Real Estate Quarterly Legal Update

Minimum Energy Efficiency Standard (MEES): lease drafting implications

In anticipation of the Minimum Energy Efficiency Standard (MEES) it is increasingly common to see tenant covenants to protect the EPC rating of premises at the time of the grant of the lease. A landlord who has an EPC with an E rating or better will not want the EPC rating to fall into substandard territory as this will affect its ability to grant new leases from 1 April 2018 and to continue to let from 2023.

Going a step further is the inclusion of a covenant preventing the tenant from carrying out alterations which would adversely affect any valid EPC rating in existence. This could fetter the tenant's ability to carry out any alterations at all. In any event it is doubtful that there is a need for the clause at all, if the lease contains the typical qualified prohibition on alterations. It must be reasonable for the landlord to refuse consent to alterations that will result in a sub-standard EPC rating.

As rent review clauses already include an assumption that the premises can be lawfully let no additional drafting is needed. The rent review surveyor would not be at liberty to assume that the premises are unlettable because they have an EPC below an E.

Compliance with MEES may result in expenditure on energy saving improvements, which the landlord may wish to recover through the service charge. There is often, an exclusion, in the service charge schedule for the costs of improvements. A well advised tenant would almost always delete a provision requiring it to pay for energy efficiency improvements. The landlord would then be left with the choice of whether to do the works (but at its own expense), or try to persuade the tenant to pay the costs provided they are reasonable (not just properly incurred). 

The landlord will want greater control over the production of EPCs. If the tenant has to obtain an EPC for an assignment or underletting or following completion of alterations the landlord should have the option to commission the EPC at the tenant's cost. This is because the landlord will, undoubtedly, be able to produce a more accurate EPC as it has access to all the relevant data and will therefore have a better chance of preserving its current EPC rating.

However, as with any new lease drafting it is important to strike a balance between including drafting to protect the landlord's position and guarding against including provisions which would be considered onerous or out of line with other leases, as this could have a detrimental effect on rent review.

Obviously MEES is driven by EU law and so it remains to be seen whether it will be consigned to the history books following Brexit.

MEES guidance

The second version of the MEES guidance has been published by the Government for non-domestic premises. It is designed for both landlords and enforcement agencies. It puts some flesh on the bones of the MEES regulations although it lacks clarity in some areas. It is not legally binding and therefore professional advice should be sought in relation to compliance with the MEES regulations.

When is a contract too uncertain to enforce?

In Anderson Properties Ltd v Blyth Liggins¹ the parties entered into a sale and purchase agreement conditional on planning permission. The seller agreed five extensions to the date for submission of the buyer’s planning application. The last extension expired on the day before the contractual termination date.

As the buyer had failed to submit its planning application it decided to waive the planning condition and complete the purchase, but the seller refused to complete. The seller argued that the agreement was unenforceable because it lacked certainty. It provided for the grant of a lease of a “care facility” to be constructed on part of the site and although the parties had agreed the form of lease for the care facility, the contract did not contain any plans identifying the land in question.

The location of the care facility would have become apparent if the buyer had complied with its obligations in the agreement and submitted the planning application. It would have been shown on the plans accompanying the planning application. So, there would not have been any uncertainty on the completion date.

The court decided that the contract was enforceable. There had been good reasons for leaving the precise location of the care facility to be determined at a later date. The buyer wanted the flexibility to negotiate with the planners and to alter designs before submission of the planning application in order to be certain of approval. The fact that the seller could not unreasonably withhold approval of the planning application showed that there was an objective method for determining the location of the care facility.

Certainty of terms is one of the requirements for an enforceable contract but this case demonstrates that not all the terms need to be certain at the outset provided that there is a contractual mechanism for determining them before completion.

Option drafting gone wrong

In Helix 3D Ltd v Dunedin Industrial Property Nominee Ltd²  the landlord had granted its tenant an option for the purchase of a freehold reversion. The option agreement provided that the purchase price would be held at £1.5m for the first two years of the option period. Thereafter, it was to be the greater of either £1.5m or the open-market value of the property (which was to be determined once the tenant had exercised the option).

The option agreement required the tenant to pay a 5% deposit on or before the service of the option notice and failure to pay would nullify any purported exercise of the option. The tenant served a notice exercising the option in the fourth year of the option period specifying a purchase price of £1.5m.

The landlord claimed that the notice was invalid because the purchase price was no longer fixed at £1.5 million, but depended on the market value of the property. If the property was worth more than £1.5m then the deposit that the tenant had paid (calculated by reference to the sum of £1.5m) was not sufficient. Had the tenant validly exercised the option in accordance with its terms?

