03 Oct 2019

The process for discharging or modifying a covenant restricting the use of premises under s84 of the Law of Property Act 1925 ("the Act") is most often invoked with regard to freehold property. The ability for tenants on long leases to pursue discharge/modification pursuant to s.84(12) is often overlooked, despite the fact that a successful application can open up the use of premises and deliver substantial commercial benefit. The case of Shaviram Normandy Limited v Basingstoke and Deane Borough Council [2019] UKUT 256 (LC) concerned a tenant wishing to change the use of an office block in order to generate profit and is a useful reminder to developers and investors of how s.84 can be used to unlock value.

Background

The Applicant sought to amend a covenant within their lease which restricted the use of Normandy House, Basingstoke (the Property), to offices only. The Applicant had purchased the headlease of the Property with the intention of refurbishing it as 114 residential flats. As well as being the local authority, Basingstoke and Deane Borough Council was also the freeholder and therefore the Applicant's landlord. Whilst the Council confirmed that the conversion fell within statutory permitted development rights in its capacity as the local planning authority, it refused to vary the headlease to permit the conversion in its capacity as landlord.

The Applicant subsequently applied to the Upper Tribunal under s84 for a modification of the clause within the lease restricting the use of the Property to offices, and also a subclause which stated that every subletting should be at full market rent and on terms approved in advance by the landlord.

Legal Issues

Pursuant to s.84(12) of the Act a tenant can apply for the removal/modification of a restrictive covenant within its lease so long as the lease term is at least 40 years and at least 25 years have already expired. In order for the Upper Tribunal to make an order to discharge or modify a restrictive covenant it must be convinced that one of four grounds applies. The grounds are (as numbered within s.84(1)):

(a) That the covenant is now obsolete due to changes in the character of the property/neighbourhood or other circumstances;

(aa) That the covenant impedes some reasonable use of the land and either does not secure any practical benefit of substantial value to the benefitting party or is contrary to public interest;

(b) That the party entitled to the benefit of the covenant has agreed (either expressly or by implication) to it being discharged/modified;

(c) That the proposed discharge or modification will not injure the party entitled to the benefit.

It is common for applicants to seek to rely on multiple grounds to maximise the chances of an application succeeding. In this case the Applicant relied on grounds (aa) and (c) in respect of the main restriction as to user, and ground (a) in respect of the subclause concerning arrangements for subletting.

Change of Use

The Tribunal's analysis focused on ground (aa), with the Applicant's reliance on ground (c) ultimately proving unnecessary. There was no argument regarding the fact that the residential use of the Property could constitute reasonable use for the purpose of ground (aa), and so the dispute centred on whether the restrictive covenant provided any practical benefit to the Council.

The main area of dispute as to "benefit" was the financial effect of a modification. The Applicant argued that the Council would receive a higher rent for the building, and the reversion value would be greater, if the Property was converted into residential flats. The Tribunal considered expert reports contrasting a simple repair of the Property with full refurbishment, having regard to a separate clause within the lease which stated that the Applicant was required to use its "best endeavours" to keep the Property fully let.

The experts agreed that a full refurbishment of the Property would be required to maximise the marketability of the Property, and so the Tribunal found that refurbishment of the Property was required through the "best endeavours" clause. They then compared the rate of rent and value of reversion of the Property – in a refurbished state – when used as either offices or flats.

  • Value of reversion as offices - £3m
  • Value of reversion as flats - £3.125m
  • Annual income as offices - £160,000
  • Annual income as flats - £144,500

Based on the above figures, the modification of the covenant to allow flats would lead to a modest increase in the value of the reversion and a modest decrease in the rental income. The parties had focused on the value of the reversion in their submissions and the Tribunal agreed that this was the most important aspect of the evaluation. It therefore concluded that the continuation of the covenant would secure no ongoing practical benefit of substantial value in this regard.

The Council tried to argue that the covenant secured other benefits – the continued use of the Property as offices would secure economic advantage for the town, and if this covenant were relaxed it would lead to other tenants of the Council seeking to relax similar covenants in their leases. The Tribunal concluded that the "economic advantage" argument had not been made out on the basis that there was no compelling evidence that there would be any substantial shortage of office space in the town in the near future. It was similarly unpersuaded by the "thin end of the wedge" argument regarding other buildings; it determined that there had already been similar conversions nearby and the modification of the use of the Property would not materially affect other properties.

The Tribunal therefore agreed with the Applicant that the covenant did not secure any practical benefit for the Council and should be modified so as to permit the residential use by the addition of the wording "…or as a residential building comprising 114 flats" to the end of the user clause (unless the parties agreed alternative wording between them).

Sublease Consent

The Tribunal went on to consider the Applicant's argument regarding the clause that required that every subletting of part of the Property had to be on terms approved by the Council. The Applicant argued that this clause was obsolete. The Tribunal expressed doubt about whether it had jurisdiction to modify/release the covenant at all as it was not a restriction "as to the user" of the land and hence did not fall within the remit of s.84. It nevertheless went on to say that even if it did have jurisdiction it was not satisfied that the covenant was obsolete. The Tribunal held that the covenant would still fulfil its function of providing comfort to the Council regarding the letting of the Property in its new residential context. This aspect of the application was therefore rejected.

Commentary

This case highlights the potential usefulness of s.84 to a tenant on a long lease who wishes to unlock the commercial potential of a building via a change of use. Regardless of how restrictive the user clause within the lease might be, if one of the four grounds can be made out then discharge or modification could be possible. This case provides some clarity on common arguments that a landlord might run in opposition to a s.84 application, and shows that a well-informed and well-prepared applicant can look to overcome these arguments provided that persuasive evidence and argument is presented to the Tribunal.

One important point which arose in the judgment is how use of a property is assessed. The comparison is not between the restricted use and the intended use, but the current use and the intended use. For example, just because a restrictive use covenant is in place, does not mean that the lessee has to use the property in that way; they could not use the property at all. In this case, however, the clause requiring the Applicant to use "best endeavours" to keep the Property fully sublet carried with it a requirement to refurbish the Property. This meant that the Tribunal had to assess the value of the Property as offices on the assumption that it had been refurbished, as assessing it in its actual state would have been allowing the tenant to benefit from its ongoing breach of the best endeavours clause.

Finally, the wording which the Tribunal ordered as a modification to the restrictive covenant did not give the Applicant a wide range of options as to future use. This suggests that, although the Tribunal did exercise their discretion to modify, they are unlikely to simply discharge a covenant in its entirety, and any modification will be fairly strictly limited to the parameters of the Applicant's proposed use.