Real Estate Quarterly Legal Update

The dangers of joint venturing

A joint venture will normally be carefully documented.  However, a recent Court of Appeal decision illustrates the dangers of progressing the deal whilst the detail of the contract is still being negotiated.

Equity has always striven to rescue a party who has relied on certain assurances to their detriment.  This includes the imposition of a constructive trust which is more commonly known as a Pallant -v- Morgan equity.  Essentially if A and B agree that A will acquire a specific property for the joint benefit of both A and B, and in reliance on that understanding B refrains from attempting to acquire the property then A holds the property as constructive trustee for both A and B.  Equity will not permit A to keep the property from his own benefit to the exclusion of B.

This was exactly the arrangement that Generator Developments LLP asked the Court of Appeal to find against its alleged JV partner, Lidl UK GmbH in the case of Generator Developments LLP -v- Lidl UK GmbH¹.

Both parties were interested in a development site in Brentwood, Essex.  Generator became aware of Lidl's interest and thought it could to improve its negotiating position by joining forces with Lidl. 

It was envisaged that Generator would obtain planning permission to develop a mixed-use scheme. Lidl would acquire the site in its own name.  Upon the grant of planning permission, Lidl would transfer its interest to Generator, taking a lease back once the store was developed.

Lidl acquired the site for £8.6m.  The heads of terms for the joint venture were never finalised and a written contract never materialised.  Indeed, Generator was aware that Lidl's board had not approved the joint venture (and were in discussions with other developers).  In April 2014 Lidl informed Generator that negotiations were over and it was looking at other options.

Generator claimed that Lidl's withdrawal would constitute a breach of the alleged constructive trust which had arisen in their favour, and issued proceedings against Lidl. In the proceedings, Generator sought a declaration as to the existence of a Pallant -v- Morgan constructive trust.

Generator failed at first instance and the Court of Appeal has recently rejected its appeal.

The court explored the effects of the "subject to contract" label.  Whilst not fatal to the establishment of a Pallant -v- Morgan equity the court noted that the parties, being experienced, commercial and legally represented “well understood … the meaning of the words “subject to contract” which appeared in the Joint Venture Heads of Terms.  This pointed to the fact that there was no “arrangement or understanding” between the parties.  Generator had never expected to acquire any interest in the land otherwise than by way of a legally enforceable contract, and, as the Court of Appeal put it, “a ‘subject to contract’ agreement is no agreement at all”.

The Court of Appeal also found that the draft lock-out agreement produced by Generator clearly reflected Generator's understanding of the position. It began by reciting that the parties were in negotiations ‘with a view to agreeing’ the proposed transaction”. It also provided a mechanism for Generator to withdraw from the proposed transaction, expressly stating that the lock-out agreement did not commit the parties to the proposed joint venture.

The Court of Appeal found that Lidl was perfectly entitled to withdraw from the negotiations and Lewison LJ concluded “…it cannot be unconscionable to exercise a right which has been expressly reserved to both parties by means of the “subject to contract” formula; and which Generator had even more clearly reserved to itself in the draft lock-out agreement.  It cannot be unconscionable for one party to follow a course which the other party has insisted was open to itself.”

This case means that it will be extremely difficult to assert a Pallant -v- Morgan equity, especially where the parties are commercially astute and legally advised.

As Lord Walker stressed in Yeoman's Row Management Ltd -v- Cobbe², equity will not intervene in a case where the parties expressly agree that a putative agreement is binding in honour only. The words “subject to contract” will make it almost impossible for a claimant to establish a Pallant v Morgan equity.

So, draft agreements are just draft agreements and courts will not entertain claims which arise from failed negotiations.

Can a landlord refuse consent to assign on a mixture of reasonable and unreasonable grounds

The case of No.1 West India Quay (Residential) Ltd -v- East Tower Apartments Ltd³  concerned a tenant who held 999 year underleases of 42 apartments in a 33 storey building. Each underlease contained a covenant not to assign the whole of the property without the prior written consent of the landlord, such consent not to be unreasonably withheld.  Almost all commercial leases allow tenants to assign with the landlord’s consent, which cannot be withheld unreasonably. This is an unusual covenant in residential leases, most residential leases merely provide for the landlord to be notified of any assignment. It is perhaps not surprising, therefore, that residential assignments have not generated much litigation.