The judge agreed that something had gone wrong with the language in the option. His view was that a reasonable person would not expect commercial parties to have fashioned “a lottery” in which the buyer would have to guess correctly what the open-market value might be in order to serve a valid option notice.

In the judge’s view, commercial parties would expect the validity of the option notice to be ascertainable immediately on the exercise of the option. So the parties must have contemplated that the figure on which the 5% deposit would be based would be either ascertained, or ascertainable, when the deposit needed to be paid. The answer was to interpret the option agreement to mean that the deposit was to be calculated by reference to the price specified in the option notice – and not by reference to the open market value, which had yet to be ascertained.

The judge accepted that this might mean that the tenant could unilaterally limit the amount that it paid by way of a deposit, but 5% of £1.5m was a considerable sum, which provided the seller with substantial security for the performance of the contract.

The moral of the story is: as always – test the drafting to see if, and how, it works in different scenarios.

A drafting error leads to loss of right to rescind

Where a contract is in writing, what the parties have written, rather than what they intended to write, will constitute the agreement. The intentions of the parties at the time of drafting the agreement are irrelevant, and an objective test will be applied as to what a reasonable person understands the language to mean. The court will give the words their natural meaning even if this may lead to detrimental consequences for one party. The court is not there to save that party from a bad bargain.

In Dooba Developments Ltd v McLagan Investments Ltd³ the parties had entered into a contract for the sale and purchase of land with a headline price of £12m. The land was to be developed as an Asda superstore, with cafeterias, restaurants and a petrol filling station and the agreement was subject to the satisfaction of four conditions precedent.

Either party was entitled to rescind if “any of the conditions have not been discharged” by dates stipulated for each particular condition. A further provision in the contract gave the parties the right to rescind “if all of the conditions have not been discharged.… by the longstop date”, which was 23 July 2014.

Planning permission was granted in March 2014, but Asda attempted to rescind the agreement immediately after the longstop date on the ground that the highway condition had still not been fulfilled. Asda interpreted to clause mean it could rescind if "any" of the conditions had not been satisfied by the long stop date. The seller claimed that Asda's right to rescind had not arisen.

The High Court looked at a number of clauses in the agreement referring to “any of the conditions” and “all of the conditions”, and the judge ruled that the phrase “if all the conditions have not been discharged” meant exactly what it said. So the power to rescind only arose only if none of the conditions had been satisfied by the longstop date. The highway condition had not been satisfied by that date, but there was a triable issue as to the remaining conditions. Therefore, Asda’s rescission notice had been premature and the contract remained in force.

This was not what Asda wanted but this was what the contract said; all the conditions had to be unsatisfied for the right to rescind to arise.

Electronic signature of deeds

The Land Registry has published a consultation which seeks views on its proposals to introduce digital conveyancing documents with e-signatures to be used for real estate deeds.

Whilst this is not full blown electronic conveyancing it does represent a major shift in Land Registry practice. Security will be a major concern in any electronic system and the Land Registry will need to convince users that their proposals are sufficiently robust.

The consultation closes on 5 April 2017.

Side letters to lease triggers the law on penalties

We are getting used to the new legal landscape for penalties following the Supreme Court decision in Cavendish Square Holding BV v Talal El Makdessi [2015] and now we have the first case which illustrates how the law can affect landlord and tenant relations. Side letters are commonly used to provide concessions to tenants outside the strict terms of the lease. In Westwood v Conduit Street Development Ltd⁴ the court had to decide whether a termination provision in a side letter fell foul of the rule against penalties.

The tenant had a 15-year lease of retail premises in London. The initial rent reserved by the lease was £110,000 per annum, but the parties entered into a side letter reducing the rent during the first five years of the term, and then capping it at £125,000 per annum for the next five years of the term (even though the open market rent might increase on rent review in the interim).

The rent concession was terminable if the tenant was in breach of any of its obligations under the lease. Unsurprisingly, at some point the tenant’s rent was late and the landlord claimed to be entitled to terminate the side letter. The rent would therefore revert to the open market rent which was now £232,500 per annum.
The rule against penalties does not affect primary obligations in contracts. However, if secondary obligations, triggered by breaches of contract, impose consequences on contract breakers that are out of all proportion to any legitimate interest of the innocent party then the court can find such obligations to be void as penalties.

The judge refused to go along with the landlord's argument that the rent concession was a discount for prompt payment and therefore terminable if payment was late.

