Unintended consequences of the Leasehold and Freehold Reform Bill

Landlords could soon have to foot the costs of litigation against leaseholders with no prospect of recovery.

Hidden among the many far-reaching changes proposed by the Leasehold and Freehold Reform Bill and the consultation on reducing ground rents, clause 34, covering litigation costs, of the Bill has received little public scrutiny, despite its sweeping and unintended consequences.

Clause 34 states that a landlord's litigation costs will not be regarded as relevant costs when determining the amount of variable service charge or administration charge in respect of leasehold property.

Under the changes proposed by the Bill, all contractual rights a landlord may have under a lease in respect of its litigation costs against a leaseholder will be removed, meaning litigation costs can only be recovered by order of a judge on an application to the court or tribunal.

The clause will affect every landlord in England and Wales – including leaseholders who have enfranchised and taken ownership of the freehold; right to manage (RTM) companies made up of leaseholders; and institutional landlords.

This impact of clause 34 brings to light how parts of the Bill – designed to protect and support leaseholders – may in fact lead to significant issues for many in the residential property sector, undermining the leasehold model to a point where entire housing schemes are unsustainable to maintain.

Among those affected by clause 34, enfranchised leaseholders and leaseholder RTM companies, with limited property management experience, are most likely be reliant on potentially expensive external legal advice – the cost of which they may now be unable to recoup.

Why might landlords want to litigate against leaseholders?

Landlords may want to litigate against leaseholders for a handful of reasons – but two types of dispute are particularly common causes of litigation.

First, if the leaseholder has defaulted on payment of its service charge; and second, where a leaseholder is in breach of their covenants under the lease.

In the first case, if clause 34 comes into force in its current form, a landlord would need to fund all legal costs associated with bringing an action entirely from its own resources.

Typical costs include letters before claim, court and tribunal fees, and fees for legal representation. These costs would need to be funded upfront by the freeholder, which as a result of the Bill's other proposals, may well be the leaseholders themselves.

This creates a situation where pursuing a defaulting leaseholder will mean compliant leaseholders who own or manage the freehold will have to fund the cost of such actions.

This will very likely deter freeholders from taking action for non-payment of a service charge. If a number of leaseholders fail to pay their service charge, this could lead to falling standards in the repair and maintenance of buildings and more costly insurance cover.

In the second case, clause 34 may deter landlords from taking action against leaseholders in breach of covenants such as leaseholders engaging in antisocial behaviour contrary to the terms of the lease.

If there is no right under the lease to recover costs, then there is no reason for the freeholder (who would not be affected by the antisocial behaviour) to risk its own money bringing an action.

Leaseholders who are also freeholders would also no doubt be reluctant to risk their own money on funding such an action.

In either case, the freeholders or RTM company will not be able to recover the costs associated with seeking appropriate legal advice without a court or tribunal order.

This means they may decide to take no action, or to take inappropriate action in the absence of legal advice.

If no effective action is taken, this could encourage other leaseholders not to pay their service charge or breach their lease covenants, leading to a potential deficit in the service charge fund and the degradation of the leasehold scheme in question.

Who will suffer as a result of the proposed changes?

Landlords now find themselves facing an unenviable situation, where the cost-benefit analysis of using the legal system to enforce the proper functioning of leasehold schemes is weighted heavily towards costs.

However, it is ultimately leaseholders who contribute to service charges and comply with their lease who will be disadvantaged by the actions of those leaseholders that do not.

It is likely the already over-stretched court service will also face a significant volume of new cases from those forced to recover costs through tribunal, where before no judicial involvement was required.

Practitioners in this area believe the provisions of the Bill should be amended to permit landlords to levy a reasonable charge to cover the cost of enforcement of lease covenants from all leaseholders such that a 'fighting fund' can be built up.

Without this, leaseholders will be dis-incentivised to pay their service charge and comply with their lease covenants.

This article was authored by Merle Wray, Real Estate Partner at Fieldfisher Birmingham, with assistance from trainee Jonathan Comfort.