This case study is based on a real instruction. Names, addresses and identifying details have been changed, and figures rounded, to protect client confidentiality.

The instruction

We were instructed by a private freeholder who owned a converted Victorian building in South London containing nine flats, all let on long leases. He had agreed to sell the freehold reversion to a ground rent investor for £185,000 and the sale had exchanged.

Two months later his solicitor received a letter from a firm acting for six of the nine leaseholders, asking why no notice under section 5 of the Landlord and Tenant Act 1987 had been served. Our client had never heard of one.

What the right of first refusal actually requires

Part I of the Landlord and Tenant Act 1987 gives qualifying tenants of flats a right of first refusal. Before a landlord makes a relevant disposal of premises to which the Act applies, he must first offer that disposal to the qualifying tenants on the same terms, by serving notice under section 5.

The Act applies where all three of these are satisfied:

• Qualifying premises. The whole or part of a building containing two or more flats held by qualifying tenants, where the non-residential parts do not exceed 50% of the internal floor area.
• Qualifying tenants. More than half the flats in the premises must be held by qualifying tenants. Broadly, long leaseholders qualify; assured and assured shorthold tenants, business tenants and any tenant holding three or more flats in the building do not.
• A relevant disposal. A sale of the freehold or a head lease is the obvious case, but the definition is wide and catches many transactions freeholders do not expect.

There are exemptions. Local authorities and most registered providers of social housing are excluded landlords. So is a resident landlord in a building that is not purpose-built, contains no more than four flats, and where the landlord has occupied a flat as his only or principal home for at least twelve months. Certain disposals are also excluded — gifts to family members, disposals by way of mortgage, compulsory purchase, and transfers between companies in the same group.

Our client fell into none of them.

Why this is the one leasehold obligation with a criminal sanction

This is the part freeholders consistently underestimate. Under section 10A of the Act, inserted by the Housing Act 1996, a landlord who makes a relevant disposal without having complied with section 5, and without reasonable excuse, commits a criminal offence.

It is a summary offence carrying a fine at level 5 on the standard scale. For offences committed after 12 March 2015 there is no upper limit on that fine — a point worth noting, because a great deal of published guidance still quotes a £5,000 maximum. Where the landlord is a company, a director, manager or secretary who consented to or connived in the offence may be personally liable.

Most leasehold obligations are enforced through the tribunal and a costs order. This one is enforced by the magistrates’ court.

The bigger commercial problem: the sale does not stay sold

The criminal exposure is serious, but in practice it is the civil consequence that causes the damage. Sections 11 to 12B allow the qualifying tenants, once they discover an unlawful disposal, to serve notice on the new owner requiring information about the disposal, and then to require that purchaser to transfer the interest to their nominee on the same terms and at the same price.

The buyer therefore does not get a clean asset. Any competent conveyancer acting for a ground rent investor will raise the point, and increasingly they do — which is why a missed section 5 notice tends to surface at the worst moment.

What we did

We were instructed to value the reversion properly and to advise on the position. Three things followed:

• We confirmed the building was qualifying premises and that seven of the nine flats were held by qualifying tenants — comfortably over the half required.
• We valued the freehold reversion at £178,000, against the £185,000 agreed. The agreed price had included an element for the roof space, which on inspection had no realistic development prospect given the roof structure and the terms of the top-floor leases.
• We advised that the cleanest route was for the disposal to be unwound by agreement and the interest re-offered to the leaseholders under a properly served section 5 notice, rather than waiting to be compelled.

The outcome

The investor agreed to rescind. A section 5 notice was served offering the freehold at £178,000, with the statutory acceptance period of two months. Six leaseholders accepted, formed a company, and completed the purchase at that figure within the statutory timetable.

Our client received £7,000 less than his original sale price and paid two sets of abortive legal costs. He avoided a criminal prosecution, an order compelling his buyer to transfer, and the possibility of personal liability. On the facts, that was a good outcome.

A checklist before you dispose of a freehold

1. Ask whether the Act applies before you agree terms, not after exchange. Qualification turns on the make-up of the building and the leases, and it is quickly established.
2. Count the qualifying tenants properly. A leaseholder holding three or more flats in the building is not a qualifying tenant, which can flip a marginal building either way.
3. Check the disposal type. The definition reaches beyond a straightforward sale. Granting a head lease, transferring between connected companies outside a group structure, or disposing of part can all be caught.
4. Price it before you offer it. The section 5 notice must state the terms, and you are bound by them if the tenants accept. An offer pitched on optimism rather than valuation is an offer you have to honour.
5. Keep proof of service. The statutory timetable runs from service, and disputes about whether notice was given are common.

Frequently asked questions

What is a section 5 notice?

A section 5 notice is the formal offer a landlord must serve on qualifying tenants under the Landlord and Tenant Act 1987 before disposing of an interest in a building containing flats. It sets out the terms of the proposed disposal and gives the tenants at least two months to accept. Only if they decline, or the period expires, may the landlord sell to a third party — and then only on the same terms.

What happens if a freeholder sells without serving a section 5 notice?

Two things. The landlord commits a criminal offence under section 10A, punishable by an unlimited fine, with directors and officers of a corporate landlord potentially liable in person. Separately, the qualifying tenants can require the new owner to transfer the interest to their nominee at the same price, so the buyer’s title is not secure.

Does the right of first refusal apply to a building with commercial units?

It can. The Act applies where the non-residential parts do not exceed 50% of the internal floor area — a more generous threshold than the 25% that currently applies to collective enfranchisement. A shop with flats above will often be caught.

Can leaseholders waive the right of first refusal?

They cannot waive it in advance, but they can decline the offer once made, or simply let the acceptance period expire. That is precisely why serving the notice is in the freeholder’s interest: it converts an open-ended liability into a closed one.

Acting for freeholders

Blakes Chartered Surveyors act for freeholders, portfolio landlords, resident freehold companies and managing agents as well as for leaseholders. We value freehold reversions for sale, advise on right of first refusal and enfranchisement exposure, and negotiate premiums.

For freeholder-side work we operate myfreehold.com — valuation by Blakes and legal work by our associate firm Arcadia Law on a single instruction, covering section 5 notices, section 13 and section 42 claims, disposals, informal extensions, licences and variations.

Call 020 7373 7373 or email info@blakessurveyors.com. RICS regulated firm no. 752265.