The Right of First Refusal (s5 Notice)
Reviewed July 2017
This guide is designed to illustrate the requirements and process involved in the disposal of an interest in land by a Landlord and the circumstances in which a tenant may have a Right of First Refusal. It is designed to be a summary of the points to consider rather than detailed technical advice. This guide should not be relied upon as legal advice and you should contact us for advice on your specific circumstances.
Under the provisions of the Landlord and Tenant Act 1987 (‘the Act’) a Landlord or head leaseholder of a building comprising of a number of flats who wants to make a ‘relevant disposal’ of his interest in a premises, must, in the majority of circumstances, give the ‘Qualifying Tenants’ of the premises first refusal to purchase that interest before offering it to any third party.
If the Landlord fails to comply with the procedure set out in the Act, then they could face criminal sanctions.
Who are ‘Qualifying Tenants’?
A Qualifying Tenant is a tenant who is a long leaseholder who holds their lease directly with the person wishing to sell their interest. Shorthold tenants, assured tenants, business tenants, or an otherwise qualifying tenant who owns three or more flats in the same building will not be Qualifying Tenants.
Does the Right of First Refusal apply?
There are four issues to consider when to the determining whether the right of first refusal applies. If the answer to any one of these points is ‘no’, then the Landlord can dispose of the premises as he wishes and does not need to comply with the Act.
i) Does the Act apply to the Premises?
The premises will be subject to the right of first refusal if it contains 2 or more residential flats held by Qualifying Tenants on long leases.
If the premises are only partly residential, then in order for the right of first refusal to apply, the internal floor area of the residential part must represent 50% or more of the internal floor area of the premises as a whole. The internal floor area of any common parts is not taken into account when calculating the proportion of residential and commercial use.
ii) Is the Landlord, a Landlord under the Act?
Most Landlords must comply with the procedure of the right of first refusal if they are looking to make a relevant disposal. There are some exceptions:-
- Resident Landlords in non purpose built blocks of flats. The Landlord must occupy a flat in the premises as their only residence and they must have done so for at least 12 months ending on the date of the relevant disposal.
- Local Authorities registered housing authorities, housing trusts etc.
III) Are there sufficient Qualifying Tenants?
More than 50% of the flats in the building must be held by Qualifying Tenants for the Act to apply.
IV) Is the disposal ‘a relevant disposal’ under the Act?
A relevant disposal is the disposal of a legal interest in a property to which the right of first refusal applies. Most commonly a relevant disposal will be the sale of a freehold, or a superior interest. However, it could also be, for example, the grant or surrender of a lease.
Transfers within families, or trusts and transfers pursuant to bankruptcy, or divorce are not seen as relevant disposals under the Act. If the Landlord is a company and if a transfer to an associated company is intended, then this will also be exempt from the procedure set out in the Act, so long as the companies have been associated for more than two years.
What happened if the Right of First Refusal Applies?
If the right of first refusal applies, the Act sets out a strict procedure which must be followed by the Landlord and the Qualifying Tenants. Different timescales and procedures apply depending on how the Landlord wants to dispose of the premises. Legal advice should always be sought prior to any first steps being taken. This briefing note will focus on a standard disposal where a contract and transfer are intended to be used.
Where the right of first refusal exists, a Landlord must, under the Act, first offer the premises to the Qualifying Tenants, before offering it on the open market, or for sale by auction. He must serve formal notices on the Qualifying Tenants. These notices are known as Section 5 Notices. The procedure involved in offering the right of first refusal to Qualifying Tenants should be completed prior to the relevant disposal taking place. This will either be before an exchange of contracts or completion of a transfer, if no exchange takes place.
The s5 Notice
The Landlord must serve a s5 notice on at least 90% of the Qualifying Tenants, or on all but one if there are less than 10 Qualifying Tenants in the block. The notice gives the Qualifying Tenants the right to acquire the interest that the Landlord proposes to dispose of and the terms on which the Landlord proposes to dispose of it on. The s5 notice must state the period in which the Qualifying Tenants must accept the Landlord’s offer. This must be a date no less than two months from the date of service of the s5 notice. If the Landlord cannot serve all of the S5 notices on the same day, then the acceptance period for accepting will be on the latest possible date for all of the s5 notices. This means that the overall period in which the Landlord is not permitted to sell may be longer than two months.
Procedure for Qualifying Tenants upon receipt of a s5 notice?
The s5 notice is a non negotiable offer. Therefore, the price and other terms are either to be accepted or rejected by the Qualifying Tenants.
Qualifying Tenants should be aware that s5 procedures must be followed and completed in order for the Landlord to be able to sell, or contract for sale with a third party.
In order to accept the offer, more than 50% of the Qualifying Tenants must agree to proceed. The group of Qualifying Tenants should join together and serve what is known as a s6 notice within the given time period. This notice will notify the Landlord that the Qualifying Tenants wish to proceed on the terms offered. In order for the s6 notice to be valid, it must meet the various requirements set out in the Act.
Once the s6 notice is served there will then be a further 2 month period within which the Qualifying Tenants can discuss how they want to hold the premises. This can be as individuals, a trust or by a limited company created to hold the interest. Once this has been decided the group will be known as the ‘nominated person’ and the Landlord should be notified.
Once the offer has been accepted and the Landlord notified of the nominated person then within a month a contract will be produced. A period of 2 months will then follow where the nominated person will sign the contract and pay a 10% deposit. Completion will then take place 7 days later.
What is the procedure if Qualifying Tenants do not wish to exercise the Right of First Refusal?
If there are not enough Qualifying Tenants to accept the Landlord’s offer or if none of the parties are interested in purchasing the Landlord’s interest in the premises, then the initial 2 month period will pass. At the end of this period of time, the Landlord will then, within 12 months of his notice, be free to sell the premises to a third party of his choice on no worse terms than in the initial offer. If the Landlord wishes to change the terms, or lower the sale price, he must first offer the right to the Qualifying Tenants on the new terms and/or at the lower figure before disposing of the interest to a third party.
What costs are involved?
The Landlord is responsible for the costs involved in the service of a s5 notice, unless a notice of withdrawal is served after the first four weeks of the nomination period specified in the s5 Notice. If a notice of withdrawal is served, the withdrawing party will be responsible for the other party’s legal costs.
What are the sanctions if the Landlord fails to comply with their obligations under s5?
If a Landlord fails to comply with their obligations under the Act, the Landlord may face either or both a criminal prosecution, or a civil action.
- Criminal Prosecution:
The Landlord will be guilty of a criminal offence if without reasonable excuse he makes a relevant disposal of the premises without having complied with the requirements of Section 5 of the Act or in contravention or prohibition of Sections 6-10 of the Act. A person found guilty of such an offence will be liable to pay a fine. If the Landlord is a corporation, an officer of the body, for example, a director may also be liable in their personal capacity.
- Civil Prosecution:
Any interested person may bring civil proceedings against a Landlord in default of their obligations under the Act. Firstly they must serve a notice requiring the default to be made good. If, after 14 days after service of the notice, the default has not been remedied by the Landlord then they may make an Application to the Court. The Qualifying Tenants can also serve a notice on the new owner demanding details of the transaction, including the price paid; they can then take action to force the new owner to sell to them at the price he paid.