to HM Land Registry (see 7.7(2) above) will be registered as the freehold owners of their particular unit or units under separate title numbers;¹¹ and

• (2) the commonhold association will be registered as the freehold owner of the common parts of the commonhold with a separate title number.²⁷⁴

ACQUIRING THE FREEHOLD AS PART OF THE CONVERSION PROCESS

• 7.9 We now set out our recommendations for reform in the context of the first scenario discussed above, where leaseholders need to acquire the freehold collectively as part of the conversion process.

• 7.10 As noted above, in Chapter 4, we recommend that, where the freeholder of the building does not consent to the conversion to commonhold, leaseholders will need to acquire the freehold compulsorily by making a CFA claim. As a result of this recommendation, converting will involve two processes.

• (1) Buying the freehold of the building through a CFA claim (determining matters such as the extent of the property to be acquired, and the premium payable for that acquisition); and

• (2) Putting in place the commonhold management structure (for example by setting up the commonhold association and preparing the CCS).

• 7.11 To mitigate the costs and delays that might otherwise be caused by following two distinct processes, we explained in the Consultation Paper that leaseholders would be able to streamline the two processes of buying the freehold collectively and converting to commonhold. Streamlining the two processes would however remain optional. Our intention is to provide leaseholders with as much flexibility as possible when acquiring the freehold and choosing the management structure for their building. Participating leaseholders would have the following options to consider.

• (1) Leaseholders could exercise their right of collective freehold acquisition and stop there.

• (2) Leaseholders could bring a CFA claim and, at a later date, after having acquired the freehold, decide they want to put in place the commonhold management structure. As certain consultees pointed out, leaseholders may want time to familiarise themselves with the commonhold regime before taking the further step of converting to commonhold. Leaseholders would be able to convert to commonhold by lodging the requisite commonhold documents at HM Land Registry (set out at paragraph 7.81 below).²⁷⁵

• (3) Leaseholders could bring a CFA claim and, during the process of that claim, decide that they want to put in place the commonhold management structure. These leaseholders would be able to put the commonhold structure in place at the same time as acquiring the freehold, by lodging the requisite commonhold documents at HM Land Registry (set out at paragraph 7.81 below) when registering the freehold transfer.²⁷⁶

• (4) Leaseholders could commence a bespoke claim to “acquire and convert”. This process has been specifically designed to provide the most effective way of acquiring the freehold and converting to commonhold. The acquire and convert procedure incorporates all the steps necessary to acquire the freehold and the additional steps necessary to put in place the commonhold management structure. The Leasehold Knowledge Partnership (“LKP”) and the All-Party

Parliamentary Group on Leasehold and Commonhold Reform (“APPG”) said that, “if commonhold is shown to work then logically any future collective enfranchisement would look to convert to commonhold at the same time”.

• 7.12 In the Consultation Paper, we suggested that leaseholders might wish to commence a claim to acquire and convert, but decide at a later date that they only wish to acquire the freehold (and not convert).²⁷⁷ At present, there would be nothing in the legislation that would compel the leaseholders to convert after having commenced an acquire and convert claim.²⁷⁸ They could, at a later stage, decide that they only want to acquire the freehold, and not put in place the commonhold structure.²⁷⁹

• 7.13 While this remains the case under our recommended regime, on reflection, where leaseholders are uncertain about converting to commonhold at the outset of the claim, it would be preferable for them to commence an ordinary CFA claim, and have the option to convert at a later stage (option (3) above). That would avoid leaseholders having to take any preparatory steps for a conversion which may not in fact proceed. Where leaseholders do commence an ordinary CFA claim, there will be a natural point at which leaseholders should make the election to convert in order to avoid wasting costs. Leaseholders would, for example, be advised to make the election prior to settling the terms of any leasebacks to the former freeholder, who would be required to take a unit on conversion.²⁸⁰ We consider it far more probable that leaseholders, during the process of the CFA claim, will learn of the benefits of commonhold and wish to convert, rather than, during the acquire and convert claim, decide that they wish to remain leaseholders and not convert.

• 7.14 Leaseholders who are already familiar with commonhold and make the decision to convert at the outset should use the acquire and convert procedure (option (4)). This process is the quickest and most cost-effective way of converting where the freeholder does not consent. We recommend below that guidance should be produced that will inform leaseholders of their options, and the differences between conversion and acquiring the freehold collectively. The rest of this part of the chapter focusses on the streamlined acquire and convert process.

• 7.15 While we did not ask consultees a specific question about the acquire and convert procedure, a number of consultees commented that the streamlined procedure would reduce unnecessary cost and complexity. The Chartered Institute of Legal Executives (“CILEx”), for example, identified a number of benefits of the streamlined process, including reducing costs and raising consumer awareness:

Streamlining of processes is necessary in achieving a workable solution to commonhold which is familiar to consumers, legal practitioners and other relevant parties. In turn, this shall invariably hope to reduce costs by eradicating unnecessary complications and arbitrary distinctions between buying your freehold under enfranchisement laws and buying your freehold under commonhold laws...

This has the added benefit of providing leaseholders with flexibility to change their mind half way through the process should they wish to continue onto a commonhold conversion where they had initially only planned to enfranchise or vice versa.