Instead the judge decided that the parties had agreed to set a reduced rent, with a default to a higher rate in the event of any breach of the tenant’s obligations. The judge held that the obligation to pay the reduced rent was the tenant’s primary obligation and the liability to pay the higher rent was a secondary obligation, triggered by the tenant’s breach of contract.

So, was that secondary obligation extravagant, exorbitant or unconscionable when compared with any loss suffered by the landlord as a result of the late payment? The judge accepted that the termination provision would not apply in the event of trivial breaches of the lease (even though the side letter was expressed to be terminable on “any” breach of the tenant’s obligations). However, the termination provision operated both prospectively and retrospectively, because it stated that rent due under the lease would become payable “as if this agreement had never existed”. In other words, the tenant would have to pay additional rent for all the preceding and subsequent years of the term, in addition to paying interest, costs and damages, if the rent was late. In addition, the financial consequences for the tenant would be the same, whatever the breach might be and whenever it might occur, without any regard to the consequences for the landlord.

The judge ruled that this was penal (and would have been penal even if the effect of the termination provision was prospective only) because it was out of all proportion to the legitimate interest of the landlord in the performance of the lease. Consequently, the termination provision was unenforceable and the side letter continued in full force and effect.

Can a right of way be granted in the registration gap?

The ‘registration gap’ is what is referred to as the period of time between completion of a property transfer and the subsequent registration of the transaction at the Land Registry.

Registration gaps are becoming increasingly problematic as registrations are taking longer to complete as the case of Baker v Craggs [2016]⁵ illustrates.

The registration gap is one of the issues which the Law Commission has been asked to consider as part of its proposed review of the land registration system.
In relation to registered land, legal title does not pass to the transferee until they are registered as proprietor at the Land Registry. The transferee is merely the owner in equity until registration.

By contrast, on completion of a transaction involving unregistered land, legal title passes on completion. The transaction must be registered at the Land Registry within two months, failing which the legal title will revert to the transferor.

In this particular case, Mr and Mrs Charlton completed the sale of part of their registered land (the Property) to Mr Craggs on 17 January 2012. Unfortunately, Mr Craggs’ solicitors were not able to register the purchase at the Land Registry until 16th May, long after the expiry of the priority period conferred by their official search of the register.

In the meantime, on 14th March, Mr and Mrs Charlton had sold part of the retained land (the Retained Land) to Mr and Mrs Baker. Thanks to yet another conveyancing failure, the transfer to Mr and Mrs Baker included the grant of a right of way over the Property which had already been sold to Mr Craggs.

Mr Craggs objected to the Bakers’ exercise of the right of way, claiming that the grant was ineffective because (despite the expiry of the official search) his purchase took priority over it. At the time of the grant of the right of way, Mr Craggs was the beneficial owner of the property (but not the legal owner, because his purchase hadn’t yet been registered). Nevertheless, the court held that his beneficial ownership qualified as an overriding interest, because he had been in occupation of the property when the right of way was granted.

Such an overriding interest could take priority over the right of way. However, the court then pointed out that overriding interests can be overreached by the sale of a “legal estate” (which expression includes, said the court, the grant of a right of way).

Mr Craggs’ beneficial ownership was, indeed, overreached because the right of way had been granted by two trustees (i.e. the Charltons) to whom capital money (i.e. the purchase price for the Retained Land) had been paid. Mr Craggs was therefore stuck with an unexpected right of way across his property.

The court applied the doctrine of overreaching in a most unusual way. Overreaching requires the "conveyance of a legal estate by two trustees of land". The Charltons were indeed holding the Property on trust for Mr Craggs during the registration gap. But the conveyance in question was the grant of an easement, not a conveyance of the land. It was therefore necessary to show that the easement was a legal estate. Newey J found that the correct interpretation of section 1(4) of the 1925 Act was that an easement was a legal estate.

The use of the doctrine of overreaching seems very harsh on Mr Craggs as he became subject to an extremely burdensome right of way which seems inconsistent with the concept that the Charltons held the property on trust for Mr Craggs.

Possibly the most surprising aspect of this case is that neither side queried the validity of the right of way granted by the Charltons after the Property had already been sold. Both sides appear to have accepted this as yet another consequence of the “registration gap” between the date of completion of a sale and the date on which the buyer is actually registered as the new owner at the Land Registry. Until the buyer has been registered, the seller retains all the powers of a legal owner, including the power to grant easements over the land.