The tenant decided to sell the apartments. It successfully obtained consent to assign eight leases subject to payment of outstanding service charge arrears.  However in relation to subsequent applications the landlord sought to impose further conditions which the tenant believed to be unreasonable.  It brought proceedings against its landlord for declarations that the landlord had unreasonably withheld consent.

The issues before the Court were:

1. Was it unreasonable for the landlord to ask for a bank reference in respect of the relevant proposed assignees?
2. Was it unreasonable for the landlord to require an undertaking for £350 plus VAT to cover the costs of a surveyor inspecting the relevant properties and to require such inspections as part of its consideration of the relevant applications?
3. Was it unreasonable for the landlord to require an undertaking for £1,250 plus VAT to cover legal fees in respect of the relevant licences to assign?

The High Court found that a landlord could not be expected to speculate about the financial position of a tenant on the mere basis that he had the funds to acquire the apartment.  It was reasonable for a landlord to seek reassurance about the ability of an assignee to pay the service charge and to ask for a bank reference.

It was also reasonable for the landlord to instruct a surveyor to determine whether there had been compliance with the repairing and alterations covenants in the relevant underleases, especially as the apartments had not been occupied by the tenant (but had been let to a succession of short-term occupiers).

However, it was unreasonable for the landlord to require payment of legal costs of £1,250. There was no evidence to suggest that the licences cost the landlord more than £350 each. 

Therefore, the landlord was found to have unreasonably withheld consent.

On appeal the only issue was whether the landlord had acted lawfully in refusing consent on a mixture of reasonable and unreasonable grounds.  The Court of Appeal reversed the High Court decision and concluded that the fact that one of the reasons behind the decision was bad did not strip the other good reasons of meaning or effect.  The landlord's duty is limited to proving that its overall decision was reasonable.

The decision here on the unreasonableness of the landlord’s legal fees may not be much help to commercial tenants. The decision was based on paragraph 2 of schedule 11 of the Commonhold and Leasehold Reform Act 2002, which provides that a variable administration charge (which includes sums payable by a tenant of a dwelling for or in connection with the grant of approvals under a lease) is payable only to the extent that the amount of the charge is reasonable. There is no equivalent specific statutory provision for commercial tenants.

Although each case will turn on its own facts, this decision indicates that there is little or no difference between what a landlord can reasonably request by way of information in a commercial and residential context. A landlord will be entitled to request financial information about a proposed assignee. 

Penalties rule does not apply to CVAs

A CVA allows a company to come to an arrangement with its creditors over its affairs.  If approved by three quarters by value of creditors voting on the CVA, it binds all creditors regardless of how or whether they voted.

In 2016, British Home Stores entered into a CVA, reducing rents by up to 75%.  The CVA provided that, if it was terminated, these discounts would be reversed so that landlords could claim in full against BHS.

BHS entered into administration soon after the CVA was agreed.  The administrators tried to find a buyer for the business whilst paying the reduced rents under the CVA.  When no buyer was found, the company was liquidated and the CVA terminated.

The liquidators asked the High Court to determine whether BHS was obliged to honour its agreement to pay full contractual rents to its landlords dating back to the approval of the CVA, arguing that this would amount to a contractual penalty. 

The High Court decided that the rule against penalties did not apply to CVAs, and BHS had to pay the full back rent as an expense of the administration.  The Court found that:

• A CVA is a hypothetical contract and the usual contractual rules will not apply.
• A company putting forward a CVA cannot subsequently claim to have been oppressed by it.
• The clear intention of the CVA was to ensure that landlords were not disadvantaged if the CVA was terminated, by being forced to accept a concession which was expressed only to apply while the CVA remained in force.

No wriggle room for the developer

The facts of Gaia Ventures -v- Abbeygate Helical (Leisure Plaza) Ltd⁴  revolve around the redevelopment of Elder Gate in Milton Keynes. The dispute arose from the developer's obligations to make an overage payment of £1.4 million to the long leasehold owner of the ice rink who had sold their interest to the developer.

Mr Justice Norris begins his judgment by saying - 'How hard do you have to work to make yourself liable to pay £1.4 million? The essential question to decide in this case is whether a developer used 'reasonable endeavours' to achieve 'as soon as reasonably practicable' the satisfaction of certain conditions upon the fulfilment of which the developer became obliged to make an overage payment of £1.4 million.'

