The Right of First Refusal: Part 1 - Private Sale and Section 5A Notices

Are you a landlord looking to sell your interest in a block of flats or are you a leaseholder looking to purchase that interest?

If you answered ‘yes’ to either of the above then you need to be aware of the right of first refusal and the obligations imposed under the Landlord and Tenant Act 1987 (‘the Act’). This series will look at what the obligations of each party are, the steps that need to be taken throughout the transaction and the consequences of failing to comply.

What is the right of first refusal?

When a landlord intends to dispose of their interest in a building, whether it is a freehold interest or a superior leasehold interest, the long leaseholders (those holding a lease of more than 21 years) of the building must, in most circumstances, be offered the right to acquire it before any third party.

It is extremely important for a landlord to ensure they have complied with their obligations under the Act as there can be severe consequences for not just them, but also potentially any third party purchaser if it is found those obligations have not been met. The consequences of failing to comply will be covered in more depth in part three of this series.

When does the right of first refusal apply?

Not all buildings will be subject to the right of first refusal; however, the right will usually apply where:

• There are two or more flats within the building
• No more than 50% of the building is used for non-residential purposes
• More than 50% of the flats in the building are held by ‘Qualifying Tenants’.

What is a ‘Qualifying Tenant’?

In order to be a Qualifying Tenant, the leaseholder must have a lease term of at least 21 years. The lease can be a fixed or periodic tenancy but a tenant under a shorthold or assured tenancy will not be a Qualifying Tenant. In addition, if a leaseholder owns three or more of the flats in the building, they will be excluded from being a Qualifying Tenant in respect of any of their flats.

There are some exemptions, however it is always best to seek independent legal advice on your specific circumstances to see if the right of first refusal applies.

Section 5 Notices

The type of notice a landlord is required to serve is dependent on the way in which the interest is to be sold. Most commonly, an interest will be sold by private sale and Section 5A Notices will need to be served; or the interest will be sold at auction, in which case the landlord must serve Section S5B Notices.

Private Sale – Section 5A

Prior to being able to sell their interest to a third party purchaser, the landlord must serve Section 5A Notices on at least 90% of the Qualifying Tenants.

The Section 5A Notice will need to state:

• What is being disposed of (i.e. a freehold or leasehold interest)
• The price the interest is being sold for (this will be non-negotiable)
• Details of any deposit required to be paid
• A statement that the notice constitutes an offer by the landlord to enter into a contract on the terms set out in the Notice which may be accepted by the requisite majority of qualifying tenants.
• The date by which the leaseholders may accept the terms (being not less than two months from the date of the notice).
• The date by which the leaseholders must confirm who the nominated purchaser is (being a further period of not less than two months).

In order to serve an acceptance notice, the requisite majority (being more than 50% of the Qualifying Tenants in the building) must join together to proceed. For example, if there are six flats in the building, at least four will need to participate and if there are two flats, both must join together to accept.

Once the acceptance notice has been served, the leaseholders have a further two months to confirm to the landlord who the nominated purchaser is. The property can be held in the names of one or more individuals, a trust or by a limited company. A limited company is usually the preferred option, especially where a number of leaseholders are participating.

Following notification of the nominated purchaser, the landlord has a period of one month to send the contract of sale and then a further two month period follows in which the nominated purchaser must sign and return the contract and pay the deposit. Once the signed contract has been received by the landlord, exchange must take place within seven days.

What happens if an acceptance notice is not served?

If the Qualifying Tenants do not serve an acceptance notice within the two month period, the landlord is free to sell their interest to a third party for up to 12 months after the expiry of the acceptance period. However, it is important to be aware that the landlord cannot sell their interest for a lower price than that which was set out in the Section 5A Notice.

Other methods of sale

The process explained above differs if a landlord intends to dispose of their interest in a building at public auction and in the next instalment of this series, we will take you through the auction process and cover some frequently asked questions.

Upcoming Instalments

Part 2: Auction Sale and Section 5B Notices

Part 3: The Consequences of Failing to Comply with the Right of First Refusal