What is the right of first refusal for leaseholders and how does it work?

What is the Right of First Refusal?

The Right of First Refusal (RFR) represents a significant protection for long leaseholders of flats in England and Wales. This right, established under the Landlord and Tenant Act 1987, gives qualifying tenants the opportunity to purchase their building before the landlord can sell it to a third party. The Right of First Refusal requires landlords to offer their property to qualifying tenants before selling it to someone else. This right:

• Is established under Section 5 of the Landlord and Tenant Act 1987 (as amended)

• Applies to most private sector residential buildings containing two or more flats

• Gives leaseholders priority to purchase the freehold or head lease of their building

• Requires landlords to make a formal offer to tenants before disposing of their interest

• Is a criminal offence for landlords to ignore (unlike many other leasehold rights)

This right is particularly valuable for leaseholders as it can:

• Prevent the building from being sold to an undesirable landlord

• Give tenants control over the management of their building

• Potentially result in a more favourable purchase price than through other enfranchisement routes

• Provide an opportunity to acquire the freehold without having to initiate the process.

Why do landlords sell the freehold?

After selling off a block or converted house with long leases, the majority of the value has already been extracted by the seller who may have retained the freehold interest. Freeholders may sell the freehold interest for various reasons:

• To realize the investment value of ground rents

• To capitalise on future marriage value when leases become shorter

• To generate income from insurance commissions and service charges

• To consolidate or restructure property portfolios

• As investment vehicles for pension funds and overseas investors

• To facilitate development potential or future redevelopment opportunities

For leaseholders, these sales can create uncertainty, as a new landlord may have different management priorities or fee structures. The Right of First Refusal provides a crucial opportunity for leaseholders to intercept such sales and take control of their building.

Frequency of freehold sales

The sale of freehold reversions is a significant market activity in the UK, though precise comprehensive data is limited due to the private nature of many transactions. However, research by the Leasehold Knowledge Partnership has indicated that between 2017-2019, approximately 7,000-10,000 freehold reversions were sold annually in England and Wales.

Qualifying tenants

To be a "qualifying tenant" under the 1987 Act, a person must:

• Hold a long lease (originally granted for more than 21 years)

• Not own more than two flats in the building

• Be a tenant of a flat (houses are not included)

A building must have at least 50% of the flats occupied by qualifying tenants for the Right of First Refusal to apply.

Excluded properties

The Right of First Refusal does not apply to:

• Buildings with a significant proportion of commercial use (more than 50% non-residential)

• Buildings containing fewer than two flats

• Buildings where the landlord is a charitable housing trust, local authority, or housing association

• Properties where the landlord lives in the building and has done so for at least 12 months (if the building contains four or fewer flats)

When is the right of first refusal triggered?

The Right of First Refusal is triggered when the landlord intends to make a "relevant disposal." This includes:

• Selling the freehold

• Granting or assigning a head lease of more than seven years

• Transferring the property to an associated company

Importantly, not all property transactions require the landlord to offer the Right of First Refusal. Exemptions include:

• Transfers by way of gift or succession

• Transfers through a will

• Sales by court order

• Transfers between family members

• Sales by a mortgagee exercising power of sale

• Compulsory purchase orders

The Formal Process for Exercising the Right

The process for exercising the Right of First Refusal follows a strict statutory procedure with specific timelines.

Step 1: The Landlord's Offer Notice

When a landlord wishes to sell, they must serve a formal offer notice (Section 5 Notice) on at least 90% of qualifying tenants, which must include:

• The terms of the proposed disposal

• The price being sought

• Any deposit required

• The specific property interests being offered

• A clear statement that it's a Section 5 Notice under the Landlord and Tenant Act 1987

• A date by which tenants must respond (at least two months from service of the notice)

There are different types of notices depending on whether the landlord already has a buyer lined up:

• Section 5A Notice: Used when the landlord intends to sell on the open market but hasn't yet found a buyer

• Section 5B Notice: Used when the landlord has already agreed terms with a third-party buyer

Step 2: Tenant Response

Once served with a notice, tenants must:

1. Decide whether to accept the offer: This typically requires consultation among qualifying tenants and often the formation of a company to purchase the property

2. Serve an acceptance notice: If more than 50% of qualifying tenants wish to proceed, they must serve an acceptance notice within the specified period (minimum two months)

3. Nominate a purchaser: The accepting tenants must nominate a person or company to purchase the property on their behalf (typically a company formed specifically for this purpose)

Step 3: Progressing to Completion

After acceptance:

1. Contract stage: The landlord must provide a contract within one month of receiving the acceptance notice

2. Exchange of contracts: The nominee purchaser has at least two months to exchange contracts after receiving the contract

3. Completion: Takes place according to the terms specified in the contract, typically 4-6 weeks after exchange

If tenants don't respond within the set timeframe or fail to follow the prescribed process, the landlord is free to sell to a third party on the same or similar terms for a period of 12 months.

Practical Steps for Leaseholders

Before Receiving a Notice

Proactive leaseholders should:

• Establish communication channels among all leaseholders in the building

• Research the likely value of the freehold or head lease

• Consider forming a residents' association if one doesn't already exist

• Gather information about the building, including a list of all qualifying tenants

• Explore funding options for a potential purchase

After Receiving a Notice

Upon receiving a Section 5 Notice:

1. Verify the notice's validity - check it contains all required information and has been properly served

2. Call a meeting of leaseholders - discuss whether to accept the offer and gauge the level of interest

3. Secure professional advice - consult with solicitors experienced in landlord and tenant law and consider obtaining a valuation

4. Form a company - if proceeding, establish a company to be the nominee purchaser (typically a company limited by guarantee or a RTM company)