The conditions needed for the payment (agreement for the terms of a new venue for the ice rink; surrender of substation leases; and variations to easements benefitting other land) were finalised in the period of 18 days after the long stop date. This aroused the landowner's suspicions particularly when the initial overage agreement was settled in 2003 and allowed a number of years for the conditions to be satisfied.

Mr Justice Norris referred back to the judgment in Rhodesia International Holdings Limited -v- Huntsman [2007] which provides valuable guidance upon endeavours obligations more generally:

"There may be many reasonable courses which could be taken in a given situation to achieve a particular aim. An obligation to use reasonable endeavours to achieve the aim only requires a party to take one reasonable course, not all of them, whereas an obligation to use best endeavours probably requires a party to take all reasonable courses he can. In that context, it may well be that an obligation to use all reasonable endeavours equates with using best endeavours..."

The understanding of 'as soon as reasonably practicable' is more clear cut - the party needs to achieve the end as soon as it can and not at a time convenient or best suited to it.

In this case it was judged that through a means of prevarication, procrastination and simply "sitting  back and let[ting] events take their course" the developer failed to show the necessary effort to achieve its contractual commitments to the beneficiary of the overage.

The judge believed that the developer was attempting to secure the various stages of the site assembly for its own benefit without reference to its contractual obligations. On this basis it found against the developer.

It is worth remembering that by agreeing to use "reasonable endeavours" you cannot simply refuse to do something because it might not be in your own self-interest.

Tackling unfair leasehold practices

The Government has recently issued its response to its consultation on "tackling unfair practices in the leasehold market".

The headline proposal for reform is the government's declaration that it will "bring forward legislation as soon as Parliamentary time allows to prohibit new residential long leases from being granted on houses, whether new build or existing freehold houses".

• the ban is on new leases; it does not affect existing leases;
• the ban relates to houses only;
• where land is currently subject to a lease, then sale off on sub-leases may be permitted  but this exception only applies to land that was subject to a lease as at 21 December 2017

It is widely understood that it is far easier to set up a leasehold scheme for the maintenance of common parts and facilities because positive obligations will run with the land.  Therefore the Government needs to consider how it will address this if developers can no longer use a leasehold framework for housing developments.

The government also plans to introduce legislation to limit ground rents on new leases of residential property over 21 years to a peppercorn which will have a significant effect on the value of reversions.

The restriction will not apply to existing leases.  However the government plans to address existing onerous ground rents by:

• encouraging developers to extend compensation schemes and support to existing leaseholders with onerous rents (or rent reviews).
• getting the Law Commission to consider:
  
  • clarifying the law relating to unfair terms when a lease is sold – currently only the original leaseholder can challenge a lease under the unfair terms law; and
  • making it easier for leaseholders to exercise their right to buy their freehold or extend their leases (see below);
• introducing a right of first refusal for tenants of houses. The equivalent right of first refusal for flat tenants is set out in Part I of the Landlord and Tenant Act 1987.

It is critical that the government puts some flesh on the bone quickly as developers will need clarity, not only to plan future developments but also to handle the completion of existing schemes.

Commonhold

The Law Commission has published a call for evidence to garner information as to why commonhold has failed to gain popularity and what changes can be made to make it a more attractive alternative to residential leasehold.

Commonhold was introduced in 2004 as a new way to own property. It allows a person to own a freehold ‘unit’ – like a flat within a building – and at the same time be a member of the company which manages the shared areas and buildings.

Commonhold has a number of potential advantages over leasehold. These are:

• Ownership doesn’t run out – unlike leases which expire and can be costly to extend.
• Standard rules and regulations apply
• Owners have a stake in the wider building and do not have a landlord – instead, owners run the shared areas together.

Despite these advantages fewer than 20 commonhold developments have been created. Manchester and London have just one commonhold scheme each.

The Law Commission is asking for views on three broad themes:

• What the difficulties in creating or converting to commonhold are
• What issues make commonhold unattractive to homeowners
• What issues make commonhold unattractive in the wider property sector

Later this year, a detailed consultation paper will set out options to address the issues.