In addition, having one streamlined process is also likely to improve consumer awareness of leaseholder rights, as the differences in the two ownership models only begin to arise towards the latter stages of the process and are limited to differences in property management. In turn, it shall become easier for practitioners to advise leaseholders on the options available to them.

. the enfranchisement procedure is already well known to practitioners, who would therefore be able to advise more easily on commonhold conversions notwithstanding the lack of these in practice.

Recommendations for reform

• 7.16 We agree with consultees that an ability for leaseholders to acquire the freehold and convert to commonhold at the same time would be a very helpful tool. We therefore recommend that a streamlined acquire and convert procedure should be facilitated.

Recommendation 16.

• 7.17 We recommend that it should be possible for leaseholders to acquire the freehold through a collective freehold acquisition claim, and convert to commonhold, by following a streamlined “acquire and convert” procedure.

THE STREAMLINED ACQUIRE AND CONVERT PROCEDURE

• 7.18 As explained in the Consultation Paper, facilitating the acquire and convert procedure would require certain changes to be made to the existing commonhold legislation.²⁸¹ First, there are certain discrepancies between the CFA process and the conversion process which could make the streamlined process difficult to achieve without reforming the law. In particular, the way in which leaseholder consent is currently evidenced differs between the two claims. There are also differences between the circumstances in which leaseholder consent, once given, may lapse or be subject to conditions. To accommodate the streamlined procedure, it would be necessary to bring the two processes into alignment. Second, the streamlined procedure would be helped by an ability for leaseholders to control the conversion application themselves, rather than rely on the freeholder to submit the application, as is the position in the current law. In the Consultation Paper we made proposals to address these two issues and sought consultees’ views. We also asked consultees whether any further changes could be made to the commonhold legislation to make the streamlined procedure more effective.

• 7.19 We now set out how the acquire and convert procedure will operate, and, in the light of consultees’ responses to our consultation questions, we make a number of recommendations to better facilitate the streamlined process. We consolidate these recommendations at paragraph 7.83 below.

Initial steps

• 7.20 Before commencing a claim to acquire and convert, participating leaseholders should take a number of organisational steps. They should:

• (1) set up a company to act as the commonhold association. A copy of the commonhold association’s certificate of incorporation will need to be provided to HM Land Registry when registering the new commonhold;

• (2) agree how the freehold purchase will be financed and decide the circumstances in which the claim to acquire and convert might be withdrawn (see discussion from 7.39 below); and

• (3) prepare the CCS, or decide how and when the CCS will be prepared. A copy of the CCS will need to be provided to HM Land Registry when registering the commonhold. In response to the Consultation Paper, a few consultees expressed concern that the preparation of the CCS might be deferred to a later stage of the process, rather than being prepared at the outset. They argued that preparing the CCS at a later stage of the process would not enable the views of those who have not agreed to the conversion (but would be required to take a commonhold unit) to be taken into account. However, in the previous chapter, we explain the basis on which participating leaseholders must prepare the CCS in order to protect the interests of those who have not agreed to the conversion (such as the former freeholder and non-consenting leaseholders). Because protections will be built into the process of preparing the CCS, leaseholders will be able to prepare the CCS at the outset, before bringing a claim to acquire and convert, or defer its preparation to later in the process, while still ensuring the interests of those who have not consented are protected.

• 7.21 Leaseholders may wish to record any agreement reached about how the claim is to proceed in a “participation agreement”. While not a statutory requirement, participation agreements are already commonplace in CFA claims.

Serving the Claim Notice to acquire and convert and evidence of leaseholder consent

• 7.22 Once the above preparatory steps have been taken, the leaseholders may serve a “Claim Notice to acquire and convert” (the “Notice”) on the freeholder. We recommend that the content of this Notice should be prescribed by law. The leaseholders will name the commonhold association as the “nominee purchaser” who will acquire the freehold from the freeholder ²⁸²

• 7.23 The Notice should make clear that if, for any reason, conversion does not take place, the leaseholders still support the collective acquisition of the building. Leaseholders would therefore be able to decide at a later stage only to acquire the freehold and not convert to commonhold.

• 7.24 We suggested in the Consultation Paper that the Notice could stand as evidence that the requisite leaseholder consents have been obtained for both the CFA and conversion claims ²⁸³ We also suggested that the Notice could stand in place of existing form COV by incorporating the details of individuals who will take a commonhold unit on conversion.

• 7.25 It is highly likely that the same leaseholders will be supporting the CFA claim and the conversion to commonhold. In Chapter 4, we recommend that the same category of leaseholders should be eligible to participate in a CFA claim and the conversion to commonhold. We also recommend that the same threshold of leaseholder support as is required to bring a CFA claim should be required to convert to commonhold. Namely that eligible leaseholders of 50% of the flats in the building, must support the decision. The result is that if leaseholders are able to acquire the freehold collectively, they will also be able to convert to commonhold.

• 7.26 Enabling the Notice to act as evidence of leaseholder consent to both claims would, however, require certain changes to the existing law. As we note above, the way in which leaseholder consent is currently evidenced is different in a CFA claim and on conversion to commonhold. In a CFA claim, leaseholders evidence their agreement by signing the CFA claim notice. On conversion to commonhold, each leaseholder must indicate their consent by completing a prescribed form CON1. In addition, there are differences between the circumstances in which consents, once given, may lapse, be withdrawn or be subject to conditions.