5. Arrange financing - determine how the purchase will be funded and collect initial contributions

6. Serve acceptance notice - ensure this is done within the deadline and meets all legal requirements

7. Proceed with the purchase - following the statutory timetable for contracts and completion

Common Pitfalls and How to Avoid Them

For Landlords

Common pitfalls for landlords include:

• Failing to serve notices - not serving notices is a criminal offence that can result in a fine and make the transaction voidable

• Incorrect notice contents - notices must contain specific information; errors can invalidate them

• Improper service - notices must be served on the correct tenants in the prescribed manner

• Proceeding with sale too quickly - landlords must allow the full statutory periods before proceeding with an alternative sale

For Leaseholders

Common pitfalls for leaseholders include:

• Missing deadlines - strict time limits apply and missing them will forfeit the right

• Insufficient majority - failing to secure acceptance from at least 50% of qualifying tenants

• Inadequate funding arrangements - not having finances in place when needed can result in failure to exchange or complete

• Improper nomination - the nominee purchaser must be properly specified and meet legal requirements

• Failing to check the property being offered - ensuring the disposal includes all relevant parts of the building and associated property rights

Legal Work Involved

Legal Work for Leaseholders

The legal work required for leaseholders typically includes:

1. Initial advice on the Section 5 Notice: Verification of validity and explanation of options

2. Company formation: Creating an appropriate corporate structure for the nominee purchaser, including:

   • Drawing up Articles of Association

   • Registering with Companies House

   • Creating a shareholders' agreement

   • Establishing decision-making processes

3. Preparation of acceptance notice: Drafting and serving the formal acceptance

4. Conveyancing work:

   • Title investigation

   • Searches and enquiries

   • Review of existing leases

   • Review of management obligations

   • Drafting or approving the transfer document

   • Handling deposit payment

   • Exchange and completion formalities

5. Post-completion work:

   • SDLT (Stamp Duty Land Tax) returns

   • Land Registry applications

   • Setting up service charge accounts

   • Transferring management responsibilities

   • Dealing with existing contractors and service providers

Legal work for landlords

Landlords will need legal assistance with:

1. Preparation of Section 5 Notices: Drafting compliant notices for service on tenants

2. Responding to acceptance: Handling the process if tenants accept the offer

3. Contract preparation: Drawing up the sale contract within the statutory timeframe

4. Conveyancing work: Similar to standard property transactions but with attention to the statutory requirements

5. Alternative disposal: Advice on proceeding with sale to a third party if tenants don't accept

Timescales

A typical Right of First Refusal process follows these timescales:

• Landlord's notice period - at least 2 months for tenant response

• Contract provision - within 1 month of acceptance notice

• Exchange of contracts - at least 2 months after contract provision

• Completion - typically 4-6 weeks after exchange

This means the entire process typically takes 6-9 months from initial notice to completion.

Remedies when landlord fails to offer right of first refusal

The Landlord and Tenant Act 1987 provides significant remedies for leaseholders when a landlord fails to comply with the Right of First Refusal requirements. These remedies give leaseholders powerful tools to address non-compliance, which is particularly important given evidence suggesting widespread failures to offer this right.

Criminal sanctions

Unlike many other leasehold rights, failure to comply with the Right of First Refusal carries criminal penalties:

• Criminal offense - a landlord who fails to serve the required notices commits a criminal offence under Section 10A of the Act

• Potential fine - on conviction, landlords can face a fine (currently up to £5,000)

• Prosecution - proceedings may be brought by the local housing authority or the Director of Public Prosecutions

While criminal prosecutions are relatively rare in practice, the existence of criminal sanctions underscores the importance Parliament placed on this right.

Civil remedies to force transfer

The most powerful remedy available to leaseholders is found in Section 18 of the Act, which states that if a relevant disposal is made without following the RFR procedure:

1. Majority required: A majority of qualifying tenants (more than 50%) can serve a notice on the new owner

2. Compulsory acquisition - this notice requires the new owner to transfer the freehold or head lease to the tenants' nominee purchaser

3. Same terms - the transfer must be on the same terms as the original transaction, including the same price paid by the new owner

4. Time limits - tenants have 6 months from discovering the transfer to serve this notice

This remedy essentially allows leaseholders to "step into the shoes" of the new owner and acquire the property on the terms they acquired it.

Practical steps to exercise rights

If leaseholders discover their building has been sold without being offered the Right of First Refusal:

1. Verify eligibility - confirm the building qualifies and the disposal was a relevant disposal under the Act

2. Gather evidence - obtain proof of the transfer, typically through Land Registry searches showing the new owner and the date of transfer

3. Act quickly - remember the 6-month deadline from discovering the transfer (not from when it occurred)

4. Build consensus: Obtain agreement from a majority of qualifying tenants

5. Formal notice - serve a properly drafted Section 18 notice on the new owner

6. Prepare for completion - form a nominee purchaser company and arrange financing

Legal Challenges and Limitations

While these remedies are powerful, leaseholders should be aware of potential challenges:

• Limitation period - the 6-month deadline is strictly enforced

• Proving knowledge - there can be disputes about when leaseholders first "discovered" the transfer

• Exemption claims - new owners may claim the disposal was exempt from the RFR requirements

• Third party rights - complications can arise if the new owner has already granted rights to third parties

• Practical enforcement - court proceedings may be necessary if the new owner refuses to comply

Alternative options

If the right of first refusal doesn't apply or has been missed, leaseholders still have other options:

1. Collective Enfranchisement - under the Leasehold Reform, Housing and Urban Development Act 1993, qualifying tenants can force the landlord to sell the freehold

2. Right to Manage - giving leaseholders control over the management of their building without buying the freehold

3. Lease extension - individual leaseholders can extend their leases, which can address some concerns about the property's management

4. Appointment of a manager - in cases of poor management, tenants can apply to the First-tier Tribunal for the appointment of a manager