Practical advice:

• The growing registration gap is causing problems; careful consideration is required to identify the correct parties to serve and receive notices and appropriate drafting is required to mitigate the difficulties arising from delayed registration.
• Contract clauses could be used to enable a buyer to compel a seller to serve any required notices in the period between completion of a transfer and its registration.
• As suggested by the judge in the case of Stodday Land Limited and Ripway Properties Limited -v- Pye, the transferee could serve notice as the seller's agent prior to registration.
• Applications to register should be submitted as soon as possible after completion and the progress of the application monitored.
• Buyers and their solicitors must ensure that the buyer has priority over any subsequent transactions by the seller. In the case of Baker -v- Craggs, the buyer’s pre-completion search should have protected Mr Craggs, but priority was lost when his initial application to the Land Registry was cancelled.
• Remember that priority searches cannot be extended.

Introduction of the new private fund limited partnership

Following the Government’s July 2015 consultation, the legislative reform order (LRO) to introduce private fund limited partnerships (PFLPs) was laid before Parliament and is expected to come into force on 6 April 2017.

The LRO amends the Limited Partnerships Act 1907 and introduces a new regime which applies to UK limited partnerships which satisfy certain conditions and elect to be treated as a PFLP. The purpose of the new regime is to ease the level of administrative burden which currently applies to investment funds structured as UK limited partnership and to ensure that the UK remains an attractive domicile for such funds.

An application for PFLP status may be made by the general partner of a limited partnership at the time of initial registration of the partnership or at any time after registration. An application for PFLP status may be made in respect of a limited partnership which is already in existence on 6 April 2017 but the ability to withdraw capital contributions without being liable for the debts and obligations of the partnership up to the amount withdrawn will only apply to capital contributions made on or after 6 April 2017.

In order to apply for PFLP status, a limited partnership must satisfy the following PFLP conditions:

• It must be constituted by an agreement in writing; and
• It must be a collective investment scheme (as defined in section 235 of the Financial Services and Markets Act 2000 but ignoring, for this purpose, any exemption).

Although satisfaction of the PFLP conditions will need to be assessed on a case-by-case basis, in practice any private investment fund which is structured as a limited partnership should satisfy these requirements.

A number of important benefits will apply to PFLPs which do not apply to other limited partnerships, including:

• a white list of activities which provide clarity on the activities which limited partners can carry out without being considered to be taking part in the management of the partnership and placing their limited liability status at risk;
• the removal of the requirement for limited partners in new PFLPs to contribute capital and (in relation to capital contributions made on or after 6 April 2017) the removal of the restriction on withdrawing capital contributions without being potentially liable for the debts and obligations of the partnership up to the amount withdrawn;
• greater freedom in relation to who may wind up a PFLP;
• exemption from certain statutory duties; and
• easing of certain administrative requirements.

Developers cheer Supreme Court rating decision

There is a statutory assumption, for rating purposes, that premises are valued in a state of reasonable repair. This stops rate payers from allowing their premises to fall into disrepair in order to obtain a lower valuation. However it was generally understood that properties are assessed in their actual state and condition if they are incapable of beneficial occupation because they have been stripped out in readiness for redevelopment or refurbishment.

However the Court of Appeal decided to ignore this in SJ & J Monk v Newbigin [2017]⁶. The premises were used as offices and had been stripped out for redevelopment. The Court of Appeal decided that the “principle of reality” could be displaced by the contrary statutory assumption. This meant that the premises were valued as if they were in a reasonable state of repair because it was deemed that the necessary repair works could be carried out economically.

Thankfully the Supreme Court has now overturned the decision. It found a distinction between disrepairs that should not affect rateable value and redevelopment works which make the premises uninhabitable.

If an objective assessment of the premises would conclude that the premises were undergoing redevelopment works and were therefore incapable of beneficial occupation then you cannot ignore reality. In these circumstances you cannot apply the statutory assumption and value the premises as if they were in a reasonable state of repair.

So, in this dispute the Supreme Court decided that the premises were being redeveloped and were incapable of beneficial occupation so the rating list must be altered to reflect reality. The description of the premises on the rating list had to be altered to “building undergoing reconstruction” and the rateable value reduced to £1.

This important decision has provided clarification of the law. Buildings undergoing significant works as part of a refurbishment scheme or redevelopment, will not have a rates liability whilst these works are being carried out. This will be welcome news to developers as the previous Court of Appeal decision was viewed as a disincentive to development as it would add a significant cost to any project. However advice should be sought on a case by case basis to determine whether the works are extensive enough to take the property out of the rating list.

<sup>1. [2017] EWHC 244 (Ch)
2. [2016] EWHC 3012 (Ch)
3. [2016] EWHC 2944 (Ch)
4. [2017] EWHC 350 (Ch)
5. [2016] EWHC 3250 (Ch)
6. [2017] UKSC 14</sup>