There are moves afoot to prevent new houses being sold as leaseholds. This could cause difficulties for management of housing estates where there are shared facilities unless robust alternative arrangements are put in place to replace leasehold tenure. This article consider the alternatives to leasehold and what can best take its place.

What is happening to leaseholds?

Residential Leasehold tenure generally is coming in for bad press at the moment. A government consultation is underway which looks likely to result in an overall prohibition of the sale of new leasehold houses with very few exceptions.

Flats can only realistically be sold as leaseholds (after Commonhold tenure, introduced in the Commonhold and Leasehold Reform Act 2002, failed to take off at all). Leasehold provides a useful mechanism for the management of properties with shared facilities like an entrance hall and lifts, and shared structures like foundations and roofs. There is also a lot of statutory protection in place for leaseholders.

There is no legal reason why individual houses (whether detached or terraced) should not be sold on a freehold basis where there are no shared facilities. However, there are numerous housing estates where there are shared facilities such as private roads, car parks and shared grounds.

The problem of shared facilities

In the 1960s and 1970s, estates roads and open spaces were frequently adopted by the local authority after construction leaving no shared facilities for the owners to maintain. More recently, new planning regimes, designed to limit Council expenditure, have resulted in increasingly elaborate Section 106 Agreements which provide for roadways, sustainable drainage systems, open spaces, recreation areas and car parking to be privately maintained. The responsibility for organising this rests with the developer but almost always, the developer will sell the estate properties on the basis that a Management Company is appointed to organise the maintenance of shared facilities and the individual property owners on the estate share the cost.

Where there are shared facilities of this kind, arguably there is a good legal reason to sell houses on a leasehold basis, just as there is with flats with shared facilities. Leasehold ownership ensures that obligations to pay for maintenance remain binding on the property owner as properties are bought and sold. This cannot necessarily be guaranteed where houses are sold on a freehold basis. Therefore, if the right to sell houses with shared facilities on a leasehold basis is lost then there is a risk that one problem will simply be replaced by another.

It is obviously very important that obligations to pay for the maintenance of shared facilities are binding and enforceable on all householders on an estate. Without this, some will pay and some may not. If there are insufficient funds, facilities may fall into disrepair or common areas may become overgrown and neglected. This in turn will spoil the enjoyment and amenity of the properties and may even lead to a fall in value of the houses.

The legal problem

Conventionally, positive obligations (such as the requirement to make a payment) do not "run with the land". This means that although the original owner will have agreed to make payments in the original Deed of Transfer, when his freehold property is sold that obligation does not automatically pass to the new owner. Leasehold ownership is different because the new owner purchases the lease and is responsible for all of the obligations in the lease whether these are positive obligations or not.

Developers selling freehold houses with shared facilities have often tried to circumvent the problem of positive obligations not "running with the land" by obliging any new purchaser to enter into a Deed of Covenant with the Management Company (or other party providing the site maintenance) when they buy a property. Under this Deed of Covenant the new purchaser will be required to pay for the maintenance of shared facilities and (importantly) require any further purchaser buying from them to also enter into a Deed of Covenant when they buy. In effect, this sets up a chain of covenants which depends on each new owner making a direct agreement to pay because they are not obliged to pay just because they own the property.

Unfortunately this system can prove problematic. Unless set up correctly with appropriate restrictions registered on the property title at the Land Registry, preventing registration of the new owner until the Land Registry has confirmation that the Deed of Covenant has been entered into, the system can easily break down. The particular difficulty is that, once new owners have not entered into a Deed of Covenant, they are not in turn obliged to require their purchaser to enter into a Deed of Covenant, so the chain is broken.

These arrangements break down surprisingly often. Where there is no Deed of Covenant in place there are still some legal arguments which can be used to try to recover a contribution for maintenance, including the "burden and benefit" principle which states that a party receiving a benefit ought to be required to pay for it. That however is not always an effective back-up solution, so overall a system that relies on a chain of covenants is risky and inadvisable.

Estate rentcharges - a better solution

A far more straightforward solution, which we regularly advocate, is the use of a system of estate rentcharges. There is a common misconception that rentcharges are archaic and are being phased out. With very limited exceptions, this is true except in relation to estate rentcharges. An estate rentcharge is a charge created for the purpose enforcing covenants or obtaining contributions towards the cost of service maintenance and repairs. Any such rentcharge created by a developer for these purposes is and will remain perfectly valid and enforceable.

Although a rentcharge scheme does not strictly speaking make positive covenants "run with the land", the rentcharge itself runs with the land and failure to comply with the terms of the rentcharge can result in enforcement action being taken against the current owner of the land. Effectively this means that the positive obligations imposed in the rentcharge are binding on the current owner.

Reliance on a system of rentcharges means that properties can be bought and sold without the necessity for each purchaser to sign a Deed of Covenant and without the risk that this step will be overlooked and the chain of obligation will be broken.

Rentcharge arrears are easy to collect compared to payments due under a Deed of Covenant, very much in line with collection of leasehold arrears. This means that deficits should not build up and maintenance can be carried out as planned. Rentcharge schemes can mirror arrangements for leasehold schemes with reserve funds for any major or unexpected expenditure. Likewise covenants can be imposed to manage practical arrangements on the development, such as parking on estate roads or use of common grounds. In general a rentcharge scheme offers the benefits of leasehold without the stigma that is now attaching to leasehold tenure.

But still not perfect

A system of estate rentcharges is not without criticism. Many of the protections that apply to leaseholders in respect of payment for services do not apply to freehold owners (whether paying under a Deed of Covenant or a rentcharge). The rules in relation to consultation for major expenditure do not apply. There is no implied test of reasonableness for charges like there is for service charges paid by leaseholders. Freeholders do not have the right to go to a tribunal to dispute charges and do not have a right to insist on taking over responsibility for management of the shared facilities if they are unhappy with the arrangements in place.

What next?

It is obviously very important for developers and house owners that the arrangements for selling houses work fairly for all parties. If, as seems likely, the Government bans the sale of houses on a leasehold basis, house purchasers may seem better off in terms of avoiding ground rents and other charges. However, where they share facilities (as will be the case on almost all modern housing estates) there may also be disadvantages. Lease obligations are well understood, very strong and relatively easy to enforce. There is no real widespread common practice for freehold estates managing shared facilities. Some developers already use very effective and well thought through rentcharge schemes. Unfortunately, others use very weak covenant arrangements which break down quickly and become unenforceable.

Nobody benefits if schemes for estate maintenance are badly structured and removing a leasehold option for houses may increase the risk of estates becoming unmanageable in the future. If leasehold can no longer be used, we strongly urge that a system of estate rentcharges is adopted, rather than a system of a chain of covenants. This will best protect developers in offering houses for sale on a basis that is attractive to the market and which protects their future reputation – no one wants to have their brand attached to a run-down estate in the future. It will help to attract good management companies, confident that they will have the tools they need to manage the shared facilities effectively and profitably. It is also good for the home owners themselves, ensuring proper provision of services and upkeep of common areas and robust apportionment of charges between the home owners on the estate.

Hopefully the market will increasingly recognise the benefits of using estate rentcharges for housing estates if (and we suspect when) leasehold houses are no longer an option. 

This article is for general information only and reflects the position at the date of publication. It does not constitute legal advice.